At Fisher Investments, we hate most annuities—particularly deferred annuities. But most brokers love them.
Why? Deferred annuities pay—for brokers! Commissions can run as high as 10%! That's a huge incentive for brokers to sell them to as many people as possible, and it’s easy to fall for their pitch. Now, maybe you don’t care how much the broker gets paid. After all, we’ve all got to make a living somehow. But why does an insurer have to offer such high payouts? If the product is so great, they should be an easy sale—meaning the insurer would pay very low commissions.
Otherwise intelligent and careful-with-money investors can be snookered by fancy annuity lingo. Income you can’t outlive! Attractive! Fancy features! A guarantee. So why should you hate most deferred annuities? In our opinion, they are often a Trojan horse, with the guarantee often amounting to nothing more than a sales pitch.
Fisher Investments offers an I HATE ANNUITIES™ conversion program designed to help you understand the details surrounding your annuity to determine if it’s a suitable investment given your financial goals. If appropriate, we can help you transition to a more sustainable investing strategy. To find out more, call us at 800-940-0182, or click here to complete a brief information request form.
An old saw says annuities aren’t bought—they’re sold. Often, in our view, mis-sold! Brokers peddle them by playing on emotions, usually with little regard for the client’s best interests. Scared of volatility but want growth? Indexed annuities often advertise stock market participation with no downside. Need growth but worried about the market killing your retirement income? Variable annuities advertise market returns and guaranteed withdrawals. Tired of stock volatility altogether but want something higher-yielding than bonds? Fixed annuities are just the ticket!. Brokers say all this and more, using buzzwords like “guaranteed” to hook you. But if you bite, you may find yourself stuck in an expensive, illiquid, inflexible product that’s frequently better for your broker than you. That’s why we hate most deferred annuities, and you should too.
Take indexed annuities. They advertise market-like returns* when stocks are up, with a floor to protect you if stocks decline. But the preceding asterisk refers to performance caps and/or participation rates, which severely limit your long-term return. Many cap the annual return at rates lower than the market’s long-term average.
Average returns aren’t normal—most years are up big or down, and up far more often than down. In 2013, a hypothetical indexed annuity tracking the S&P 500, with a participation rate of 30%, would have returned about 9%—but the index did 30%.i Over time, the opportunity cost can cost you much more in upside return than you’d gain from a price floor during a bear market. And caps and participation rates can change annually—making it difficult to find their true value. The person selling you that annuity may not even fully grasp how these factors can decimate your return. After all, the explanation of how they work is usually buried deep within thick brochures chock full of legalese.
Variable annuities, by contrast, don’t have a ceiling limiting growth, but can carry huge internal costs and fees. Read the prospectus—a lengthy tome typically written in legalese—and you’ll find layers of fees. An annual administrative fee. An annual mortality and expense fee. Subaccount fund management fees. If you want the guaranteed minimum death benefit or lifetime withdrawal benefit, those will cost you, too. Even if you never activate them! -
Over time, these fees add up. Let’s say you invest $1 million in a variable annuity with a 70% global equity and 30% fixed income strategy in the subaccount in 1995 and let it grow through 2013. Without fees, that $1 million would have grown to almost $4 million. But a hypothetical variable annuity’s annual fee of nearly 4%—not uncommon—would knock nearly $2 million off your total return (Exhibit 1).
Exhibit 1: Hypothetical Fees Effect on Returns
*70% MSCI World Index/30% BofA Merrill Lynch US Treasury Index. Performance is presented inclusive of dividends and interest.
^Hypothetical investment equivalent to the above blended index, less assumed annual annuity expenses of 3.95%. The assumed annual expenses include Mortality & Expense Risk of 1.18%1, Administrative Fees of 0.19%1, optional Guaranteed Minimum Death Benefit (GMDB) of 0.61%2, optional Guaranteed Lifetime Withdrawal Benefit (GLWB) of 1.03%2, and Fund Expense for underlying funds in a variable annuity of 0.94%2.
Source: Fisher Investments Research, Morningstar Inc., SEC, Insurance Retirement Institute.
Now, you might say, “Well that’s ok—I’m getting a guarantee! It’s worth it.” But what’s really guaranteed? It may not even be returns! Variable annuities’ subaccounts—whether invested in equities or fixed income—are exposed to the market. They can decline in value. What’s really guaranteed is the income withdrawal rate—usually a minimum percentage of your investment that you’ll be allowed to withdraw each year once you annuitize. Or maybe the death benefit or other minimum withdrawals. (If you pay for them.) What’s more, insurance companies aren’t impervious to default—AIG comes to mind.
Unfortunately, by the time many annuity owners realize this, it’s tough and costly to get out. Most indexed and variable annuities have “surrender charges,” which can start as high as 15% for indexed annuities before declining over the life of the contract. To ditch a fixed annuity prior to term, you might incur a market value adjustment if interest rates have risen. Why is a high surrender fee necessary? To make sure you fund your broker’s huge commission—another reason you should hate annuities!
If you’ve worked hard for a comfortable retirement, you probably want your money to fund that retirement—not your broker’s! Good as brokers and sales materials might make annuities sound, there are likely better, cheaper, more efficient ways to reach your goals.
Learn more about Fisher Investments I HATE ANNUITIES™ conversion program by calling us at 800-940-0182, or completing a brief request form. Our professional advisers can help you understand the details surrounding your annuity and help you transition to a more sustainable investing strategy if appropriate.
iSource: Factset. Annual S&P 500 total return in 2013 was 32.4%, rounding down to 30% here for simplicity.