Varialbe Annuity Issues

[Bjorn]

My practice is more of a "Go to guy for all things money" rather than a tax person. I hope this post is acceptable for the forum.

I'm looking for different points of view on the Variable Annuity.

In General Suze Orman hates them as does most TV Entertainerment / Financial People.
When I visit with clients I see a valid need for protection of retirement assets in many circumstances. If they can afford to keep all the risk themselves no need for the VA, just do mutual funds for the very wealthy.

Here are some of the things I like about them:
I know the worst case up front and can use the words "For Sure" and guarantee.
They allow my client to invest in the market with downside protection.
The client can have an income stream for life without annuitizing.

Down Sides
Insurance costs are much higher than mutual funds ~
Complicated products take more explanations so clients understand fees paid and risks transferred to the insurance company. Needs a highly trained person to service the contracts.


Am I an idiot for offering this protection to my clients?

I'm ready for the full frontal attacks. Please back up your point of view with more than, "Suze Says they are bad."
Mahalo

[sea-tax]

I see it like this:

Annuities are not for everybody. They are however under the right set of goals and circumstances a great planning tool.
Have they been oversold in the past? Sure but it wasnot the annuity that put that ball in motion it was the insurance salesperson who was only thinking of themselves.
Bjorn- I think you selling annuities or at least recommending them is great just remember that you have a fiduciary responsibility to your client first and foremost. SO long as you guide your decisions by this philosophy I think you will be OK.

About the talk show hosts and the sorts , I always tell my clients to consider the source. Those type of people are being paid to do one thing first and foremost and that is to sell advertisement . While they may be entertaining and sound as if they really care they don't. That usually puts the Suzie comments to bed real quick.

[Corduroy Frog]

The Big Problem

with these things, Bjorn, is that they are only "shrink-wrapped" versions of mutual funds, and are not forthright about purported economic performance.

When I say "shrink-wrapped" let's say a customer chooses for his money to be invested in Fidelity Magellan, certainly one of the largest funds in existence. The variable annuity puts its money in a house account, not Fidelity Magellan. Then they invest PART of the money into Fidelity Magellan, and holding back the rest to pay themselves fees. But when they advertise -- they advertise the full-up Magellan performance. Not very honest, although I'm certain if an investor cares to read the prospectus, he will uncover this scheme somewhere in the fine print.

Bjorn, it is not uncommon, especially with 401k plans, for Magellan to return some 13%, but the investor receives only 8-9% under the Variable Annuity scenario. Throw in a few bad years, and over the course of 20-30 years the insurance company can make more than the investor.

Can such an arrangement be good? I think so, if there is a stop-loss provision. Let's say Fidelity Magellan with the above fee arrangement, but combined with a minimum 5% return. That way the investor gets something for the fees (less risk) and the insurance company gets their return over the course of many people investing over many years. This might even be the security of choice for older people with substantial savings and not willing to risk much.

In general, as you can tell, I am not a big fan of these variable annuities. I also attack the fee issue because I believe an arrangement such as what I've described above is unconscionable. However, I am NOT in favor of stripping away all fees. Guys like you have to make a living and when I need a stockbroker, I want to pick up the phone and call someone who will make money carrying out my wishes. I just don't think he should expect to make more than me when I'm the guy putting up the money.

[Zee]

What about index annuities?

Indexed annuities are the "hottest" item on the market. Why? They are the most profitable to sell with up to 10% commissions. Of course, the commission is paid by the insurance company at "no cost" to the purchaser (of course not) and there "guaranteed" returns are an easy sell. But, the surrender charges can be as high as 25%. This is the product most often sold at the "free dinner" seminars Seniors attend. They're an easy target. Most of the ads I've seen suggest only those with $500,000 in ready cash attend. There is generally a cost of $1000 to attend for investment advisors, CPA's, attorneys, and financial planners (I wonder why).

[JohnH]

I think you said it well...

As I see it, you pretty much summed up the variable annuity situation with the comment, "I know the worst case up front...".

So if for some reason your client is interested in guaranteeing that his investment returns are poor, then by all means sell him the worst case, which in most situations would be a variable annuity.

[George Boutwell]

Enough Apples And Oranges for Fruit Salad

There are variable annuities, and then there are variable annuities with a guarantee. I think you are asking about the latter. (Companies like Fidelity Investments, in which I have great faith, sell only variable annuities without a guarantee, for reasons they have not been able to explain to me.)

The insurance company is able to offer the "guarantee" because it plays around in the futures market to make sure it can't lose. This costs a certain amount of money, so the yields are slightly less. If you and I had ten billion dollars, we could protect ourselves against market loss by buying and selling puts, also. It is just not practical for the average investor.

A variable annuity with a guarantee, for those who don't know what we are talking about, is a contract that says: If the market goes up, you get the increase (or almost all of it). If it goes down, we still guarantee that you will get your money back (or your money back with a 3% yield, for example). Back when fixed-income yields were not much more than 3%, this was a no-brainer, which is why people who thought they had brains, avoided them.

Some of them will "lock in" gains -- if the market goes up 10% this year, you always get to keep the 10%, even if it goes down 20% next year.

I don't sell these products but I recommend them to clients who are skittish about investing in equities. I generally send them to a stockbroker/friend/client who has a lot of money in one himself, and has tripled his investment while others have made maybe 50% on CD's.

[BOB W]

Those Guarantees.....

.... come with a premium charge as I recall....????

[JohnH]

I don't really care

I'm not concerned about what Suze Orman, Bob Brinker, my stockbroker friends, or any other financial advisors might recommend regarding VA's (although as previously stated, most financial advisors dont like them). But I won't start recommending VA's until Consumer Reports starts recommending them.

[Bees Knees]

If not a variable annuity that guarantees principal and a guaranteed minimum interest rate, then what product would you recommend to someone who is not willing to risk losing money in mutual funds? In other words, is there anything better for the conservative investor?

[George Boutwell]

That's what I said

.... come with a premium charge as I recall....????

As I wrote

>This costs a certain amount of money, so the yields are slightly less.<

As far as Consumer Reports (mentioned in another post) is concerned -- let's think back to last March:

>>NEW YORK (CNNMoney.com) -- Following a botched infant car seat crash test that forced the withdrawal of the test results and a public apology, Consumer Reports announced it is changing some internal procedures and policies. . . .In its announcement Tuesday, Consumer Reports blamed a "series of misjudgments" and "miscommunication with an outside lab."<<

Like many people, I have more faith in journalists (who edit and publish Consumer Reports) than in government regulators. But neither are infallible, and no one who works for Consumer Reports has any experience dealing with real people with real phobias about anything to do with the stock market.

[BOB W]

[QUOTE=George Boutwell;39042]As I wrote

>This costs a certain amount of money, so the yields are slightly less.<

.[/QUOTE:

Sorry George> I missed that when I quick read all the posts.....................

Isn't there a problem if the equities lose too much money?

[Joe Btfsplk]

If not a variable annuity that guarantees principal and a guaranteed minimum interest rate, then what product would you recommend to someone who is not willing to risk losing money in mutual funds? In other words, is there anything better for the conservative investor?

To minimize risk, you could invest in a closed-end bond fund, some of which are tax-exempt and some are also selling at discounts to net asset value.

For additional information see:

http://www.successful-investment.com/TFI/index.html

[George Boutwell]

To minimize risk, you could invest in a closed-end bond fund, some of which are tax-exempt and some are also selling at discounts to net asset value.]

That's a great idea if you agree with Dennis Milligan, new chairman of the Arkansas Republican Party, that "I think all we need is some attacks on American soil like we had on September 11."

That would surely drive interest rates down again, and therefore bond prices would rise.

On the other hand, anyone who expects interest rates to rise above their flat 5% today (whether it's 30 days, or 30 years) should probably stay away from bond funds, which not only fall when rates rise, but fall even faster because their investors are the first to sell at a loss.

Besides, don't you have to pay a premium for someone else to buy Treasuries for you?

[Bjorn]

Variable Annuity Feedback

I'm enjoying the banter and excellent feedback. Sometimes it is hard to go against convention. My point: There is a place and when fees are properly disclosed appropriate and I think too many tax / financial people immediately jump to VA = Bad.

Corduroy Frog mentioned:
I agree with Frog. It is fraud to advertise a rate of a mutual fund when the VA prodduct charges additional fees to insure against loss. All rates of return should be net of disclosed fees. No doubt some sales people {Not a true consultant} would be dishonest in this area.

I'm most familar with the VA side of the American Funds. I'd say 4% internal charges are a bit steep in your example of the Magellan fund doing 13% and the sub account earning 9%. The main issue is not a 20-30 year run. Most investors can ride the bumps if they are sure they are going to be in the market that long. My concern is the person who retires with 500,000 in March of 2000 and watches her husband's 401k turn into a 201k. In this true example Terri's husband died in 2002 and about 45% of her market value was gone when compared to the March of 2000 high. If she was in the any mutual fund she would have received the market value and had much lower expenses. Her husband insisted on paying the additional fees, about 2% to protect against this unknown. While most people took a huge loss she got a huge bump to her account and started fresh with the high water mark of the highest anniversary value.

The investor will receive the better of market value or the guaranted value. Obviously most of the time the market value is higher or the company could not pay people like Terri, if the husband dies young.

Zee discussed indexed annuities. I have not found a customer they were suitable for.

John H mentioned knowing the worst case scenario.
The key is the client will get the BETTER of market conditions of a sub account {mutual fund with higher fees} OR the worst case minimin guaranteed scenario.

George Boutwell has excellent points as well.
The main reason for the VA is the guarantee, it allows nervous investors to be in the market and pay a premium to the insurance company because they know the down side in advance and enjoy all the upside potential for a reasonable fee.

The lock in feature is very nice if you enjoyed the March of 2000 market high and had the guaranteed income benefit your income check would never go down and you could not outlive the income and most people don't know the contact is NOT annuitized. It is liquid. If money is needed and you take out 10% of your nestegg the benefits continue at 90%. Many VAs are never annuitized.

Bob W
I Agree. Disclosure of fees in critical. When I insured my house, a disclosed premium was paid to transfer the risk to Travelers. Sadly my nieghbor's home just two doors down was leveled by fire that caused 600k loss. I can assure you, both he and Terri above were not complaining about premium when the collected on the policy.

Bees Knees
As interest rates go up bond funds net asset values prices can drop. Certainly less risk, but in my opinion even after expenses the conservative long term investor can guarantee a 5% return in most VAs {after expenses} and if the market beats the 5% they get the higher value and I don't think too many bond funds can match it consistently but it is an option for the client.

I trust nothing 100%, not even my beloved Morningstar. Consumer reports is not the end all, however it is very respected and the opinion deservers consideration.
Briefly.
In general void I say avoid VAs if client is young and may not be a long term person.
If the client can hold onto the risk personally.
If the client does not understand the product.


Policies are rather complex and require proper education to the client so he or she knows each benefit and cost. Personally I won't allow a client into a VA unless they can explain all policy benefits back to me.

Commisions vary but are about 5% with some type of trail.
A sincere thank you to all the feedback on this issue.
Bjorn.

[Joe Btfsplk]

That's a great idea if you agree with Dennis Milligan, new chairman of the Arkansas Republican Party, that "I think all we need is some attacks on American soil like we had on September 11."

That would surely drive interest rates down again, and therefore bond prices would rise.

On the other hand, anyone who expects interest rates to rise above their flat 5% today (whether it's 30 days, or 30 years) should probably stay away from bond funds, which not only fall when rates rise, but fall even faster because their investors are the first to sell at a loss.

Besides, don't you have to pay a premium for someone else to buy Treasuries for you?

You can't escape risk since there is always a risk. Bonds may decline in value if interest rates rise but if you buy anything else the risk of a decline as well as the chance of a price increase is greater than the possible price fluctuation in bonds. An open end bond fund will always sell at net asset value but a closed end bond fund may sell at a discount which offsets the 'premium' and other costs of operating the fund. Also, if interest rates rise and bonds decline, the fund have expiring bonds that will be replaced by higher-yielding bonds, so on a long-term basis things even out to some extent.

I personally do not recommend putting all your eggs in one basket of either stocks or bonds. If you are a buy-and-hold investor you should diversify between various types of equities and debt instrument along with some real estate and other assets. Trading up on your home is a good long-range approach (but could clobber you on a short-term basis).