I have RSS feeds from all the main news sources that pick up on any annuity story, so I see most, if not all stories written about annuities. This allows me to do my part and try to correct mistakes the authors make, which are usually vast, and it allows me to comment to you on the stories as well. What upsets me the most is when I see stories that keep getting reprinted when they are old and out dated.
This is the case in this post. There was a story on annuities published on the Motley Fool yesterday dated February 6th 2007. The problem is the story is at least 4 years old, perhaps even older, and 90% of the information is outdated and incorrect. I have already commented on this story in the recent past, but I feel the need to comment again because the story is so outdated it is a bit incredulous and they keep reprinting it.
The name of the story is variable annuities: The Lowdown and you can find it by going to Yahoo news and search the term annuity or variable annuity. The story starts out in the usual way, bashing financial advisors who sell annuities.
Here is the opening line: “Insurance salesmen often push variable annuities — mutual fund-like instruments (which generate hefty commissions) upon investors.”
Now, I can easily defeat the commission argument of their statement and will do so in a very near future post. For now I will address why this story should not have been published and how they are negligent in the information they are distributing. If any advisor gave out this blatantly wrong information they would lose their license.
The first thing that comes up is fees and they frame their argument this way: “variable annuity fees can be steep. They’ll typically scarf up more than 2% of your holdings each year, according to Morningstar. That’s negative growth.”
All investments carry fees and all fees are negative growth. Why frame the variable annuity fees this way and let mutual funds, even no-load funds, get away Scott free on their internal charges?
There is no reason other than their biased behavior against these products. Essentially, they believe no one should ever buy an annuity. Any advisor or publication that tells you never to buy one single product or investment is a publication you should steer away from.
The reason I say this is because the publication or advisor either does not understand the product or investment, which is the case with 99% of the anti-annuity crowd, or they are not giving you the full spectrum of products available. In either case it is not unbalanced advice it is the equivalent of pushing there own belief system onto you.
Next, and this shows the date of this article, which I remind you is dated February 6th 2007, is they use the tax argument. The argument is why defer taxes and pay ordinary income on distributions from the annuity versus long term capital gains tax of mutual funds.
Here is what they said: “Earnings grow tax-deferred in a variable annuity, but when the tax is ultimately paid, it’s at your normal rate, which can reach nearly 40%. Compare that with the long-term capital gains rate of just 20%. Even if your tax bracket isn’t very high, if you choose to withdraw most of your annuity funds at one time, that will likely kick you into a higher bracket.”
Here are a couple of points I want to make loud and clear. 1. The top tax rate is 35% not 40% (this is clearly a pre-2003 article republished) and taxes are graduated, which means that not all of your income is taxed at the top rate. 2. The top long term capital gains tax rate is 15% (again, proof this is a pre-2003 article) not 20%.
They also fail to point out that mutual funds tend to spin off more short term capital gains, which are taxed at ordinary income, than long term capital gains. They fail to tell you that the annual distributions from mutual funds can put you in a higher tax bracket and you may be subject to AMT, alternative minimum tax, on top of it. Considering most individuals are in a higher tax bracket when they are working and a lower tax bracket when they are retired this entire statement is plain dumb.
This next quote is a gem. Here is what the, living up to their names, ‘Fools’ say: “It often takes at least 15 years before the performance of your variable annuity will match the after-tax returns of investments in a taxable account. You’ll be tying up your money for a long time.”
They make a blanket statement like this and back it up with zero facts. Here are some facts for the ‘Fools’. A study conducted in 1999 by Arnott and Jeffery and confirmed by Arthur Levitt , former SEC Chairman, concluded that the average mutual fund investor looses between 2.5% to 5% of their total return due to taxes they have to pay on the distributions the investor receives.
Whatever ‘study’ they used to come up with 15 years to break even must be using gross numbers, not net after tax numbers. Plus, they never state where they come up with 15 years anyhow, so until they disclose the study that shows it takes 15 years to break even I consider this argument invalid and incomplete.
The ‘Fools’ went on to write this: “The “death benefit” that will pay your beneficiaries at least as much as you put in to the annuity is often a selling point. But it frequently costs more than it’s worth. Long-term investments in good stocks are likely to increase, not just maintain, their value.” They also bring up the stepped-up cost basis on stocks and mutual funds, but it is covered by the following statement.
Umm, no one is selling or buying a variable annuity because of a death benefit. They are buying or selling annuities because of the living benefits they offer. No soup for you!
They say this next…this is good: “As with instruments such as IRAs, if you withdraw funds before age 59 1/2, you’ll be charged a 10% penalty. Better be sure you won’t need that money soon.”
No way! An annuity is a long term investment? I guess mutual funds are not. 95% of all investments bought or sold in this country are for the long term investor. While the 10% penalty is a very valid point, it makes little sense as I just stated that most investments are long term. Plus, they never mention that you can get money out without the 10% early withdrawal penalty using a 72Q calculation, but hey, never let the facts get in the way of a good story.
I am not surprised by their final bullet point. Here is what they said: “variable annuities offer the option of annual payments. But, you could achieve annual income effectively in other ways, such as by selling off small portions of stock holdings each year or investing in other income-producing securities.”
Anyone who has done a study or a hypothetical illustration of systematic withdrawals from equity portfolios knows it is not always as simple as they are saying it is. They totally ignore the living benefit income guarantees in their final statement. I guess I am not surprised considering the article is at least 4 years old and living benefits where really just beginning to come to the marketplace.
I wrote the ‘Fools’ and told them to stop reprinting old and out dated information, I doubt I will hear back from them. To give out wrong information on current tax rates is almost criminal or at the very least blows their credibility right out of the water. If an advisor gave out wrong information even wrong simple information like the current long term tax rates and they gave out the wrong information, like the ‘Fools’ did, they would be in serious trouble.
I do not know who read their material and why, but clearly people should go elsewhere for their information, especially concerning annuities. I do not care if you dislike annuities, as I have always stated, but if you are going to write a negative article about them please use the right information. Do not run a story that is old and try to pawn it off as something new otherwise you will look foolish.
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