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All Tricks, No Treats: Annuity Abuses

Warning: what you are about to read is based on actual events. It is highly recommended you read in a well-lit room and preferably not alone. 

Sometimes our biggest fears we never see coming.  They are seemingly innocuous: clowns, little dogs, hummus; you name it.   Add annuity/insurance salespersons to the list. Oh, they are usually quite friendly, outgoing and likeable.  Dressed in an unassuming, Macy’s sort of way – crisp, clean but unremarkable. They have mastered the art of chit-chat & small talk.   They thrive on the unannounced, pop-in visit, be it home or office – by law, they are not allowed to call & solicit. Or, even more crafty, you receive an embossed invitation to a local restaurant for a swanky meal.    You don’t see it coming.

Annuity Al (or Ann) - we’ll call ‘em AA; as they will drive you to drink heavily - will immediately disarm you with pleasantries about your family, acquaintances or a common fondness (disdain) of President Trump.  The adept, circle around to your family’s financials is where the real pros pan for gold. They coo such soothing terms like safety, simple, protected, secure, guarantee, commission & tax free.  Doesn’t that sound great?  Yes answers are always preferable.

Next up is a little financial profiling but without you really realizing it. It’s like AA has cast a spell over you.  In this hypnotic trance, you freely share your personal financials, family information & long-term goals. No documentation is required, just a ‘yes’ to shrewdly worded questions – nothing too invasive.  AA will run some projections & be in touch. ‘Say hi to Michelle’…  

In seemingly no time, AA gets the spreadsheet of projections back to you. All nicely packaged with your name in ornate, bold letters.  What are all those huge numbers? My menial investment will turn into that? I can be a timeshare owner within 3 years!  This is guaranteed right? AA clears his throat in a yes sounding rumble.  Sign me up. Anyone with khaki pleats that snappy has to be trustworthy. You don’t see it coming.  

A week later you receive what you think is a King James Bible in the mail.  Nope, just the annuity contract. Might as well be written in Latin but you thumb through it as a show of good faith, due diligence.  You think you saw disclaimers, risk, loss, taxes, charges, expenses and variable during the drive-by.  Just legalese stuff – AA has me covered.  Michelle gets the go-ahead for impractical, convertible sports car shopping.  

The year-end statement arrives!  This can’t be right – I’m down money.  And what’s this net surrender charge balance?  And what are these sub accounts? M & E expenses? Does that mean ME?    I’ll give AA a call – he’ll get this all straightened out, right?

AA’s tone has changed.  He says I have a 12-year surrender charge schedule.  If I withdraw any money, I will have a 15% penalty and other potential penalties & ordinary income taxes. He just assumed I was over age 59½?  I’m going to start using Michelle’s coloring shampoo. AA tells me to hang on – the market will come back. What?? I thought I had a guaranteed rate of return something north of my shoe size.  ‘No, those were just the projections,’ AA chimed. ‘In reality your account is subject to market fluctuations like any other equity investment. There is risk of loss.’ The car gets repo’d. You never saw it coming.

What’s my take-away from this harrowing tale?  Quite a few things:

  • Annuities and insurance products are complex.  This complexity is rarely communicated properly by the selling agents.  Likely, because they, themselves, aren’t suitably trained. The old adage: ‘Annuities aren’t bought, they are sold’, still rings true today.

  • Annuity Riders are attached benefits but can also attach confusion.  Ask for clarity and if they layer additional cost.

  • The tax advantages are usually vastly overstated.  We see these products sold within IRA’s which is akin to financial malpractice.  The tax & estate consequences can be mind boggling. If tax avoidance is a high priority, there are many other legal & far less expensive strategies.

  • Selling commissions (5-10%) are glossed over as non-existent.  This simply isn’t true. The surrender charge schedule, which the insurance company mandates, is their way of clawing back the commission they fronted to the selling agent if the consumer cancels the contract prematurely.

  • Mortality & Expense Fees (M & E) are usually around 1-2% annually depending on issuer. In addition to M & E costs, there are sub account fees in variable annuities which can levy another 1% or more annually.  All told, I’ve seen contract expenses north of 4%.

  • These products are very much in regulators’ cross hairs.  If you feel you have gripe and can’t resolve it with the insurance company, contact the National Association of Insurance Commissioners (NAIC).

This is not to say that all annuities are goblins and all agents are Boogie Men.  There are occasional, legitimate needs for them. Fidelity and T Rowe Price, for example, have rolled out relatively inexpensive, no-load products.  As for fixed annuities, they may fill a conservative portfolio niche to compliment social security. Consumers just need to proceed slowly, ask the right questions & have all documents reviewed before signing.  Hopefully, this little yarn will help you keep your guard up so next time you’ll see it coming. 

Fiscal Fitness is a publication of Houlihan Asset Management, LLC for the benefit of its clients and friends. Houlihan Asset Management. Wealth Counseling/Asset Management. Copyright 2019


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