Getting good financial advice can oftentimes mean the difference between securing a stable future or struggling to make ends meet year after year. Unfortunately, though, what may seem like a good fit for your financial objectives could end up costing you. It is important to get into details to avoid annuity scams and other financial investment fraud.
Because most people don’t want to gamble with their savings, it is essential to find financial vehicles that work well, and to avoid the others, keeping in mind that when something sounds “too good to be true” it usually is!
One area where consumers need to be particularly careful is with annuities. These financial vehicles – which offer tax-advantaged growth and a whole host of other potential benefits – typically also come with a plethora of “fine print” associated with them where the “tradeoffs” are outlined in terms of what you must give up in order to obtain the benefits.
Annuities to Avoid
As insurance carriers bring more annuities on board to keep up with rising demand, the “bells and whistles” associated with these products may initially appear to offer the best of all worlds. But, while you may be lured in with the promise of a healthy return, along with the possibility of guaranteed lifetime income, you need to be careful because these added benefits could actually be traps.
Some of the most common “annuity scams” to avoid include the following:
Variable annuities can be particularly risky for those who are at or near retirement. That’s because the return on a variable annuity is tied to the performance of underlying equity-related investments that are held in the insurance company’s sub-accounts.
While variable annuities do offer the opportunity for market-related returns, the long list of fees that are associated with these financial vehicles can end up taking a fairly large chunk of the gain – if there is any.
Just some of the fees that you can incur as the owner of a variable annuity include:
- Advisor commission. Depending on the annuity, the salesperson who sells it may earn an up-front commission. This, in turn, can equate to an immediate drop in the amount of money you have going to work for you.
- Administrative fees. Many variable annuities have a separate administrative fee. These charges typically go towards covering the cost of service and marketing. On average, administrative expenses on variable annuities can range from .10% to .30% of the contract’s value each year.
- Mortality expense (M&E). A variable annuity is essentially an insurance product. As such, these annuities may offer a death benefit – which in reality is often just a method of paying your beneficiaries the amount – or the remaining amount – of what you put into the annuity. The M&E charges can usually range from .50% to 1.5% each year.
- Investment expense ratio. As a variable annuity owner, you do not actually own the underlying investments. Rather, these are held in the insurance carrier’s “sub-accounts.” In turn, there is a management fee involved for these investments which will usually run from .25% up to 2.00% of the value in the account each year.
- Surrender charges. If you take out more than a certain amount of money from your annuity (typically more than 10% of the contract value) within the annuity’s surrender period, you will be hit with a surrender charge. In some cases, the surrender charges can be in excess of 10%. Typically, the surrender charge percentage will grade down over time until it eventually reaches 0%.
- Rider costs. If you have added any riders to your annuity, you will oftentimes have to pay an additional amount of premium for these extra benefits. Depending on the rider, you may be charged anywhere from .25% to 1.00% of the policy’s value per year.
All told, the fees associated with variable annuities can be as high as 3% – or even more in some cases. This can drastically cut your return in up years and add to the losses in years where the underlying investments perform poorly.
Variable annuities have such a bad rap that well-known financial authorities like Ken Fisher, the chairman, founder, and CEO of Fisher Investments, have been outspoken about just how much they “hate” annuities.
Fisher regularly touts that the “too good to be true” promises made by salespeople pushing variable annuities are misleading at best, and dangerous to one’s retirement and financial future.
Variable annuities are oftentimes rife with “magic” words like guaranteed principal and guaranteed return which have absolutely nothing to do with how the annuity contract actually works.
With that in mind, before committing to a variable annuity – or any type of annuity, for that matter – it is important to read over all of the fine print so that you know what to anticipate. Working with an annuity specialist can be beneficial – particularly if that expert has access to annuities from multiple insurance carriers. That way, you can be better matched with an annuity that truly meets your needs.
“Hybrid” Annuities With Too Many Riders
Over the years, insurance companies have tried to come up with ways to make annuities more appealing to potential purchasers. One strategy has been the offering of “hybrid” annuities. While not exactly a ‘scam’, hybrid annuities often don’t live up the marketing hype.
The term ‘hybrid’ annuity can refer to variable annuities or indexed annuities with income riders tacked on. Annuity companies stray from the path by trying to create one product that offers Income Now, and Income Later, and Safe Growth.
The analogy we’ve used for years is that of the Swiss Army knife- it may have 57 blades, a toothpick and a screwdriver, but not one of them works well. With hybrid annuities, when you combine different characteristics into one product, far too often, all you get is a case where the ‘jack of all trades is the master of none.’
Like other types of annuities, hybrids may contain features like a death benefit, and/or accelerated payouts if you qualify based on a terminal or chronic illness, or you need to reside in a nursing home.
Growth… And Income?
As to the investment component, hybrid annuities can be misleading. You may see them advertised as offering 6 to 8% returns, as well as a way to hedge against inflation. But that’s not necessarily the case. In fact, there are several factors that need to be addressed if you’re considering a hybrid annuity.
First, the growth “guarantee” is not based on the annuity’s contract value, but rather only on the income rider. Also, while there is the opportunity for return based on upside market performance, growth can be limited if the underlying investments do not perform well. In addition, the income riders that are added to a hybrid annuity will oftentimes require an additional amount of premium – which in turn, can lower your overall return.
Many of these annuities come with high fees, including back-end surrender charges, so they can actually be costly – regardless of whether you surrender the contract or keep it for a long period of time.
Overall, while the name “hybrid” might sound impressive – and could lead potential investors into believing they are receiving the “best of all worlds” with all of the bundled benefits – the reality is that these annuities aren’t typically able to live up to their advertised potential.
So here again, before you make what could be an expensive and long-term financial commitment, you need to make sure that you discuss your objectives with an annuity specialist and that you have all of your questions answered before you move forward.
Annuities with Harsh Market Value Adjustment (MVA) Provisions
If you own a deferred annuity and you make a withdrawal, you may find that you’ll incur a market value adjustment, or MVA, that causes the crediting rates to go up or down in response to market conditions.
For instance, if you purchase an annuity that earns a fixed rate of interest, the insurance company will hold these funds in their account for the length of the designated guarantee period.
At the end of this guarantee period, you will typically have a window of time when you will face no withdrawal charges. Likewise, at the end of this period, the offering insurance carrier will typically declare a new current interest rate – or renewal rate. This rate may be higher or lower than your previous rate, based on market then-current conditions. (But it will not be lower than the guaranteed minimum interest rate on the contract).
If you opt to cancel, or surrender, your annuity before the end of the rate guarantee period, there will be a market value adjustment made. This adjustment is essentially for the purpose of protecting the insurance company against investment losses that could be incurred by early withdrawals.
So, while “MVA annuities” do have the potential of offering higher interest rates than traditional fixed annuities, you run the risk of losing that higher rate going forward. This is in addition to incurring a surrender charge on the withdrawal if you do so within the annuity’s surrender period.
How to Find an Annuity that Works for You
Because all annuities can have various pros and cons, it is important to narrow down the one(s) that make the most sense, based on your specific objectives, and to avoid the rest. Doing so, however, can be time-consuming, as annuities typically have a lot of “fine print.”
One way to ensure that you are moving in the right direction – without having to spend hours scouring through small print details – is to work with an annuity specialist who has access to a wide range of insurance companies. That way, you can better ensure that you’ll be getting objective advice, as versus simply being “sold” a product.
At DCF Annuities, we offer good solid education regarding how different annuities work – and how they may, or may not, be right for you. So, if you’re in the process of considering an annuity, but you still have questions or concerns, Contact DCF for more information.