3 Annuity Contract Footnotes Advisors Should Explain

Although most annuities require an initial payment, like investments, they mainly track index performance without dividend benefits. However, unlike index funds, they may offer downside protection.

For example, let's say a client is interested in a fixed indexed annuity, but after discussing their goals and reviewing the contract, you realize it's a poor fit, as they want their returns to be equal to that of their traditional index fund.

In this case, you must explain how the annuity may result in returns approximately 1% lower than traditional index funds over the same period, as they focus more on participation rates, compared to investments.

Identifying clients' goals, comparing them to the footnotes and helping them find a product that will allow them to reach their goals sooner will solidify the advisor's position as an experienced resource.

2. Understanding Surrender Charges

One of the biggest things that gets overlooked in annuity contract footnotes is the surrender period, or the timeframe which clients cannot withdraw funds without a fee.

Clients are often unaware if their annuity includes a surrender period, or they assume the surrender period for one annuity will be the same for each product – and that's where an advisor's guidance comes into play.

Let's say a client invested $300,000 into a registered index-linked annuity, or RILA, , but they didn't express that they may take out a significant amount in the second or third year to buy another home in a warmer climate.

If the client doesn't recall the footnote that highlights the penalties of taking out money in year three, they can end up losing money rather than compounding it.

Advisors creating an environment where clients feel comfortable expressing their plans clearly can help ensure that clients pick an annuity that does not include a surrender charge.

More than anything, advisors must have their clients explain their situations in as much detail as possible, as the advisor needs to fully understand and make sure the clauses align with clients' goals.

3. Explaining Costs and Fees

The way fees are paid with annuities can be confusing, leading many clients to believe fixed index annuities and many RILAs are "zero fee" products.

This claim can drive clients to express interest in these products, even though they may not know what they're getting into.

It's important for advisors to clarify that while these products are marketed as having no fees, the returns shown to clients are net of all fees.

The costs are paid through the general account of the insurance company, where income from the product is used to pay fees and purchase necessary options.

Advisors receive commissions from these fees, as noted in footnotes, and this structure must be transparently communicated. Being upfront about how advisors are compensated can increase trust, leading clients to feel more confident in the advice provided.

Explaining key details to clients during initial meetings can help prevent misconceptions, especially when the advisor highlights these top three footnotes.

The true value of an advisor lies in their ability to teach their clients about the implications of a product, rather than to secure a sale.

Holding regular review meetings with clients to explain key takeaways helps clients have a clear understanding of the implications from these footnotes.

Paresh Shah, CFP, is the founder of PareShah Partners, a financial services firm. He has been a member of the Million Dollar Round Table for 18 years.

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