Often times, clients reach out to CWM looking for an opinion on an investment (or product) that just sounds too good to be true. They are intrigued by the “guarantees” and “I can’t lose money” features. The first thing that comes to mind: It’s an expensive annuity.
First, disregard the sales hype often used to sell those “too good to be true” products. It goes like this: “You can invest in the market and NEVER lose money”. Such a claim is misleading since these “promises” are provided by so-called living benefit riders which are expensive. In addition, historically insurance companies impose severe surrender penalties forcing many investors to stay in the product anywhere up to 7 – 10 years.
Recently, a client asked CWM to review an annuity purchased in March 2008 through a well-known insurance company. The client admitted that she did not understand how the annuity worked other than that she was guaranteed 7% per year for 10 years. The value was “guaranteed” to be worth $235,000 in the 10th year. Sounds too good to be true? Here are the REAL facts:
Statement – as of March 31, 2016
Initial Investment (IRA): $120,000 (3/18/2008)
Surrender Value: $129,700
Death Benefit Value: $144,000
Benefit Base Value (GMIB): $186,700
Total Annual Annuity Expenses – 3.50%
Surrender Value ($129,700): During this eight year period, the average annual rate of return is a measly .96% ($120,000 growing to $129,700). With total annual expenses of 3.5%, the surrender value is directly related to the performance of the investments, minus fees. According to Morningstar, the S&P 500 returned a negative (-37%) during the first year this client purchased the annuity. The annuity portfolio would have to return 66.7% JUST TO BREAK EVEN. It is no wonder why the surrender value is only worth $129,700 eight years later.
Death Benefit Value (annual expense - .45): The death benefit is always the sounding cry of those that believe wholeheartedly in this questionable product. The annuity’s death benefit is often pointless or superfluous. Simply, each year on the anniversary date (March 18th), the death benefit value is “locked” if worth more than the initial investment. Assuming the client died on 3/31/16, the beneficiaries would receive $144,000 which equates to an average annual return of 2.31%.
Benefit Base Value - Guaranteed Minimum Income Benefit (annual expense - .85): This is the value that gets a guaranteed 7% increase each year. However, before you rush to call your annuity salesman, it’s best to understand the true facts.
The GMIB guarantees the income payments when the contract is annuitized (converted into monthly income) based on the Benefit Value ($186,700)....That’s it. The benefit value is arbitrary to the client, especially when the income payments are not necessary to maintain lifestyle. However, even assuming the contract is annuitized, the income payments directly REDUCE the surrender value and death benefit value. So basically, the insurance company is returning the clients own money.
Annuities Are Not Bought, They’re Sold - FORBES
Looking back, the volatility in the market in 2008 was a time ripe for annuity salesman to “pitch” those things investors wanted to hear. Unfortunately, annuities were being sold by insurance sales agents using unethical tactics. Frightened investors and greed from commission based sales representative led to record annuity sales in 2008.
Don’t get me wrong, some annuities make sense in certain situations. However, in order to recommend any investment strategy or product, a trusted financial advisor must understand the overall financial situation rather than focusing on those products that pay the most commissions. With this approach the results of a financial plan should dictate what strategy or products make the most sense.