How To Safely Buy An Annuity
You are advised to seek out a “trusted adviser” to help you select just the right investment product for you. However, there is so much misinformation that finding a trusted advisor for an annuity sold or purchase could be difficult.
I am not going to recommend you go it alone. Far from it. But what I want you to do is some serious homework, more so than just a Google search for "buy my annuity" before selecting an annuity sales adviser.
Here are the steps I recommend to safely buy an annuity:
Start Comparison Shopping
I believe the #1 thing you can do to prevent yourself from being ripped off when buying an annuity is to comparison shop. It is that simple.
Get quotes from different sources. This does NOT mean you ask your current adviser to get you quotes from different carriers. It is way too easy for an adviser to stack the deck and make the annuity s/he wants to sell you look like the best thing since sliced bread. I mean you ask several different sources for their best quote for the type of annuity you are interested in.
Get quotes from Certified Annuity Specialists, online services, discount brokerages, insurance agents, or financial advisers. Get quotes from people who will receive a commission for the product and quotes from people who won’t. Some carriers will even sell directly to consumers and give you quotes over the phone.
Insurance agents and some financial advisers will want to have a face-to-face meeting with you as soon as possible (either in your home or at their office), as they are convinced if you meet them in person, they can “close” you (meaning: they can get you to buy from them). But whether you get quotes emailed to you, over the phone, or from a face-to-face meeting, do not purchase or sign anything, and take no action until you have at least three quotes from 3 different sources. This is key when having an annuity for sale.
Cultivate Some Objectivity
When dealing with your current adviser (if you have one), even if that person is your first-born and you love her/him more than your own life. Many advisers are charismatic, charming, and persuasive – that’s how they got their job!
I had a client, who when advised of the thousands of dollars she was losing in fees from the variable annuity her financial adviser had sold her, actually started defending the adviser. I later found out every time she made a buy suggestion for her portfolio this particular adviser flattered her by telling her he was going to buy the same for his portfolio! Really?!? If her suggestions were so great why was she paying him?
Maintain Some Balance Between Fear And Greed
The two emotions in residence when we deal with our money. We fear losing it (and thus want safe and secure investments), but we also want the maximum return possible (only possible with a high amount of risk).
Become familiar with your limits for risk. Decide how much you are willing to give up (return-wise) for safety. Do not let the twin monsters of fear and greed reign over you.
Use The Process
When you are satisfied you have enough quotes, use the worksheet or your scribblings to organize the important features of the annuity (as described in this book), rank the features according to your priorities, and determine which one is best suited to what you need and want in an annuity. Once you have identified the best product, recontact and work with the person or organization who provided you with that cash annuity quote.
This type of comparison shopping is a radical concept not only for the financial services industry but for people like Muriel who are used to using a “trusted” 20 adviser. I mean, isn’t that the whole point of having a “trusted” adviser? So you can leave the decision making to them? So you don’t have to be bothered? After all, doesn’t the adviser have specialized knowledge about these products you don’t have? Isn’t that what those management fees are for? Well, theoretically, yes, that is what you are paying them for. However, theoretical life is often very different from real life. And the sad fact is some financial advisers are restricted to only a limited number of insurance carriers or are given financial incentives to “push” a certain carrier’s products.
Even true “fee-only” CFPs® who are not annuity specialists may rely on a recommendation from an outside “trusted” adviser (who is going to receive a commission from the sale). And after all, I am not saying you have to give up your “trusted” financial adviser. I simply am recommending you comparison shop from different sources. What could be the harm? If your adviser has the best product, s/he should have no objection at all to you doing this. If s/he is offended or balks at the concept get another financial adviser pronto.
People who do not regularly use or have limited contact with financial advisers (such as Jim and Jane) may also feel uncomfortable doing this. After all, the insurance agent is licensed by the state. Doesn’t this mean s/he is the expert? The short and emphatic answer is “no.” All it means is s/he is licensed by the state to make sales presentations of specific products to you. And, as Jim found out, better to do some homework before buying an annuity than afterward.
DIY-ers such as Bill may be the most comfortable with this process. But it is important to remember gathering quotes is only the first step in the process – more still needs to be done.
In your quest for quotes, especially if you are looking online, it will not be long before you come across some very negative opinions about annuities. I call this the Annuity Controversy and think it is important enough to summarize what I have found and what might explain this phenomenon:
The Annuity Controversy
Why annuities are such a controversial subject is a bit of a mystery to me. They are an asset class like stocks, bonds, real estate, life insurance, mutual funds, etc. And for each they are either a suitable asset class or an unsuitable asset class, depending upon each person’s financial objectives, financial wherewithal, risk profile, age, health, and other factors just like any other asset class.
But if you spend any amount of time at all on the Internet searching for information about annuities it will not be long before you suss out there are many financial advisers who are very vocal opponents of them. Here are some of the reasons I think this is so:
The “RETURN” Factor
Many financial advisers are almost exclusively focused on either Internal Rate of Return (IRR) or Return on Investment (ROI). Their admirable objective is always to obtain the highest possible return for their client (hopefully taking the client’s risk tolerance into consideration).
Their objection to annuities is they feel other asset classes will provide a higher return. The problem with this perspective though is that because the end date for the annuity is unknown (in the case of someone receiving lifetime income), it is difficult to compare it to another income instrument like a bond, which does have a predetermined end date. So usually the annuitant’s life expectancy is used in a comparison like this, but that may or may not be accurate if the annuitant doesn’t have the good manners to die right at her or his expected expiry date.
Another huge problem with a focus on IRR/ROI is one simply cannot compare an asset class with no guarantee to one with a guarantee. This is comparing apples to oranges. Because of the guarantees accompanying the annuity, it is in an entirely different category of investment than, say, an investment in a traditional stock mutual fund.
How can a product with an income guarantee be compared to a product with NO income guarantee at all? In my opinion, annuities are not to be compared to traditional investment vehicles; they should more accurately be thought of as a purchase of a future income stream. This is a different perspective than that of someone who invests in a traditional investment vehicle with the [usual] intent of walking away sometime in the future with their capital and a lump sum of profits from their investment. Many financial professionals make the mistake of applying the metrics of this type of investment mind-set to annuity products.
But most importantly, I have never seen an anti-annuity financial adviser take into account how much return the guarantees are worth to the purchaser of the annuity. While a mutual stock fund may return a higher IRR/ROI than an annuity no one bothers to take the cost of sleepless nights, anxiety over market volatility, and depression over the uncertainty of being able to retire with sufficient funds, which occurs with an investment in a traditional at-risk investment into account when figuring the IRR/ROI. Certainly, the guarantees existing in an annuity and the peace of mind along with its purchase are worth giving up some amount of IRR/ROI on the part of the annuity purchaser. What is that amount? What is that worth to the purchaser? Shouldn’t that amount be added to the IRR/ROI of the product?
And finally, financial professionals sometimes forget “expected” returns are nothing but someone’s best educated (or not-so-educated) guess. Or they are something cooked up from an “average” of the past performance of the asset class. Past performance is not indicative of future performance, and it is well-known returns are not correlated year-to-year. So I am suspect of financial professionals who dismiss annuities based on a comparison to some hypothetical expected or average return.
The overarching focus on IRR or ROI as described above keeps some financial professionals focused on the cash value of the annuity to the detriment of the guarantees. When an annuity is used traditionally as an income producing vehicle, it is important to know how the cash is going to accumulate. But the only reason to buy an annuity is for the guarantees it offers. In that sense, how the cash is going to accumulate is secondary to the guarantees.
When looking at these types of annuities, it would be better to focus on the guarantees. However, in the case of an annuity purchased solely for tax deferral of gains, the cash value is of primary importance, and there may not even be any guarantees for gain in the contract. In that case, a better focus might be an in-depth analysis of the tax advantages about the fees charged for the annuity.
Media reports of abuses by less-than-ethical sales advisers who either lie outright about the features of the product or who disregard suitability requirements and pressure retirees/seniors to purchase annuities with less than favorable features (but perhaps extremely favorable commissions). Thus placing the purchaser in difficult financial situations later when s/he cannot obtain her/his money without a substantial penalty or when the value of the annuity has vastly underperformed the promises of the salesperson occasionally surface and are widely reported on.
While sales abuses do exist (as in every industry) and while it is a good idea for people to be on their guard, the press sometimes goes overboard and paints all advisers with the broad brushstroke of negligence. The press coverage can give the impression all annuities are bad or all sales advisers are out to get you. This is a great disservice to both advisers and potential annuity purchasers alike. But let’s face it, a story about someone getting ripped off is more likely to catch the public’s attention than a GAO report advising retirees to buy annuities for their retirement income plans.
Less Money For Them
Then there are financial advisers who talk annuities down because all funds placed into an annuity are therefore not available to them to invest or manage (for a fee). The most egregious example I witnessed in this regard was a presentation done by a CFP® who was ostensibly conducting a retirement seminar but who proceeded to give out more misinformation and outright lies about annuities than I have ever heard in one place (or in such a short amount of time) before.
His virulent attack on annuities (whether through sheer ignorance or intentional manipulation) caused me to investigate him and his firm more thoroughly. I found out he was promoting an asset management program that balanced client stock portfolios monthly, with a monthly fee for every balancing. Sad but true.
And finally, there are those advisers who talk annuities down because the person who sells the annuity may receive a commission for the sale. Ironically, this criticism may come from advisers who charge a 1% or higher management fee per year, which comes directly out of the client’s investment capital (thus reducing the amount of the client’s capital). With an annuity, the commission paid to the salesperson is usually only a one-time deal and is paid out of the insurance carrier’s general fund, never from the annuity buyer’s premium (thus not reducing the amount the buyer’s capital). So what’s the beef here?
Another form of commission hysteria is the belief if an adviser receives a commission on a product s/he cannot possibly be unbiased in her/his recommendation and will either recommend an unneeded product or simply the product paying the highest commission. This attitude usually comes from fee-only advisers or planners who wish to have the sanctity of their recommendations unquestioned. Sorry. Being the skeptic I am, everyone’s recommendations come under scrutiny. Being fee-only does not give you a free pass. But nice try.
Regardless of which particular flavor of commission hysteria the anti-annuity adviser is infected with, the absolute best way to protect yourself from someone you suspect is pushing a product just for the commission is to use the information and process outlined in this book. Use this process with people who will receive a commission and use it with people who won’t. The results may surprise you.
When To Ditch An Annuity Sales Adviser
Now you are armed with information which will allow you to navigate through the morass of conflicting opinions out there; you should turn your attention to some specific reasons warning bells should go off in your head when dealing with a potential annuity sales adviser. Deal with them if you must but if you recognize your adviser doing any of the following, proceed with extreme caution. And don’t forget: you’ve been warned!
- Cold calls you (defined as you don’t know them, they don’t know you, and you were not expecting the call).
- Semi-cold calls you. You don’t know them, they don’t know you, but they were referred to you by the company (or government agency) from which you are shortly expecting to retire. Many companies provide financial planning services for retiring employees as an outgoing benefit. This is usually done by contracting with a third-party financial planning firm. But just because this firm has contracted with your employer does not mean you have to use them, and it does not mean the adviser has the best recommendations. Make sure you subject any recommendations for annuities by these advisers to the same process outline in this book.
- Pressures you to have a face-to-face meeting as soon as possible (like this afternoon!).
- Insists on meeting you in your home without regard for whether that is comfortable for you or not or does not at least offer you the option of an office meeting. This may mean they are working out of their car. They may offer to meet you at a coffee shop. But do you want to speak about sensitive and private financial matters amidst the public hustle and bustle of a coffee shop?
- Appears to be an extremist (either loathes annuities with the ferocity of a lion or who believes everyone on the face of the earth should have one). Any adviser who would summarily dismiss an entire asset class out of hand is suspect, so is any adviser who believes a certain asset class is a must for everyone.
- Can’t answer your questions about the annuity or doesn’t seem to know how it works. This does not mean you should expect the adviser to be carrying around every minute detail of every type of annuity in her/his head. But if the adviser is recommending a particular annuity s/he should know it inside and out.
- Does not thoroughly explain to your complete understanding why her/his recommendation is a good one.
- Tries to make you feel bad or seems offended when you indicate you are going to shop around with different sources. May even indicate they won’t work with you in the future if you persist in this stupid comparison shopping thing. Good. Let them go.
- Tries to get you to proceed with the purchase because there is “nothing to think about today” and the time to “think about it” is during the “free-look” period.
- Tries to rush you into proceeding with the purchase because “rates are about to change” and s/he wants you to “lock in” this great deal. You may want to confirm with the carrier that a rate change is imminent, but you should never skimp on the due diligence process outlined in this book.
- You are told you have to apply for the annuity to see if you qualify for it.
- Suggests in any way the annuity is somehow guaranteed by any government entity (state or federal).
- Encourages you to fudge numbers on the suitability form or any form, for that matter. Or makes up numbers for you.
- Uses scare tactics to try to get you to purchase. This may take the form of predicting an imminent market collapse and the loss of all of your retirement savings or some other disaster. Being reminded you may outlive your money (especially if you have very limited funds, to begin with) doesn’t count, however. That is a distinct possibility.
- Presents products which sound too good to be true. (14% interest!)
- Tells you the annuity will save or shelter your assets so you can qualify for government aid if you need to enter a long-term care facility. If this is your motivation for purchasing an annuity, please contact an independent elder law attorney first. The rules for these things change frequently, and you should not take the word of a sales adviser on such an important matter.
- Talks about “doubling your money” when it is only the Guaranteed Income Base that doubles.
- Is not completely transparent, up-front, or knowledgeable about fees. Predicts non-guaranteed fees are either unlikely to or won’t be changed by the carrier. Predictions are for psychics. Is your sales adviser a psychic? If so, get next week’s winning lottery numbers from her/him right away!
- Suggests you take out a reverse mortgage on your residence (or any loan) to fund an annuity.
- Encourages you to place all of your liquid assets into the annuity.
- Indicates the percentage roll-up on a lifetime income rider is your ROI or your “earnings.”
- Promises of returns far in excess of those currently offered by the market. (14% interest!)
- Likens an annuity to a pension plan.
- Assures you nobody has better products than the ones s/he are offering. This may be true, but you’ll be the one to determine that by following the process outlined in Section B.
- Tells you comparison shopping is not necessary because s/he works with (or can quote from) 50+ (or whatever number) different insurance carriers. Or tells you comparison shopping is not necessary for any reason. If the sales adviser is so confident s/he has the best products let her/him show it with the best quote.
- Invites you to a “seminar,” “workshop,” or “educational/informational meeting,” which may include a free dinner or lunch (à la Muriel in the Case History examples). The topic is usually related to retirement (e.g., Social Security) or some aspect of investing. You should automatically mentally categorize all of these events as “sales pitches.” Go if you are desperate for the free meal, but understand the information you receive will be limited and of the “teaser” variety in which you will get just enough information to convince you of the need for the presenter/adviser’s follow-up help. Unfortunately, even those “adult ed” non-credit classes/events held at local community colleges are not excluded from this warning (see “Less Money for Them” above). Just because the class is held at a local community college does not mean the presenter is an unbiased educator endorsed by the community college although it is likely the attendees will believe this is the case (and the presenter will do little to disabuse them of their belief).
- Mentions the word “hybrid” in relation to an annuity. Describes the annuity as a “hybrid” annuity. There is no such thing. This is sales jive designed to make you think the annuity is somehow new, superior, special, or different from other variable or fixed annuities on the market. This is not true. I can assure you the annuity you are looking at is either a fixed or a variable annuity, and calling it something different does not make it different or special.
- Tells you the annuity is a way you can participate in market gains without any loss if the market declines. This is the classic line used to push fixed index annuities. It is wrong. In a fixed index annuity the owner’s premium is never invested in the market so technically there is never any participation in market gains. Also, the focus of this “sales pitch” is how the cash value accumulates – which is guaranteed to be a range so it cannot be predicted (you have to use 0 as a guaranteed amount). And finally, most of these products are sold with a lifetime income rider so how the cash accumulates is secondary to the guarantees of the rider. If anyone tries this line on you, proceed with extreme caution.
- Presents you with a book with their name on it as the author (with maybe a co-author). This is usually a stapled paperback booklet with large print, many graphics, and speaks in glowing terms about the subject, most likely a fixed index annuity. There is a lot of emphasis on how the annuity would have performed compared to a stock market index. This book is intended to give you the impression the sales adviser is a bonafide authority on the subject, and you are lucky s/he took time out of her/his busy schedule to grace your humble abode. What you may not know is these books can be ordered by the sales adviser with her/his name imprinted on them; the sales adviser may have had nothing to do with the writing of it at all. Lately, though, my understanding is the more advanced marketing organizations will help their sales associates “re-write” portions of the book in their own words (with perhaps a new cover graphic), so the book appears more authentic and unique to the sales associate. A quick check on Amazon.com (where the book will NOT show up under the author’s name) will tip you off it’s simply a marketing ploy. If you need a paper with which to start your BBQ, put that marketing book to good use.
- Focuses on non-guaranteed (hypothetical) elements of the contract. The non-guaranteed elements of the annuity contract should be described to you thoroughly and accurately. But the adviser who wants to talk more about what the contract might do, may do, or is likely to do than the guaranteed elements is suspect.
- Focuses on what the contract “would have done” if you had just purchased it 2, 5, 10, or “x” number of years ago. Keeps your attention on “what you would have now” in the above scenario. This, of course, is designed to give you the impression that what happened in the past is going to happen in the future. But as everyone knows, past performance is not indicative of future performance. If the annuity sales adviser you are getting a quote from keeps forgetting this, just keep reminding her/him. Better yet, get a quote from someone else.
- Tries to talk you into purchasing an annuity because of the upfront “bonus” the carrier is offering. Or worse yet, tries to portray an upfront bonus as an “immediate return of “x” percent.” I’ve seen bonuses offered as high as 10% of the initial premium. That “bonus” is nothing but a manipulation of the Guaranteed Income Base. In other words, it is a marketing ploy, designed to give you the impression you are receiving something other carriers will not give you. Reread Section B, Step 2, Critical Comparison Point #1: Guaranteed Income Base. Use the process!
A Note About Fiduciary Duty
Fiduciary duty is defined as “an obligation to act in the best interests of another party.” Registered Investment Advisors and CFPs® who provide financial planning services are considered to have a fiduciary duty to their clients and are held to this higher standard of responsibility.
You should be aware life insurance agents do not have a fiduciary duty to their clients. Does this mean you should not use a life insurance agent to get a quote? No – they often have access to some fabulous annuity products others cannot or will not quote. Just be aware of this fact and use the process outlined in this book to protect yourself.
What Is A Certified Annuity Specialist®?
While you can get annuity quotes from many different sources, you may want to check to see if there is a Certified Annuity Specialist® in your area. Many life insurance agents sell annuities only as a sideline and many financial advisers at major brokerage houses will need to walk (or call) over to the brokerage’s annuity department to get information.
A Certified Annuity Specialist® is professional designation for someone who has devoted many hours of extra study and testing on annuity products, principles, and strategies and who continues to update their knowledge base with an extra 30 hours of continuing education every 2 years (above and beyond what is required by the state for licensure).
Certified Annuity Specialist® Nationwide Listings
What If You Already Own An Annuity But Did Not Comparison Shop?
Don’t panic. Information will be your best friend. Regardless of the type of annuity you own, there is never any harm in having it reviewed for current performance, suitability, and options.
Collect other quotes and enter to compare. If the surrender charge period for your current annuity is still in effect, consult with the adviser who gave you your top quote (assuming it is better than your current annuity) to see if it may be advantageous to switch over despite the surrender charge which may be imposed. You might be pleasantly surprised.
Do not simply switch over to a new annuity without checking with an adviser as annuity exchanges can be complicated.
A Critique Of Our Fictional Advisers And Clients
So how did our fictional advisers and clients make out? What mistakes did they make? The shorter answer would come from asking “what did they do right?” which was practically nothing. Nobody comparison shopped. Nobody educated themselves (in general or specifically) until long after the sale.
Jim and Jane:
Didn’t comparison shop.
Didn’t educate themselves on annuities in general or in specific (until long after the sale).
Accepted Josh as an expert because he was a licensed insurance agent (and because they liked him).
Let greed take over – never questioned a return of 14% when CD’s are returning 1%.
Offered an unrealistic “return” rate.
Presented the roll-up rate on an income rider as “earnings.”
Focused on and presented only one product.
Told Jim and Jane the state was guaranteeing the annuity.
Didn’t comparison shop.
Didn’t understand what she wanted or what she bought.
Didn’t verify the product she bought was the type of product she thought she was getting.
Didn’t know the product his client was interested in.
Placed her in a variable annuity without telling her about the fees.
Didn’t clarify the 8% income rider roll-up was simple interest, not compound.
Didn’t make sure Muriel understood what she was buying.
Poor Bill. He made so many mistakes I am not sure where to start. Probably his biggest mistake was a closed mind. Because of his family’s bad experience with an annuity many years ago, he felt he already knew all about annuities. Missing out on the way annuity products have changed over the years caused him to miss out on a good opportunity to guarantee himself a stable, secure, lifetime income.
Also, his insistence on “going it alone” with outdated info did not help. Made the common investor mistake of “chasing” returns by buying the top performers of the previous year (the ones least likely to be in the No. 1 spot next year). Finally, greed reared its ugly head with his decision to continue to risk all of his liquid cash savings while at the same time relying on them for income for basic needs. A risky proposition, indeed.
Because of the guarantees they offer, income annuities are a unique financial asset, and they may make an excellent choice for the conservative portion of a balanced risk portfolio. If a life insurance policy can be considered protection against the financial implications of dying prematurely, the income annuity can be considered protection against the financial implications of living too long.
There are no other investment products in the marketplace that will continue to pay the purchaser an income when the purchaser’s account value is $0. The benefit of this type of guarantee (a person cannot outlive his/her money) cannot be overstated, especially in this era of medical advances and unprecedented longevity.
In my opinion, if you have less than $500K cash assets going into retirement, you need to investigate annuities as a way to produce income for your retirement. And the less cash you have, the more important it becomes.
It may turn out an annuity is not for you, but you will have the satisfaction of knowing for sure. If it turns out an annuity is a good choice for you if you follow the process in this book you will have the satisfaction of knowing you have the best one for you. Your chances of having been ripped off will be very very low.