If It Sounds Too Good To Be True... (November 2007)
Variable annuities have exploded onto the market over the last couple of years with marketing and adverting boasting the perfect retirement investment. But are they?
Recently a client came into my office asking why he shouldn’t put all his retirement in a variable annuity that guaranteed a 7% yearly return minimum (if the mutual funds didn’t do well), a lifetime payout interest of 5% to 7%, guaranteed withdrawal for the rest of his life with completely no risk, and complete access to his account. I told him to leave the prospectus and come back in a week. After a week, I discovered that what he understood to be the truth was far from the actual truth.
I find the marketing material on variable annuities to be misleading and filled with half truths. The following is a brief overview of the pitfalls:
• The guaranteed minimum accumulation interest comes with a yearly cost and the value of the account at the end of the accumulation period is not your money unless you annuitize.
• When you annuitize an annuity, the internal rate of return is well below market rates.
• The available mutual funds inside an annuity tend to be poor choices and regularly under-perform their respective index classes.
• Mortality and expense charges piled on top of the mutual fund costs cancels out any tax deferred benefit.
• The GMIB (Guaranteed Minimum Income Benefit) is not interest but is pulled out of principal—you are pulling out your own money. The cost of this rider is used to insure the gap between calculated life expectancy and actual lifetime is covered if you outlive your expectancy.
• If you pull money out of the contract while in the GMIB pay down period you destroy the current GMIB payout.
• If the mutual funds are down when you take money out you can collapse the GMIB rider.
Variable annuities sold through different carriers vary, but most are variations on this basic theme. When looking at an annuity you have to ask, “How is the insurance company giving my client guaranteed interest above market rates and still making a profit? Additionally, how are they paying their sales force and the mutual fund company?” The answer is: they are not. If it sounds too good to be true, it is. You think you are buying a Lexus, but once you drive it off the lot you will realize you own a Hyundai. Caveat Emptor—buyer beware.
*This article is not a recommendation to buy or sell and should not be considered investment advice. Please consult IPS or another financial advisor before making any investment decisions.