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Many investors are apposed to adding annuities to their investment
portfolios even though they offer guarantees not offered with other
investment options. The general public seems to have an adverse
opinion of annuities even though there is very little
understanding. How is this misconception created and
perpetuated?
Who influences our opinion:
Financial Advisors:
Although investors do not pay a commission for an annuity,
advisors who sell annuities receive attractive commissions from
insurance companies. These lucrative commissions motivate many
advisors to make unsuitable annuity recommendations to investors
whose needs may be better suited by utilizing other financial
options that pay less commissions and cost less.
In addition, annuity commissions differ between annuity classes,
products and providers. Higher commissions are better for the
advisor but generally worse for the investor. Higher
commission are usually offset by higher management costs and longer
surrender periods.
Many financial advisors that sell annuities are just agents with
an insurance license; not financial professionals licensed to sell
investments. This is an important distinction. For the
most part, financial advisor are only going to recommend products
they are licensed to sell and earn a commission. When
considering an annuity purchase, ensure the financial advisor not
only has experience but has an insurance license, a series
"7" securities license and is a Certified Financial
Planner (CFP®). The Series 7 license is the most
comprehensive securities license. The CFP®
designation is the most respected designation in the industry with
respect to personal financial planning.
It is not difficult to obtain an insurance license or to complete
an annuity form. Because of this, many people - attorneys,
accountants, other non-professionals, get their insurance
license to sell annuities and earn a quick and easy
commission. Buyer beware! If you are purchasing an
annuity from someone who lacks experience and does not have a series
7 securities license, you could be influenced into making a decision
that is not in your best interest.
Conclusion - We tend to favor advice from people we trust.
People we trust may have our best interested at hand and will likely
offer advice to the best of their ability. Ability is the
operative word. Trust is important, but a person's ability is crucial
to your financial success and security. Ensure the person
recommending an annuity has extensive experience, an insurance
license, series 7 license and preferably is a
"certified" financial planner with the CFP®
designation. In addition, work with an advisor who will meet with
you frequently to review your annuity.
Financial Publications:
Magazines survive by advertising and sales revenue. They
must attract readers because readers increase circulation. A
larger circulation attracts bigger advertising accounts and these
accounts generate more advertising dollars.
Editors know what side of the story sells magazines and it is not
the good side but the bad and the ugly. To attract readers,
writers must provide interesting content and because of this,
publications tend to not only sensationalize a story but present the
story in the most shocking perspective to heighten the readers
interest. This creates a skewed perspective by the reader who
draws misconceived conclusions that are eventually shared with
family, friends and colleagues.
Editors also know what side of the bread is buttered. To protect
advertising dollars, the articles they publish must attract the
readers to the advertisers. Some of the largest advertisers of
financial publications are mutual fund families and one of the biggest
competitors to mutual funds are annuities.
The result? Editors publish articles on annuities from a
very negative perspective. Are all annuities good? No.
Are the good annuities good for everyone? No. Annuities come
in different shapes and sizes and are very complicated insurance
products. Editors can be great writers but writing ability
doesn't make them experienced financial professionals.
Conclusion - Know the qualifications of the
writer. Have they ever been a licensed professional such
as an insurance agent, investment advisor, tax specialist and/or
certified financial planner? Do they have practical
experience? If so, for how long? Are they distinguishing
between an immediate or differed annuity? Is the annuity
fixed, variable or an index annuity. Are they including the
benefits of riders. Are they comparing the cost to other
investment options? If you don't know the answers to these
questions or you do and know the writer lacks expertise, take what you read with a grain of salt. In other
words, don't believe everything you read.
The Mechanical
Complexity of Annuities:
Annuities are complicated insurance products with many moving
parts, options and limitations. They are so complicated, many
advisors that sell annuities lack thorough knowledge.
Prospectuses for variable annuities should be provided by the
advisor to the potential purchasers. Fail to provide a
prospectus is a violation. The prospectus is cumbersome,
confusing and boring. Because of this, very few people read
the prospectus including advisors. Due to the lack of
understanding, investor's misconceived expectations may be adversely
affected by prevailing market conditions creating a negative
experience.
Conclusion - Interview various advisors. Have each
advisor educate you on the product, its options and
costs. An ethical advisor should highlight the benefits of the
product as well as the drawbacks or tradeoffs. The pros and
cons so to speak. A good advisor will manage your expectations
by explaining how that product will compare to other investment
options in different market scenarios. Most importantly, a
knowledgeable advisor can explain why the type of annuity they are
recommending is the most appropriate investment option for you based
on your age, goals, objectives and risk tolerance.
Investor Experience:
Investor experience varies among the type of annuity immediate or
deferred and deferred annuity options - fixed, index and
variable. The mechanics of each one are dramatically different
in comparison with the only common thread being they are all
insurance products - Annuities. An investor investing in an
index annuity may expect average market returns with a minimum rate
of return guaranteed. When the market does extremely well, but
the index annuity reaches its cap rate, the investor opinion of the
index annuity becomes tainted. If they decide to sell the
index annuity, they may incur a surrender charge adding to the distain.
However, an immediate annuity does not invest in the market at
all. An immediate annuity is more like a pension that guarantees
an income for life. Annuitization rates increase as the
investor gets older. An 80 year old may find an annuitization
rate of 10% much more attractive than prevailing CD or money market
rates that could drop adversely effecting their standard of living
when on a fixed income.
Conclusion - If you are speaking to someone who has had a
negative experience, ask what kind of annuity they had, what was
their expectation when they purchased it, what specifically created
the negative experience and what were the prevailing market
conditions.
Common Misconceptions:
They are expensive - expensive is a subjective term.
What might be expensive to one person may not be to another.
Expensive compared to what?
Front-End Load - Unlike a class A share mutual fund that
typically charges a 5.75% commission up front, 100% of your
investment goes to work for you with an annuity. The investor
does not pay a front-end commission for an annuity.
According to Jack Bogle, founder of Vanguard mutual funds,
the average fee for mutual funds both load or no-load, rang between
1.3% and 1.5%. Currently, MetLife's Preference Plus Select or
PPS annuity with a Lifetime Withdraw Guarantee or LWG rider with a
joint survivor option has an annual fee of approximately 2.3% for
the class B option. Is the extra 1% (100 basis points) too much to
pay for a principal guarantee and a guaranteed income for life for
you and your spouse that can only increase in subsequent years
helping to offset the effects of inflation? With this LWG
rider, it is not necessary to annuitize to receive the lifetime
guarantee.
High and long surrender charges - Surrender charges are
like class B shares of a mutual fund. Surrender charges and
periods vary between insurance companies, products, and
classes. MetLife's PPS annuity, class B, has a 7-year
surrender period with a decreasing surrender charge starting at 7%
in the first year decreasing gradually to 2% in the 7th year and 0% thereafter.
Class B shares for mutual funds typically have a 5% contingent differed
sales charge (CDSC) in the first year that gradually decreases to 0%
over a 6 year period. It is important to note that class B
shares of a mutual fund have higher management fees than class A
shares until the B shares convert to A shares when the CDSC drops to 0%
(approximately 6 years). For annuities, the MetLife class B
option has the lowest management fee compared to other class options
for their PPS annuity. If you have a short time horizon,
annuities may not be your best option.
Conclusion - In general, annuities are long-term
investments appropriate for investors that are risk adverse with
longer-term time horizons . Although annuities are appropriate
for many investors they may not be appropriate for you. Know
the product, understand the options and work with an advisor that
has experience and proper credentials before you purchase an
annuity.
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