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Call the Safe Money Guy: My Road Sign Epiphany

May 2, 2013 By 4 Comments
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English: Beware of warthogs road sign near Wat...

On a recent drive on the Tollway through the far South end of Chicago near the Indiana state line all of a sudden there it was the solution to all of the financial planning issues that I help clients deal with.  There was my financial epiphany, a road sign urging drivers to “Call the Safe Money Guy.”

Call me cynical, but I generally want to check to make sure my wallet is still in my pocket when I see a sales gimmick on the order of “The Safe Money Guy” advertised.

Sadly I was moving too fast to get the name of the firm so I am forced to dig into my vivid imagination to offer my thoughts on this and similar financial services marketing approaches.

Using 2008-2009 market drop as a sales tool 

I think the whole idea of using fear-mongering as an annuity sales tactic is reprehensible, which is what I’m guessing this guy is doing.  The pitch often goes something like this:

Fed up with the volatility in the stock market?  Tired of the guys on Wall Street making all of the money?  Invest for peace of mind and protect your principal.  Call us. 

So what’s wrong with this?  Far too often the annuity or insurance product being sold carries high ongoing expenses, onerous surrender fees, and returns that often don’t look all that great when you “peel back the onion” and take a hard look at the underlying product.  This pitch is common for Equity Index Annuities, a product that prompted even FINRA to post a warning page on its site.

Leading with a product vs. a plan 

My real beef with this approach and similar ones is that they lead with the sale of financial products instead of a financial plan.   How can anyone recommend any financial product to a client without first understanding in great detail the client’s goals, risk tolerance, and their overall financial situation?

Safe from what? 

Many investors would equate safety with having little or no chance of losing money on their investments.  That’s certainly one definition.  Let me offer a few other “safety” features you might find in some of the products sold in this fashion:

  • Safety from low cost investment vehicles.
  • Safety from the returns that might be needed to achieve your longer-term financial goals.  Over the years I have stressed the point to those planning for their retirement that the biggest single risk they face is from the ravages of inflation eroding the purchasing power of their hest-egg.  I’m not advocating that folks take more investment risk than is appropriate for them, I am advocating that they balance the need for growth to stay ahead of inflation against the bunker mentality being sold by some fear-monger financial sales types.
  • Safety from product transparency.  Anyone who has ever read an annuity or insurance contract can attest to this.
  • Safety from advisor compensation that is clearly defined and based only on financial advice provided.

Look I’m not against either life insurance or annuities.  They can both have a place in a well-constructed financial plan.   There are many folks who sell annuity and insurance products who are diligent and who do a great job for their clients.  Sadly there are others who use what I consider to be some questionable sales tactics.

The recent PBS Frontline documentary The Retirement Gamble served to highlight the high fees that are rampant in some retirement plans.  The same diligence needs to be applied by retirement savers and all investors outside of their company retirement plans.

If working with a financial advisor is right for you, choose a financial advisor who puts your interests first, who understands your needs, and who can recommend financial strategies and products to implement those strategies that are right for you, not those that put the most money in their pockets.

Please feel free to contact me with your retirement planning and investing questions.   Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.    

Photo credit:  Wikipedia

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Annuities: The Wonder Drug for Your Retirement?

January 7, 2013 By 8 Comments
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Annuities: The Wonder Drug for Your Retirement?
Annuities are often touted as the “cure” for all that ails your retirement.  Baby Boomers and retirees are the prime target market for the annuity sales types. You’ve undoubtedly heard many of these pitches in person or as advertisements. Many of these pitches pander to the fear that many investors feel after the last stock market decline.  After all, what’s not to like about guaranteed income?

What is an annuity?

I’ll let the Securities and Exchange Commission (SEC) explain this in a quote from their website:

“An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates. If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.

There are generally three types of annuities — fixed, indexed, and variable. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.

Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC. You can learn more about variable annuities by reading our publication, Variable Annuities: What You Should Know.

http://www.sec.gov/answers/annuity.htm”

What’s good about annuities?

 In an uncertain world, an annuity can offer a degree of certainty to retirees in terms of receiving a fixed stream of payments over their lifetime or some other specified period of time.  Once you annuitize there’s no guesswork about how much you will be receiving, assuming that the insurance company behind the product stays healthy.

Watch out for high and/or hidden fees 

The biggest beef that I and many other financial advisors have about annuities are the fees, which are often hidden or least difficult to find.  Many annuity products carry fees that are pretty darn high, others are much more reasonable.

There are typically several layers of fees in an annuity:

Fees connected with the underlying investments.   In a variable annuity there are fees connected with the underlying sub-account (accounts that resemble mutual funds) similar to the expense ratio of a mutual fund.  In a fixed annuity the underlying fees are typically the difference between the net interest rate you will receive vs. the gross interest rate earned.  In the case of an indexed annuity product the fees are just plain murky.

Mortality and expense charges are fees charged by the insurance company to cover their costs for guaranteeing a stream of income to you.  While I get this and understand it, the wide variation in these and other fees across the universe of annuity contracts makes me shake my head.

Surrender charges are fees that are designed to keep you from withdrawing your funds for a period of time.  From my point of view these charges are heinous whether in an annuity, a mutual fund, or anyplace else.  If you are considering an annuity and the product has a surrender charge, avoid it.  I’m not advocating withdrawing money early from an annuity, but surrender charges also restrict you from exchanging a high cost annuity into one with a lower fee structure.  Essentially these fees serve to insure that the agent or rep who sold you the high fee annuity (and the insurance company) continues to benefit by placing handcuffs on you in terms of sticking with the policy.

Who’s really guaranteeing your annuity? 

When you purchase an annuity, your stream of payments is guaranteed by the “full faith and credit” of the underlying insurance company.  This differs from a pension that is annuitized and which is backed by the PBGC, a governmental entity up to certain limits.

Outside of the most notable failure, Executive Life in the early 90s, there have not been a high number of insurance company failures.  In the case of Executive Life, 1,000s of annuity recipients were impacted in the form of greatly reduced annuity payments which in many cases permanently impacted the quality of their retirement.

Insurance companies are regulated at the state level; state insurance departments are generally the backstop in the event of an insurance company failure.  In such an event, you may receive some portion of the payment amount that you expected, but likely there will some period of time that elapses before this occurs.

The point is not to scare anyone off of buying an annuity but rather to remind you to perform your own due diligence on the underlying insurance company.

Should you buy an annuity? 

Annuities are not a bad product as long as you understand what they can and cannot do for you.  Like anything else you need to shop for the right annuity.  For example, an insurance agent or registered rep is not going to show you a product from someone like Vanguard that has ultra low fees and no surrender charges because they receive no commissions.  Yet as a fee-only advisor, I generally use annuities from providers of this sort when an annuity is appropriate.

An annuity can offer diversification in your retirement income stream.  Perhaps you have investments in taxable and tax-deferred accounts from which you will withdraw money to fund your retirement.  Add Social Security to the mix which provides a government-funded stream of payments.  A commercial annuity can also be of value as part of your retirement income stream, again as long as you shop for the appropriate product.

Far too many annuities are sold rather than bought by Baby Boomers and others.  Be a smart consumer and understand what you are buying, why a particular annuity product (and the insurance company) are right for you, and the benefits that you expect to receive from the annuity.  Properly used, an annuity can be a valuable component of your financial plan.  Be sure to read ALL of the fine print and that you understand ALL of the terms, conditions, and restrictions before writing a check.

Please feel free to contact me with your financial planning and investing questions at any time, including questions about an annuity you may own or one that you might be considering.

Please check out our Resources page for links to some tools and services that might be beneficial to you.

Photo credit:  Flickr

 

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Indexed Annuities – Da Coach Likes Them Should You?

November 27, 2011 By 14 Comments
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Alumnus Mike Ditka is a Hall of Fame tight end...

Mike Ditka recently began doing radio commercials for an insurance group touting their Indexed Annuity product. He ends one of the commercials with his characteristic “… tell them Mike Ditka sent you…” Given that Da Coach was a member of the last two Chicago Bears championship teams since the days of leather beater helmets (1963 as a player and 1985 as coach) he is perhaps the preeminent pitchman here in Chicago.

Should you pick up the phone and say that Coach sent you?  Let’s examine a few issues.

What is an Indexed Annuity? Per the FINRA website, EIAs (Equity Indexed Annuities) are complex financial instruments that have characteristics of both fixed and variable annuities. Their return varies more than a fixed annuity, but not as much as a variable annuity. So EIAs give you more risk (but more potential return) than a fixed annuity but less risk (and less potential return) than a variable annuity.

EIAs offer a minimum guaranteed interest rate combined with an interest rate linked to a market index. Because of the guaranteed interest rate, EIAs have less market risk than variable annuities. EIAs also have the potential to earn returns better than traditional fixed annuities when the stock market is rising.

Reuters recently ran a piece on these products. A few points raised in the article:

– Hidden fees and commissions. Commissions typically run between 5 percent and 10 percent of the contract amount, but can sometimes be more. These and other expenses are taken out of returns, so it’s hard for buyers to determine exactly how much they’re paying.  

– Complex formulas and changing terms. The formulas used to determine how much annuity owners earn are so complex that even sales people have a hard time understanding them, and they can change during the life of the contract.

– Limited access to funds. Buyers who try to cash out early will incur a surrender charge that typically starts at 10 percent and decreases gradually each year until it stops after a decade or more.

–Limited upside. An annuity’s “participation rate” specifies how much of the increase in the index is counted for index-linked interest. For example, if the change in the index is 8 percent, an annuity with a 70 percent participation rate could earn 5.6 percent. However, many annuities place upside caps on the index-linked interest, which limits returns in strong bull markets. If the market rose 15 percent, for example, an annuity with a cap rate of 6 percent would only be credited with that amount.

I’m guessing that Mike Ditka is not an inexpensive spokesperson. Nor do I believe that ads on our local CBS radio affiliate are cheap. This goes to reinforce the point about high expenses and fees from the Reuters article. In fact I have been told that annuities are among the highest revenue generators for financial sales people, to me this creates a potential conflict of interest.

Additionally, any annuity product is only as good as the insurance company behind it. Before buying into any annuity be sure to understand who the insurer is and get information about their financial health.

An Equity Indexed Annuity might or might not be a good solution for your situation. In fact many of the proponents of these products point out that their performance has by and large been as expected over the past several years.

Rather than focus on any particular financial product or investment vehicle, start with a financial plan. Determine your financial goals, your risk tolerance, and your time horizon to achieve your goals. Look at your current resources and compare these to what you might need to accumulate to achieve your goals. Only then are your ready to look at what financial or investment products might be appropriate for you.

Lastly I would encourage you to ignore celebrity endorsements for financial products or services. While Mike Ditka might be an exception, there are many stories of athletes and celebrities making really poor financial decisions and being ripped off by financial sales people and advisors. If you buy the wrong brand of snack food based on their endorsement, not much downside. The same can’t be said if you pick the wrong financial advisor.

Please feel free to contact me with questions on Index Annuities or any aspect of financial planning.

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Annuities in 401(k) Plans-My Questions and Concerns

February 11, 2010 By 7 Comments
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Recently the Department of Labor (DOL) and the Treasury asked the public to comment on whether the idea of requiring employers to offer lifetime annuities as a rollover option for 401(k) plans is a good idea.

On the surface this is a good idea with much merit. The recent volatility in the financial markets and the economy has reduced the 401(k) balances of many workers. Many plan participants feel uneasy about how to best allocate their 401(k) contributions while working and equally unsure about how to take distributions from their accounts in retirement. Poor investing combined with another market downturn could put a serious crimp in the ability of many Americans to make their nest eggs last for their lifetimes.

These proposed annuities would conceivably work much like traditional defined benefit pension plans. Workers would receive income for their lifetimes that they could not outlive. There might even be options to guarantee lifetime income for a surviving spouse or other beneficiaries.

This all sounds good on paper. My concerns center on the implementation of such a plan.

1. Annuities are generally offered and guaranteed by insurance companies. Is this how the administration envisions this annuity option working? If so, which insurance companies would be allowed to offer these rollover annuities? Would there be any controls to ensure that the insurers meet some minimum tests for financial strength?
2. Fees and expenses are a key element of any annuity product. Would there be some oversight and regulation to ensure fair and reasonable expenses? Who would define what constitutes fair and reasonable expenses? Higher fees generally equal lower payouts for annuitants.
3. Would the annuities offer inflation protection as in the public sector or would the payout remain flat as with many commercial annuities and corporate pension payments?
4. A much discussed regulatory initiative centers on making 401(k) plan fees and expenses more transparent and standardized. Often, 401(k) plans administered by insurance companies are anything but transparent regarding fees and expenses. Will the addition of this annuity option add to the confusion regarding plan fees and expenses?
5. Will annuity payments be based upon some sort of standardized formula such as age, years of service etc.? Will this formula be standardized across the all employers or will the insurers be free to offer whatever payouts “the market will bear?”
6. If an insurer offering a rollover annuity product was to experience financial difficulty who would stand behind the participant’s payments? The already strapped PBGC? State insurance regulators? Someone else?

Again, on paper this is a good idea. I fear that this good idea could turn out badly for plan participants if these and many other questions are not ironed out on the front end.

Filed Under: Annuities