We experienced our first major stock market correction in several years earlier this week. As I write this the market is recovering but who knows where things will go.
Just like clockwork if we see a prolonged period of volatility you can count on a new wave of ads touting various types of annuity products as the answer for investors worried about the stock market. Annuity sellers love stock market turmoil. Those of you who follow my blog know that I have a special level of contempt for those who sell financial products by invoking fear.
Stan Haithcock wrote Annuity sharks smell blood with market volatility recently at Market Watch. This was one of those articles that after reading it led me to wish I’d written it. Stan’s opening paragraph provides a great overview.
“Any time the stock market has a bad week or experiences extreme volatility, the annuity sharks start smelling blood in the investment waters and will be on the attack to lock your money into their “perfect product.” Current indexed- and variable-annuity sales pitches can sound enticing and almost too good to be true, so it’s important to keep your head and understand the contractual realities and proper uses for annuities in a portfolio.”
Mike Ditka and Indexed Annuities
My dislike of fear-mongering annuity ads started a few years ago when the local news radio station was full of ads touting indexed annuities as the cure for the risky stock market. The group enlisted former Bears coach Mike Ditka as their pitchman. Ditka can probably sell anything to the win-starved fans of the Chicago Bears.
I personally think using any celebrity spokesperson to sell financial products is reprehensible and takes something as serious as someone’s financial well-being and equates it to the decision of which snack food to buy.
Though I’ve tried to keep an open mind about these products, I’ve reviewed many contracts over the years and have never found one that seemed to have much redeeming value for the contract holder. By this I mean I’m not sure what the product does for them that a properly diversified investment strategy with a well-conceived retirement income plan couldn’t do just as well or better for a whole lot less money.
Indexed annuities, sometimes called equity-indexed annuities, offer limited upside participation in a stock market index such as the S&P 500. The reason they are sold as an alternative to the risky stock market is they offer either a guaranteed minimum return each year or a limit on how much of a loss the contract holder can incur each year. The sales pitches will vary and they are often also touted as an alternative to CDs.
A few things to be leery of if you are being sold one of these products:
- Long surrender periods. I’ve seen policies where the surrender charges last for 10 years or more.
- High fees and commissions. The fees internal to the contract serve to provide nice compensation to those selling them. Why do you think agents and registered reps are so eager to sell you an indexed annuity?
- Hard to understand formulas to determine your return. The premise is typically that you will participate in a portion of any gains on an underlying market benchmark such as the S&P 500 and that there is some minimum amount of return that you will make no matter how the index performs. Make sure you understand the underlying formulas that determine your return and any factors that might cause a change in the formula. Check out FINRA’s Investor Alert on Indexed Annuities as well.
- Limited upside participation in the underlying index.
Additionally the sales pitches can be confusing. Make sure you understand what you would be buying, all of the underlying expenses and most important why this is the BEST solution for you.
Variable annuities and riders
Variable annuities generally have underlying investment choices called sub-accounts that function like mutual funds. They also have internal fees called mortality and expense charges that cover the insurance aspect of the contract. These fees can vary all over the board. Many contracts also carry surrender charges for a number of years from the issue date as well.
While the value of the VA will vary based upon the investment results, several riders or add-ons can create certain product guarantees. These riders come at a cost and that cost will impact how long it takes for the contract holder to come out ahead.
Two popular living benefit riders are guaranteed minimum withdrawal benefits (GMWB) and guaranteed minimum income benefits (GMIB).
A GMWB rider guarantees the return of the premium paid into the contract, regardless of the performance of the underlying investments via a series of periodic withdrawals.
A GMIB rider guarantees the right to annuitize the contract with a specified minimum level of income regardless of the underlying investment performance.
Both types of riders entail added costs and require varying time frames to be eligible for exercise and/or to recover the cost of the rider.
A variable annuity with or without one of these riders may be the right choice for you. You are far better off shopping around for the best product versus allowing yourself to be sold via a slick sales pitch.
The Bottom Line
Renewed market turmoil means a new wave of annuity sales pitches reminding prospects how risky stocks can be. Financial planning should always trump the sale of any financial product so investors who are worried about the volatility in the stock market will generally be better served by having an overall financial plan in place from which the appropriate products for implementation will flow.
Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.