As I wrote yesterday, there is precious little good to say about variable annuities. If you want to leave a legacy for your heirs there are better ways to do it. If you want to have income in retirement there are less expensive ways to do it. However, the urge to hold on to your wad of retirement cash, preferably leaving it to your heirs, is super intense in humans. Many people simply want what annuity salesman are selling. Today’s book starts from there.
This one acknowledges right off the bat that they are expensive. This author is sick of fee-only advisors like me being condescending about them making a living selling annuities. Sure, they’re expensive. But it’s what people WANT so us fee-only financial advisors should STFU and give the people what they want. This book, “How To NOT Get Ripped Off When Buying An Annuity” by Alessandra Derniat, introduces the credential “Certified Annuity Specialist”, which appears to mean that she got training on annuities in the years following when she started selling them. Because, as she points out in her book, annuity salesmen are not trained on the actual workings on annuities, they’re only trained on how to sell.
What helps Sandy Derniat sleep at night is that she really believes that there’s value in what she offers that makes it worth the high cost. The value she touts is in the GUARANTEE. You are GUARANTEED this income stream. You get to sleep at night. The fact that I could construct a bond ladder that would guarantee you the same income stream while leaving your kitty accessible to you, the fact that the guarantee has very little actual financial value, the fact that a bit of education could push you past your emotional miscalculations into making better financial choices – those aren’t mentioned in this book. She capitalizes the word guarantee. In her section about what to avoid she mentions that any theoretical or possible upsides should be ignored, since you are buying this product for the guarantee. What goes unsaid is that you should stay in an equity portfolio outside of an insurance wrapper if you’re after upside potential. She’s right: the *ONLY* reason to bear the cost of an annuity is for the guarantees.
It was a good companion piece to yesterday’s diatribe against variable annuities. This one just says, “heh, you want one, here’s what the words mean.”
It was also short, also large print, but easy reading this time. It breaks annuities into three characteristics:
1. Variable or Fixed. Purchaser carries the risk or Insurance company carries the risk.
2. Immediate vs. Deferred. Buying a cash stream or buying a bundle of promises.
3. Single Premium vs. Flexible Premium. This is a characteristic, but not normally a choice. Either you’re buying it now with the cash in your hand or you’re arranging for this to be your investment vehicle going forward (hint: bad idea) and so the insurance salesman might handle it differently but you don’t usually have to decide, you decided before you called the sales agent.
Then there are critical comparison points.
4. What is the Guranteed Income Base? Also called Guaranteed Life Withdrawal Benefit, also called Accumulation Value, Income Account Value, etc. It’s a fictional number used as one of the multipliers we’ll see later. The sales technique is to make it seem large, typically by “guaranteeing” some huge percentage rate like 14% or to double your money in 7 years or whatever to get to it. “You give me $100K and in 10 years I guarantee it’ll grow to $240K.” The $240K in that story is the Guranteed Income Base. This number is supposed to appear so high that the buyer is supposed to have a spark of hope igniting greed in their belly.
5. Guaranteed Percentage Payout. This is different than the “guaranteed interest” you’ll get to turn your initial deposit into the Guranteed Life Withdrawal Benefit. This is the amount of the Guranteed Income Base the carrier will pay out on an annual basis. Some carriers rase the payout each year, some stagger it so it goes up in bands of five year increments, and they bury this number far below the Guranteed Income Base.
6. Which leads to the Guaranteed Payout Amount. Multiply the Guaranteed Income Base by the Guaranteed Percentage Payout to find what you are actually getting. One number alone won’t get you there, you have to multiply item 4 by item 5 to get to where you can compare apples to apples.
7. Then you look at fees. The previous book talks more explicitly about fees, this one talks more about how you get a GUARANTEE for your fees, that the high fees get you what you WANT. She doesn’t really talk much about them. She says, “There may be Mortality & Expense fees, Administrative fees, Contract Fees, Rider Fees, Distribution Charges, and mutual fund loads, among others.” Yes, that’s how the author ended that paragraph. There might be others. Because hiding fees is the art form of this industry.
The author goes on to say you may wish to add riders, being aware that riders all cost money, and sometimes the cost of the riders go up during the term of the contract, so check page 28 in the fine print to be sure. Sigh.
A good rider to consider is a joint-life payout for annuitizing. If you really want to make sure your money gets used by someone who isn’t you, make the annuity payable for life to the second to die. Yes, it reduces your payout, but if you’re sharing that money it makes sense. You can also do some sort of “term certain” for a SPIA, where you knock a bit off the life-time payout to make sure you or your heirs get at least 10 years of payments. Just be aware that you’re effectively buying life insurance at a high price when you do this. A better option would be to set aside some emergency money that you aren’t turning into a pension and leave THAT money to your heirs if you don’t need it.
Sometimes people add riders for Long-Term Care insurance or for a COLA. Every bell and whistle you add costs you money.
But don’t worry, says Sandy Derniat, you shouldn’t be thinking about this as an investment vehicle where you evaluate the return on investment. That’s not how you use insurance. You use insurance to transfer risk, and you pay for that service.
I totally agree with her on that point. After reading this book I understand more of the tricks used to make these vehicles look wonderful, and still can’t quite come up with a whole lot of good reasons to buy them, not when other, better options exist.