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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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Is Fear the Ultimate Financial Sales Tool?

March 5, 2014 by 4 Comments
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If you are like me you may have noticed a preponderance of TV and radio ads where fear is used to pitch various financial products.  If seems that these are overwhelmingly from providers of products such as annuities, insurance or other commissioned financial and investment products.   Recently I heard commercial for a variation of the insurance product called Be Your Own Banker.  Their pitch was the inevitability of a 50% loss in the stock market.  Really, come on.

Fear Is the Mindkiller

My personal pet peeve is that far too often these fear mongers seem to target seniors afraid of losing their nest eggs.

Should fear be a financial motivator? 

Ameriprise has been running a commercial asking folks if they would outlive their money in retirement.  A valid question and one in part based upon fear.

In fact many folks in their 50s or 60s looking for financial planning help as they approach retirement are asking this question.  Whether it’s fear-based or born out of a desire to be prepared it is a good lead-in to the financial planning process for folks in this age range.

On the other hand scaring people, especially seniors, into purchasing a financial product that may or may not be right for them strikes me as sleazy.

In a prior post on this blog, 5 Steps to a Lousy Retirement, I listed making financial decisions based on emotions as one of the steps to take on the road to a lousy retirement.  This especially true when you are being sold annuities or insurance products because so many of them come with onerous surrender charges meaning that it will cost you dearly to move your money elsewhere over the first 5-10 years of ownership.

Planning should precede the sale of financial products 

The logic, other than the desire to earn a sales commission, of pitching a financial product instead of a financial plan to a client escapes me.  In my world a financial planning strategy generally comes first, the implementation of that strategy including the use of appropriate financial products comes afterwards.

Inflation vs. investment loss 

Many of these fear-based product pitches cropped up in the wake of the financial crisis of 2008-09 and the corresponding drop in the stock market.

In my opinion, however, retirees should fear the impact of inflation on their purchasing power vs. losing money in the stock market.  Even a relatively benign 3% inflation rate will cut your purchasing power in half over a 24 year period.

Yes the stock market was hammered in 2008 and if you use the SD&P 500 as a benchmark the market gained very little during the decade 2000-2009.  However a diversified portfolio did reasonably well even during this “lost decade.”

Ask questions and do your homework  

Many successful financial sales types are very personable individuals.  In some cases the sales person might be your neighbor, a member of your church, or a fellow member of the local Rotary club.  This shouldn’t disqualify them as an advisor, however you should also be prepared to scrutinize their credentials and the products they may be trying to sell you with the same tough standards that you would hopefully apply to a stranger in the same situation.

As an example, with the Be Your Own Banker (or any of its variations) sales pitch that I mentioned at the outset, you need to dig very deep before writing a check for this type of insurance policy.  I went to the site and found much of the presentation confusing and found little or no information about the associated policy costs and expenses.

Whether an insurance policy, an annuity, or commissioned investment products you need to ask many, many questions of the agent/registered rep.

  • At the very least understand ALL associated fees, expenses, and restrictions on moving your money.
  • How does this individual get paid?
  • With an insurance related product how solid is the company behind the policy or annuity contract?  

Fear must be a very effective tool in selling financial products, otherwise we would not see so many fear-based product pitches.  Don’t fall for this type of sales pitch.  The only financial products that you should consider are those that are right for your situation, not those that you are scared into buying.

Need help looking at your overall financial plan and want another opinion on where you stand? Not sure if your investments are right for your situation? Concerned about stock market volatility? 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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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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5 Steps to a Lousy Retirement

April 10, 2013 by 15 Comments
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Lousy Retirement

 I’ve written a number of posts on this site about saving for retirement.  This time let’s turn it around and discuss 5 steps to a lousy retirement.

Invest in stocks at the top of the market 

This tip is timely as major stock market indexes are at all-time highs.  In fact one company, John Hancock recently ran a TV ad encouraging investors who had been on the sidelines during the current market rally to get in now.  The commercial depicted upscale couples sitting in their financial advisor’s office with a sense of optimism about the markets and feeling like this is the right time to invest.  Don’t get me wrong, I have no idea where the stock market is going from here, but four years into a major Bull Market is not the time to be thinking about just getting back into stocks.  A better approach is to have a financial plan that includes an appropriate investment allocation for your situation through the market’s ups and downs.

Invest in high cost broker sold mutual funds 

Whether proprietary mutual funds offered by your broker or registered rep’s employer or mutual funds with expensive loads, these funds are generally bad choices for most investors.  While no financial advisor works for free, unless there is some overriding reason to the contrary it is generally a good idea to avoid these mutual funds.  Rather look for a fee-only financial advisor who sells their advice and expertise and isn’t dependent upon commissions and trailers from the sale of financial products.  This type of structure lends itself to utilizing low cost index funds and actively managed funds across the whole universe of fund families.

Make financial decisions based upon your emotions 

It is said that fear and greed are the two most potent forces that drive the stock market.  Many financial products, especially many annuities (including Equity Index Annuities) are sold by fear mongering sales types with retirees and Baby Boomers as their prime targets.  An annuity might be the right answer for you, but don’t write a check until you review all the details of this or any financial product.  Don’t buy into the doom and gloom scenarios pitched by many financial sales types, especially right after a market decline such as the one we experienced in 2008-09.  Make financial decisions with a clear head, not out of fear, greed, or any other emotion.

Don’t take full advantage of your workplace retirement plan 

Why contribute to a 401(k) plan, 403(b), 457, or similar retirement plan offered by your employer?  It’s much more fun to spend the money on things you want now such as clothes, a new car, that vacation you deserve, etc.  Besides, didn’t 401(k) plans let investors down in 2008-09?  The reality is that your employer sponsored retirement plan is one of the best retirement savings vehicles going.  Even a lousy 401(k) plan is generally worth funding at least enough to receive your employer’s full match if one is offered.  Over the course of my years as a financial planner I can tell you that I have many clients who have accumulated (or are in the process of accumulating) significant sums in their retirement plan accounts that will play a key role in their retirement.

Don’t plan for retirement, just wing it 

Why spend money on a financial plan?  Retirement will just happen and I’ll be ready.  Things have always worked out for me.  The reality is that retirement is a financial journey, both accumulating enough for a comfortable retirement and managing your money during retirement.  While you might win the lottery or inherit a princely sum from some long lost relative, the reality is that a successful retirement takes planning.

As the legendary golfer Gary Player once said, “… the more I practice, the luckier I get…”  The same applies to preparing financially for retirement.  Planning, preparation, saving early and regularly, and your good common sense are all key elements in engineering a successful and comfortable retirement.

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.

Photo credit:  Wikipedia

 

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Guaranteed Income Does Not Guarantee Retirement Success

March 27, 2012 by Leave a Comment
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Retirement

I suspect in part as an outgrowth of the stock market meltdown of 2008-09, guaranteed income products (annuities) in 401(k) and other retirement plans are a major topic of discussion. The Treasury Department recently gave the go ahead for the use of annuities in retirement plans. As a practical matter the widespread use of these products is still a bit off into the future.

I wrote an earlier post in this blog and one for US News about my thoughts and concerns surrounding annuities in retirement plans. A good idea in theory, the reality of the implementation concerns me.

Saving for retirement is still the key to success

Let me focus on one additional area of concern. While a guaranteed income product that the participant would purchase as part of their investment in the plan would provide a guaranteed lifetime income stream, there is no guarantee that this stream of income would be sufficient to guarantee the retirement lifestyle the participant seeks.

Said another way, the inclusion of a guaranteed income option in a retirement plan does not absolve the participant from determining how much they need to save for retirement and how they need to allocate their investments. Even the use of a Target Date Fund or a managed account option requires the participant to ensure that the fund manager is investing their money in a fashion that fits their retirement accumulation needs.

Besides concerns such as the fees tied to these options and the selection and monitoring of an insurance provider for these products, the prospect of these products providing retirement plan participants with a false sense of security in terms of their retirement readiness concerns me greatly. A guaranteed income option might be a good tool for a retirement plan participant, but it is in no way a substitute for good old fashioned financial planning. At the end of the day, participants still need to accumulate a sufficient amount in their retirement plan accounts in order to be able to generate a meaningful monthly income stream if they choose to go the annuity route.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

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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.

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