Variable Annuities

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Nov 22, 2008 10:54 am

I know you're all probably foaming at the mouth with the commissions tied to a potential opportunity of selling someone a variable annuity, but I'm posting regarding just the opposite. 

 
I know there is a lot of knowledge on this board, and I sincerely hope someone out there is willing to provide sound advice.  I am not a registered rep, nor do I have a lot of experience in the financial services world, but I do know that variable annuities have hefty commissions tied to them, and I do know that they're not right for everyone, or even most.
 
My aunt, who probably has another 20 years or so in the workforce, is considering a variable annuity.  Her advisor tells her it's probably not the best idea for her, and then strategically tells her that there's a guaranteed point which her returns would not fall under regardless of the market (seemingly a ploy to get her to buy).
 
Can someone who's knowledgeable provide an intelligent, non-insulting/non-sarcastic comment or argument that I can present to her about why she shouldn't buy one?  I really would hate to see her make a big mistake.  Thanks.
Nov 22, 2008 11:15 am

Why should the basis of whether one buys or not buys a product be determined by whether there's a commission tied to it?  A REIT has a nice commission too, as do A share mutual funds.  Anything an advisor sells is going to have a commission except for a wrap account.

 
You also didn't give any details about your aunt other than she still has time in the workforce.  Is it a qualified or non-qualified acct.?  What is the surrender schedule on that annuity?  Are there any living benefit riders attached to it?  Were you in the meeting listening to the advisors "strategically" worded annuity pitch, or are you going off your aunt's words? 
 
Theses are all important questions when talking about annuities. 
Nov 22, 2008 11:44 am

No, I wasn't in the meeting.  Actually, I am the one who is questioning the whole thing.  My aunt doesn't think the advisor did anything wrong.  I don't know all the details, as we didn't get that far.  I've heard from several sources, including registered representatives, that some people think selling variable annuities is unethical and they avoid it at all costs, regardless of the situation.  So when I heard that she might be interested in one, this is what immediately came to mind.

 
I know my aunt, like many, is freaking out about the state of the economy, and she's concerned about her retirement.  I know she currently has a traditional IRA (I tried to get her to also open a Roth), and her current 401(k) plan at work does not offer great flexibility, nor a great company match.  Quite frankly, I think she's worried.  Because she's my aunt, and the conversation can be a bit awkward, we don't talk actual numbers, so I'm in the dark there.  She's single, no kids, recently bought a home (within past year).  I don't know what, if any, riders were attached to what they were talking about.  All I know is that she liked the fact that her returns has unlimited upside (variable annuity) coupled with the guarantee that her returns would not go below a certain percentage, regardless of the market.
 
Based on the above info, which hopefully helps you a little bit more, what can you tell me?
Nov 22, 2008 12:06 pm

So you are not in the business yet, do not understand your Aunt's situation, do not understand an option that her FA showed her, and feel because you have heard bad things about VA's, you should intervene?  Is that about it?  You are most likely the one that is about to damage your Aunt, VA or no VA.  A variable annuity can be appropriate in many situations.  In many situations, it is not.  The same can be said for any investment.  You do not have the requisite knowledge of the product or your Aunt to make a judgement.  If you are truly concerned, go with your Aunt to the FA and relay your concerns.  If he is an ethical FA, which you have no reason not to believe, he (or she) will do what is best by your Aunt.

Nov 22, 2008 12:13 pm
Primo:

So you are not in the business yet, do not understand your Aunt's situation, do not understand an option that her FA showed her, and feel because you have heard bad things about VA's, you should intervene?  Is that about it?  You are most likely the one that is about to damage your Aunt, VA or no VA.  A variable annuity can be appropriate in many situations.  In many situations, it is not.  The same can be said for any investment.  You do not have the requisite knowledge of the product or your Aunt to make a judgement.  If you are truly concerned, go with your Aunt to the FA and relay your concerns.  If he is an ethical FA, which you have no reason not to believe, he (or she) will do what is best by your Aunt.

 
Well since you seem so full of knowledge, could you briefly explain when a VA would / would not be appropriate?  General terms, of course, your majesty.
Nov 22, 2008 12:13 pm

From my time in the industry, I can tell you the most unethical ways that people do sell annuities.  Now the important thing to remember is selling annuties is not unethical, Christ if they were an unethical product then they wouldn't exist, its the way they are sold that is unethical sometimes.  For example:

 
1. Selling a qualified annuity as a product that gives the client a tax-deferral benefit
2. Not telling the client there is a surrender period on it
3. Not telling the client there is an M&E ratio attached
 
Thats all I can think of.  Now that you said that her returns would not go below a certain percentage, what does that mean?  She may be talking about the fixed acct. that is attached to all variable annuties.  Fixed accts. will usually have a guaranteed 3% or so return, but that only applies to the portion of the account that is in the fixed acct..  If she still has 20 years of work left then probably no more than 20% of the acct. should be in the fixed acct..  I'd get further clarification on what she meant by "returns would not go below a certain percentage, regardless of the market."  Hope this helps.
 
Nov 22, 2008 12:22 pm
3rdyrp2:

From my time in the industry, I can tell you the most unethical ways that people do sell annuities.  Now the important thing to remember is selling annuties is not unethical, Christ if they were an unethical product then they wouldn't exist, its the way they are sold that is unethical sometimes.  For example:

 
1. Selling a qualified annuity as a product that gives the client a tax-deferral benefit
2. Not telling the client there is a surrender period on it
3. Not telling the client there is an M&E ratio attached
 
Thats all I can think of.  Now that you said that her returns would not go below a certain percentage, what does that mean?  She may be talking about the fixed acct. that is attached to all variable annuties.  Fixed accts. will usually have a guaranteed 3% or so return, but that only applies to the portion of the account that is in the fixed acct..  If she still has 20 years of work left then probably no more than 20% of the acct. should be in the fixed acct..  I'd get further clarification on what she meant by "returns would not go below a certain percentage, regardless of the market."  Hope this helps.
 
 
Thanks, this is more the response I was looking for.  At last, I found someone in this business that does not think they're God's gift to personal finance!! 
 
What is M&E ratio?
 
I think she said that guaranteed percentage was around 6% or so, but never said anything about it being fixed.  I'll have to find out more from her.  So are you saying that within a VA there can be a portion that acts as a Fixed Annuity?
 
Lastly, the tax-deferral part.  Do you say that because most retirement accounts have this benefit and it's not a "true" selling point of an annuity?  Or do you say this because that's not what a person should look for in an annuity?
 
My understanding is that generally speaking, the number one reason someone might want to purchase an annuity is that they're worried about outliving their money.  Is that accurate?
 
Thanks, again, 3rdyrp2, you've been very helpful unlike some others.
 
Nov 22, 2008 12:35 pm
RickRoss:
Primo:

So you are not in the business yet, do not understand your Aunt's situation, do not understand an option that her FA showed her, and feel because you have heard bad things about VA's, you should intervene?  Is that about it?  You are most likely the one that is about to damage your Aunt, VA or no VA.  A variable annuity can be appropriate in many situations.  In many situations, it is not.  The same can be said for any investment.  You do not have the requisite knowledge of the product or your Aunt to make a judgement.  If you are truly concerned, go with your Aunt to the FA and relay your concerns.  If he is an ethical FA, which you have no reason not to believe, he (or she) will do what is best by your Aunt.

 
Well since you seem so full of knowledge, could you briefly explain when a VA would / would not be appropriate?  General terms, of course, your majesty.
 
When someone who does not understand what the hell they are talking about influences investor behaviour.  General enough?  The answer to your question is that it can't be answered.  You did not provide, nor do you have the information needed to answer it.  Nor can anyone as a RR give specific advice on your Aunt's situation on a message board.  You are asking complete strangers to confirm your opinions on a product you do not understand, instead of trusting your Aunt's advisor, who knows her and her situation.  Can the attitude.  You wouldn't ask someone applying to medical school to treat your cancer, would you?  You may have the best intentions at heart, but you may also be hurting your Aunt. Go with your Aunt and talk to her advisor if you feel this is a bad situation for her.  FWIW, I don't like annuities.
Nov 22, 2008 12:42 pm

A qualified account like a traditional IRA, TSP, 401(k), 403(b), etc. already is tax-deferred so its non-compliant for an advisor to recommend a client to put an IRA or 401(k) into an annuity "because it gives you tax-deferral".  That is probably up there with forging a signature in terms of being "unethical". 


Sure, an annuity will allow you to not outlive your savings, but depending on the size of the account when you annuitize, you could be getting a $36.75 check each month for the rest of your life if its a small annuity.  They determine the monthly annuity check based on your life expectancy at the annuitization age.  For example, your aunt is 65 years old, the account is $100,000, and her life expectancy is 83.  They will pay your aunt a monthly income based on the $100,000 number and the 18 years left of life number.  She dies early (assuming there is not a survivor benefit rider) and the insurance company wins, she lives long and she wins.  Its like a pension or social security, the longer you wait to receive a monthly check, the more money you will get each month. 


Big thing to remember:  There are many ways to utilize an annuity effectively rather than just as something to annuitize at some point. 
Nov 22, 2008 2:15 pm

i would wager the advisor is talking about a living benefit with a 6% provision. this is NOT a guarantee of any "rate of return." big distinction between the cash value of the annuity and the benefit base.



to answer your initial question, many years ago annuities were often sold based on benefits which had no added value to justify using them being used instead of a traditional ira. in the last 10 years or so, insurance companies have added bells and whistles almost to the point of overkill, and many of them, IN THE RIGHT SITUATION, can definitely be appropriate, and worth their cost, to justify using a variable annuity ira.



you can throw generalizations out all day, but blanket statements like "variable annuities should never be used, they are bad." just makes me think you really need to do some research. i would HIGHLY recommend you go to an appointment with your aunt. i always offer that to my "older" clients, especially in situations like this, where Mom or Aunt XYZ relies on a son or daughter for advice. if he/she refuses your request, run.

Nov 22, 2008 2:33 pm
RickRoss:
What is M&E ratio?
 
Mortality and Expense ratio.  Its insurance for the insurance company issuing the policy in case (and I may not be correct on this statement) a large number of claims are submitted at once and the policies are valued at more than the cash that the company has on hand.  It usually runs about .85%-1.2% per year, depending on the company.
Nov 22, 2008 4:58 pm

"I know you're all probably foaming at the mouth with the commissions tied to a potential opportunity of selling someone a variable annuity, but I'm posting regarding just the opposite."
 
Rick, if someone has $1,000,000 and purchases a VA from me how much will I make?  If the same person invests $1,000,000 with me and buys the Vanguard S&P 500 fund in a 1% fee based account how much money can I expect to earn?  Assume that the person will be a client for the next 20 years and the S&P grows by an average of 7% a year. 
 
  
"My aunt, who probably has another 20 years or so in the workforce, is considering a variable annuity.  Her advisor tells her it's probably not the best idea for her, and then strategically tells her that there's a guaranteed point which her returns would not fall under regardless of the market (seemingly a ploy to get her to buy)."
 
This advisor sounds a little bit like me when I'm recommending that someone is buying something other than a VA.  "Hey Rick's Aunt.  A VA is one thing that you can buy, but I don't think that you should buy one.  However, it is important that you understand them because they are something that are appropriate in many situations.  Here are the positives..... In your case, a better alternative is XYZ, but I did want you to understand why we aren't buying the VA despite the guarantees." 
 
"Can someone who's knowledgeable provide an intelligent, non-insulting/non-sarcastic comment or argument that I can present to her about why she shouldn't buy one?  I really would hate to see her make a big mistake.  Thanks."
 
No one can make an intelligent argument of why she shouldn't buy one based upon the information given.  The only one who has a clue as to whether it's appropriate is the advisor who understands her information.  If you want to learn about the pros and cons of annuities, you would come across as someone who wants to learn.  Instead, you are coming across as someone who thinks he knows something, when your post screams complete ignorance.

Nov 22, 2008 5:09 pm

3rdyrP2,


I'm reading your responses and cringing because it sounds as if you have just enough knowledge to be dangerous on this subject.


Your #1 way that people unethically sell a qualified annuity inside of a tax deferred account is to characterize the annuity as something that gives tax deferral.  I think that this is an urban myth.  Yes, it is true that this would be unethical.  However, I've simply never seen a qualified annuity that was purchased for this purpose and I've seen plenty that have been sold in an unethical manner (based upon what the client has said).
 
 
"Mortality and Expense ratio.  Its insurance for the insurance company issuing the policy in case (and I may not be correct on this statement) a large number of claims are submitted at once and the policies are valued at more than the cash that the company has on hand.  It usually runs about .85%-1.2% per year, depending on the company."

 
It's not insurance for the company.  It is primary the way that the insurance company makes their money on VA's.  It's also a way for companies who sell VULs to make more money. 
 
How do we know that it's not insurance for the insurance company?  Let's use a 1% M&E charge.  The client invests $100,000.  The account value drops to $85,000.  The M&E is $850.  If the client dies the insurance company is on the hook for $15,000.  They need insurance to cover this loss.  What if the account grows to $500,000?  The M&E is now $5,000.  How much risk does the insurance company have? $0.  The value would have to drop more than 80% before the insurance company had any risk.  So, if this was actually insurance instead of the way in which the company makes its money, would the insurance company charge more based upon decreased risk?
Nov 22, 2008 5:18 pm
RickRoss:

I know you're all probably foaming at the mouth with the commissions tied to a potential opportunity of selling someone a variable annuity, but I'm posting regarding just the opposite. 

 
I know there is a lot of knowledge on this board, and I sincerely hope someone out there is willing to provide sound advice.  I am not a registered rep, nor do I have a lot of experience in the financial services world, but I do know that variable annuities have hefty commissions tied to them, and I do know that they're not right for everyone, or even most.
 
My aunt, who probably has another 20 years or so in the workforce, is considering a variable annuity.  Her advisor tells her it's probably not the best idea for her, and then strategically tells her that there's a guaranteed point which her returns would not fall under regardless of the market (seemingly a ploy to get her to buy).
 
Can someone who's knowledgeable provide an intelligent, non-insulting/non-sarcastic comment or argument that I can present to her about why she shouldn't buy one?  I really would hate to see her make a big mistake.  Thanks.


Boy, did you come to the right/wrong place!!!!!!!!

Nov 22, 2008 5:19 pm

I hope that those who have responded to this this person are registered in the state where he/she lives. Otherwise, they are breaking the law. 

Nov 22, 2008 6:28 pm
anonymous:

3rdyrP2,


I'm reading your responses and cringing because it sounds as if you have just enough knowledge to be dangerous on this subject.


Your #1 way that people unethically sell a qualified annuity inside of a tax deferred account is to characterize the annuity as something that gives tax deferral.  I think that this is an urban myth.  Yes, it is true that this would be unethical.  However, I've simply never seen a qualified annuity that was purchased for this purpose and I've seen plenty that have been sold in an unethical manner (based upon what the client has said).
 
 
I apologize for maybe wording my response in a way that doesn't come across in a way that your company's sales consulting guy would explain it, I was trying to explain it in a way that would make sense to someone who has no idea what an annuity is.  You may not know anyone specifically who has sold it as a tax deferral vehicle, but it happens.  Trust me, I'm a fan of qualified annuities.  I'm not knocking them, I'm just trying to make the guy aware of some things to look out for.  Saying that people will sell qualified annuities as a tax deferral vehicle only would be insulting to a clients intelligence, but an advisor can say "An annuity is a great way to utilize your TSP as an income supplement to your govt. pension, and it still maintains the pre-tax/tax-deferral that your TSP currently has."  The selling pt. there isn't anything special that an annuity has instead of a regular IRA, but simply the fact that no taxable event would occur by using an annuity for that account. 
 
 
Nov 22, 2008 6:32 pm
anonymous:

"Mortality and Expense ratio.  Its insurance for the insurance company issuing the policy in case (and I may not be correct on this statement) a large number of claims are submitted at once and the policies are valued at more than the cash that the company has on hand.  It usually runs about .85%-1.2% per year, depending on the company."


 
It's not insurance for the company.  It is primary the way that the insurance company makes their money on VA's.  It's also a way for companies who sell VULs to make more money.
 
Not necessarily:
 
http://www.sec.gov/investor/pubs/varannty.htm#vch

Mortality and expense risk charge – This charge is equal to a certain percentage of your account value, typically in the range of 1.25% per year. This charge compensates the insurance company for insurance risks it assumes under the annuity contract. Profit from the mortality and expense risk charge is sometimes used to pay the insurer's costs of selling the variable annuity, such as a commission paid to your financial professional for selling the variable annuity to you.

Nov 22, 2008 7:56 pm
Hank Moody:

I hope that those who have responded to this this person are registered in the state where he/she lives. Otherwise, they are breaking the law. 

 
Telling someone with a concern to go with his Aunt to meet her FA is breaking the law?  Try harder Bobby.
Nov 22, 2008 8:25 pm
"Not necessarily:
 
http://www.sec.gov/investor/pubs/varannty.htm#vch

Mortality and expense risk charge – This charge is equal to a certain percentage of your account value, typically in the range of 1.25% per year. This charge compensates the insurance company for insurance risks it assumes under the annuity contract. Profit from the mortality and expense risk charge is sometimes used to pay the insurer's costs of selling the variable annuity, such as a commission paid to your financial professional for selling the variable annuity to you. "


Yes, necessarily.  You need to read critically and use your mind and not your eyes.   You can't think critically and believe that M&E is to compensate the insurance company for insurance risks. 
 
If this was true, the greater the risk, the higher the M&E charge.  The reality is just the opposite.  The lower the risk, the higher the M&E charge.
 
Ex. George and Sam  both invest $100,000 in a VA with a 1% M&E charge.   George makes great investment choices.  Sam makes terrible investment choices.  20 years later, George's account value is $500,000.  Sam's account value is $25,000.   George is paying $5,000 in M&E charges.  Sam is paying $250. 
 
What is George getting in return for this $5000?  Absolutely nothing.  If he dies, his family gets the contract value.
 
What is Sam getting in return for his $250?  $75,000 of life insurance.  If he dies, his family gets $100,000.  They get the contract value of $25,000 and the insurance company has to reach into their coffers for the other $75,000.
 
Why does George pay $5000 when there is no risk?  Simple.  The purpose of the M&E is to compensate the insurance company.  This is how they make their money and pay their expenses.
 
I'm not arguing against annuities.   I use them often.  I'm not complaining about the expenses.  I'm simply saying that it's complete B.S. to say that the purpose is to cover the insurance company against insurance risks.
 
I'd be happy to apologize if I'm wrong.  Can you name one insurance company that lowers the insurance charge in their VA when the risk goes down? 
 
Compare it to a UL policy.   George and Sam both have $100,000 UL policies in which the death benefit doesn't increase.  George has $50,000 of cash.  Sam has $10,000 of cash.  George pays for $50,000 of life insurance.  Sam is paying for $90,000.  In this case, the insurance charges actually are compensating the insurance company for insurance risks.
 
Information coming from a reputable source doesn't make the information accurate.  Say something that is wrong enough times by enough different sources and people start to believe it...even those who should know better.
 
My point is that the "M" of "M&E" is mostly B.S.  M&E expenses is the primary way in which the insurance company makes money on a VA. 
 
 
Nov 22, 2008 8:26 pm
Primo:
Hank Moody:

I hope that those who have responded to this this person are registered in the state where he/she lives. Otherwise, they are breaking the law. 

 
Telling someone with a concern to go with his Aunt to meet her FA is breaking the law?  Try harder Bobby.



I wouldn't quarrel with what you just said, but giving a stranger any opinion or explanation of annuities may be giving him information that he uses to make a decision. Telling this guy to do anything but go away is dangerous territory. A good rule of thumb would be to ask yourself if you would be comfortable telling your compliance director to review this communication with the public that you didn't get prior approval to make.