#annuities

BFSG’s CERTIFIED FINANCIAL PLANNER™ professionals, Michael Allbee, CFP® and Paul Horn, CFP®, CPWA®, were invited to be guest speakers for the “It’s Your Money!” workshop series. For the “Investment World” session, Mike and Paul focused on how the investment world gets compensated. Learn the differences between brokers versus advisors, what does the word “fiduciary” mean, how to find an advisor, and most importantly how certain products are sold, and the way brokers/dealers are paid. Watch the replay by clicking here.

The “It’s Your Money!” workshop series is hosted by Peter Kote for his not-for-profit Financial & Estate Literacy. These workshops educate seniors to take control of their #financial, #estate, and #charitablegiving decisions. You can check out the entire spring series here.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

(This is the fourth article in a four-part series. Click here to read Part 1, Part 2, and Part 3.)

By:  Henry VanBuskirk, CFP®, Wealth Manager

Everyone’s had that story of their friend or family member that said they got shafted by some seedy financial advisor. However, there is a huge difference between what is legal and what is ethical. The majority of these “seedy” financial advisors are still following the law as constructed, but unfortunately, most of the time it’s up to you to ask questions and know what you’re buying even when buying a product as intangible as financial advice. It’s important to work with a team that is legally required to act ethically and know that they are in danger of losing their business and professional licenses if they don’t put your interests ahead of their own.

Take, for example, Mr. and Mrs. Impulsive. They are emotionally driven decision-makers that have $200,000 across investment accounts and bank accounts and spend $100,000 per year. Mr. and Mrs. Impulsive make $120,000 per year but are under duress since they want to pay for their 5-year-old’s college tuition in the future and aren’t sure how. On a whim, Mr. and Mrs. Impulsive meet with a financial advisor her friend recommended and he recommends buying a $750,000 cash-value life insurance policy and paying for the future college tuition through cash-value loans on the life insurance policy. There are no mentions of alternative savings vehicles for minors, such as 529 plans or UTMA accounts, just a life insurance illustration. The specifics on why the life insurance recommendation is not appropriate are not important for purposes of this whitepaper, but what is important is to illustrate why the recommendation may have been made in the first place (the example I am using is based on a real client we met with recently). Here are two pages of the illustration that illustrates why:

If your eyes glazed over these diagrams and the Charlie Brown Teacher “wha wha whaaa wha” started going off in your head, don’t worry. The reason this recommendation is most likely not appropriate is simple. Notice the TP and Target Premium numbers of $20,078. That’s how much the financial advisor would be paid upfront in gross commissions if the client agreed to move forward with the life insurance recommendation. The insurance agent would then get a residual gross commission of around 2% ($401.56/yr.) or so after the first year. Not a bad payday for a couple of hours of work and usually explains why it is generally hard to have ongoing life insurance servicing 5+ years later. Also, Mr. and Mrs. Impulsive would have to pay $53,018.81 for 7 years to fund this policy and they won’t have the liquid cash available to do so. Some other alternatives to save for college are a 529 plan or a UTMA account, which can be done for a fraction of the cost. Note: BFSG does not sell any product, nor do we receive any compensation from any source other than our clients. This helps us strive to always put our clients’ interests first and to remain objective. 

Annuities:

Mrs. Impulsive knows that she needs to talk to her husband before signing the paperwork.  Mr. Impulsive during their conversation thinks about their plans to retire in 10 years but is concerned about the current market volatility.  He likes the sales pitch by the financial advisor and decides to meet with him to discuss this. The financial advisor asks, “Did you want to move forward with the life insurance recommendation?”. Mr. Impulsive says, “Mrs. Impulsive and I need more time to think about this. I wanted to ask you about our retirement plans in 10 years, but I am concerned about market volatility.  Do you have any suggestions?”. The financial advisor then proceeds to recommend moving $200,000 to a Fixed Indexed Annuity and taking withdraws from it in 10 years. The financial advisor exclaims, “The withdrawals of $10,935 would be guaranteed for the rest of your life. Keep in mind that you would be subjected to surrender charges if you took more than 10% of the contract value in any one year within the first 10 years (this is called a surrender schedule).”. Here is an illustration (again a real client situation).

Again, the reasoning why the recommendation may not be appropriate is just as important as why the recommendation may have been made. A fixed indexed annuity commission is paid out in schedules that the advisor chooses. Since the annuity is a 10-year annuity, the commission schedule is 10% over that 10-year period and most likely would be one of the following schedules (as permissible by the insurance agent’s brokerage firm). The annuity commission over a 10-year period is 10% regardless of what Schedule is chosen:

1. Schedule A: 10% upfront gross commission and no trailing gross commission
2. Schedule B: 7% upfront gross commission and 0.333% trailing gross commission starting in year 2
3. Schedule C: 3.5% upfront gross commission and 0.667% trailing gross commission starting in year 2
4. Schedule D: 1% upfront gross commission and 1% trailing gross commission starting in year 2

The calculus on which Schedule the agent wants to choose is frankly dependent on how long the agent actually wants to work with the annuity purchaser. Annuities, like cash value life insurance, are not inherently bad recommendations, but they are typically oversold since they are easy money for the agent or advisor selling them. The financial advisor didn’t mention that annuities can come in the form of advisory annuities, where no commissions are paid out and the advisor is paid based on an agreed-upon percentage of the annuity’s account value and there is no surrender schedule.  The financial advisor might not be properly licensed to sell advisory products, so this might be the reason why this was not mentioned. In any case, Mr. Impulsive stops thinking with his amygdala and starts utilizing his frontal lobe. He tells the financial advisor, “So let me get this straight.  For meeting with us for 4 hours, you’re about to make at least $40,078 off of us if we sign this paperwork. Thanks, but no thanks. We will find a different financial advisor to work with.”.

Mr. and Mrs. Impulsive then learn that there are alternative methods for saving for retirement. They also learn that crafting a comprehensive financial plan can help indicate how to save for retirement in a realistic way and how aggressive or conservative you want or need to be. The issue with annuities is advisors that pigeonhole everyone nearing retirement to make them buy an annuity or obfuscate the story to make it seem like the prospective client has to be conservative near retirement in order to make their financial plan work. This leads to advisors who overuse and oversell the annuity, leading to upset prospective or current clients that may have never needed an annuity in the first place. This is not illegal, just unethical from our point of view. To distance ourselves from this potential conflict of interest, BFSG does not sell annuities or life insurance.

Key Takeaways from this Series:

The problems that we’ve addressed in this series are:

• Advisors sometimes do not know the ramifications of the advice given.
• Clients sometimes do not question the validity of advice received.
• Clients not understanding how the person giving the advice gets paid. 

Comprehensive financial planning is a meticulous, collaborative process between planner and client. If you’ve seen yourself in one of the examples we listed in this series, we offer you to reach out to us for a complimentary financial planning meeting so we can discover what your unique needs are, what assets you have to work with, and how realistic your financial goals are. We offer objective advice and are a fee-only RIA. We do not sell any product, nor do we receive any compensation from any source other than our clients.

We are a team of CFP® professionals, CPAs, CFA® charterholders, and PhDs ready and willing to help you on your journey.  We look forward to working with you to help you achieve your financial goals and grow our wealth of financial planning knowledge with you.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

BFSG’s Senior Financial Planner, Paul Horn, CFP®, CPWA®, was invited to be a guest speaker for the “It’s Your Money!” workshop series. For this session, Paul focused on two of the most heavily sold products by financial brokers/dealers: #annuities and #mutualfunds. Learn the basics and what to look for by clicking the link https://youtu.be/yl7yxCQZ-Ho.

Is an annuity right for you? Find out by clicking here.

The “It’s Your Money!” workshop series is hosted by Peter Kote for his not-for-profit Financial & Estate Literacy. These workshops educate seniors to take control of their #financial, #estate, and #charitablegiving decisions. You can check out the entire fall series here.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

By: Arash Navi, CFP^®, CPA

It is estimated that half of all children born today in the United States and Europe will reach their Centennial birthday. The number of Americans living past their 90th birthday will triple in the next 30 years. Consequently, it makes sense that the number one worry of retirees is running out of money!

Unlike previous generations, many employers don’t offer traditional pensions and Social Security payments are estimated to equal only about 40% of pre-retirement income. There is also the uncertainty around whether or not Social Security will be available decades from now. So, it is natural that many people are looking for other “guaranteed” sources of income to supplement their retirement needs. This is where annuities come in to play.

What is an annuity?

An annuity is a long-term financial contract between an insurance company and an annuity owner whereby the insurance company guarantees a stream of future payments in exchange for an investment now.

Different types of annuities?

Immediate Annuity If you choose an immediate annuity, you typically begin to receive your stream of income shortly after your initial investment. Individuals nearing retirement tend to consider this option as a supplemental income to Social Security.

Deferred Annuity This type of annuity is structured to help investors accumulate capital over their working life and defer taxes on those earnings during that period. It offers the ability to turn these assets into a stream of income at retirement or later in life.

• Fixed Annuity – A fixed annuity provides a guaranteed amount during the payout period with relatively low risk. For older contracts, the rate of return may be around 3% or more but new contracts are often under 1%.

• Variable Annuity – A variable annuity provides a return that is generally tied to a performance of a portfolio of mutual funds that the annuity holder chooses. You carry the investment risk and have the potential to make or lose money. Often, they offer a guaranteed minimum rate of return but at the same time may cap the maximum amount of return as well.

• Indexed Annuity – An indexed annuity is similar to a variable annuity, but the rate of return is tied to the performance of a stock index such as S&P 500. Therefore, you can benefit if the stock market is performing well. Depending on the insurance provider, your investment may be subject to a minimum and maximum rate of return.

Advantages of annuities?

The main advantage of annuities is that it allows you to defer incomes taxes on the earnings from your annuity investments until you begin receiving your stream of income. Also, there is no annual contribution limits, so an individual is able to put away more money for retirement. This may be particularly appealing to investors who have maxed out their annual 401(K) and IRA contributions and/or are nearing retirement. Another benefit is that you are not subject to mandatory withdrawals (unless the annuity is qualified – like a retirement account) at a certain age and have the flexibility to choose how you’d like to receive your payments. Finally, annuities’ insurance feature can be a great estate planning tool. The death benefits to the beneficiaries in most cases will not be subject to probate and estate taxes.

Disadvantages of annuities?

The main disadvantage of annuities are the fees involved. A typical annuity is sold by an insurance broker who makes hefty commissions on it. In addition, annuities are subject to surrender charges which means if you change your mind and decide to withdrawal your investment earlier than planned, you will have to pay a penalty (most annuities allow you to withdrawal 10% of the contract value per year without penalty). Depending on the type of annuity you choose, you may face high annual fees (and even higher if there are any rider guarantees) which will further erode the rate of return on your investment. Variable annuities typically have higher fees since the potential growth is uncapped and you have the underlying mutual fund fees. Finally, keep in mind that once you began receiving your payments, the annuity gains are taxed as ordinary income versus long term capital gains which may be less beneficial for wealthy investors.

Final thoughts

There are many factors to consider when deciding to purchase an annuity and it is important to discuss your specific financial situation with an advisor to help you make the right decision that best meets your needs. An annuity may not be suitable for a typical investor due to its illiquidity, high fees, surrender charges and low rates of return. However, the possibility of higher estate taxes and longer life expectancy could make this an appropriate retirement and an estate planning tool for some.

Recently, BFSG’s Senior Financial Planner, Paul Horn, CFP^®, CPWA^®, was invited to be a guest speaker for the “It’s Your Money!” workshop series put on by not-for-profit Financial & Estate Literacy. Learn more about annuities by clicking HERE. Feel free to reach out to us if you’d like to learn more!

Additional Sources:

https://www.nerdwallet.com/article/investing/annuities

https://www.aarp.org/retirement/retirement-savings/info-2020/longevity-annuities-explained.html#:~:text=A%20deferred%2Dincome%20annuity%2C%20also,you%20will%20get%20each%20month.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

BFSG’s Senior Financial Planner, Paul Horn, CFP^®, CPWA^®, was invited to be a guest speaker for the “It’s Your Money!” workshop series put on by not-for-profit Financial & Estate Literacy. These workshops educate seniors to take control of their financial, estate, and charitable giving decisions. For this session, Paul focused on two of the most heavily sold products by financial brokers/dealers: annuities and mutual funds. Learn the basics and what to look for by clicking HERE.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.