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Annuities: The Wonder Drug for Your Retirement?

January 17, 2022 by 12 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. The pitches frequently pander to the fears that many investors still 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.”

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 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. In general, the lack of transparency regarding the fees associated with many annuity contracts is appalling.

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 variance in these and other fees across the universe of annuity contracts and the insurance companies that provide them 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 ensure that the agent or rep who sold you the high fee annuity (and the insurance company) continue 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 backed by the PBGC, a governmental entity, up to certain limits.

Outside of the most notable failure, Executive Life in the early 1990s, there have not been a high number of insurance company failures. In the case of Executive Life, thousands 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 most cases you will receive some portion of the payment amount that you expected, but there is often a delay in receiving these payments.

The point is not to scare anyone from 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 a low cost provider who offers a product with ultra-low fees and no surrender charges because they receive no commissions.

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. Adding Social Security to the mix 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.

Annuities are generally 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 retirement planning efforts. Be sure to read ALL of the fine print and understand ALL of the expenses, terms, conditions and restrictions before writing a check.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

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Annuity Sellers Love Stock Market Turmoil

March 11, 2020 by 4 Comments
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Update 3/11/2020 – We are in the midst of the worst stock market turmoil since the financial crisis in 2008, due to the coronavirus and related disruptions in the economy. It’s times like these that can fuel fear-based selling tactics by many who sell annuities. I have absolutely nothing against annuities, but I feel that no financial product should be purchased based on fear. It will be interesting if the pattern of these fear-based tactics that we’ve seen in the past materializes in this volatile stock market environment.

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.

Indexed Annuities 

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.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

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Indexed Annuities – Pros and Cons

June 13, 2014 by 33 Comments
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A recent article by Investment News’ outstanding insurance and retirement products reporter Darla Marcado discussed the increased popularity of indexed annuity products (link may require free registration) among registered reps.  The zealousness with which these products are often sold sadly invokes images of the annual Canadian baby seal hunts in which the animals are often clubbed to death so as not to damage their valuable hides, with the remains then left to rot once the hides are removed.

Indexed Annuities – Pros and Cons

As with any financial product it is a good idea to look at the pros and cons of Indexed Annuities.

Indexed Annuities – Pros

For the life of me I cannot come up with a single reason why I would ever recommend an Indexed Annuity to anyone.  To be sure I wasn’t missing something I posed this question to my fee-only advisor study group recently and they agreed.

Indexed Annuities – Cons 

Unreasonably long surrender periods.  I’ve reviewed a number of these contracts over the past couple of years and they all seem to have surrender periods of ten years or longer.  I can’t see giving your money to anyone who won’t let you have access to it for a decade.  You can of course annuitize and most contracts allow for the withdrawal of a portion (usually 10%) each year, but you’re prohibited from doing a 1035 exchange to another annuity contract if you find a better deal.

High fees and commissions.  These fees serve to reduce your returns and are often hard if not impossible to determine.  They can run in the 5% – 10% range and provide a great incentive for financial sales types to really push these products.  Make sure you demand that your rep disclose ALL commissions and fees that she might earn should you buy a contract.

They can be hard to understand.  With any financial product you should never even consider writing a check until you fully understand how it works and why it’s beneficial to you.  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 potential.  It is important for you to understand that this is not an equity investment.  Most contracts limit your participation in the underlying index.  For example in 2013 the S&P 500 gained over 32% so if your participation was limited to say 8% you would have missed out on a lot of the gain.

Confusing sales pitches. While technically not a feature of the product, it seems like the sales pitches for Indexed Annuities change to fit the times.  In the wake of the financial crises the fear mongering sales pitch was along the lines of avoiding the risk of the stock market while still participating in the upside.  These days it seems to be about the minimum returns as an alternative low-yielding CDs and other bank depository products.  Sorry there is no “wonder drug” financial product that I’m aware of.

Look this blog is not meant to provide readers with specific financial advice for their unique situation so please at the very least if someone is pitching you an Indexed Annuity (or any other financial product for that matter) ask them and yourself a few basic questions:

  • What’s in this for the financial sales person?  Is this recommendation based upon my best interests or based upon them earning a hefty commission?
  • Does this product make sense for me based upon my situation, my goals?
  • Do I understand how this product works including the upside potential and the downside risks?
  • What are the underlying expenses?  Is there a lower cost alternative that I’m not being made aware of?
  • Is this the best version of this type of product or just the version the sales person has available to sell to me? 

As with any financial product make sure you are buying an Indexed Annuity because it is right for you and not because you succumbed to a convincing sales pitch.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

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7 Questions to Ask Before Buying a Variable Annuity

June 3, 2014 by 3 Comments
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Variable annuities are often touted as an ideal retirement investing vehicle, especially by financial advisors who sell them.  Variable annuities can be a useful vehicle for retirement accumulation.  However variable annuities (and other types of annuities) are quite often misunderstood by those who are the targets of these sales pitches.  Is a variable annuity right for you?  Here are 7 questions to ask before buying a variable annuity.

What does a variable annuity do for me that I can’t accomplish outside of a variable annuity? 

This is a great question and if you ask your annuity sales person you will get a variety of answers.  I’m certainly not anti-variable annuity, but they are not the wonder drug that many brokers and registered reps selling them would have us believe.  Make sure that you ask the next person who makes a variable annuity sales pitch this very question (and a few others) and listen to their explanation.  Maybe you will get a cogent, sensible answer maybe not.

Will I eventually annuitize the contract? 

One of the benefits of any form of an annuity is the ability to create a stream of income in retirement.  This is the reason for the mortality and expense charges in every contract, this is the insurance company’s compensation for your option to annuitize the contract in the future.  If this isn’t something that you are likely to do perhaps a variable annuity is not the answer for you.  At the very least find one with reasonable expenses.

Have I maximized my contributions to my 401(k), my IRAs, and other retirement plans? 

In my experience contributing to your 401(k) or similar workplace retirement plan and to your IRAs provide a better retirement savings vehicle than a variable annuity, if for no other reason than they usually have lower expenses and don’t have restrictions like surrender charges.  In fact I often put a variable annuity lower on the list than investing in a taxable account, though this will vary person by person based on each individual’s situation.

What are the expenses? 

As mentioned above many variable annuities are laden with onerous expenses that enrich the insurance company and perhaps the person who sold you the annuity, but likely not you.  There are many lower cost annuity products offered by the likes of Vanguard and others that may be worth checking out if a variable annuity is of interest.  A fee-only advisor will likely go in this direction, but an annuity sales person can’t as there is no compensation in it for them.

What are my investment options? 

Years ago there was an SNL skit that referenced something called “bef” which was almost like beef, but wasn’t.  This is similar to the variable annuity world where the investment options are called sub-accounts.  They look, feel, and smell like mutual funds but they aren’t mutual funds.  They might even have familiar mutual fund sounding names, but they are still different and generally pricier.  Understand the investments as this is the vehicle that will fuel your accumulation in the variable annuity.

Are there restrictions if I want to move my money? 

As they used to say on Rowan and Martin’s Laugh-In (NBC from 1968-1973) “… you bet your sweet Bippy…” there are restrictions on moving your money from a variable annuity in most cases.  While I can understand taxes and perhaps penalties for withdrawing prior to age 59 ½, the surrender charges on many variable annuities serve to hold your money captive for as many as 10 years even if you find a better deal down the road.  Make sure you understand any and all surrender charges and other penalties before buying into a variable annuity and better yet avoid financial products with these charges.

Who stands behind the product? 

Annuities are guaranteed by the “full faith” of the insurance company offering the product.  Be sure to investigate the financial strength of the issuer as they are the ones responsible for making any annuity payments you might opt for.  While annuity defaults are quite rare they do happen and if it does your recourse is likely with a regulator.

Variable annuities are a valid retirement planning tool.  Just make sure that you understand what you are buying, why you are buying it, and ALL of the underlying expenses involved.  Make sure that you buy the product for the right reasons and not because you succumbed to an aggressive sales pitch.

Approaching retirement and want another opinion on where you stand? Is someone pushing you to buy an annuity and you aren’t sure if it is right for you? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services. 

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Annuities On Trial! Is Your Annuity Guilty or Not Guilty?

January 15, 2014 by 10 Comments
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You have to love financial services marketers.  The title of this blog post is actually the headline on an invitation that I recently received to a dinner session on annuities.  You can’t make this stuff up.  While this seminar invitation may be a bit cheesy, it does raise some valid questions about annuities.  In that vein here are some thoughts about annuities and about financial dinner seminars.

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Financial dinner seminars 

Financial dinner seminars are a traditional method for investment advisors, estate planning attorneys and insurance and annuity sales types to get their message out to a group of potential clients.  Common sense tells us that these seminars are costly to stage and that the advisors sponsoring them are looking for a return on their investment.  In terms of this annuity seminar or any type of financial or estate planning dinner seminar consider the following before you decide to attend:

  • The ultimate objective of the seminar is to get you to buy something.
  • Ask yourself if this is really the best route to finding a financial advisor.
  • Can you resist the pressure, direct or implied, that will be put upon you to meet with the individual(s) sponsoring the session and do business with them?

In terms of this annuity seminar in particular, I called the company sponsoring the session and pretended I had some questions before deciding whether or not to attend.  The pleasant young woman on the phone indicated that the organization was “holistic” in their approach to working with clients.  They could sell you another annuity if appropriate, manage your money, or consult on matters such as Social Security.

While this all sounds nice, the individual sponsoring the annuity seminar runs a marketing organization and was once affiliated with Tarkenton Financial a financial marketing organization run by Hall of Fame quarterback Fran Tarkenton.  In a Motley Fool piece The “Criminals” Who Sell Annuities, the author quotes Tarkenton as saying:

“There are 38,000,000 Seniors in America. Do they know who you are? Seniors know and trust an American Classic, NFL Hall of Fame Quarterback Fran Tarkenton. If you are a professional in the insurance industry focused on the Retirement and Senior Market, Tarkenton Financial can help you build your business.” 

The Motley Fool piece goes on to say “Nowhere in these ads will you find anything even vaguely along the lines of “we’ll help you help your clients achieve their financial goals.” Because, for some of these people, it’s more about building their own net worth’s, not their clients’. 

This leads me to believe that there will be a lot of direct and indirect selling at this annuity dinner session and very little about helping the attendees to achieve their financial and retirement goals.  At least the venue is a restaurant with excellent food.

Considerations before buying any annuity 

You might get the impression that I am anti-annuity.  You would be wrong.  I have nothing against annuities, only the way that they are often sold and with many of the annuity products that are pushed by insurance agents and registered reps.   Here are some things you should consider before buying any annuity product:

  • Make sure you understand all of the expenses, fees, and charges involved with the product.  I’ve seen variable annuities with annual ongoing expenses well in excess of 2%.  To say this is outrageous and obscene would be kind.  Suffice it to say expenses like this are eating away at the amount that will be available to you when it comes time to annuitize the product or to take partial distributions.
  • If a fixed annuity is paying a much higher rate of interest than other similar products ask yourself why.   Is the insurance company taking excessive risk?  Will they be able to sustain the returns needed to maintain the payments?  Is this a “teaser” bonus rate that drops down to more normal levels after a period of time?  The old adage “… if it sounds too good…” applies here.
  • Who is behind the annuity?  How strong is the insurance company?  If something happens to the insurer it falls to the appropriate state department of insurance to cover you.  There are generally limits on the amount guaranteed for annuities so you will want to read the contract and make sure you understand this all of this.
  • Many annuities contain surrender charges that impose some stiff fees if you try to get out of the contract during the first few years.  Again make sure you are aware of these fees.
  • Equity Index Annuities are often sold by capitalizing on the fears of seniors and others in the wake of a down market.  Typically the returns of these annuities are based on some percentage of an index like the S&P 500, with some minimum guaranteed return and/or floor on the amount that the investor can lose.  Again these products often carry steep surrender charges and they must be pretty lucrative for those selling them judging from the comments I received when I wrote Indexed Annuities-Da Coach Likes Them Should You?  Don’t take my word for it; check out this SEC investor bulletin.

Don’t fall for annuity sales pitches.  An annuity may be appropriate for you but the only way to really know this is by getting a financial plan in place for yourself and your family.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

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Is a Variable Annuity Right for You?

August 21, 2013 by Leave a Comment
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is a variable annuity right for you I’m asked this question from time to time.  The most recent incident was by a friend whose “financial guy” was pushing her to invest a substantial portion of her investable assets into a variable annuity that was “coincidently” offered by his employer.  This friend asked me a simple but thought provoking question:   What type of person is a variable annuity a good product for?   Let’s analyze this question.

What is a Variable Annuity? 

Investopedia defines a variable annuity as follows:  “An insurance contract in which, at the end of the accumulation stage, the insurance company guarantees a minimum payment. The remaining income payments can vary depending on the performance of the managed portfolio.”  Money invested in a VA grows tax-deferred just like a Roth IRA (note VAs are often the vehicle used in 403(b) plans and can be used in an IRA, but for purposes of this article we are only discussing after-tax, non-qualified accounts).  At some point in the future the money can be withdrawn either in a stream of payments (annuitized) over a variety of time frames with varying payouts for a survivor if applicable, withdrawn all at once, or in partial withdrawals over time.    Generally the amount contributed is not subject to taxes, the gains are subject to taxes at ordinary income rates.

Who should consider a Variable Annuity? 

I generally counsel most people to fully fund their company retirement plan such as a 401(k) first, their next priority should generally be funding an IRA (traditional, Roth, or after-tax).  This prioritization is general and certainly one size does not fit all. For example a variable annuity might be more attractive to someone who is looking for an investment vehicle where gains can grow tax-deferred and whose 401(k) plan is lousy.  4 Signs of a Lousy 401(k) Plan include:

  • A plan investment menu loaded with proprietary funds offered by the plan provider.
  • A fund line-up consisting solely of funds from a single fund family.
  • A line-up consisting of funds with high expense ratios.
  • A plan that is wrapped in an insurance company group annuity plan.

Additionally if your plan doesn’t offer a match in addition to having one or more of the above characteristics a variable annuity might be attractive to you. A variable annuity can serve as an additional leg on your retirement planning stool.  For example you might have a 401(k) plan, an IRA, taxable investments, Social Security, and possibly a pension.  A variable annuity can offer another vehicle for tax-deferred investment growth.

Expenses are a key factor 

As an insurance product all variable annuities have an insurance cost as well as the expense ratio of underlying investment sub-account.  The cost of two otherwise similar variable annuity products can vary widely. For example the annuity this friend asked me to review carried expenses that were in excess of 2% all-in for most of the sub-accounts.  This notation on the Vanguard site illustrates the wide variations in VA costs:

“* Source: Morningstar, Inc., as of December 2012. The Vanguard Variable Annuity has an average expense ratio of 0.58%, versus the annuity industry average of 2.28%; excludes fees for optional riders. Actual expense ratios for the Vanguard Variable Annuity range from 0.46% to 0.79%, depending on the investment allocation. The expense ratio includes an administrative fee of 0.10% and a mortality and expense risk fee of 0.195%. The expense ratio excludes additional fees that would apply if the Return of Premium Death Benefit rider or Guaranteed Lifetime Withdrawal Benefit rider is elected. In addition, contracts with balances under $25,000 are subject to a $25 annual maintenance fee.” 

Additionally many VAs offer additional riders or contract features such as the Return of Premium Death Benefit Rider mentioned above.  In all cases you should evaluate the cost of any riders and the benefit you would derive and then relate this to your unique situation when evaluating a given VA product. The VA that I was asked to review also had a surrender period.  What this means is that for a period of time (either 10 or 7 years in this case) you will be charged a penalty if you surrender the contract (in English this means withdraw your money).  While the insurance company might argue that this is needed to provide them with stability or some other mumbo jumbo, the fact is that you would be charged a hefty (especially in the early years of the contract) fee even if you found a better variable annuity and wanted to move your money to that product.  The surrender charge declines over the life of the surrender period and you can withdraw a small portion of your money without penalty each year.  I strongly urge you to find a VA (such as Vanguard’s or several others) with no surrender charges.

Investment choices 

Most VAs utilize sub-accounts that look like mutual funds, but aren’t.  For example the sub-account might have a name like the XYZ Annuity Fidelity Contra sub-account.  While the sub-account might invest in shares of the Fidelity mutual fund with the same name, or might even be managed by Contra’s manager this is not the Fidelity Contra fund.  If for no other reason than the higher annuity expenses, the returns will be different (and generally worse). Just like any investment vehicle the quality of the investment options and their expenses should be a key factor in evaluating a given variable annuity and even whether to invest in a VA at all.

Is a variable annuity the right choice for you? 

As with much in the realm of financial planning and investing, the answer is “it depends.”  In addition to what we’ve discussed above, ask yourself these questions:

  • What does a variable annuity do for me that I can’t accomplish with investments outside of a VA?
  • Will I annuitize the contract or take periodic withdraws?
  • Do I already have enough annuitized retirement income from Social Security and a pension?
  • Do the benefits of the VA I’m considering outweigh the expenses?
  • Why is my “financial guy” really pushing this VA?
  • How sound is the insurance company behind the product?  Do I understand what happens and who I might turn to if the insurer encounters financial difficulties?
  • VA gains are generally taxed as ordinary income, how does this fit with your retirement tax strategy?
  • VAs can trigger some estate planning issues, make sure that you understand these and are prepared to plan accordingly.  These include both tax-related issues and the fact that any money that is annuitized becomes unavailable to pass on to your heirs upon your death.

A variable annuity can be an appropriate tool in your retirement planning toolkit.  Just make sure that you understand what you are looking to buy, why you would be buying it, and ALL of the underlying expenses involved.

Please contact me with your investing and financial planning questions.  Please check out our Resources page for some additional links that might be beneficial to you.

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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.    

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Indexed Annuities – Da Coach Likes Them Should You?

November 27, 2011 by 16 Comments
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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.

Alumnus Mike Ditka is a Hall of Fame tight end...

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.

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.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if its right for you. Financial coaching focuses on providing education and mentoring in two areas: the financial transition to retirement or small business financial coaching.

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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