Beware- Variable Annuities - Letters to Mike

10/19/2006 - A caller to the Clark Howard show told Clark that not all variable annuities are bad - that in fact his product was doing quite well. Well, guess what - the market is doing well and even the most expensive variable annuities are showing positive returns.
What the caller fails to understand is his positive return is diminished by fees of anywhere from 1.5% to 2% - depending on the policy and another 1.5% to 2.5% (even higher)depending on the fees for the funds he is in. He would be doing far better in an ordinary index fund at Vanguard.
Fee-only planners like myself scoff at the claims that managed funds outperform index funds long term when in fact the evidence is clear that they do not. Inside a variable annuity, the poor returns are diminished even further by the very high expenses of the product.
Interesting to hear the caller so pleased with the funds and not mentioning that he has an underlying guarantee - or so he thinks. I would love to hear from him later on when he starts taking money out in a market downturn and finds out he is drawing down on the market value of his plan, not the so-called "guarantee."

Worst cases of 2005. I am currently working with a 72 year old woman whose husband had been talked into putting his IRA into a variable annuity. He passed away at age 75 and at least the losing investment was required to pay her a death benefit. But wait! Her sales oriented planner - rather than instructing her to take the IRA funds and put them in a mix of CD's, low cost income funds and dividend stocks, he --- yes --- convinced her to roll the funds into a brand new annuity with new surrender penalties!!!! His pitch, which he repeated to me, was that she would get a guaranteed 6% income stream she could not outlive.
True, but this involves pulling down on principal and interest and the real rate of return on the income stream is not 6% - but much much less. By not allowing the woman to shop around for the best income annuity, we are trapped inside his high commission product when competing products are paying income streams of 7%.
Of course, this woman was never shown that she could put the IRA into CD's paying 5.75% currently and income funds paying well above 7%. When she saw the ability to allocate her IRA into an open marketplace, she found that much more attractive than grabbing huge chunks of principal in the annuity setup.
Once again, a consumer who was not made aware of all the potential choices in the marketplace but just sold a high commission variable annuity.
Putting any IRA into a variable annuity is at best a questionable practice and to put a 72 year old woman into a product with 10 years of high surrender penalties is --- well -- you come up with the word for it.

Now one you won't believe but unfortunately it is true. A couple visited my office recently and confessed they had been talked into putting 100% of their IRA money - their life savings - into two variable annuities. The husband is now ill and needs to take out money, but is stunned to discover getting his own money back means paying the insurance company a huge penalty. With bank CD's paying 5.75% the notion of taking IRA money out of risky mutual funds and perhaps putting it into some CD's is also out of the question.
These folks found out much to their pain that their withdrawals of the past few years did not come from the "accumulated guarantee" but from the market value of their annuity. They had been told verbally that they would be guaranteed at least 5% and they could take it out. Lo and behold they found that was not true when it came to partial withdrawals.
Lesson here is to get a copy of the annuity contract well ahead of time and study it for the all the language and trap doors that conflict with the sales pitches. You'll be amazed at what you see!

From a recent speech I gave on this topic, an insurance agent came up to me and scoffed at my recommendation that consumers get a copy of an annuity contract before buying the product. "You can't get a copy of an annuity contract up front," he proclaimed. "That is why we have the 10 day free look period." I smiled as politely as I could and informed him that if any consumer needed a copy of his firm's contract ahead of time, they should get it with no problem and if there is a problem, I can always obtain a copy from my friend the state insurance commissioner.
He was quite unhappy to hear my reply but he could not disagree. Imagine, trying to tell me insurance contracts are not available for advance scrutiny. You gotta be kidding!