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What’s Wrong With Indexed Annuities?

With a headline like that, the next thing you normally read is: "plenty" followed by a scathing review of insurance agents and insurance products. Look, there are plenty of bad insurance agents in the field. And, there are plenty of bad products. The recent Dateline exposé of fixed and equity indexed annuities called Tricks of the Trade really has left a bad taste in the mouths of plenty of people (myself included but for different reasons)...and unfortunately many of them are seniors.

Yes, I said unfortunately. Annuities are not appropriate for everyone, and Dateline made that pretty clear. But insurance and annuities can be some of the best products for seniors. Some of what Dateline doesn't say in this exposé is actually more important than what they do say. I used to be a fan of Chris Hansen, but being in the financial services industry I know that what was offered here was not an objective reporting of facts.

Not once did I notice any of the regulators or the reporters from Dateline admit that nearly every deferred annuity has the standard 10% free withdraw option after the first year and every year after that until maturity - then all of it is accessible. They do gloss over the fact that some annuities offer a 10% free withdraw. Chris, just say "nearly all", that way you'll be telling the truth.

In fact, some companies have cumulative free withdrawals. But Dateline et al did an excellent job of implying that anytime that you withdraw money from an annuity you will pay a stiff penalty. That's just not true. Annuities are somewhat liquid, but they are really meant to be a long-term savings tool. Still, you always have access to your money in the event of an emergency without disrupting the bulk of your savings.

Compare this to mutual funds or bank CDs where you must liquidate everything in order to get any amount of money back and you pay fees on top of that. On top of that, CDs are notorious for being non-productive assets (i.e. assets that trail or barely match the rate of inflation after taxes) that if cashed in early lose 3 month or more worth of interest. Mutual funds carry contingent deferred sales charges on class B shares (the most popular shares sold by financial advisers). So, casting the fees charged by an annuity in a bad light while not also explaining that every financial product carries some type of fee is dishonest.

To be fair, annuities aren't perfect in this respect either. If you withdraw over your 10% free withdraw (10% of your account value), you are charged surrender charges, but only on the amount over 10%. How much you pay depends on the company and the contract.

But it doesn't stop with the fees. Dateline would have you believe that equity indexed annuities only come in a handful of terms, and most of them are 15+ year contracts. Again, not true. Even some of the longer contracts are only 10 years, and many companies offer 3 and 5 year contracts.

All of this can be confusing to many people, and neither Dateline nor anyone at the State Attorney General's office explained any of this on the show. hmmmmmmmmmmm. That's strange. They did; however, scold insurance companies and told them to "knock it off". Knock what off?

What's more, most insurance companies openly advertise annuities as "long-term savings vehicles", not "investments" as Hansen and Dateline call them.

Personally, I think whether you call them "savings vehicles" or "investments", it really doesn't matter.

As to the question of "can you lose money in an equity indexed annuity?", Dateline and the AG seem to think so, but this is misleading. Normally, the only way you lose money with a traditional Equity Indexed Annuity is if you cash out before the contract maturity and you "lose" because the surrender charges eat into your principal.

The annuity didn't cause you to lose anything, the fact that you surrendered the annuity early did. But that can happen on any financial product. Now, to be fair, today's EIAs have the option (key word being "option") to add riders that add an additional cost to the product, and those riders can eat into the principal if you don't earn any interest in the annuity (due to a declining market). But for people who aren't familiar with annuities, it makes it sound like EIAs are deceptive. They're not. They give people exactly what they promise.

When Chris Hansen asks Joseph Borg if he would recommend an Indexed Annuity, Borg says "no", and that he wouldn't recommend them to anybody.'s no surprise that the securities industry hates the indexed annuity business. After all, they've lost a lot of money and agents over the deal. You see, in order to sell securities, an agent needs something called a broker-dealer. A broker-dealer acts as a conduit for securities so that agents can sell investment products to the general public.

What's not mentioned in the video (which it probably doesn't belong in the video, but it would be helpful to understand) is that many (not some, but many) broker-dealers have annual new business sales quotas. These quotas are typically $50,000 or more. If you don't meet your quota, you as an agent are charged a penalty on top of the normal monthly FINRA (formerly NASD) fees that are required by the State. Nobody really talks about this aspect of the securities business, but it exists. Many financial advisers with "member FINRA" printed on their business cards must meet a quota for the year or they will be charged a penalty. To be fair, $50,000 isn't a large quota, but why bother with having one in the first place?

While some insurance companies want insurance agents to place a certain amount of business with them, insurance companies have no such official quotas, and so agents don't face any penalties for not moving product. Oh, and by the way, the pension that Mr. Borg will receive when he retires is, in fact, an annuity. It may not be an indexed annuity, but it's built on the same chassis - an annuity contract. In fact, all pension plan payouts are designed around the idea of an annuity (unless you take a lump sum). The difference between the indexed annuity and the pension annuity is that at some point, you get to have the lump sum of money in the indexed annuity. You never get a lump sum once your pension plan  payments start. Keep that in mind as you watch the show.

Another criticism of the index annuity is the "big commissions" earned by agents and advisers. But, "big" compared to what?

It's true, I've seen commissions of 9% on some products. In NY State (where I live), commissions top out at 5%. Some indexed annuities only pay 1.5%. And, keep in mind that that is a one time fee.

Let's put that in perspective because financial products don't exist in a vacuum. The most common alternative to an annuity suggested by financial advisers is to buy mutual funds. Well...what are the fees on mutual funds? Altogether, they average 2% for your typical fund, and about .5% to 1% of that goes to the agent...but the agent earns those fees every single year you hold onto the fund. What's more, advisers are rewarded by upfront commissions on the initial sale of the fund. So, if you plan on being a long-time investor, it pays for the adviser to make you a client for life with a mutual fund. And, this works out to be a lot of money over time-usually much more than the amount of money you make on any indexed annuity.

Are indexed annuities good for seniors?

That depends. Whenever I've recommended an annuity, I have always asked an important question. On the money that the individual is considering moving over to an this money something you would use in the event of an emergency (in other words is this the first place you would go for money, or the last), or are you going to depend on this for an income?

If someone needs their life savings for an income right now, they don't need a deferred annuity. Which means an equity indexed annuity is not the right solution for them. If they don't plan on using the money, then it can be an excellent way to save money for an emergency and beat inflation (not to mention defer taxation of interest and avoid taxation of social security benefits if their income meets the guidelines for taxation of benefits).

It's also a good alternative to single premium life insurance (commonly used in estate planning and transfer planning or gifting) if the senior doesn't qualify for insurance but still wants to avoid probate. But, the shortsightedness of regulatory agencies assumes that the sale of EIAs to seniors, especially older than 80, is always a bad idea. And, it seems like everyone and their brother is quick to jump on that bandwagon. But this is completely erroneous. It entirely depends on the goals of the individual. Nothing is or ever can be intrinsically good or bad. Whatever happened to the reasoning behind the purchase?

Thanks to the slick editing of the show, we don't know if the agents here have really lied about anything or not. I'm not sticking up for any of the insurance guys on the show, but you have to wonder if Dateline and the AG left out the info I just gave you, what else might they have left out?

Now, I think the show did do a good job of exposing the bogus credentials that some agents use. Also, it's embarrassing to see agents duck and dodge direct questions and give cheesy sales presentations. If you sell insurance products, you don't need to be ashamed of it. They offer real benefits in the form of tax advantages and strong guarantees that investments could never offer.

All in all I have to say that Hansen did a poor job on this one though. Shame on you Chris Hansen. You could have done a better job if you weren't looking for a sensational story to pitch the American people.

This entry was posted on May 20th, 2008 by David C Lewis, RFC. Edits may have been made to keep this entry current. · No Comments · Insurance & Savings

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