WHY I HATE ANNUITY HATERS AND YOU SHOULD TOO
One of the most common hurdles I face when a potential client comes to see me is the misinformation they have been given about annuities. Sometimes, the misinformation comes from family or friends, but more often than not, it comes from other advisors who have a vested interest in distorting the facts about annuities. One such advisor is a nationally-known annuity hater, who takes out full page ads in newspapers with this heading: “Why I Hate Annuities and You Should Too.”
This annuity hater wants you to send for, or download, information that allegedly tells you all the “horrible” facts about annuities. The truth is, much of what he provides is misleading and, in some cases, outright lies. To be fair to him, he does save most of his hatred for variable annuities, and, as most of you know, I am also not a fan because of their inherent risk and excessive fees.
Unfortunately, when he lumps Indexed, Fixed and Immediate Annuities with Variable, and paints them with
the same brush, he is doing an immense disservice to his readers. Facts are empowering and are essential to making informed decisions about your financial goals and retirement plan. Accordingly, what follows is a factual point by point refutation of the annuity hater’s arguments.
GUARANTEES: First, we should clarify that fixed annuities are not investments like stocks, bonds or mutual funds. Instead, they are insurance products that guarantee the following: (1) Predictable income you cannot outlive; (2) Protection from investment and market risk and, (3) Minimum interest earnings – in every economic
climate.Unlike life insurance, which protects your family if you die too soon, annuities protect you from outliving your income if you live too long. Moreover, unlike investing in the market, annuities guarantee that you will not suffer any losses when markets decline. And, annuity products exist that meet every consumer preference and unique financial objectives. In fact, 9 out of 10 annuity owners believe that annuities are an effective way to save for retirement (1).
FIXED AND INDEXED ANNUITIES VS. VARIABLE ANNUITIES: The annuity hater does not distinguish between variable annuities and fixed annuities. He should. Variable annuities are not guaranteed.
Market losses are common. So, what kind of returns can one expect in a fixed annuity? At the moment, a classic fixed annuity can be obtained that has a guaranteed interest rate of 2.6% - 3%. This is different than a “return”, which in market-oriented investments can be negative. Fixed and Indexed Annuities, by definition, can never have negative returns. A fixed annuity declares a rate, which is based on the insurance company’s earnings. An Indexed Annuity’s gains are based on the positive performance of a market index. Both types of annuities guarantee you against market losses.
INDEXED ANNUITIES VS. THE MARKET: The annuity hater complains about insurance companies limiting the interest that is earned. To be sure, insurance companies limit what is paid out to Indexed Annuity policyholders because of the guarantees that are offered, along with the usual and customary company expenses to develop, market and service the annuities sold. But there are two wonderful tradeoffs. First, any gain credited to the account represents real money, not a paper gain. Second, such gains can never be lost.
Furthermore, what the annuity hater does not point out are the fees paid to him and all other mutual fund or money managers. These fees limit market gains and add to market losses. He also tends to cherry-pick market gains when comparing real market returns versus Index Annuity returns. The truth is that Index Annuities have, over the past 20 years, competed extremely well with market gains (2). Moreover, market gains are meaningless “paper gains” unless you cash in every year at market highs, while any annual gains in an indexed annuity are realized and locked in.
EXPENSES AND FEES: The annuity hater also complains about the expenses, or fees, associated with annuities. Once again, he fails to distinguish between Variable and Index Annuities. Index Annuities do have charges that are made only when money is prematurely taken out of an annuity in excess of the 10% per year that is typically allowed. I prefer to call this feature a “guaranteed buy back of your contract” rather than a penalty. Variable Annuities not only have the same surrender fee structure, but also have management fees, as well as death benefit and income benefit fees.
Index Annuities may have additional fees when an OPTIONAL benefit or rider is added to the policy, such as guaranteed lifetime income, enhanced long-term care or death benefits. But, if these additional benefits are not
needed or desired, no fees are levied. All of this is fully disclosed in brochures and statements of understanding, which are considerably easier to understand than the confusing prospectuses Variable Annuities and mutual funds must provide. Moreover, all Indexed Annuities come with a money back guarantee, called a “free look” period (typically 20 days), wherein if clients are not satisfied with their contracts, they can cancel them and receive all of their money back. Investment products do not offer such consumer guarantees or protections. Not surprisingly, the annuity hater ignores this benefit.
SURRENDER COSTS AND LIQUIDITY: Annuity haters often criticize the surrender charges that most annuities have. To be sure, market-oriented investments can be cashed in at any time and do not have official “surrender charges”. There is a cost, however. In addition to the annual fees, which often range from 1% - 2%, the inherent risk of such investments could cost you much more than any surrender charge. Cashing in after a loss in the market locks up those losses forever. And experiencing market losses just before or after one’s retirement can be especially debilitating.
If you think about annuity surrender fees as a “necessary cost” for necessary guarantees, they become much more understandable and acceptable. The annuities we recommend – Fixed, Immediate and Indexed – guarantee complete protection from market losses, income for life and minimum interest rates. These benefits are not free and are an expense to the insurance company. Other costs include regulation compliance, mandated reserving, product development, marketing and servicing annuity owners. To pay for these expenses, the insurer invests the premium it receives. To maximize profits and to cover expenses and obligations to contract holders, insurers must retain its investments over several years. If annuity contracts are cancelled too soon, these expenses will outweigh investment returns and the insurance companies will suffer losses.
So, what’s the fairest method to prevent losses? Most would agree that the surrender charge method is the best, because it imposes the burden of repaying unrecovered expenses only to those who caused the loss by not fulfilling contractual obligations. Thus, surrender charges are the best tools for ensuring that ALL annuity owners receive the most competitive interest rates and the insurer is protected. Please also keep in mind that a cost is not a cost unless it is incurred. And, over 95% of all contracts are
never surrendered. It is also extremely important for annuity owners to always have access to what I have always called “comfort zone” cash – money available in banks or under one’s mattress – to pay bills, cover emergencies, take trips, etc.
It is also extremely important to keep in mind that annuities allow for free 10% withdrawals every year, provide 100% withdrawal for long-term care needs, can be used as collateral for loans, offer a lifetime of liquidity (income) after one year, can be replaced by other annuities offering bonuses and have surrender-free death benefits. Moreover, there is always a Guaranteed Buy Back of your contract at a rate known to you that improves every year. In short, those who decry annuities as illiquid, are at best misinformed and at worst, are promoting lies.
LIFETIME INCOME RIDERS: Annuity haters often seem bewildered by the exceptional benefits available to annuity owners who have added Lifetime
Income Riders. Again, they often confuse variable annuities with Indexed Annuities – either knowingly or through ignorance. So let’s again differentiate between the two. Variable annuities (the type we DON’T offer) have market risk, and the value of the sub-accounts chosen could go up or down. If they go up, money can be made assuming positions are cashed in. If they do down, money can be lost and income payments could be less than expected. This is called risk. Indexed Annuities, on the other hand, are not only safe, but have a baseline income guarantee. Moreover, if the markets are helpful, the income guarantees could actually be considerably higher. Annuity haters are profoundly remiss in ignoring or mis-stating the benefits of these Income Riders. They also do not seem to understand that the guaranteed income stream not only can last as long as the annuity owner does, but can be turned on and off. This means that the remaining money in an annuity contract can be taken out at any time. This is quite different from annuitizing a contract. The key difference is that with an Income Rider, you still own and have control of the annuity account value, whereas with annuitization, you convert all values to a promised payment stream.
HIGH COMMISSIONS: Another deception promoted by annuity haters is that annuities pay high commissions. It is true that I am paid a commission after the sale of an annuity. However, this payment is NOT taken out of your premium and the commission does NOT reduce the amount you pay into the annuity. Instead, it is taken
from the insurance company’s profits. In addition, unlike a managed brokerage account of mutual funds that charge a fee – which is taken out of account values EVERY YEAR – I am only paid once. Thus, over time, financial advisors who charge fees generate considerably more “commissions” than I do. If they are “fee based”, they charge you every time they visit with you or provide written advice. Others charge a commission every time a stock, bond or mutual fund is bought or sold. Many actually are charging you some combination of the above, and such charges are levied against your account whether you are making money or not.
TAX DEFERRAL: Another huge benefit annuities offer is their tax-deferred status. This status has been granted by the U.S. government and is embedded in the
IRS code. Those of you who already own annuities, know that the advantage of tax-deferral provides a powerful boost to annuity earnings. With higher tax brackets and longer life expectancies, the benefit of tax-deferral becomes even more powerful. I have likened it to “triple compounding” – that is, you earn interest on your principal, interest on your interest and interest on money that would normally go to Uncle Sam and the state. And, this is true whether you have annuities in tax-qualified accounts like IRA’s or in non-qualified accounts that would normally be taxed. In addition, upon one’s demise, all the funds in an annuity are transferred FREE OF PROBATE, and can be paid out over time in a tax-advantaged way to your heirs.
COMPLAINTS: One of the biggest red herrings thrown at us by annuity haters is the claim that FINRA and the SEC have reported numerous complaints and that annuity contracts can be changed at the whim of the insurers. This is a reference to a 2004 (13 years ago) SEC report that related exclusively to variable annuities, not Indexed Annuities. Indeed, Fixed Indexed Annuities had recorded over 6.5 billion new policies by 2014 and less than ½ of 1% of their owners have filed complaints.(3). Moreover, FINRA regulates securities products, not annuities, so referencing FINRA is flat-out dishonest. And finally, insurance companies cannot “reserve the right” to change anything. Any non-guaranteed feature must be clearly identified in promotional materials and contracts.
Finally, I would like to offer 4 Points of Caution regarding those who “Hate” or “Don’t Sell” annuities. Please read the fine print of their offer and ask:
What is the minimum amount they expect you to invest?
OFTEN IT IS AT LEAST $500,000.
What are the limitations to cancel or modify their offer to convert your annuity into their managed accounts?
IN MANY CASES, ONCE YOU ACCEPT THEIR OFFER, YOU CANNOT EVER BACK OUT.
How will any reimbursement of surrender charges be made? Will they pay it immediately or through a credit of their advisory fees?
TYPICALLY, IT’S NOT DONE RIGHT AWAY AND, INSTEAD, TAKES THE FORM OF A SMALL FEE REDUCTION OVER AS MANY AS 15 YEARS.
Are you willing to lose money in a risk-based investment?
REMEMBER, THEY MAKE MONEY WHETHER YOU DO OR NOT.
Please call me if you need more information about the content of this newsletter. Or better yet, call for an appointment, 913-661-9492, to enjoy a cup of coffee and some dark chocolate while discussing all of this face to face. Also, feel free to share this newsletter with anyone you know, especially any annuity doubters or haters. They may change their tune after reading this.
(1) Much of this can be found in “9 Answers Every Investor Needs to Know About Annuities” NAFA, 09252014, www.nafa.com
(2) Geoffrey VanderPal, Jack Marrion and David F. Babbel “Real World Index Annuity Returns” Journal of Financial Planning (March 2011)
(3) NAIC, the National Association for Insurance Commissioners, Complaint Report by Product Type, 1995 – 2013, compiled by Dr. Jack Marion