August 31

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Annuities and Free Steak Dinners

FAMILY UPDATE

My ten-year-old, Jesse, loves his Mommy. He cuddles her each night. When he does he asks her:
"Are you comfortable?"
If she says, "yes," then Jesse says, "Can we have a conversation?"
If she says, "yes," then he says, "Then it's a real cuddle."
We've been watching a show on Netflix on how to train your cats to do tricks. We've been trying with limited success. We have a training table that we use for the dog, but as you can see below Hemingway the cat wants in on the action.

With the present market volatility, annuity salesmen are out in full force. They take advantage of people like you using fear as their main selling point. During scary times, they know that their message is going to get more attention.

Recently I’ve had a few clients move their money into annuities which is so upsetting. They are moving their money from a diversified portfolio of stocks and bonds- which is a powerful, long-term growth strategy- to a far inferior product. Moving money into annuities will cost them a huge amount of gains over time.

I’ve heard the same pitch over and over. Maybe you have too.

"You don’t want to lose all of your money, do you? This could be another 2008. Back then people lost all of their money. You are retired now. Are you willing to take that much risk?" they say.

(In 2008 no one lost all their money. While it was one of the worst recessions since the Great Depression, you would have seen your accounts drop temporarily by 37%. Even then your accounts would have recovered and then some within a few short years later.)

"Don’t you want guarantees on your money? We can offer guarantees," they say.

It sounds great right? Who doesn’t want guarantees on their money?

But the devil is in the details.

These products can only be sold by brokers, not fiduciaries (like me). Brokers get paid commissions. Fiduciaries do not. Brokers can put you into products as long as they are loosely suitable for your situation. Fiduciaries are bound by law to put your interests ahead of their own.

The commissions on annuities are high. Usually around 7%. That’s right. If you put $100,000 into an annuity, the salesman receives $7000 in compensation. No wonder they give you such a hard sell.

Brokers are also notorious for churning accounts. This means that they move people from one annuity to another in order to get paid over and over again.

Annuities come in all kinds of flavors, sizes, and colors. I would argue that annuities are the single most complicated product I see on the consumer financial market. I’m going to make this as simple as possible.

The definition of a pure annuity is actually pretty straightforward. An annuity is a contract that guarantees you a set amount of money each month for the rest of your life.

Social Security is an excellent example of an annuity. The federal government is guaranteeing you a check for the rest of your life. Once you die, the check stops. That is the very definition of an annuity. A teacher’s pension is another example of an annuity.

But the financial industry likes to take very simple concepts and make them incredibly complex.

The most common types of annuities being peddled right now are variable annuities and equity-indexed annuities.

Variable annuities are complicated products that allow you to invest in variable accounts — similar to mutual funds. A variable annuity allows you to have certain monthly income guarantees while still investing your money in the markets. The prospectuses for these things are hundreds of pages long.

Variable annuities have significantly higher fees than index funds and exchange-traded funds. When I say "more," it is pretty extreme. The low-cost funds that I use charge an annual fee of .05% on average. Variable annuities charge fees anywhere from 3-4%. That’s right. Annuity fees are thirty to forty times more expensive.

Insurance companies make huge profits from this vehicle, and consumers get very little benefit if anything at all.

Equity indexed annuities are a hot topic, as I see them being sold at nearly every "free" steak dinner seminar in town. The sales pitch is: you can’t lose any money if the stock market goes down, and if the stock market goes up, you get some of the gains.

What they don’t tell you is, that while you won’t lose any money if the markets go down, you are very limited in the amount of money you make if the market goes up.

Last year the markets were up 28%. Most equity-indexed annuity holders made between 0-3%. Doesn’t sound as good, does it?

Here are some more things you should know about annuities before deciding.

Taxes.

Annuities are taxed in a rather inefficient manner. All growth in an annuity is taxed as regular income. Generally speaking, income taxes are higher than capital gains rates. Growth in stock prices is taxed as a capital gain.

Surrender Penalties.

Want some money out of your annuity? Not so fast. Most annuities charge you a significant penalty if you take more than 10% of your money per year. Most penalty periods can last anywhere from 5 to 12 years. Penalties for withdrawals in excess of 9% are common. In other words, once you buy an annuity you’re stuck.

Age Restrictions.

You must be at least 59-½ to withdraw money from an annuity or the IRS assesses a 10% penalty.

So what do you do if you are pitched an annuity at a free steak dinner? Be wary, chew your food, and take your time. Of all the annuity owners I’ve met, about 5% of them actually understand what they own. Try not to listen to the hype.

Dave’s final take on annuities: grrrrrr…. (that’s a growling sound).

I can’t help but go back to the fact that a diversified portfolio of stocks and bonds has unparalleled historical success. Why reinvent the wheel? Why make something more complicated than it needs to be?

If considering an annuity, please let me know, and hopefully, I can talk you off the ledge.

Be Blessed,

Dave

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