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.
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.
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Great article, Roger. And I agree . . . I can’t think of one single reason a person would want an indexed annuity.
Unfortunately, I know why brokers and insurance agents want to sell them . . . for that big commission check.
Russ thanks for the comment. Clearly the high commissions are the main reason for the enthusiasm with which Indexed Annuities seem to be marketed.
Roger,
Great article. It is hard to see when indexed annuities are a fit for clients but there is no shortage of reps who will push this in their sales pitch. I see clients who are completely confused by what they own and are devastated by the fees and surrender charges to get their money back.
Thanks for the comment Andrew. I agree with you. And I’ve also seen folks become very frustrated when they realize what it is that they own, how much it costs, and the onerous surrender charges.
I had the pleasure of reviewing an indexed annuity some time ago.
The mark, er, potential buyer, was told she would see returns as high as 24%/year. Yet, I saw that the calculations for returns capped each month at 2% and had no maximum loss in a given month. To be clear, if the market rose 5% each month for 3 months, but then dropped 6% in month 4, this resulted in zero return for the 4 months.
Even without these odd crediting schemes, the typical return is based on the index, with no dividends. The bottom line is that the combined fees 3% or so, combined with that missing dividend, totals 5% or more. That’s quite a cost for downside protection.
Worse yet, these products are regulated as insurance products. The disclosure is not what we are used to from say, a mutual fund or ETF. No easy way to download the disclosure and sift through the details.
Joe thanks for the comment and I hope all is going well. I’ve never seen a return calculation quite like what you described but I’ve also never seen one that resembles a good deal for the contract holder either. All in all Indexed Annuities are generally a bad deal for everyone except the rep selling them in my opinion and experience.
Roger,
I’m kind of surprised to hear you say that you “cannot come up with a single reason why I would ever recommend an Indexed Annuity to anyone.”
[Warning: seedy, greedy licensed insurance agent has arrived to try to explain his defenseless and evil product through lies and obfuscation!]
I’ll start by completely agreeing with the fact that many advisors do not sell these annuities properly and with the client’s best interest coming first. That’s the whole problem with the “suitability” standard, which is a topic for another time.
I have two questions to start off:
* How many people are in the fee-only advisor study group?
* Are any of them licensed to sell life insurance and annuities?
If someone is not licensed and unable to offer a particular product to their client, how well can they really know the product?
How likely are they to say “your situation may warrant considering a fixed annuity, but unfortunately I’m not licensed to discuss that with you. I recommend you speak with Mr. Greedy Seedy Insurance Agent next door.”
You say that “All in all Indexed Annuities are generally a bad deal for everyone except the rep selling them in my opinion and experience.”
Really, you think they are NEVER appropriate in any circumstance? (I’m interested to know if you think any other financial products are completely a bad deal in all situations.)
So why do these products exist?
Were they just another scheme hatched up by the evil insurance companies to bilk unsuspecting “marks” out of their money and pay exorbitant commissions to the greedy, seedy agents?
Is that really what you believe?
Are indexed annuities bad solely because the advisor receives a commission for selling them? Is a product that pays a commission always bad? (If so, then auto and home insurance, life insurance, and anything else that is “sold” must be bad too.)
There are many of articles and books out there that demonstrate the proper use and design of these contracts. Those who have already decided that they are always against indexed annuities would probably just say that the author is biased because they sell them.
Like I said, I agree that there really are “greedy, seedy” insurance agents out there that don’t know enough or don’t care enough to properly advise people on indexed annuities. Unfortunately, we must always be wary of ulterior motives.
Indexed annuities are clearly very controversial among advisors. Is this only based on the merits of the contracts and nothing else?
Is it possible that advisors are really bickering over whether one income structure is superior to another?
Roger, I respect your credentials, reputation, and commitment to your clients – I really do. I would submit that indexed annuities are excellent products IN CERTAIN CIRCUMSTANCES, and that you owe it to your clients to learn what those circumstances are so that you can give proper advice when warranted. (Even if it means referring clients elsewhere.)
Respectfully,
James Mahaffey
James thanks for your comments and let me address them.
There are nine of us in the study group. I don’t know how many of my colleagues hold an insurance license, however I do as I was advised years ago that I could get in trouble here in IL for providing advice on a client’s insurance policies/needs without one. I frankly have no idea if this is true. I will say this, at least here in IL. Being licensed to sell insurance products and having any knowledge about them are unrelated. The initial licensing exam is pretty simplistic and the ongoing CE is less than a joke. I would stack the knowledge of my study group colleagues against most any advisor or financial product sales type I’ve ever encountered. For the record I have never sold any insurance or financial product, my compensation is totally from fees paid by my clients.
I have used annuities in the past when warranted. Usually it was to do a 1035 exchange from a high expense product to a lower cost one.
Additionally I use the services of a few trusted insurance agents when a client has a need for insurance such as life, disability, LTC, health, or P&C. These are competent, qualified professionals whose knowledge and integrity benefit our mutual clients. I receive no compensation for these referrals and don’t begrudge them their commissions for delivering the right insurance solution for my client.
This brings us to Indexed Annuities. I have a couple of clients who had contracts prior to engaging my services. The contracts are awful and the benefits derived are paltry in relationship to the costs and restrictions of these policies. If you can show me a situation where this is the right product (and not just a suitable one, but the absolute best solution) I’m all ears.
Why do these contracts exist? From these and other contracts I have reviewed my opinion is that this is a product designed to prey on fear and is designed to enrich the bank account of the insurance company and the agent/rep selling the product. Again please tell me what I’ve missed here.
I’m not anti-annuity I am anti Indexed Annuity and also anti any other type of annuity that involves high fees and expenses, poor underlying investment sub-accounts, and absurdly long surrender periods.
Hi Roger,
Thank you for taking the time to reply to my comments.
I’m glad to hear that you “use the services of a few trusted insurance agents… [who] are competent, qualified professionals whose knowledge and integrity benefit our mutual clients.”
Have you discussed fixed index annuities with them? I’m just curious. Since they are trustworthy, perhaps they could show you some successful examples.
INCOME RIDERS
One thing that should be discussed is income riders, or Guaranteed Minimum Income Benefits, that have become very popular. These riders GUARANTEE a specific lifetime payment you would receive in each year of the product, WITHOUT annuitizing the contract. Yes, there is an annual fee charged for this rider, usually .5 – 1.25%. It’s critical to understand that this fee is charged from the accumulation value, not the “benefit base” which makes up the rider.
So, here’s an example:
A 58-year old worker plans to work until age 70. He has seen his IRA rise and fall over the years, and it has caused a great deal of stress.
He KNOWS that the money in this IRA will be used for income. He will need it, in addition to his (deferred) social security income to maintain his standard of living.
He puts $100,000 into a fixed index annuity with a GMIB rider. Immediately, he receives a 15% bonus. His “benefit base” is now $115,000. Moreover, he will earn 8% “roll-up” or simple interest each year for 12 years. Every single year for 12 years, $9,200 is added to his benefit base. After 12 years, his benefit base is guaranteed to be $225,400.
(Please keep in mind, this is the BENEFIT BASE, not the accumulation account. He can’t just take out this $225,400. It forms the basis of his lifetime benefit.)
At 70, he begins taking his lifetime income of $11,834 yearly. (This is 5.25% of the benefit base at that time. It is 11.83% of his initial premium.)
The years go by, when he is 89 he has taken all $225,400 of the benefit base. Nevertheless, it continues for as long as he lives.
This example is based on an actual product on the market. (I can provide the illustration if you care to see it.)
Are there trade offs? Yes, of course.
If he decides he doesn’t want the contract any more and wants to cancel in year 2, there are penalties! Over time, the fee for the income benefit rider reduces the accumulation value. The “guaranteed” values on the accumulation side are ugly, but you have to understand what’s going on. There are fees coming out for the income rider (in this case .85% annually) and 0% assumed annual stock market growth!
I think this is a very good product for someone sick of the market roller coaster and wanting to have safe, guaranteed growth until retirement, followed by guaranteed lifetime distribution upon retirement.
If you think this is a terrible scheme hatched to enrich insurance companies and agents, please let me know what solution you would suggest in this situation.
Respectfully,
James Mahaffey
James thank you for your comment. I will craft a more detailed response as I do have a few additional questions. But one quick one, why is it a good idea to put the annuity in an IRA account? Thanks.
The primary benefit of putting the annuity in an IRA is for the wonderful additional tax advantages that it will provide!
(just kidding…)
It’s a good idea because the client is guaranteed that in 12 years his $100,000 will turn into a $225,400 benefit base, 5.25% ($11,834) of which will then be paid as annual income for the rest of his life.
The 15% premium bonus is guaranteed, as is the 8% annual roll-up ($9,200) based on the new base of $115,000. If he decides to begin the income payments earlier, he can. The illustration shows the guaranteed amount for each year of the contract.
Simply put, the client’s retirement is completely guaranteed and protected. He doesn’t have to worry about market performance, cycles, or allocations.
James thanks again for the comments. A few questions and comments:
What happens if the client dies before he were to begin taking the income stream?
Is the income stream amount a single life, joint and survivor or something else? Are there a range of lifetime income stream options?
It also appears as if the client is locked into the rider from the day he chooses it? What are his options of his circumstances change? Is he out the amount paid each year for the rider? What if he finds a better deal and wants to do a 1035 exchange? You alluded to this but can you provide some details?
How does this scenario dovetail with the client’s required minimum distributions at age 70 1/2? I’ve read where deferred annuities can cause real problems with the RMD, any thoughts? Annuities in an IRA are in my opinion a questionable at best option.
You and others who sell this product seem to be fixated on the risk inherent in the stock market. I have a different take. My message to anyone approaching or in retirement is that your biggest risk comes not from losing money on your investments but rather from outliving your money. With the scenario you described it seems that this person is subject to the impact of inflation from day 1, but especially once the income stream commences. As you certainly know a 3% rate of inflation will erode your purchasing power by ½ over a span of 24 years.
From your comments you strike me as being intelligent, do you honestly believe all of the stuff used to sell Indexed Annuities surrounding the risk of the stock market or does this just make a good argument to try to sell these products? I find it hard to believe that you do.
Overall I think locking someone into an Indexed Annuity product such as the one you described just doesn’t seem like an optimal solution for someone nearing retirement. Between the costs, the loss of control, and the opportunity costs even the scenario you illustrated doesn’t look that great to me.
Thanks for replying again Roger, and for the compliment.
By “all this stuff” I’m not sure if you mean something I’ve written, or something else that you’ve heard elsewhere.
I think that market risk is a real thing, and that it has affected real lives. I recently sat with a 58-year-old who has a grand total of $22,500 saved for retirement. She really did wonder if there would be anything there when she retired… and no, I didn’t prod this comment; we were just discussing her assets and hadn’t discussed any philosophies, strategies, or products etc.
You’ve clearly decided what you believe about this product. We all must ask ourselves if we are willfully blind to ideas that don’t fit in our paradigm.
If you’re really interested in getting answers about this example, please email me. You’ve made up your mind based on premise, so taking time here to engage in further details is unlikely to result in anything productive.
If I may make a request, would you PLEASE answer two of the questions that I previously wrote and have not been addressed. I’m particularly interested to hear what you think.
#1: Have you discussed indexed annuities with the insurance agents that you recommend? Seems like it could be an uncomfortable situation depending on the circumstances.
#2: What do you suggest for this client?
Really, I want to know. I’m here to learn, not win an argument, prove someone wrong, or insult people. If there’s something that would better serve my clients, I want to know about it! If I’ve been drinking so much Kool-Aid that I can’t see straight, help me out!
Ideally, anything you offer would also work for the Walmart employee with only $22,500 saved, as mentioned above. Or the 60-year-old cook with only $17,500 in her IRA and looking to begin taking income in six years.
Given your experience, I would surmise that you don’t have (m)any clients like this anymore. Would they require a different strategy? [Sorry if that started a topic for a different day!]
Respectfully,
James Mahaffey
James thanks for your comments.
In the case of the woman you described certainly there are folks who are afraid of the stock market, that doesn’t mean that avoiding it in total is the right strategy. I have a number of fearful clients and I try to factor in that fear to an extent in my planning and investing advice.
As for how I would advise the hypothetical client I wouldn’t even consider offering any suggestion without knowing his entire situation. If all his retirement assets consist only of the $100,000 IRA and Social Security I can’t imagine locking the $100,000 up in an Indexed Annuity.
As for discussing Indexed Annuities with insurance colleagues I’m not sure why I would do this. I’m pretty comfortable with the contracts I’ve personally reviewed and some pretty extensive reading that this is a product that I’m not comfortable recommending to anyone in my client base. I use these folks for their expertise in insurance products, when I have used an annuity product it is always a product with no loads, no surrender charges, etc.
I’m sure this isn’t what you meant, but are you saying the only alternative for folks with lower balances are high cost Indexed Annuities or other expensive insurance or investment products? You are right I typically don’t work with folks in this situation, I do refer them to qualified colleagues who do however.
Roger, It is not surprising but still quite sad that out of your group of 9 that nobody has ever taken any time to actually learn what the Index Policy can do! I have to ask one question so I don’t have to write a novel here. If I showed you actual accounts that smoked what you and your “PANEL of 9″ achieved in the last 3 or 5 years with No Risk using that Evil Indexed Annuity, will you publish the results ? If so, Let’s Get To IT! If NOT then you are all just smoke and mirrors. Oh, and by the way your comment about fees and commissions? that’s just a LIE! You see my clients only pay fees from GAINS, and the commission never invaded principal. This is unlike your world. I was paid 1 time by the company. No recurring fees like your world! Not like your panel that gets fees in good and bad times. That is the fee drag I love to illustrate. So you talk it over with ” The PANEL” and we can go public. I think its important that people who post inaccurate dis-honest and intentionally slanted information be called to validate those statements. I await your response. In addition I would invite any accounting firm to authenticate the data we present! I will pay the fee for that. I do so hope you will stand behind your words.
Blair thanks for your comment. I don’t believe that I said my study group colleagues were uninformed about these products. I am always open to learning more about these products or anything else that is a better “mousetrap” for my clients. I do find it interesting that when I tried to check out the website listed with your comment I received a fatal error message. This is often a characteristic of comment spammers.
Thanks for the heads-up. No spam! I assure you, I am quite real and have left messages for my web master. It will be up within 24 hours. Lets stay on course, if you will, I. Do we have a go ahead on the challenge ? You seem to have a good audience that supports your belief system, I would think it would be a piece of cake to blow away the Evil Annuity returns! After all, those lousy caps and fees surely must have killed the return to the investor! Maybe one of the other know it-alls will step up and accept. I’m here if you ever decide to validate what you preach! Be well Blair
Wow I must have really struck a nerve. I’d love to see these results and more over an example of a client situation where this would be the ideal, best solution. I would also consider a guest post on this topic from you if you are interested. If so I’d be glad to share my parameters for guest posting “offline” with you.
Roger , You didn’t strike a nerve or a tendon. Simply put, after 29 years in this industry I have a great passion for the TRUTH!. This applies to the medical , financial political and environmental world. When I see a blanket statement such as you made “For the life of me I cannot come up with a single reason why I would ever recommend an Indexed Annuity to anyone” it unnerves me! That is a irresponsible and ignorant statement. That would be like a medical practitioner stating all antibiotics are bad. I can only guess that you have looked at a half dozed or maybe a dozed annuities in your life. Yo need to do more homework before you scare a hard working American pre -retiree away from a asset that has never lost a penny of anyone’s money EVER! That’s right No one has ever lost a penny in an Indexed Annuity unless they violated the terms of the contract. Sorry, you and your equity mob cant make that claim. This is why I challenge you to back up your horrific review with facts ! Don’t feel bad, Nobody is willing to, they just love to talk the talk . If you want to bring real value to your column at least read the Wharton Study on Indexed Annuities or Moshe Milevsky one of the most respected mathematician’s who works with Warren Buffet and his take on annuities. Don’t expect to learn anything from the hack advisers I see posting here! It is sad that I have to even correct individuals who profess to educate others on Annuities. https://www.youtube.com/watch?v=_8T6WXIifPk
Blair “For the life of me I cannot come up with a single reason why I would ever recommend an Indexed Annuity to anyone” is a statement of my opinion and based upon my knowledge and experience. And scare tactics, I think those selling Indexed Annuity products (and in many cases other annuity products) have cornered the market on the use of fear tactics. Lastly a guarantee, however secure or not that it is, does not mean that the annuity holder will have an adequate amount for retirement.
Sadly retirement planning goes far beyond the scope of just selling someone a product, taking your commissions, and moving on.
Why don’t you post these supposed annuity contracts (with names and other personal information blurred out) and prove your point? Until them you are nothing but hot air. Insurance companies are not playing Santa Claus. Index annuities pay PALTRY returns because they were designed to compete with lowly CD’s.
From your other article: “n annuity’s “participation rate” specifies how much of the increase in the index is counted for index-linked interest.” – that is really the killer argument for me. But “buying the index” is such a household word by now people don’t care for the fine print anymore.
Chris thank you for your comment. I’m not sure, however, that I understand the point that you are trying to make.
Since we have already moved past “CHECK” and “CHECKMATE” to which you are not willing to validate the superior performance of “NOT USING AN INDEXED ANNUITY” I will ask you to solve a recent prospects dilemma. You can feel free to use a lifeline of the like minded advisers here. Please do not respond with more generalities and cryptic nonsense.
CASE STUDY
Male 86 year old
100,000 in a CD coming due 30 days ago
Goals: 1.) Get a better rate of return then .05%
2. Leave a legacy to his 2 grandchildren of $100,000
So use all your market wisdom to solve this REAL WORLD PROBLEM using all the tools you have at hand!
I will show the solution that was implemented in real life. I hope this may bring some reality to this thread as thus far its just a bunch of bullies trashing an asset class they clearly DO NOT understand.
I await your plan to be revealed. Anybody can join in by the way!
Blair I’m assuming that since this is a post about Indexed Annuities that this was your solution. I’m dying to learn how this works, educate me please.
Roger Roger, Roger I will BUT you need to use your toolbox that you believe brings greater options, flexibility, lower fees, no surrender period. and most of all eliminating the need to deal with the GREEDY Insurance Scam-artist. Please build your solve using this simple problem that was brought to me by a radio show listener. It is pretty funny that not one of you supporter’s is willing to validate anything in this peaceful debate! I await to see the plan. This by the way is a 5th grade solve in my world.
Blair I’m not going to engage in this “competition” it’s a bit sophomoric don’t you think. So if you feel like you have a great solution (which I presume illustrates a good application for an Indexed Annuity) please feel free to share it. I’d be doubly curious to learn why selling this type of product to an 86 year old is not akin to medical malpractice. My approach is a bit different, I don’t focus on selling someone a product but rather providing an overall financial planning solution so its likely we would have addressed this issue already in the course of our planning for the client.
I don’t focus on selling someone a product but rather providing an overall financial planning solution Nor do I ever! However, your Wall Street toolbox isn’t built on math and science as the actuarial side of the insurance world is. In your world it is always based on assume and consume. We will assume we are going to earn a ? rate of interest and we will consume(spend) a given rate of interest. Now you are at the mercy of sequence of returns. and your ” retirement plan” is nothing more then a game of chance. How else can you explain earning an average rate of return 10.1%, spending 5% and being broke in 20 years. That is the flaw with Wall Street’s distribution mindset. Take care Roger, and if you are ever truly interested in learning whats in your blind spot instead of making broad erroneous generalizations give a call. take care
You invest in bonds and stocks (heavy in bonds for safety). That’s exactly what the insurance companies do. CD’s is NOT investing! You are comparing apples to oranges. One of the oldest tricks in the insurance industry books.
Roger:
I am so happy that I came across your website and articles. I wanted to speak about a situation related to fiduciary duty/suitability standards about the product discussed in this article.
I trusted a family member (my fault I know) to purchase an indexed annuity with the outrageous return claims agents are known for.
I suspected that it was too good to be true, so I started hesitating and told me he would give me a $5,000 incentive from his commission to move to his firm.
Knowing this extreme conflict of interest, is this something the agent could lose his insurance license over and could it be an opportunity to get out of his frualent sales pitch and horrible product?
Thanks
Thanks for visiting and for your comment Ed. To be honest with you I do not know the legal/regulatory issues associated with what he did. Depending upon how badly you want to get out of this you might approach your relative and indicate that you want to void this whole transaction if possible and that you want your money back. Beyond that you go to the management of the insurance company and/or his broker-dealer firm. Another avenue might be the insurance commissioner in your state. No guarantee that any of this will work, but these are some places to start. It might come down to speaking with an attorney, but you will need to weigh that cost with the benefit of getting out of the annuity. Good luck.
All – per below…What recommendations would you make here?
BLair Aaronson says:
CASE STUDY
Male 86 year old
100,000 in a CD coming due 30 days ago
Goals: 1.) Get a better rate of return then .05%
2. Leave a legacy to his 2 grandchildren of $100,000
So use all your market wisdom to solve this REAL WORLD PROBLEM using all the tools you have at hand!
I will show the solution that was implemented in real life. I hope this may bring some reality to this thread as thus far its just a bunch of bullies trashing an asset class they clearly DO NOT understand.
I await your plan to be revealed. Anybody can join in by the way!
Aubrey thanks for your comment. The suspense is killing me. Please reveal the real-life solution. I wait with baited breath. I have to say I am always amazed by the zealousness that annuity sales types defend these products. I’m guessing the commissions must be pretty lucrative. In truth I don’t know what I’d propose because I don’t know this individual’s entire situation and financial planning goes well beyond recommending one product or another.