Beware of the annuity house of mirrors
We’ve all been to a state or local fair and stood in front of the funhouse mirrors that make you look fat or skinny, and warps your body into all kind of strange shapes.
There are people who want to be skinny, so they stand in front of the funhouse mirror that makes them look that way. Of course, when they walk away, reality taps them on the shoulder.
Similarly, too-good-to-be-true annuity riders can distort reality for gullible annuity buyers and too eager annuity salespeople.
A good friend of mine owns an annuity distribution company that oversees a number of agents and he always complains that his salespeople are constantly distracted by what he calls, “shiny things.”
He’s referring to items like upfront bonuses, high-income rider percentages, incentive trips, and soft money (hidden) compensation arrangements that are too often the focus and motivation for annuity sales.
Instead of prioritizing the overall goals of each specific customer, too often the sales pitch focuses on the sizzle of the product and not the steak. Because the annuity sales message goes largely unregulated and practically anything can be said or promised, you need to know the facts behind these common annuity bullet points.
Everyone likes free money, and some annuity carriers feed into this dream by promoting an upfront bonus just for placing your money in their annuity. What a nice gesture, right? Isn’t that nice of that annuity company to be so generous. Hmmmm …
Nothing in life is free, and there are only 100 pennies in every dollar. In most cases, when an upfront bonus is offered, the insurance carrier is taking something away in another part of the contract. This makes sense, but somehow that kindergarten logic doesn’t translate in too many annuity sales. People seem to want to buy the dream, and feel like they are smarter than their neighbor.
Bonuses aren’t always a bad thing, but buying an annuity because it has a nice upfront bonus is like buying a car because it has a nice stereo system. If an annuity offers an upfront bonus, then that should be part of all the contractual guarantees you need to consider as a whole before making any buying decision. These bonuses are typically vested over the surrender charge period, and usually are attached to long-term contracts. The higher the upfront bonus, the longer the annuity company is going to lock your money up with surrender charges.
So if your annuity agent is touting the upfront bonus and seems to be spending too much time there, tell them to turn the volume down and show you the contractual engine instead.
High percentage income riders
Since income riders became popular a few years ago, I get hundreds of calls a month from people saying that “I own an 8% annuity,” or some inordinately high return number that stands out in a low interest rate world. It’s sad and tragic how many people actually believe that some insurance company is channeling the interest rate ghosts of Jimmy Carter and hooking them up with a great CD-type rate. The reality check here is when the 10-year Treasury is less than 3%, then some genius at an annuity company hasn’t figured out how to give you 8%. Common sense anyone?
By definition, an income rider is an attachment to a deferred annuity that is a separate calculation from the accumulation value part of the annuity. Yes, there is typically a high percentage annual amount that grows until you turn on the income, but here’s the contractual catch with an income rider:
- You cannot peel off the interest from the income rider like you can a CD or bond.
- You cannot access the income rider calculation lump sum … ever!
- You cannot transfer the income rider total to another annuity.
- Once you start taking income, the annual growth percentage stops.
- You can only use the high percentage income rider amount for income (or confinement care in select policies).
Income riders can be a flexible and efficient way to solve for lifetime income needs that start at a future date, but only if you fully understand the upside and limitations of the contract. Longevity annuities and income riders are the only two ways to solve for this income later need in the world of annuities, so they do have their place if target-date income is the goal.
Annuity house of mirrors
I blame annuity salespeople for not explaining the house-of-mirrors effect of these policy additions, but annuity buyers need to take some responsibility as well. When it comes to annuities, if it sounds too good to be true, it is — without exception.
Below are a few 2×4-to-the-forehead tips for the Annuity house of mirrors:
There is no free money Annuity house of mirrors: Upfront bonuses
Jimmy Carter CD rates don’t currently exist Annuity house of mirrors: High percentage income riders
You cannot get all the market upside with no downside Annuity house of mirrors: Typical indexed annuity pitch (aka hybrid-hype nonsense).
Income streams cannot increase with market index returns for the life of the policy Annuity house of mirrors: Current TV and radio ads.
In other words, step away from the annuity circus mirror, because eventually you will be staring at the contractual policy mirror. I always tell people that the contractual realities of the policy will eventually reveal themselves, so why not just start and finish there.
You will be glad you did.
Originally published 10.7.14 by MarketWatch.com – http://www.marketwatch.com/story/beware-of-the-annuity-house-of-mirrors-2014-10-07