"‘Avoid Purchasing Investments from Friends’ — Suze Orman's Candid Advice on Indexed Annuities"

Suze Orman's Warning on Indexed Annuities

• Advice Against Friend Recommendations: Personal finance expert Suze Orman cautioned against purchasing indexed annuities based on recommendations from friends, emphasizing that such advice is often motivated by sales commissions rather than the investor's best interests. She highlighted that a $50,000 indexed annuity could yield a commission of $2,500 to $3,000 for the recommending friend.

• Listener's Situation: Orman addressed a 75-year-old widow named Betty, who was advised by a friend to invest in an indexed annuity by cashing in her short-term U.S. Treasuries. Orman argued that adding an annuity to Betty's existing income sources, which include Social Security, a pension, and interest from Treasuries, was unnecessary.

Understanding Indexed Annuities

• Definition and Mechanics: An indexed annuity is an insurance product that ties its growth to a market index, such as the S&P 500. Instead of direct market investment, the insurance company credits interest based on the index's performance.

• Key Features:

  • Participation Rate: This determines the percentage of the index's gain credited to the account, typically ranging from 80% to 90%.
  • Rate Cap: This sets a maximum return for a period, meaning even if the index rises significantly, the credited interest may be capped (e.g., a 4% cap on a 15% index rise).

Potential Drawbacks of Indexed Annuities

• Limited Gains: The structure of indexed annuities means that investors may not fully benefit from strong market performance due to participation rates and caps.

• High Fees and Penalties: Accessing funds before the surrender period, which can last up to 10 years, may incur steep penalties.

• Inflation Risk: Guaranteed rates may not keep pace with inflation, potentially diminishing purchasing power over time.

• Insurer Reliability: The strength of an annuity is contingent on the financial stability of the issuing insurance company, with state guaranty funds providing limited protection.

Orman's Investment Recommendations

• Simpler Alternatives: For retirees like Betty, Orman suggests avoiding the complexity and costs associated with indexed annuities. Instead, she recommends investing in low-cost index funds or ETFs that track the S&P 500, such as the Vanguard VOO ETF.

Conclusion

• Final Thoughts: While indexed annuities offer some protection and market-linked growth, they may not be suitable for every retiree. Orman stresses the importance of making investment decisions independently and consulting a qualified financial advisor to evaluate options based on individual retirement goals.