Annuities…..A Call to Action
The annuity story is a powerful one. It speaks directly to our basic primal needs of safety first. After having met the safety requirements that our lizard brain so demands, the more advanced part of our brain has been educated to seek growth. This combination is what creates the spot where annuities thrive. The problem is that far too often, people are lead to drastically overpay for this promise of possible growth with certain safety. It’s just packaged in such a way that it is very difficult for the end investor to see what it is truly costing her. Although it far too often means leading people to an uncomfortable conclusion, I still find it very satisfying to first help them work through and understand the annuity waters to which they were led, and then to do the best with whatever it was they have bought (or are considering buying) prior to me working with them.
Not all annuities are problematic
First, a little background is in order. I use the term annuity here which really paints a large swath of products with too identical of brush strokes. I do not believe there is anything inherently evil with plain vanilla annuities. In fact, my opinion is that they have an important place in generating retirement income – even more so than most of my peers. Additionally, I think that role will continue as more and more people will be retiring without a traditional pension. A traditional annuity serves a function that no other product can: it perfectly matches and balances the risks of outliving your money and your money outliving you. Examples of annuities I am NOT referring to in this post are: a single premium income annuity, a low cost variable annuity in place for tax deferral only, and your straight forward fixed or equity indexed annuity products. Instead I am primarily referring to a) variable annuities that simply come with too many bells and whistles and b) most equity indexed annuities. These are the products that cause people to overpay in ways I have found that the average investor has difficulty in spotting. [Quick hack for you: What if you don’t know which annuity is in front of you? Simply ask me. Or ask an advisor that is only compensated for investment advice. For heaven’s sake, don’t ask a salesman].
Culprit #1
The first big scheme that cause investors to wind up overpaying for this promised land/holy grail of growth with safety is through misunderstood caps and allocation duties assigned to them within the product. Caps refer to the limits on the amount of earnings the investor can earn in any given period. Most investors easily grasp this concept and understand it as the fair exchange they are seeking in order to obtain protection. To date, every equity indexed annuity contract that I’ve read is issued with the warning that the company will cap interest each year and this cap is subject to change at the discretion of the insurance company. In the ones that I have read, you know what the cap is in year one, but then it is up to the insurance company to set in the future. And I’ve yet to meet someone who trusted an insurance company enough to be at their whims for future caps on the investor earnings. Yet they enter into this contract each time an annuity is bought.
As for the allocations, the investor will often be required to make a choice as to how the earnings inside of the annuity are earned. The dynamics of how many of the investment options work can be complicated and lead to disappointing results. The poster child of this for me is the monthly point to point. The reasons why are too lengthy for an article (feel free to call me 800 – 928 – 4001 if you do need to know more) but from the ones I have seen are set up so that it is virtually impossible for the investor to make much of a positive return. A general word of caution here is that many investors don’t even realize they have been assigned the duty to make allocations among the strategies offered to them through the product.
Culprit #2
The second big way people wind up overpaying for annuities is that they simply don’t understand what they own and in turn how to actually monetize the benefits to which they are entitled. In fact, I have yet to find a specific individual who brought an annuity they had already purchased that could actually correctly explain what it is they own. Not a single one!! All they remember is “Guaranteed 6%”. In their minds, they can leave the policy alone and be comfortable with their guaranteed return. The problem is that the road that leads to that 6% isn’t the same road that is taken by basic investments. Most often there needs to be some point where the product turns into an income stream in order to monetize these benefits.
In one case (true story) I spent hours reading a prospectus and product brochure but was still unable to determine just how the product worked. I have several securities licenses, a couple decades of industry experience yet it took some calls the issuing company to determine how the annuity actually worked. It frustrates me to imagine the investor who doesn’t have the luxury of being well versed in industry terminology and having experience that can help guide them towards their understanding of the product. In this specific case though, we were able to work together with the client and coach them on ways to get the most out of what they had already purchased. But this took considerable effort to understand and then to make the appropriate adjustments.
What now?
The product is not evil. The salesmen are not evil. In fact, I know a good one that uses them in the right ways that he believes in for his clients. It is more of a symptom of a system that is convoluted. Just think for a moment if you worked directly with a pharmaceutical rep instead of your doctor. You would be taking perceived advice from an inherently conflicted individual. There’s nothing wrong with the pharma rep at all, but you want to take advice from your doctor who is looking after your best interest. In this case, the annuity salesman is just that. He is the equivalent of the pharmaceutical rep that understands his product. He will most likely not have the knowledge of you like your doctor does to say whether or not you should actually take that product.
In practice, we rarely just kill off annuities that have already been purchased by clients before we were introduced. The surrender costs and foregone benefits associated with just pulling the plug are usually just too prohibitive. But the work that we get to put into making sure and rescue the client to get the most out of the situation they are in is very gratifying and worthy of having been the final part in this series of stories that drive me to work each day.
