You have worked hard your entire life to save up your nest egg. It might be your IRA, 401(k), tax sheltered annuity or brokerage account. You want to find a place to park your nest egg that is safe, but still has a reasonable return. You are thinking about or you have already put your money into an annuity. But do you really know your annuity?
You may be like most other annuity owners with whom I regularly meet, but who were never told about the key terms of their annuity. You may be unaware of the initial and continuing payments made to the annuity issuer and the annuity peddler. You may not know you have to pay a withdrawal penalty to take your money out of the annuity during a penalty period. You may think you have “guarantees” of your principal or rates of return. You were probably never told that the annuity issuer could change the terms of your annuity without your knowledge. And you probably have the mistaken belief that your annuity is some sort of “investment.”
Annuity companies and annuity peddlers make boatloads of money from you.
As we discussed last week, there is no shortage of people who are trying to separate you from your money. In the financial services industry, it’s the annuity peddlers. Annuities are among the highest commission financial products out there, so there are lots of people willing to peddle them. According to industry disclosures, typical commissions run 6%-8% of the amount you deposit into your annuity. Certified Financial Planner® Lou Melone, the managing partner of the Registered Investment Advisory firm Budd-Melone, LLC, recently reported at a Michigan Association of CPAs conference that it is estimated that approximately 80% of so-called “investment advisors” in the financial services industry are just salespersons peddling products.
Industry disclosures indicate that annuity companies are charging their annuity customers up to 4% annually for the management of the annuities. This is 4 to 8 times the ½%-1% that the average mutual fund charges annually. These fees can really hit you where it hurts, your wallet. According to Ken Fischer in Annuity Insights, if you invested $100,000 in 1997 in a 70/30 blended investment comprised of 70% MSCI World Index/30% Merrill US Treasury Index, your nest egg in 2014 would be $299,000. However, with that same investment in an annuity with a typical annual fee structure of 3.95% over that same period, your nest egg would be about half, or only $152,000. The annuity issuing company and annuity peddler get the other half.
With a deferred or variable annuity, you cannot get your money back for a certain period of time, unless you pay a surrender charge penalty.
When you buy a deferred or variable annuity, you agree to keep the money with the annuity issuing company for a minimum period of time, which I have seen as long as 20 years. If you take your money out of the annuity before that time period is up, you pay a surrender charge penalty, which I have seen as high as 50%.The annuity companies are counting on a certain percentage of their 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 huge pay day from the surrender charge penalties.
Do not count on any annuity “guarantees” because the annuity company can change your annuity without you knowing it.
Annuity peddlers will often parrot the annuity marketing materials that advertise the “guarantee” of a certain percentage annual return, or the “guarantee” that you will get the return of your principal, or the “guarantee” that you only participate in the market increases and not the market downturns. Do not believe any of these “guarantees;” they may happen or they might not. For example, I have seen one annuity company change the “guaranteed return” on an annuity from 3% to 1½% in year two of an eleven year surrender charge penalty period because the prospectus allowed it to do so.
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?”
Annuity companies these days are putting provisions in the annuity contracts to allow the annuity company to unilaterally change the terms of the annuity contract by changing the prospectus. I call these weasel clauses, since they allow the annuity companies to weasel out of their financial obligations. I recently contacted an annuity company that was not following the terms of an annuity contract issued in 1999. I was told that they did not have to follow the annuity contract because of a provision of the prospectus. I reviewed the 118 page online prospectus and discovered that it was dated within the last year. When I asked to see the 1999 prospectus, I was told it did not exist. The company regularly changed and “updated” its prospectus each year with a Securities and Exchange Commission filing. Only the most recently filed prospectus controls.
Deferred and variable annuities are not “investments,” but 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 earned until you pull the money out. The income tax on the earnings is deferred so long as the money is kept in the annuity. With some annuities, you can direct how the funds are invested, and in others, the annuity company decides. However, in any event, your annuity “investment” is never diversified. Regardless of where the annuity funds are invested, your annuity contract is still only with one single company. All of your eggs are in one single basket.
IRA annuities, which are also called “qualified annuities”, are a type of annuity that is often subject to abuse by the annuity peddlers. IRAs, by definition, are tax deferral vehicles. For traditional IRAs, you put pre-tax money in the IRA and pay tax on the funds and their earnings when you take them out of the IRA. For Roth IRAs, you put in post-tax dollars and it all comes out tax-free, including the earnings. Why would you ever want pay an annuity company 4% per year to hold tax deferred money in a second tax deferral wrapper? I have yet to hear any justifiable reason to ever put any IRA money in any annuity, other than to make money for the annuity peddler and the annuity company.
And as Paul Harvey used to say, “And now you know the rest of the story.”
By Matthew M. Wallace, CPA, JD
Published edited July 15, 2018 in The Times Herald newspaper Port Huron, Michigan as: You’re making the annuity company rich