Annuity IQ

The Motley Fool published an article today called ‘3 Reasons to Buy a variable annuity’. I guess the author was trying to be cute and witty, he wasn’t, and laid out a poor argument against variable annuities and, instead, recommended individual stocks.

It is no secret that I hate the Motley Fool, I think they are, more or less, the jackasses of financial reporters. I still remember their high flying recommendations they made on Oprah in the late 90’s. They said to the audience that they should buy what they like because it would be a good investment, of course, they were dressed in their stupid fool outfits. After the market melt down they again returned to Oprah, but this time there were no fun and games. Oprah ripped into them and it was fairly amusing, I guess they learned nothing from their past embarrassments.

Now, I do not like to use this word or maybe I am in a combative mood today, but this guy, John Roesevear, is an idiot. In his poorly crafted article he said there are 3 reasons to buy a variable annuity, I guess he can’t count because his third reason was really 5 additional reasons to buy a variable annuity.

Here are John’s ‘3’ reasons to buy a variable annuity:

Your broker’s Ferrari is getting a little long in the tooth, and you want to make sure he can afford a shiny new one.

Really John, is that the best you have? Do you think this is funny? How about your bosses Ferrari that they earned by falsely giving people the idea that investing is simple? How about you all apologize for your crappy recommendations of buying Janus funds and tech stocks back in 98-99? Yeah, I thought not.

Not only is that statement insulting it is totally untrue. In all of my experience I have never seen an advisor drive a Ferrari to work, ever. A variable annuity is no different than buying mutual funds or managed money, they may cost a few basis points more, but they guarantee more and provide tax deferral.

The difference between a variable annuity, mutual funds or managed money is the variable annuity has the option, not a requirement, to collect all the commissions upfront. Mutual funds and managed money may pay upfront but they also provide trail commissions over the long term. At the end of the day all loaded funds, managed money and variable annuities pay about the same over a 7 year period.

You’re not eligible to invest in a hedge fund, but you still want the cocktail-party cachet of paying outrageously high fees for mediocre investment performance.

Apparently John looks at averages and not investment strategy. If you average all mutual funds together, including your prized Vanguard funds, they are ALL mediocre in performance. If you look at specific investment strategies on the other hand you may see stellar performance. I am sure that hedge fund investors and managers take offence to your idiotic comments as well. If it weren’t for hedge funds Sears and Kmart would not have merged and the stock would not be anywhere near the $190 mark it is currently at. I can point out several other examples, but the hedge fund guys need no help from me to defend themselves.

Here is where John cannot count:

You’ve maxed out your 401(k) and IRA contributions, are still 15 to 20 years from retirement, are in a high tax bracket now but expect to be in a lower one when you retire, want a product that will provide you with a “guaranteed” minimum income, and don’t want to spend much time on investment research.

John, each comma represents a separate thought and, in this case, a different reason. Man, I thought I did poorly in English, but at least I have an excuse, I am dyslexic. I especially like the quotes around the word guaranteed, I guess he is asserting that that is bogus. Let me run through each of these 5, not 1 John, but 5, points he makes in this final reason.

He is correct on the maxing out of your 401 (k) plan, but that is no secret, everyone says that. What disturbs me the most, is that everyone of these drive by advisors always say that before you invest in an annuity max out your retirement plan, but they very rarely make that point when talking about mutual fund investing.

If you are 15 to 20 years away from retiring then a variable annuity may make sense, so can a host of other investment options. What John clearly does not get is the fact that the variable annuity can provide living benefits that can generate income without annuitization. John does not understand that retirees are seeking a growth and income plan, not an accumulation plan alone.

A variable annuity fits a growth and income plan with living benefits and are, therefore, suitable for retirees as well. Yet, the Fool continues to push accumulation stocks instead of income producing products.

If you are in a high tax bracket now and expect your taxes to go lower, which happens to most retirees, a variable annuity definitely makes sense. What John does not understand is the taxation of mutual fund distributions and how they affect your taxes. Unless you are in the lower tax brackets, 20% or less, then a variable annuity does make sense, again I will talk about taxation at a later date.

People are buying variable annuities with a guarantee living benefit, why the hell do you think sales have taken off so much over the last 7 years, John? 80% or more of all new annuity business has a living benefit rider on their contract. What bothers me about his reason is the quotes around the term guaranteed. John, these are contractual guarantees not made up guarantees.

As a matter of fact, variable annuities are the only equity based product that can use the term guaranteed. I think that statement speaks volumes, don’t you? I mean how many mutual funds do you see saying they can guarantee you anything? Yeah, that’s what I thought John, none.

His last point about not wanting to do investment research, this proves he’s a complete idiot. Most sub-accounts are researched by consumers, brokers and, of course, the insurance company. As a variable annuity comparison site I get questions all the time about sub-accounts and living benefits. Clearly John has no idea what investors are thinking or feeling at this stage of the game. Way to know your audience John.

John also claims that there are loads to some of the sub-account investments in variable annuities. In 14 years I have never seen a load inside of a variable annuity contract. I would like to see what product he is talking about. I guess I am not surprised that a financial writer has not taken the time to learn about these products. Instead they pick out what other writers criticize and stick with that, they like to spread ignorance.

Here is how John wraps up his article:

If you do decide an annuity is for you, consider letting your broker find another way to finance that Ferrari — there are lower-cost varieties available directly from leading fund companies such as Vanguard and Fidelity. But for most investors, buying a portfolio of solid long-term performers like Nokia (NYSE: NOK) or Starbucks (Nasdaq: SBUX) — or even just a simple index fund — will yield much better results in the long run.

OK, again with the Ferrari comment, get over it, John. Maybe the editors at the Fool should consider cutting your salary because you are just not funny enough. As far as your low cost solutions, they stink. No-load variable annuities have few sub-accounts to choose from, they have weak death benefits and they offer no living benefits (which negates one of your reasons for buying a variable annuity, duh).

Instead you recommend individual stocks? Is that your way of reducing risk? Wow, good advice John. To make the statement; “Will yield you much better results in the long run” is an irresponsible statement. John, do you know what stocks are going to do over the long run? Do you know for a fact that those stocks will be strong performers or that they do not have accounting or fraud issues? Do you really think people will continue to pay $4 for a cup of coffee? You don’t know, but you make the assumption that you do know.

What I do know is that taking income at the wrong time from a portfolio is retirement suicide. I do know a variable annuity can help solve that problem. I do know that variable annuities offer guarantees far superior than any other product. I do know you have absolutely no clue about what you are talking about and are out of touch with the individual investor. I do know that people who read this and say, ‘wow, he must be right’ are actually being misled by you. I do know this officially solidifies The Motley Fool as foolish.

OK, so you may have read my last post about 1035 exchanges and the article from Malcolm Berko, well, there is aftermath from this article. I just hung up with a family member, you may not know this but my entire family are all financial advisors, and she had a client who read this article and wants to follow its poor advice.

There is a history with this client, it was inherited from an unscrupulous broker, and the client felt cheated, even though the existing product fits well for her needs. I could not believe this clown, Berko, who usually gives good advice from what I have read, has given the green light for people to churn their book of business. Not to mention given investors really, really, bad advice.

In this case the client owns a Hartford L share variable annuity, it is expensive but, it is a solid annuity, and has the 7% GMWB attached to it. The client is maxing out the 7% and it is out of surrender, but it the cash value is less than the initial principal amount. The client invested $208,000 and it is now worth $196,000, she has withdrawn $60,000 or so from the contract already, so if she switched contracts she would have to take the bonus to make up the difference and to keep her income the same.

The problem is this, it is a zero gain for the client to do this. She is paying a little less than 3% a year for her current annuity, with no surrender penalties, but switching to a new bonus contract equals no gain for her. She would be going into a 9 year contract with a base M&E cost of 1.55% and would have to pay another .50% for the same benefit she has now. The average fund expense is about 1% or a little more.

When you add up all the costs the new contract is toping 3.05% and 3.25% with a death benefit. Not to mention the income will still be less than what she is getting now, even with the same exact benefit. That is crazy considering she is paying less than 3% now in the existing Hartford contract with no surrender schedule left.

Even though my family member would make a nice commission on the sale she is hesitant to allow the customer to make this move. Being an ethical advisor she asked for my opinion and told her the client should not do this, she already knew this but, she wanted to get a second opinion.

Bad advice is just bad advice and I have no idea why Mr. Berko wrote that article, but you should be very leery of following what he has written. I am afraid he has given this industry another black eye and opened a whole new can of worms for advisors and compliance personnel.

If you exchange a contract you better have a very good reason for doing so. The argument Mr. Berko laid out is just not good enough.

You would think I would be happy to see a positive article about exchanging one annuity for another, but guess again. When it comes to any 1035 exchange people should carefully weigh ALL of their options.

In this particular article an advisor, who is nationally syndicated and usually offers decent advice, suggested that a reader exchanges their variable annuity for another one. The issue the client has is they are afraid the market will have a down turn and their positive gains will be erased. Instead of recommending aspirin for the client’s headache the writer recommended cutting off their head.

The problem I have with this article is that the client is still in a surrender period and this writer suggested that the client switch into a bonus contract. Unfortunately, I see this tactic used way too often and sometimes it makes complete sense, but usually it does not.

Here is why it does not make sense in this case. The client is older, in their 70’s, and the contract has a 6% surrender penalty. The starting principal was $81,000 and the current value is $142,000.

In order to exchange the contract the investor would have to pay the 6% penalty on their initial investment of $81,000, this would cost them $4,860 in fees. In the article the advisor did acknowledge the fee, but he said it could be offset by a 5% variable bonus annuity contract. Which is true, but when he calculated the bonus amount he used the gross number of $142,000.

The reality is the bonus would only be paid on $137,140 or the net amount that makes it to the new carrier and not on the $142,000 as he suggested. The new bonus annuity contract would also start a new surrender period and have a higher cost than a traditional variable annuity. He recommended this so the client could step-up their living benefit to the current market value.

What the client should explore before they make this drastic maneuver is to see it the existing insurance carrier would allow them to upgrade their living benefit. Many carriers will let existing policy holders upgrade their older living benefit to a newer one. The difference is the client would not pay the surrender penalty and the broker will not collect a new commission.

As you already know, I am not anti-broker in anyway shape or form. What I do not like to see is bad advice geared to pay the broker and have little positive impact on the consumer. There are 100 good ethical reasons to exchange one variable annuity to another, but it is the one or two bad reasons which perpetuate the industries tarnish reputation. This is one of those examples of bad advice that could lead to problems for the agent down the road.

Think about this, if the new contract blows up for some reason and the client seeks the advice of an attorney it will not end well for the advisor. The attorney would ask why you recommended that the client pay a 6% surrender penalty to move to a new contract.

They would also investigate whether or not the newer benefit could have been added to the older contract, which would have saved the client thousands of dollars. In other words, the advisor will probably have to write some pretty big checks if this situation turned bad.

It is this type of situation that will continue to tarnish the annuity industry. If the client is worried about losing money or market volatility they should either see if the benefit can be upgraded or move the money into the guaranteed fixed account until they feel comfortable with equity investing again.

If you keep your business clean you will reap the rewards. This may not happen overnight, but it will happen over the long term. All of the big producing brokers I know have all been around for a long time and are very ethical. They attribute their success to always trying to do the right thing for their clients.

annuities work and are great investments, but by using a questionable sales practices, or by giving out questionable advice like this writer did, will only continue to hurt the industry. If we all work to always do the right thing for our clients we will see regulations decrease instead of increasing to an unreasonable level.

In a recent Investmentnews.com article there was a debate about annuities in 401 (k) plans, specifically adding immediate annuities to these plans. While I generally agree that adding an income annuity to a retirement plan may not be a bad idea I do disagree with the idea that variable annuities are a bad retirement plan vehicle.

Immediate annuities are fine investments with a specific goal, they generate income. What they do not do is generate increasing income over the long term, generally speaking of course. The primary motivation and appeal to immediate annuities is the simple fact that it will generate income for as long as you live, a good thing. The problem is what about inflation?

Immediate annuities stink against hedging for inflation even though there are some immediate annuities that do provide cost of living increases every year. The inflation hedge that you can opt-in for with these contracts means smaller income now for larger income later.

Using a variable annuity on the other hand, even with higher fees, with a living benefit inside a 401 (k) plan is essentially the same thing and, in fact, more effective. Contrary to popular belief using the variable annuity gives the participant the option of investing how they choose, either aggressively or more conservative, at the same time the participant will not have to worry about market losses. This would allow for a hedge against inflation while providing lifetime income for the participant.

We all know what happened a few years ago with the market decline so wouldn’t it make sense to use a product that could lock in your gains to provide you with future income? Wouldn’t this reduce the plan sponsors fiduciary responsibility? I think so.

Here is why, during the market correction employees started suing their employers for breach of fiduciary responsibility because their 401 (k) plans lost money and they did not have adequate investment options, safer investment options. This is, of course, after employees sued their employers for not offering low cost investment options in the late 1990’s.

Now, if the employer used a variable annuity with a living benefit, that locked in gains for either lifetime income guarantees or return of principal, and protected the employee from market down turns there would be little complaining by the plan participants. If this happened all of those ‘paper’ gains from the 1990’s would have been saved. Those gains would have reset the guarantees of the 401 (k) and the employee could rest assured that their future income would still reflect those massive gains. The employer would then have fulfilled their fiduciary responsibility and there would be little or no litigation.

Instead, variable annuity critics, say no way the extra cost is not worth it and scare participants and employers from offering such plans. What the critics do not grasp is how these benefits work and why they make sense in retirement plans. All the critics can see is an extra fee paid and the imaginary ‘double tax deferral’, which is just a plain stupid argument to begin with, and not the vast advantages of the variable annuity.

What the critics do not understand is that many people will not invest in their 401 (k) plan, or invest too conservatively, because they do not like the stock market. They do not understand that some people will only invest in money market accounts inside of their retirement plans. This is because many participants fear risk and because of this fear the participants are contributing to the amount of people not saving enough for retirement.

A variable annuity with a living benefit inside of a 401 (k) plan can help eliminate that fear. If the investor realizes that they could invest without the worry of market losses they would take advantage of the retirement plan. Yet, the critics think they are doing everyone a service by trying to save them money, and they are to a certain extent, but at the same time the pennies they may be helping people save could cost the participant thousands in market losses.

I think if there were more low cost variable annuity plans available the critics would be more accepting of these plans. If you had a product that could lock in gains for future income and a death benefit guarantee for the participant’s heirs for a reasonable cost what would there be to complain about.

In my opinion using a variable annuity instead of an immediate annuity makes much more sense. You have a hedge against inflation and you have downside protection while at the same time you will have guaranteed future income.

There was a recent article posted on thestreet.com talking about four alternatives to variable annuities. What the author failed to mention was there is no true alternative to a variable annuity and the suggestions made have totally different objectives and purposes than what a variable annuity can provide.

Basically, the author said to look at fixed annuities, equity index annuities, immediate annuities and variable life insurance. Each one of the previous listed annuity products are different from variable annuities and are not relevant to why people actually buy a variable annuity.

Many of you reading this post already know the differences between the afore mentioned products, but lets rehash them anyhow.

A fixed annuity is a product that guarantees your principal and will pay you either a level or variable interest rate. This product is totally different than a variable annuity which invests your money into sub-accounts that fluctuate with the market. The only things these two products have in common is the fact that they are issued by insurance companies, they both use the term ‘Annuity’ in their name and they can both be annuitized.

Equity index annuities are not an alternative to variable annuities. An equity index annuities return is tied to the market or to a market index, but typically an equity index annuity will give you a return similar to a fixed Annuity over the long term. This is true because of participation rates, caps, averaging, spreads or combination of these gems that they offer.

An immediate annuity is an income producing product that will guarantee you payments for a certain period or for the rest of your life. Typically, an immediate Annuity does not offer any upside potential and your payments are locked in for the term you chose when you purchased the product. How in the world this product could be compared to a variable annuity is beyond me.

Variable life insurance is not even an annuity product, just look at the name ‘variable LIFE INSURANCE’. The only thing variable life has in common with annuities, of any kind, is the fact that they are issued by an insurance company. This is a life insurance product that does allow you to invest in sub-accounts, but this product is not really a good investment alternative.

Variable life insurance has an annual renewable term insurance component to it. This means as you get older the cost for that insurance goes up, typically. Because of the rising cost of insurance many people say that the only way a VUL really makes sense is if you over fund it. This type of insurance does have its place, but not as a replacement for a variable annuity.

When I took my life insurance license class, 13 years ago, the one statement stood out above all was when my instructor said, “Life insurance is a horrible investment”. After 14 years in the business I have to agree with his statement. Life insurance is life insurance and not a smart way to save for retirement, unless it is part of a bigger financial plan.

The bottom line is this, a variable annuity offers investors the best of all worlds. If you want a principle guarantee you have it through some type of living benefit. If you want to hedge your investments, you can with the use of a living benefit and a guaranteed fixed account (which, usually, do not carry any fees).

If you want to make sure your heirs have money left when you pass on, a variable annuity has several death benefit options to choose from. Even though the death benefit may be taxable and there is no step-up in cost basis it will still accomplish your goals and leave a legacy for your heirs.

To say that there are alternatives to a variable annuity is correct, but the four alternatives laid out in this article are not correct. People have to face the facts and the facts are variable annuities offer investors protection, diversification and relative simplicity under one umbrella. The variable annuity accomplishes this at a relatively low cost, something only a few of the ‘alternatives’ offer.

Do not get me wrong, I think the article was fairly well written and positive for insurance products. The issue I had with it is that there are not any real alternatives for a variable annuity. There are similar investments that can be made outside of the insurance world, but none of these other products offer the security or options that a variable annuity can provide.

Related Link: term insurance