The brokerage firms, banks and insurance companies have a product for every situation. Right now the situation is fear and they feed this fear with ‘safe’ products. These firms make money when money moves. They do not make money if investors develop a prudent portfolio and remain disciplined to that strategy. Annuities help people believe their money is safe, when in fact in the long term they lose money. Best advice, stay wawy from annuities.
Souvenir Programme, inside cover (Photo credit: CT State Library)
Any prospective customer who takes the time to understand annuities runs away screaming. A recent report by consulting firm Cerulli Associates puts the matter as delicately as it can: “Information about variable annuity purchases reveals that they do not appear to be based on educated decisions.”
Consider the experience no-load fund giant T.Rowe Price had when it sent potential customers software to help them determine whether variable annuities were right for them. The program factored in the investors age, income, tax bracket and investment horizon — and it regularly told potential buyers that they would be better off in a plain old fund. An educated consumer, as it turned out, was not a good prospect for annuities.
If folks really knew what they were buying, how could you explain the $21 billion of annuities sold in 1996 that went into IRAs? IRAs, already tax-sheltered, benefit not a whit from the annuities deferral feature.
Insurance agents and stockbrokers make a heft commission when selling variable annuities, much more than the commission on mutual funds or stocks. This hugh incentive costs consumers big in the short and long term.
The Equity Index Annuity EIA may sound like a great way to deal with market volatility but beware. In the long run this product will cost you big. When you control one risk you may add another. Inflation risk is perhaps your worst enemy going forward. Financial institutions will promote products that deal with consumer fear rather than advising investors on what is right for them. Finally the additional fees and the foregone dividends will cost you returns in the long term.
Should you pick up the phone and say that Coach sent you? Let’s examine a few issues.What is an Indexed Annuity? Per the FINRA website, EIAs (Equity Indexed Annuities) are complex financial instruments that have characteristics of both fixed and variable annuities. Their return varies more than a fixed annuity, but not as much as a variable annuity. So EIAs give you more risk (but more potential return) than a fixed annuity but less risk (and less potential return) than a variable annuity.EIAs offer a minimum guaranteed interest rate combined with an interest rate linked to a market index. Because of the guaranteed interest rate, EIAs have less market risk than variable annuities. EIAs also have the potential to earn returns better than traditional fixed annuities when the stock market is rising.
Reuters recently ran a piece on these products. A few points raised in the article:
— Hidden fees and commissions. Commissions typically run between 5 percent and 10 percent of the contract amount, but can sometimes be more. These and other expenses are taken out of returns, so it’s hard for buyers to determine exactly how much they’re paying.
— Complex formulas and changing terms. The formulas used to determine how much annuity owners earn are so complex that even sales people have a hard time understanding them, and they can change during the life of the contract.
— Limited access to funds. Buyers who try to cash out early will incur a surrender charge that typically starts at 10 percent and decreases gradually each year until it stops after a decade or more.
–Limited upside. An annuity’s “participation rate” specifies how much of the increase in the index is counted for index-linked interest. For example, if the change in the index is 8 percent, an annuity with a 70 percent participation rate could earn 5.6 percent. However, many annuities place upside caps on the index-linked interest, which limits returns in strong bull markets. If the market rose 15 percent, for example, an annuity with a cap rate of 6 percent would only be credited with that amount.
If it sounds too good to be true it probably isn’t. In addition to the following tips the EIA does not pay you the dividends earned by the index. These funds go to the insurance company.
