The Benefits And Risks Of Annuities

Shawn (00:00): Are you curious about the real story behind those free steak dinner invitations for annuity seminars? Well, in today’s episode, we will uncover the benefits and risk of annuities and why you should be cautious when attending those enticing events. Let’s get some perspective. Welcome to another episode of Christian Financial Perspectives. Today we’re going to be talking about annuities, which we’re kind of surprised that the last time we covered this topic was about two years ago. So I guess time flies when you’re having fun on a program like this. Bob (00:38): I guess so, because it does seem like we talk about annuities more often, but I think it’s because I’m getting free steak dinner postcards. Every week, I get at least two of them. Sometimes I get three of them, and I’m always telling Rachael, “Hey, maybe we ought to go to one of these.” Shawn (00:55): I told you last time one came through, I’d be happy if Rachael would go with me since she was the one invited. I would love to go and just listen to the pitch. Bob (01:04): And then ask questions. By the way, most of the time they’re framed in a point of about estate planning or they’ll be…like you think you’re going into an estate planning workshop or you think you’re going to something on lowering your taxes or getting more social security. It’s always kind of a twist. And then I always go look at the bottom of the postcard. In tiny, tiny print, it starts talking about annuities and insurance claim paying abilities. So Shawn, today, it has been a couple years since we just had a full program of annuities. Shawn (01:38): Because annuities get mentioned. It’s a financial product. So it gets mentioned in many other episodes. Bob (01:44): And all of our listeners and I know my clients, they get all the invitations every week, too. So we’re going to talk about the benefits and the risks. I think it’s important. There are benefits definitely. So we don’t want to just come out it being all negative. There’s some great benefits in annuities. Shawn (02:01): We want to try to give everyone listening, watching – whatever that might be – an objective fiduciary perspective on annuities. So that’s why I say the benefits and the risks because if you go to one of those events with the free steak dinner, you will not hear about any of the risks in a objective clear manner. Bob (02:22): That’s true. Shawn (02:23): So hopefully this will help. Full disclosure, we do have some annuities that we help manage for clients, but they are a very specific type of variable annuity. It’s for tax purposes. It doesn’t have a lot of extra fees. There’s no commissions. Exactly. Bob (02:37): I’ll read the scripture today. It’s kind of interesting how it goes with this. Okay. You’ll see how it goes with this later. Definitely. And maybe we will read it again it at the end. So it’s 1 Peter 5:8, “Be of sober spirit, be on the alert. Your adversary, the devil prowls around like a roaring lion seeking someone to devour.” Okay, so I thought of this because many times these high commission salesmen are kind of out there looking for something to devour. Shawn (03:09): Yeah. Well, and just do some basic math, Bob, right? You have these annuities that most of them are going to pay a commission of say up to 10%. Well if you send out 10,000 flyers/annuity invitations to a steak dinner, you spend what? Maybe $10,000? Oh, Bob (03:27): Well you’re going to spend probably $10,000-15,000 just to get the people there. Shawn (03:31): Then of the 10,000, let’s say a hundred people respond and you actually have a steak dinner for a hundred people, you only need what, one or two people to agree to spend a $100,000 to $200,000 on an annuity and you’ve paid for the whole thing. Bob (03:45): Gosh. I’ve heard people putting $500,000 in one of these annuities. And so right off the bat, I mean they could make, let’s say they’re just getting a low of a 6% commission, that’s $30,000 right there that they get back. By the way, they always say, no, we don’t get paid a commission. That’s a lie. Shawn (04:03): You get paid by the annuity company. I mean that’s the commission. Bob (04:07): Alright, well let’s go over the benefits. I want to cover the positive sides first, the benefits, and then we’re going to cover the risks of annuities because there are some major benefits and I think the very first benefit is one of the major benefits for dollars that or you’re having to pay tax on, and that’s because you get number one benefit is tax deferral. Shawn (04:29): Similar to the tax deferral that you get in an IRA. So once it’s in that annuity, even if it wasn’t originally qualified or tax advantage money, you do get that benefit within the annuity. So the growth, the interest of dividends, it’s sheltered from the taxes until you want to spend it by withdrawing the money. Bob (04:47): So why would you put IRA money then into an annuity? Shawn (04:52): That’s a good question. I don’t really have a good answer for it. Bob (04:54): You get deferral twice, but you only need it once. Shawn (04:58): So really the only reason you would use it for the tax deferral is if it’s non IRA money in the first place. Bob (05:02): That’s correct, yeah. Or non 401k money. By the way, anytime we mention qualified and non-qualified, what that means is qualified money has tax deferral. It’s like a 401k, a 403b, an IRA, Roth IRA. Those are qualified plans. And then non-qualified would just be like what you have at your bank and you have to pay tax on it. Or if you have a brokerage account and you have to pay tax on the dividends. Shawn (05:30): Yeah, individual brokerage account, joint brokerage account, whatever it might be. So the second benefit, guaranteed death benefit. Bob (05:36): That’s a big benefit. I just had a person I talked to, gosh about four days ago and they were in and they had about $700,000 in an annuity and they said that’s the reason they did it was for the guaranteed death benefit. But what you got to understand is that you’re paying for that if you… Shawn (05:55): Well, similar to life insurance. There’s a cost of providing that death benefit. Bob (06:02): If you’re buying an annuity strictly for the tax deferral and then you want the layer of a guaranteed death benefit on that, you’re paying an annual fee for that. By the way… Shawn (06:12): Those hidden fees that are expenses, expense ratio, whatever you want to call it, but they’re fees that are affecting your long-term growth. Bob (06:21): You remember me telling you, I went and looked at the benefits of annuities and I pulled up an article that was by annuity.org or something and it said annuities have no fees and I couldn’t believe it. Shawn (06:33): And you were looking for the disclosure of like, well hold on. Obviously, they do. Bob (06:40): Huge. Shawn (06:41): They all have some kind of fee. Bob (06:44): Right. I could not believe what I was reading. I mean just pure deceit and lies. I don’t know how else to say it, but that is a benefit. You get tax deferral, you can add on a guaranteed death benefit if it already has that built in, you’re paying for it. And we will explain that here in a minute. A third benefit is a guaranteed withdrawal benefit, and don’t get this mixed up between that’s what it’s paying you. I’ve had people say, “Well it’s giving me a guaranteed withdrawal benefit of 5%.” I said, “Well, isn’t that nice? You’re getting a guarantee that you can take back 5% of your money every year?” That doesn’t mean that it’s growing at 5%. That means you can take it back at 5%, but they’ll call it a guaranteed income benefit as well. But it has to do with, gosh, I get to take 5% of my own money or 4% of my own money every year. So it’s going to last at least 20 years if it’s making 0% for sure. Shawn (07:40): Yeah, that’s right. And really the only time the annuity company would be on the hook for anything is if you happen to get to the point in your life where you’ve withdrawn more than what is remaining in the account because it is a guaranteed withdrawal benefit. So at that point, okay, now they’re on the hook, but I’ve yet to see someone that actually lived long enough to withdraw it down to zero and then the annuity company still had to keep paying the withdrawal benefit. So really you just withdrew your account down to zero. Bob (08:11): So if you do the math, Shawn, you think about that, the annuity company’s basically saying, well, we need to make something in the next 20 years because if you’re pulling 5% a year times 20, you’re going to take out 100%. So yeah, I would hope that it would make something in 20 years and it will, I mean be realistic. Shawn (08:31): Let’s go into our fourth benefit before we go over the basic types of annuities. It can be low cost. Bob (08:35): Yeah, they can. Shawn (08:36): So most importantly, low cost commission free advisor annuities are available without any surrender penalties from day one, but they are not promoted as heavily like the high commissioned ones. Bob (08:47): I don’t think you would ever go to one of these free steak dinner workshops where they had to pay $10,000 to get you there from all the invitations. I mean they’re not paying $10,000 just for you. I understand that. Shawn (08:59): But to get the group together. Bob (08:59): But to get the group, by the way, you said 100. You’re lucky if you get 25 or 30 if you mail out 10,000 today because people do get so many of them. They can be low cost and it can give you these benefits. So as an example, we have a low cost advisor annuity. It’s just $20 a month and you get all… Shawn (09:19): The normal benefits of an annuity. Bob (09:21): Tax deferral. If you want to add on the expenses for the guaranteed death benefit or guaranteed income benefit, you can, but it’s disclosed and it’s very clear and upfront. Okay. Shawn (09:30): And there’s no commission involved with it. Alright. So the three basic types of annuities are, number one, fixed interest rate annuities, much like a cd, but the interest is tax deferred until you want to withdraw it. And then number two, fixed indexed annuities. These types of annuities are linked to capture some, but not all, some of the returns from a stock or bond index that you choose. And today, some offer many indexed options. Bob (09:56): This is the biggest, probably, annuity that’s sold today. Now this is where they’ll say, well, there’s no expenses. Well, so let me ask you. You get to choose an index, like you can choose an S&P 500 index or you can choose a small cap index or a large cap or an international index. So let’s say you choose the S&P 500 index. Let’s say it was a really, really good year like we’ve had in the last couple of years and that S&P 500 index, because of a few companies that really drove it, went up 15%. Well, if you chose that 15%, but you only got back say 3% or 4%, where’d the other 9% go? Shawn (10:33): To the annuity company? Bob (10:33): Exactly. Well wait, there’s no expenses. Shawn (10:38): Exactly. Bob (10:38): It’s just the math. I mean anybody that makes the comment that there’s no expenses to these is outright lying. And then the third type of annuity is a variable annuity, and that’s very simple. It’s kind of like a 401k because that performance depends totally on what you choose. You’ll usually have over a hundred investment choices in it from small cap, the large cap to sector funds like utility or an energy fund or a technology fund. But whatever you pick is going to go up and down with the markets. Shawn (11:11): Really again, they do vary. Like we were talking about before, there are some that have very low cost or like a fixed just 20 bucks a month kind of a cost. But very similar to if you had a brokerage account or you had an IRA, whatever the investment options are that you choose to invest in, that’s what ultimately determines the overall value of it. But since it isn’t an annuity, if you had a variable annuity for non-qualified non-tax advantaged money, wasn’t already an IRA, then it allows you to invest that more similar to if you had that in an IRA as a normal brokerage account. Bob (11:46): Yeah, that’s correct. Shawn (11:48): That’s where that could be helpful. But the annuities are always limited to, there’s what they almost call, basically they call them subaccounts, but it’s not just you can invest in any stock and mutual fund and ETF that you want. Well, these are what are available for that company. Bob (12:03): Right. You can’t invest in individual stocks in a variable annuity. Okay. Shawn (12:07): So the risks. Bob (12:08): Okay, so we talked about the benefits. We’ve talked about the three types. Now we come to the risks. Shawn (12:13): The majority of annuities have hefty surrender penalties because of the high commissions they pay salespeople to sell them. So you could be stuck for many years without getting back what you invested. And pretty common would be if it’s a five-year surrender penalty, then it means most likely it was a 5% commission to the person who sold it. If it’s a 10 year surrender penalty, probably a 10% commission. Bob (12:36): 8-10%. Yeah. Shawn (12:37): 8-10%. Exactly. So that’s just something to keep in mind that if they have a high surrender penalty and someone told you there’s no cost or there’s no fees or they’re not making a commission, well they lied to you because that’s why there’s a surrender penalty. Bob (12:51): And they always come up with the excuse, “Well, you don’t have to pay anything, you don’t pay me anything.” That’s true. The annuity company pays them, but if you want your money back, you do pay them. You put in a 100k. Now all of a sudden, if you want that a 100k back a few months from now or even a year from now, and it’s made 5%, 5% plus 100 is $105,000, but you want your money back, you’re only getting 92k. So what’s the deal with that? Shawn (13:12): Bob, based on that logic that you’re not paying the salesperson anything, that’s the same thing as if I go and buy a car and the car salesman says, “Well, you’re not paying me anything.” No, of course I’m not paying you anything. I’m paying the dealership for the car and they’re paying you, so you are getting paid by me. Bob (13:30): And as soon as you drive that car off that lot, it’s less in value because of the sales charges that you had to pay. Shawn (13:37): So number two, many have very high annual fees that can reduce your annual returns. This is primarily true of fixed indexed and variable annuities with guaranteed withdrawal and or death benefits because it costs money to provide those benefits. Bob (13:51): If you do a little research, you can find this yourself. I mean, you’ll find that these can get as high as 2.0-2.5% a year. So if your money’s making 7% and you’re paying 2.5%, you’re giving up nearly a third of your return. Shawn (14:03): Now you’re getting a lot less actual net return. Bob (14:06): Because of those high fees. Number three, this is a big one that a lot of people don’t realize is they’re not heavily regulated as far as the fixed and fixed index. The variable is because it’s a securities product, but the fixed and fixed indexed annuities are not a security product, therefore they’re not heavily regulated. Shawn (14:26): They’re considered an insurance product. So if you have an insurance license, which is a lot easier to get and a lot less regulation compared with actual investment products, just about anybody can sell them. Bob (14:37): So the unfortunate thing because of this is deceitful sales practices are very common in this field and a lack of regulation and required disclosure about what you are getting into. Shawn (14:49): Just as a general rule of of thumb, if someone is recommending a product to you or service to you, and they are compensated directly based on how much they can convince you to buy of said product or service, they have a monetary incentive to do what’s best for them, not what’s best for you. And that’s the case, especially with the fixed and fixed index annuities. That’s the case. They’re not a fiduciary advisor, they’re not doing what’s best for you that happens to align with their interest. They’re doing what’s best for their own interest, even though some people might be legitimately trying to help. The problem is there’s still that built in high monetary incentive to do what’s best for the salesperson, not the customer. Bob (15:31): It’s called a conflict of interest. Shawn (15:32): Exactly. So number four, which goes right into that, annuities can pay high commissions. So the ones that do are heavily promoted through the free workshops. They give you these expensive meals to entice you to come. Salespeople, they’ll spend $7000 to $10,000 or even more depending on how many they actually mail out for invitations. And then the cost of buying the meals and the marketing because they know they can easily make back their cost with very persuasive and high pressure presentations on just one single annuity sale because of the commissions. So they get a few sales, they are way ahead. The typical commission is anywhere from 5% to 10%. The annuity company pays a salesperson as soon as the money is invested. So just think about it, one $500,000 annuity can make a salesperson between $35,000 and $50,000 as soon as they get someone to write the check to the annuity company. Bob (16:23): Isn’t that amazing? Shawn (16:25): Yeah. For comparison, we’re a fiduciary investment management company. We charge a maximum of 1% on assets that we manage per year, but that means for a 5% commission, we’d have to manage the assets and maintain a good relationship with our clients for five years to get the same that an annuity company would pay a salesperson day one. Bob (16:47): That’s interesting what you said there, too. We have an incentive to maintain the relationship. They’ve been paid. Shawn (16:55): They’re gone. Bob (16:56): And maybe they’ll have a little bit of what’s called a trail commission, but it’s not anything like that 5% or 6% upfront. Shawn (17:04): Sometimes it’s what, a quarter of a percent, maybe, per year? Bob (17:07): Exactly. So those conflicts of interest are really out there. Shawn (17:13): That’s our fifth risk. The high commission annuities create a huge conflict of interest between the salesperson and you, the customer. So here’s the conclusion of the benefits and risk of annuities. Bob (17:24): We’re down to the end now. Shawn (17:25): There’s only four, so stick with us. Don’t be fooled into attending persuasive, free steak seminars that don’t tell you the whole story. Bob (17:33): If you have a friend that’s gotten one of those and they said they’re going, I would advise them not to go. They’re pros at what they do. They go to workshops by the annuity companies and learn how to say the right words. Shawn (17:47): It’s the same kind of tactics as the, I just blanked on it, the timeshares. You get in one of those timeshare places and it’s almost impossible to escape. They try everything in the book to like, “Well, are you too dumb to see a good investment?” Or, “You can’t make a decision.” Bob (18:06): They start saying stuff like that. Shawn (18:08): “You’re wasting my time. Well, don’t you want this?” Blah, blah, blah. Bob (18:11): So we got number one, don’t be fooled. Number two, please be on your guard against every kind of deceptive sales practice they can think of to sell you that. Number three, I advise to do your own independent research. Search for terms like “high commissions and annuities” or “annuity scams” on the internet, and you’ll see a lot of articles. Shawn, I noticed when I did this, I found a lot of articles by different states, the government has gotten involved in saying, “Be careful of these scams.” Even cities have said, “Be careful of these,” because there’s a big concern because it’s taking advantage of elderly people. Shawn (18:51): That’s right. Do your own research. As much as we want to be a trusted source of education in the area of finance, don’t just take our word for it. Look this up. You can find the proof. It’s out there. If it’s www.AnnuitiesAreAwesome.com, and it’s telling you that they’re totally fine to invest and there’s no fees, well, okay, consider the source of what you’re researching. Bob (19:11): I think this last one is one we want to end up on a good note. There are a few good commission free, low cost annuities out there offered through fiduciary fee-based advisors. But the temptation is so much greater to sell the high commission because you’re going to get 10 to 20x more upfront. Shawn (19:30): Yeah, exactly. We hope this has been informative for you today, and please if you hear of any of your friends that plan on going to a free steak annuity workshop or a free steak estate planning workshop or whatever it is that they want to call it, but the key in there is that “FREE really nice dinner”. Bob (19:48): And look for the fine print at the bottom of the postcard. Shawn (19:50): Warn them and if anything, maybe tell them to listen to this episode on the benefits and risk of annuities and hopefully it’ll save them. That’s all for today. As always, thank you for being here and God bless. See you next time. [DISCLOSURES] * Investment advisory services offered through Christian Investment Advisors Inc dba Christian Financial Advisors®, a registered investment advisor registered with the SEC. Registration as an investment advisor does not imply a certain level of skill or training. Comments from today’s show are for informational purposes only and not to be considered investment advice or recommendations to buy or sell any company that may have been mentioned or discussed. The opinions expressed are solely those of the hosts, Bob Barber and Shawn Peters, and their guests. Bob and Shawn do not provide tax advice and encourage you to seek guidance from a tax professional. While Christian Financial Advisors® believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability.