The salesperson is a trusted acquaintance. The office is comfortable and you are excited about finally making a decision regarding your nest egg. Then, your mood improves even more when you hear the words, “7% return on investment each year.”
“Where do I sign?” “Not so fast, my friend,” warns annuity expert Jeff Voudrie, president of Common Sense Advisors.
One of the core beliefs of people that invested with Bernie Madoff was that somehow, some way, they would always see a positive return on their investment no matter how the markets performed. Looking back, it’s hard to believe that so many intelligent people believed in the phony wizardry of Mr. Madoff.
Annuities are similar, says Voudrie, because the language in the documents explaining them seem to promise robust returns irrespective of the markets’ performance. And, like the promises that Madoff made to his clients, the illusion of large returns in annuities are nearly impossible, Voudrie adds. “Most of the purchasers wouldn’t have bought these products if they’d known the truth, that in the vast majority of cases, what they earn is almost completely dependent on the stock market.”
People who sign over their precious life savings for annuities should be completely informed about the actual conditions of those annuities, Voudrie cautions, for several reasons:
Insurance companies are offering large bonuses to salespeople who successfully lure investors with their annuity pitches
Once you sign on the dotted line, you release the salesperson of all liability, including his or her failure to explain the disclaimers and fine print on your new agreement
No annuity can be separated from market performance. “Guaranteed returns” have all sorts of conditions that should give any wise investor pause.
In his extensive reporting on annuities, which has earned him widespread vitriol from various insurance companies (coupled with abundant thanks from savvy retirees!), Voudrie has repeatedly spelled out the huge risks of investing in a typical annuity.
Think of an annuity as a machine with many moving parts, all influencing the amount of money that you can hope to receive from it. Blanket terms such as “guaranteed returns” and “income for life” do nothing to explain the many levers that determine an annuity’s eventual value. Voudrie has broken down the gears within an annuity machine by focusing on three parts:
1. Actual value of the annuity
2. Virtual value of the annuity
3. Value of the annuity when distribution begins
Regarding the actual value of the annuity–the most important aspect of your investment–he shares these facts:
There is no automatic, guaranteed increase to this value
It rises and falls based on the performance of the stock or bond subaccounts you’ve selected—just like a mutual fund
It rises only if there are true underlying gains on investment AFTER management fees are deducted
It can decrease to zero in light of market losses and withdrawals, as with a mutual fund or brokerage account
It is not an indicator of how much you would receive if you cashed in the policy because surrender penalties are not yet subtracted
Two key numbers you should verify before buying an annuity, therefore, are management fees and surrender penalties. If you are fine with ongoing annual management fees of 3-4% and the amount of your surrender penalty, then perhaps you will want to continue with your purchase. Keep in mind, though, that the only reason there is a surrender penalty is so that the insurance company can recoup the commission they paid the insurance agent either through higher ongoing management fees if you own your annuity for years or with the surrender penalty if you surrender it.
Another round of facts that you should consider are those that focus on the second lever in the annuity machine: the virtual value of the annuity. Voudrie alerts:
This value increases during the accumulation period only of your annuity
It is the amount used in lifetime income payment calculations
You will receive this higher value only if you meet certain conditions, such as: not cashing in early or remaining alive during the entire accumulation phase
Your beneficiaries will not receive this greater amount if you pass away during the distribution phase
So what is the use of this virtual value, the amount consistently touted by the salesperson? It has little relevance, Voudrie advises. “When do you get the make-believe bucket balance?” he asks, “Likely never. The only way you EVER get the full make-believe bucket balance is if you live long enough that your annual payments exceed the bucket balance. Whether or not your guarantee has any benefit to you depends on your ability to live longer than the money in the real bucket lasts.”
As for the third moving part in the annuity machine, the value when distribution begins, Voudrie offers more sobering tips: “The only time your ‘income guarantee’ comes into play is if you live beyond that point when your principal and gains run out. You can read in the fine print: ‘The income base is the amount on which guaranteed withdrawals are based; it is not a liquidation value nor is it available as a lump sum.’” In layman’s terms, “The virtual value of the annuity won’t ever be available as a lump sum, and remember, it stops increasing the day you start taking income.”
Given these caveats, Voudrie has written a publication called How 7% Annuity Income Guarantees Create a False Sense of Security and Threaten to Leave Tens of Thousands of Retirees Disappointed and Stranded. These “guarantees” are, in a word, Madoffian.
That could be why Sen. Elizabeth Warren (D-Mass.) released an investigation of the annuities business that discovered 13 of 15 insurers her office contacted “offered salespeople perks and kickbacks—including expensive vacations and other prizes—to push their products. Such incentives create conflicts of interest, Warren warns. Plus, sellers earn commissions that can be 7% of more of your investment.”1
The old saw about “anything that seems too good to be true, probably is” fits annuity promises in the huge majority of scenarios. No wonder salespeople are offered huge incentives to push them.
Please comment or share your queries and feedback here, I’m always happy to answer your questions.