You may have invested some or all of your nest egg in annuities. Are you aware of all of the terms and conditions of your annuities? Do you know the cost to you when the time comes that funds are needed out of your annuities?
You may have been told that you pay no commissions on annuities. In actuality, you do pay commissions in the form of internal charges, administrative expenses and surrender charge penalties. Annuities are among the highest commission financial products available, so there is no shortage of people willing to peddle them.
The commission paid to the annuity salesperson increases the higher the surrender charge penalty and the longer the surrender charge penalty period. The year one surrender charge penalty of your annuity can approximate the commission paid to the annuity salesperson.
I have seen surrender charge penalties as high as 50% and initial surrender charge penalty periods as long as 20 years. If you need the funds and have to make a withdrawal out of your annuity before the surrender charge penalty period expires, the surrender charge penalties will generally have to be paid out of the principal of your annuity.
Because annuity commissions are so lucrative, annuity peddlers often represent that they are investment advisors. So how can you tell if your investment advisor is an annuity peddler? Here are just a few signs for which you want to be on the lookout:
Annuity sold without looking at all your investments. Annuities can be useful tools as part of a diversified investment portfolio. However, if you put all of your investable assets in annuities, this is putting all of your nest egg in one basket. This is rarely the wisest investment strategy.
There are a number of investment broker companies that prohibit their investment advisors from selling an annuity to a prospect, unless the advisor has reviewed the prospect’s entire investment portfolio, and annuities will make up less than 50% of the prospect’s portfolio. I have known advisors who generally recommend that no more than 25% of your investable assets be in annuities, and even less if you are over age 75, and none if you are over 80.
If your investment advisor sold you an annuity without looking at your entire investment portfolio or puts more than 25% of your investable assets into annuities, he or she likely is an annuity peddler.
Your investment advisor only sells annuities. Your investment advisor should offer you a variety of investment options in addition to annuities, such as mutual funds, stocks and bonds. When your investment advisor is a one trick pony and only sells annuities, you probably have an annuity peddler.
You have an indexed annuity. Equity-indexed annuities, also called fixed indexed annuities, are often sold with the assurance of stock market gains with no risk of losing your principal. You are told that your entire initial investment is protected if the market tanks.
Allen Roth, in this month’s AARP The Magazine, states that these index annuities are among “the worst investments and financial products you can sink your money into,” and are one “of the most glaring examples of unwise investments [he’s] seen in [his] career as a certified financial planner.” He goes on to say:
“If you read the fine print and use a little common sense, you’ll find the guarantees are mostly illusion. How can an insurance company take your money, pay the planner a commission, invest the rest mostly in conservative bonds and still give you market returns without risk? Does it seem more plausible that the thick disclosure documents are there to protect you — or the insurance company?”
In all probability, if you have an indexed annuity, you have been stung by an annuity peddler.
The teller says: “You can get a better return if . . .” You are at the bank or credit union to renew your certificate of deposit that is earning 0.2%. The teller says: “You can get a better return if you talk to our investment advisor.” You are then directed to an investment advisor who only offers you annuities for these better returns.
Often bank and other financial institutions base employee compensation on the amount and value of products they sell or assist in selling. The more annuities sold and the higher the dollar amount of those annuities, the higher the employee’s take-home pay.
You are offered guarantees. Be wary of anyone selling annuities who represents that an annuity has a guarantee of a certain rate of return or a guarantee that your initial investment is protected. The likelihood is that, as Allen Roth has stated, “the guarantees are mostly illusion.”
I have seen rates of return guaranteed only if you die. I have also seen high teaser rates of return guaranteed for only a short period of time such as six months, which are then recovered with higher internal charges and administrative expenses later on in the life of the annuity.
Then there were the annuities whose guarantees of withdrawals without surrender charge penalties could only be exercised in a 30 day window every five years. There are also the IRA annuities whose guarantees of rates of return and/or penalty-free withdrawals could only occur if you never ever withdraw more than the annual required minimum distribution.
I have had more than one client shocked to learn after a spouse’s death, that guaranteed death benefits in excess of their investment in an annuity were 100% taxable as ordinary income. They were told by the annuity peddler that these death benefits were just like life insurance. However, life insurance would have been 100% income tax-free.
And these guarantees are only as strong as the financial stability of the company. Remember all of the Chrysler and General Motors retirees who lost their “guaranteed” retirement benefits.
You are offered “Medicaid-friendly” or “VA-friendly” annuities. It is typically the annuity peddler who will represent to you that if you purchase a special “Medicaid-friendly” or “VA-friendly” annuity, you can still qualify for Medicaid or VA benefits. In most all instances since 2006, the income and/or the principal of these annuities are considered available resources and must be spent down before qualifying for these governmental benefits.
You should be especially wary of annuity peddlers who appear to be estate planning outfits or veteran organizations. They will often use informational seminars with food to lure you. The seminars are designed to frighten you into protecting your assets by purchasing a trust estate plan from them or having them apply for your veterans benefits. You are then told that your estate plan won’t work or you won’t qualify for veterans benefits unless you consolidate all of your investments into annuities with them.
Some words to the wise. If you are purchasing an annuity, especially if you are a senior, look carefully at the surrender charge penalty percentages and the surrender charge penalty period. Only purchase those annuities for which you do not have any expectation of a need for those funds during that period or can withdraw funds without penalty. Make sure surrender charge penalties are waived upon disability or death. And do not necessarily rely upon any annuity guarantees.
By: Matthew Wallace CPA, JD
Published edited May 4, 2014 in The Times Herald newspaper, Port Huron, Michigan as: Indecision is no excuse for not estate planning