How To Read The “Warning Label” Of Annuity Products

July 28, 2017

I love silly articles that I see on social media sites, and my kids and I love to look at warning labels for things that make us laugh. This article combines both of these highly entertaining things that I like. Since most warning labels are in existence because of someone actually doing the things that are being warned against, I always want to meet these people.

As entertaining as I find wacky warning labels, not all warning labels are intended to be funny. And actually, not all warning labels are actually warning labels, either. Some come disguised as sales literature for financial products.

Buyer beware

Case in point: I recently met with someone who had a 401(k) account from a prior employer, and her financial advisor had recommended that she roll it over into an equity index annuity with him. She had not decided whether or not to purchase the annuity before our conversation, thankfully. During our meeting, we looked at the “warning label” (aka the fee disclosures) for the proposed annuity to see if it was a good deal. Here’s what we found:

  •  10 year “surrender charge” — this means that if she wanted to get out of the annuity for any reason, including to change investments, advisors, or for poor performance, etc. in the next 10 years, she would have to pay a hefty fee to do so;
  • “Mortality & expense” fees — this is the insurance component, along with the sales charges (aka what the advisor would be paid,) and administrative fees;
  • “Management” fees — this was the investment component, which was in excess of 2.5% per year.

Finally, the track record of the investments inside the annuity was less than stellar, so she could potentially be paying 2.5% to actually lose money. If I could write a warning label for this annuity, I might have it say something like, “Product contains excessive fees,” or “Warning: your advisor might make more money on this than you do.”

After reviewing all of this information, she obviously decided to opt out of the annuity and transfer her prior account to her current employer’s 401(k) instead — knowing that her 401(k) had much lower fees combined with the ability to make changes to the investments without penalties, I think she made the right choice. The annuity’s “warning label” gave enough information about the product to make her consider another alternative.

Know what to look for

The lesson here is that investment products don’t come with explicit warning labels like hair dryers or plastic bags, but the language is there if you know where to look. Before you make any significant financial commitments, be sure that you fully understand the fine print on the warning labels, even if it’s not labeled as a warning.

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Should You Invest in an Equity-Indexed Annuity?

April 17, 2017

Should you consider investing in an annuity linked to stock market returns but with less risk than the stock market? I recently had a coaching session with an employee who had invested a lump sum distribution from a retirement account into an equity-indexed annuity. Did she make the right decision, she wondered, and should she add more to the annuity or diversify into something else?

Remind Me What an Annuity Is, Please!

An annuity is a contract between you and an insurance company in which the insurance company agrees to make periodic payments to you, starting immediately or at some future time, in return for payment from you, either in a lump sum now or over flexible installments over time. With a “fixed annuity,” the insurance company agrees to a fixed return and a fixed payment. With a “variable annuity,” the rate of return and the payment vary depending on the investment choices within the contract.

So What is an Equity-Indexed Annuity?

An equity indexed annuity is the lovechild of a fixed and a variable annuity. With an equity-indexed annuity (EIA), the insurance company will pay an interest rate linked to a stock market index if the market index is up, with a guaranteed minimum rate if the market is down. In the case of the employee I spoke with, she would earn an annual rate of return linked to the performance of the S&P 500 during the accumulation phase of the annuity, capped at 6%. If the S&P 500 index went down, her return would be 0% for that year.

Who is a Good Candidate for an Equity-Indexed Annuity?

The primary financial planning purpose of an annuity is to turn a sum of money into a stream of income you cannot outlive. An equity-indexed annuity makes the most sense for an investor who is a) looking to create a future fixed income in retirement and b) who is not comfortable with direct stock market risk but would like to participate partially in potential stock market returns. In the case of this employee, she was willing to accept a cap on returns of 6% in return for no loss of her investment if the market declined.

She was also within 10 years of retirement and much more concerned about maintaining the value of her savings than she was in generating out-sized returns. It’s important to have both fixed and flexible sources of income in retirement so ideally an investor would refrain from putting all their retirement savings into an annuity. I encouraged this employee to keep some of her retirement funds in her 401(k) and IRA so she would have a source of income to meet flexible expenses in retirement such as a big vacation, dental work or an unexpected home repair.

Who is Not a Good Candidate for an Equity-Indexed Annuity?

A more aggressive investor would not be comfortable capping returns at 6% – especially in a year when the S&P 500 index went up 20%. Plus annuities generally have high fees which can eat into investment performance. EIAs typically have high surrender charges during the first 8-10 years of the contract so once purchased, you’ve got a strong incentive to stay put.

The moderately aggressive to aggressive investor could consider accumulating savings in a diversified portfolio of low fee index funds. That investor could potentially build a larger nest egg and then purchase an immediate annuity at retirement with some of those savings if interested in turning them into a stream of income. Because of the higher fees, younger investors are also generally not good candidates for equity indexed annuities. Finally, an investor who doesn’t ever plan to turn their savings into retirement income is not a good candidate for an annuity.

Was it a Fit for Her?

Was an equity-indexed annuity a good fit for this employee? After weighing the pros and cons, her conclusion was “yes.” She was willing to trade upside potential in order to eliminate the risk of losing money.

She was planning to annuitize within ten years – turning her annuity into a stream of payments in retirement. Moreover, she had chosen a reputable insurance company with an A+ rating from A.M.Best. Although she was excited about the annuity return/risk profile, she decided it would be best to continue to keep some of her retirement money in her employer plan so she’d have some flexible sources of income to meet unexpected retirement expenses.

Do Your Homework

Annuities are very complex investments. Before signing on the dotted line, make sure you’ve read and understand all the provisions in the contract. If you are considering an equity-indexed annuity, start with this fact sheet from FINRA. Check out the financial strength of the issuing insurance company and make sure it has a high rating for its financial position. If possible, get an unbiased second opinion from a financial planner in your workplace financial wellness program or a fee-only CFP® professional.

 

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

 

Do You Understand Your Advisor’s Recommendations?

April 21, 2015

I recently spoke to a friend who wanted to ask my opinion about her current financial advisor. Knowing that I have a slight addiction to chocolate, she offered me her homemade Godiva Hot Chocolate with a chocolate coated bottom for my trouble. Of course I would have offered my opinion at no cost, but who am I to turn down her homemade hot cocoa? As I listened, she started to describe how she was referred to him though a family friend so she did not feel the need to do a background check or ask him questions about how he gets paid. She took it on faith that if her family member recommended him then she would be fine. Continue reading “Do You Understand Your Advisor’s Recommendations?”

3 Hidden Pitfalls Coming to a 401(k) Statement Near You

December 18, 2014

When you see your 401(k) balance or even a projection of your future balance when you retire, do you really know what that number means for your retirement? If you’re like most people, you probably don’t. A $200k balance may look like the most amount of money you’ve ever had so you can easily think it will be more than sufficient even if it turns out to be nowhere near enough to generate the income you’ll need to retire comfortably. Continue reading “3 Hidden Pitfalls Coming to a 401(k) Statement Near You”

What Old School Insurance Sales Reps Won’t Tell You

August 01, 2014

I will admit that I own life insurance…lots of it. If a meteor were to fall from the sky and incinerate me today, my kids would benefit tremendously from a financial standpoint. They’d miss the wisdom (yeah, that’s what we’ll call it…) that I could pass down to them over the next 50+ years but they’d be OK financially.  Continue reading “What Old School Insurance Sales Reps Won’t Tell You”

Are Annuities a Good Deal or a Rip-Off?

September 26, 2013

A couple of weeks ago, my colleague Linda Robertson wrote a blog post about annuities, in which she described how happy her father was about a variable annuity that she sold him when she was a financial advisor. That may sound a bit puzzling since variable annuities have gotten a lot of bad press due to their high fees. But for those fees, you’re basically buying some form of insurance, which is why they’re sold by insurance companies. Here are some situations in which an annuity might actually make sense for you depending on what you’re looking to insure: Continue reading “Are Annuities a Good Deal or a Rip-Off?”

How to Invest for Income When Rates Are Rising

September 19, 2013

One of the biggest challenges facing current and future retirees is shifting from investing for growth to investing for income. This is especially difficult in today’s environment of low and possibly rising interest rates. Let’s start by taking a look at some options for getting investment income in retirement: Continue reading “How to Invest for Income When Rates Are Rising”

ABCs of Annuities

September 10, 2013

Although I haven’t sold insurance or investments for almost a decade in my role as a financial educator, my happiest client from those days is my dad, who purchased a deferred variable annuity from me. There is quite a bit of negative press about the high fees and long surrender charges with some annuities, but what makes my dad a satisfied investor are the safety nets provided from the benefits riders that can amount to an alphabet soup of abbreviations.  So what is an annuity, and how does it help my dad sleep at night without worrying about his money? Continue reading “ABCs of Annuities”

5 Potential Changes That Could Affect Your Retirement

February 07, 2013

The more I think about the funding shortfalls with Social Security and Medicare, the disappearance of traditional defined benefit pension plans, and the lack of Americans’ saving for retirement, the more I realize that there will likely be some major changes in the future of retirement and retirement planning. Everyone talks about entitlement reforms like raising the Social Security retirement age and reducing Medicare benefits. But here are 5 other possible changes affecting retirement that you may not have heard as much about and some things you can to prepare: Continue reading “5 Potential Changes That Could Affect Your Retirement”

If It Looks Too Good To Be True…

February 10, 2012

Have you ever seen one of the infomercials about a workout routine, a diet program, or a piece of exercise equipment and said to yourself “that just looks too good to be true”?  Well…so did this guy!  In a video that has become an internet sensation, Furious Pete shows how he made a remarkable physical transformation (you have to check out the video to see just how amazing the transformation is) and took both before and after photos in only 5 hours as proof. Proof?  Yep!  Proof that his transformation was not completely legitimate. Nor was it the product of hard work, diet, or exercise.  Continue reading “If It Looks Too Good To Be True…”