You may have spent your hard-earned savings on one or more deferred or variable annuities. The likelihood is that they were sold to you as an “investment”. If you are like most annuity purchasers, what you were not told is that the annuity peddler probably made a boatload of money from the annuity sales commission.
Annuities are among the highest commission financial products out there. There is no shortage of people willing to peddle them. According to industry disclosures, typical commissions run 6%-8% of the amount deposited into the annuity. Because of the money involved, there are regular reports of abuses in annuity sales practices. One common reported abuse is that annuity peddlers will lie about the annuities in order to get someone to buy them. Occasionally the annuity peddlers will get caught lying to make the sale. MetLife Securities Inc. (MetLife) was caught recently doing this.
If you replaced an existing annuity with a MetLife variable annuity from 2009-2014, you have a 3 in 4 chance that you do not have what you thought you had. The Financial Industry Regulatory Authority (FINRA) announced earlier this month, the largest fine ever relating to variable annuities. FINRA fined MetLife $20 million and ordered it to pay $5 million to customers for making negligent material misrepresentations and omissions, basically lying, on 72% of variable annuity replacement applications from 2009-2014. Each lie made the new annuity look more beneficial than the customers’ existing annuities. Some of the lies that FINRA found that MetLife had made were:
- Saying the new annuity was less expensive than the old annuity when in fact the new annuity was more expensive.
- Understating the value of the old annuities’ existing death benefits.
- Failing to inform the customer that they were losing important benefits in the old annuity that were not in the new annuity, such as accrued death benefits and income guarantees.
The annuity peddler will often tell you that you do not pay any commission on the annuity, they get paid by the company. That is only partly true. While the company does pay the upfront commission, they do not do it out of the goodness of their heart. The company is going to want to get paid. The annuity company gets paid from you two separate ways: surrender charge penalties and internal charges.
With a deferred or variable annuity, you cannot access your money for a period of time, which I have seen as long as 20 years, unless you pay a surrender charge penalty, which I have seen as high as 50%. When you buy a deferred or variable annuity, you are agreeing to keep the money with the annuity company for a period of time, which can be as long as 20 years. If you take you money out of the annuity company before that time period is up, you pay a surrender charge penalty, which can be as high as 50%.The annuity companies are counting on a certain percentage of the annuity holders to have to cash in their annuities to access their money during the surrender charge penalty period, at which time, the annuity company gets a big pay day from the surrender charge penalties.
You pay the annuity company 3%-4% per year to hold your money in your annuity. Industry disclosures indicate that most annuity companies are charging their annuity customers 3%-4% annually for the management of the annuity. These are called internal charges. Included in these internal charges are management fees and mortality and expense charges. Most annuity peddlers will not tell you that you have to pay the annuity company 3%-4% per year to hold your money in the annuity.
Deferred and variable annuities are not “investments”, they are a tax deferral wrappers around an investment. With deferred and variable annuities, you put your money in and do not get taxed on any of the income until you pull the money out. The income tax is deferred so long as the money is kept in the annuity. The annuity company then invests the money in a variety of financial instruments. If you have a variable annuity, you generally direct which mutual funds in which your money will be invested. With other types of deferred annuities, the annuity company decides what investments are to be made.
IRA annuities, which are also called “qualified annuities”, are another type of annuity that is often subject to abuse by the annuity peddlers. IRAs, by their very nature, are tax deferral vehicles. For traditional IRAs, you put pre-tax money in and pay tax on the funds and their earnings when you take them out. For Roth IRAs, you put in post-tax dollars and it all comes out tax-free. Why would you pay 3%-4% per year to put tax deferred money into a second tax deferral wrapper? I have yet to hear any justifiable reason to put any IRA money in an annuity, other than to make money for the annuity peddler and the annuity company.
Annuity peddlers will often state that you can get a better return with the annuity than with other investments. What this means is that your money that is invested in the annuity will have to outperform the investments you could have made outside the annuity by more than the 3%-4% internal charges of the annuity. Run the other direction of anyone tries to sell you an annuity because you can get a “better return” with the annuity. For example, if you had a 2% “guaranteed” return on an annuity, the annuity company has to have an investment return of 5%-6% to cover the “guarantee” and the internal charges. You can only imagine how risky that investment has to be to get that kind of return.
You should not count on any annuity “guarantees”. The marketing materials of annuities will often advertise the guarantee of a certain percentage annual return or the guarantee that you will get the return of your principal. Well it might happen or it might not. Annuity companies these days are putting provisions in the prospectuses or the annuity contracts to allow the annuity company to unilaterally change the terms of the annuity contract in certain circumstances. I call these weasel clauses, since they allow the annuity companies to weasel out of their obligations.
For example, I have seen an annuity company change the “guaranteed” return on an annuity from 3% to 1½% in year two of an eleven year surrender charge penalty period. Certified financial planner Allen Roth stated in AARP The Magazine not too long ago:
“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?”
If someone tries to sell you an annuity, get a second opinion. Is an annuity an appropriate place to park your money that you cannot get to for a period of time without paying a surrender charge penalty? Or would you be better off putting your hard-earned money to better use in a solid diversified investment portfolio or even a CD? Do your homework before you sign that annuity application. You might be able to save yourself thousands or even tens of thousands of dollars in expenses and penalties.
By: Matthew M. Wallace, CPA, JD
Published edited May 29th, 2016 in The Times Herald newspaper, Port Huron, Michigan as: Get a Second Opinion with Annuities