There has been an epidemic in the United States of inappropriate high-fee financial products being sold to unsuspecting investors. These financial products, mostly annuities, are being pushed by financial services companies and their annuity peddlers, who are not looking out for your or other investors’ best interests. The companies and their salespersons are more interested in making money for themselves.
The financial services companies are making boatloads of money because the annuities and other financial products have high internal charges that can be 4% or higher each year. The annuity peddlers are making boatloads of money because annuities and the other stuff they are selling, like certain REITs, are among the highest commission financial products out there. The White House estimates that these unnecessarily high fees and charges are costing you and other investors of retirement accounts $17 billion each and every year.
To help curb these abuses by financial services companies and their salespersons, earlier this year, the U.S. Department of Labor has instituted new rules. The new rules are partially effective April 10, 2017 and fully effective by January 1, 2018. When fully effective, an advisor who provides investment recommendations to you as an IRA, 401(k) or other retirement plan participant will be legally required to provide that advice in your best interest, and not their own.
The advisor is now a fiduciary. This means that the advisors who handle your tax-advantaged retirement account assets must now select investments that are the best for your situation, and cannot just peddle financial products that make the biggest profit for themselves. Under the new rules as a fiduciary, the advisor can only make reasonable compensation from the investment, not the exorbitant fees as in the past. Also, the advisor can no longer make misleading statements about conflicts of interest. As a result of these new rules, sales of high-commission annuity products are expected to slow down.
Well there’s good news and there is bad news with these new rules. The good news is that advisors must act as fiduciaries with regard to your retirement accounts. The bad news is that firstly, it only applies to tax-advantaged (pre-tax) retirement account assets, not after-tax investment account assets. Financial services companies and their salespersons can continue to peddle annuities and other financial products, such a certain REITs, with financially abusive fees without disclosing this fact to you, so long as the source of your funds are not tax-advantaged retirement accounts. So it is still open season for annuity peddlers with regard to your after-tax investment accounts.
Secondly, the other bad news is that existing investments and financial products that are in place when the new rules become effective April 10, 2017-January 1, 2018 are grandfathered in and not subject to the new rules. The advisors can continue to recommend that you continue to hold them, even if it is not in your best interest, but theirs and can continue to charge exorbitant fees. Only new advice needs to be in your best interest and subject to the reasonable compensation standard.
Be on the look-out for financial advisors who want to put your IRAs or other retirement account assets into annuities or other high-commission financial products, such as certain REITs, before April 10, 2017 or January 1, 2018. If they can get the annuities or other financial products in place before the new rules take effect, they are not subject to the new rules for those products. Those products continue to be subject to the old rules. The advisors do not have to be a fiduciary as to those products. The products do not have to be in your best interest, but can still be in the best interest of the advisor making exorbitant fees. Wait until after January 1, 2018 before you decide to take any action on any new annuities, and see if the advisor is still recommending those financial products.
I have heard many comments by financial advisors about these new rules. On the one hand, some advisors are lamenting how onerous these new rules are, how they decrease options for investors and that they are just bad for the industry. On the other hand, other advisors say the new rules are no big deal because they are already acting in their clients’ best interest and that it will only be a few more papers to file. You can probably guess which group are the annuity peddlers who sell high-commission financial products.
When contemplating purchasing an annuity, there are three situations in which you should be extra-vigilant: 1) When an annuity is presented as an “investment”; 2)When the advisor recommends you cash-in an existing annuity and purchase a new annuity; and 3) When the annuity has a “guarantee” of a certain rate of return or protection of your principal.
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.
Annuity peddlers will often state that you can get a better return with the annuity than with other investments. Industry disclosures indicate that most annuity companies are charging their annuity customers 3%-4% each year. 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
I have observed and it has been reported a common practice among annuity peddlers to recommend cashing-in an existing annuity and purchasing a “better” annuity. Oftentimes there are substantial surrender charge penalties when you cash-in your existing annuity. What you are not told is that when you buy the new annuity, the annuity peddler is going to get a huge commission. The real purpose of replacing your old annuity with a new one is that it is a great payday for the annuity peddler.
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?”
Whenever you are investing, choose your financial advisor carefully. It is wise to choose an advisor that will act as a fiduciary, who will put your interests above their own.
By Matthew M. Wallace, CPA, JD
Published edited December 4, 2016 in The Times Herald newspaper Port Huron, Michigan as: New rules take bite out of annuity peddlers’ income