Annuity IQ

If you have not picked up John Huggard’s Book, “Fifty Reasons why variable annuities may be better Long-Term Investments than Mutual Funds” you should grab your copy today.

You can get your copy here: John Huggard This is not an affiliate program and this has nothing to do with Annuity IQ. I just believe so strongly in the information that I believe every adviser should read this material.

Here is the link again: http://www.atlasbooks.com/marktplc/00694.htm

If you do not know who John Huggard is here is his bio:

John Huggard is the senior member in the Raleigh law firm of Huggard, Obiol and Blake, P.L.L.C., limiting his practice to estate planning and financial litigation. John is also a Certified Financial Planner and full-time faculty member at North Carolina State University where he has taught introductory and advanced courses in law and personal finance for more than twenty-five years. John is an Alumni Distinguished Professor and is a member of the Academy of Outstanding Teachers at North Carolina State University. John is a Board Certified Specialist in Estate Planning and Probate Law. He is the author of The Administration of Decedents’ Estates in North Carolina (Michie Pub. Co.), The North Carolina Estate Settlement Practice Guide (West Pub. Co.), and Living Trust, Living Hell: Why You Should Avoid Living Trusts (Kendall-Hunt). Additionally, John has published several magazine articles on legal and financial matters. John has been extensively interviewed and quoted in The Wall Street Journal, Smart Money, USA Today and other financial publications. John regularly lectures to professional groups on topics dealing with variable annuities, taxation and finance. John received his undergraduate degree and law degree from the University of North Carolina at Chapel Hill and his master’s degree from Duke University. John’s hobbies include flying, competitive target shooting and scuba diving. He is recently retired from the U.S. Navy where he served as a captain in the JAG Corps.

Money Magazine and Mr. Updegrave have written another mind numbing article where he made a startling revelation to his readers. Whether or not they saw the revelation is another story, but it is right there in print.

In this article Mr. Updegrave said, “For example, I’m fine at tinkering with retirement calculators and monitoring investments - though I’m careful to keep my wife informed. She’s good at the big-picture stuff.”

The part of the quote I want to comment on is the, “She’s good at the big-picture stuff” because this is his overall problem. He is fine with ‘tinkering’ with calculators, but is poor with the big picture stuff, both of these admissions run dangerously close to self admitted lack of knowledge and imagination.

As an expert shouldn’t you do more than just ‘tinker’ with things and shouldn’t you have a grasp of ‘the big picture’? You would think so, but apparently this stuff does not matter to him. Financial advisers do more than just ‘tinker’ with calculators and peoples financial well being and try to match the investment selections for their clients to their goals, risks and objectives while keeping ‘the big picture’ in mind.

Since Mr. Updegrave does not get ‘the big picture’ and only likes to ‘tinker’ with peoples financial well being it should be a red flag to his readers. Those words, as subtle as they were, in my opinion, were an admission of the truth. He simply does not understand the common problems of investors and likes to ‘tinker’ with the advice he gives and he does not worry about ‘the big picture’.

Tinkering with people’s money and investments is horrible and an insult to people who take him seriously. Do you see doctors tinkering with people’s health? Of course not, but I guess it is OK to tinker with peoples financial health. You can not do a financial plan on a calculator because there is more to it than simple calculations.

I believe this is why his advice is so generic and cold, it is simple repetition and it always goes like this; “Invest in the S&P 500 index fund and forget other advisers advice”. When I read those recommendations all that flashes through my head is HAL, from 2001: The Space Odyssey, saying those words in his cold computer voice…am I giving away my age here?

Since he admittedly does not grasp the big picture and only likes to tinker around with calculators it is painfully obvious why he does not like variable annuities. You need independent thought to understand the product and how it works and where it fits into the big picture of retirement security.

How many times have we heard that variable annuity tax deferral is worse than capital gains on taxable accounts, but is it really? I have seen tons of mathematical examples of how the capital gains tax rate is superior to tax deferral, but very rarely, if ever, do you see a real example.

I wanted to show a very straight forward illustration on how tax deferral is better than taxable accounts. I ran 2 hypothetical illustrations using American Funds Investment Company of America one with taxes and the other tax deferred, but I did include a 1.5% M&E cost along with the fee of the mutual fund.

In a nutshell, the tax deferred account won, even with higher fees.

Here is the scenario $100,000 investment made into ICA by a couple who earn $100,000 a year in income. Their Federal tax rate is 25%, long term capital gains are at 15% and their state taxes, which most people forget about, are 5%. I did show that the taxes were paid from the distributions, after all how can you show a true after tax return if it was shown any other way. Taxes are due no matter if distributions are reinvested or taken as cash and even if you pay taxes out of pocket that is money you could have been reinvesting and it still reduces your rate of return.

In the variable annuity example I simply used the 1.5% M&E fee with the fund expenses.

Here are the results: (click on the image to enlarge)

Clearly the variable annuity performed better, contrary to popular belief.

You look and you decide.

Jefferson National is hitting the street hard with their Monument Advisor flat fee variable annuity product. They have issued a challenge to compare their flat fee variable annuity to other variable Annuity contracts, boldly stating that they are cheaper than 99% to 100% of the contracts currently available.

With their flat fee at $20 per month it would seem they are correct, but deeper analysis would prove otherwise. Here is where they get you:

“Jefferson National’s Monument advisor has a $20 flat insurance fee on more than 97% of our underlying funds. Certain funds also have a transaction fee ranging from $19.99 to $49.99 per transaction, depending on the number of transactions per year. See the prospectus for details. Like other variable annuities, the customer pays fees of the underlying funds selected (currently ranging from 0.23% - 2.72%; except for Rydex VT Inverse Gov’t Long Bond Fund which is currently 5.12%) plus the fees of any advisor hired. The range of underlying fund fees reflect the minimum and maximum charges after contractual waivers that have been committed to through at least May 1, 2008.”

The added expense of transaction fees, between $20 and $50 dollars (with a maximum cost of $74.99 per transaction), those costs can add up very quickly for the consumer. The other interesting thing is their average fund expense is high, between .23% and 2.72% with one fund at 5.12%.

One really has to consider where the company is making their money from. No company could turn a profit on only charging $20 a month and not be catching a piece of the fund action on the side. That would explain why their fund charges seem higher than normal, industry average for sub-account expenses is slightly over 1%.

Let’s take the challenge, shall we. A $50,000 investment made in a traditional variable annuity with total expenses equaling 2.8% a year, the consumer will pay $1,400 in total expenses. This provides you with a living benefit, death benefit, includes fund expenses and covers the cost of commission paid to the advisor.

Let’s look at Monument Advisors contract with $50,000 invested. You will pay; $240 a year in ‘subscription fees’, 1.30% (an average cost) in fund expenses we assume no transaction fees, although some would apply. You will pay $890, plus any applicable transaction fees, in the first year. A whopping savings of $510! This, of course, will not cover the cost of your additional expenses if you bought this product from an adviser.

If you buy this product from an adviser they will charge you an annual percentage of the assets. In my experience the smaller the account the higher the fee is. On $50,000 I will assume only 1.5%, but usually an adviser will charge 2% on an account that size. Now, we have to add that fee to the already mentioned costs above. $890 + $750 (the cost of the adviser’s fee) = $1,640. That is $240 above the broker sold annuity, not including any transaction fees.

For all that cost what are you getting? Nothing. The death benefit is contract value, which could be at zero upon death, and there are no income guarantees at all. Market timing is not really allowed in most of the portfolios, many have 30 day or more hold periods, so that is not a good reason to buy it.

If you want tax deferral only there is no question that this is the best product available, if you buy it direct. If you want advice or guarantees then look at a traditional variable annuity, it makes much more sense for the consumer.

It is all perception versus reality and this product is perceived to be the best or cheapest out there, but the savings are mostly perception. This is especially true if you are purchasing this contract through an adviser.

Also, credit ratings do matter and Jefferson National is still in the B’s with their credit rating, which makes me very uncomfortable. Even though the money is invested in separate accounts if the company stumbles and the state steps in they will still restrict your ability to access your money.

If you are seeking guarantees for yourself or your heirs then consider a traditional annuity product, it actually offers those protections. At the end of the day the costs will all even out unless you buy it direct without an adviser.

As for the ‘annuity Rescue Challenge’ there is no challenge and little need to rescue Annuity holders. Given the fact that they are advocating going direct with the carrier and not have you hire an adviser it makes me wonder what financial professional, in their right mind, would do business with a firm that wants to put them out of business?

I had canceled my Money Magazine subscription last month and today was contemplating why I canceled it. Then I got to the article that initiated my cancellation. It was titled; ‘All You Really Need to Know about Dumping an annuity’ by Denise Topolnicki. This has been an increasing popular title in many articles over the past couple of months.

What disturbed me the most about this article was it bundled both equity index annuities and variable annuities together. These are two completely separate investments and need to be identified as such. The variable annuity is a registered product which has standardized rules for sale and is governed by the NASD. A variable annuity product also offers sub-accounts to invest in which gives you significant upside potential along with certain guarantees through living benefits.

The equity index annuity is a guaranteed investment that performs as well as a traditional fixed Annuity and is regulated by the states. This product has a minimum guarantee, caps, spreads and in some cases averaging of the index if follows. Since you are not really investing in the index you choose in the product your upside is limited to the good will of the issuing carrier, based on their cap, spread or averaging method. Also, these products historically have high surrender schedules which can last up to 20 years in some cases, the average is about 10 years.

Since these two products are clearly different they should not be grouped together. Never the less, Money and many other publications make this mistake. Grouping equity index and a variable annuities in the same category is like saying a mutual fund and an individual bond are the same. The only thing they really have in common are that both are investments, but they have very different objectives.

The Money article I am referring to had provided 6 ways to ‘dump’ your annuity. It also references that annuities are ‘lousy’ investments, which is not accurate and was an uncalled for statement. Clearly they could have framed the article better and been more neutral on them, but I digress.

The 6 ways they list are also very well known in the industry as it takes advantages of basic contract structures. Here are the 6 ways they give:

Free look the contract, only if you purchased it recently.

If the annuity is unsuitable ask for your money back, but according to them all annuities are unsuitable. The likelihood of asking and getting your money back is also highly unlikely. They are essentially telling you to blackmail the adviser and the firm. In this case you would be threatening a lawsuit or legal action if you do not get your money back, I thought they disliked strong arm tactics?

Appeal to regulators for help, in other words file a complaint. If blackmailing the adviser and the firm does not work then file a complaint and destroy the adviser’s livelihood. While some adviser’s may deserve this because of questionable tactics, the vast majorities of adviser’s do not deserve this and are entitled the benefit of the doubt, especially if it is a biased source telling you what to do.

Look for loopholes in the contract allowing for 10% or more in free withdrawals from the annuity contract. That is not a loophole that is standard practice and has been for decades. I think that statement is a testament of their knowledge of these products.

Perform a 72 q calculation to get money out pre-59 ½ without the IRS penalty. This is a good idea, but it works just like a 72 t calculation and the payments have to be equal and substantial lasting for 5 years or 59 ½ whichever is longer. Since these are based on account value chances are the amount taken in withdrawals will be small and defeats the purpose of even recommending this option.

Swap out your annuity into a low cost alternative, but wait until the surrender schedule is up or reduced to a lower level. This is a viable option, but you may be giving up substantial benefits by just switching contracts. These benefits might be a higher guaranteed income base or a higher death benefit value as compared to the new contract. Switching an Annuity should be carefully considered and is not a decision that should be made because Money told you to do it. Considering Money says to watch out for switching annuities are they negating their own advice?

Those are the 6 ways they tell you to ‘dump’ your annuity, but they are not new ideas and do not look at the bigger picture. The reality is you or your adviser bought the Annuity for a reason and you should make sure that your objectives have changed before you make such a drastic move.

Also, given their lack of knowledge on the products it would behoove you to seek qualified investment advice before ever listening to a source geared to provide advice to the masses. Remember this is the same magazine that recommends the best mutual funds to own every month or so and they are never the same mutual funds.

annuities are complicated to a degree, but with the help of a qualified adviser you can get the right advice from someone who actually knows how the product works. Nothing, except experience, can replace a financial adviser. This article was the reason I finally canceled my Money Magazine subscription and, by the way, if you cancel your subscription they will offer you substantial savings if you give them another year. How about that as a money saving idea!