Why do they keep trying to sell you that annuity?

Why do they keep trying to sell you that annuity?

It seems that banks are in annuity overdrive these days. Consumers are staring down CD rates as low as 0.50% wondering if there is something else out there. Bank salespeople are often quick to offer annuities. There are several types of annuities available, with the most popular being the variable annuity. The bank salespeople, often falsely referred to as financial advisors, make it sound as if these products are the best things since the Wright Brothers took flight. I say buyer beware.

The bank and its securities division are in business to make money. This is okay if the compensation among all the bank’s product offerings were the same, allowing for unbiased advice. This is not the case, however, as annuities provide the biggest payday to the bank and its sales force (6-7% average commission for the salesperson).

Annuities are costly because they are insurance-based products that have to make up the cost of what they are guaranteeing you. For example, many annuities guarantee that you will never lose principle, while at the same time allowing you to make money through separate accounts similar to mutual funds. The reality is, and a better explanation of this offer is, that your beneficiaries are guaranteed your principle upon your death, not you. This guarantee had little benefit during the financial crisis if you were at the doorstep of retirement.

According to Morningstar, the average expense of a variable annuity is 2.2%. If you invest $10,000 into an annuity and the market returns 8%, in 20 years you should have $30,882 including fees. If you instead invested in an index portfolio costing you 0.20%, you would have $44,498; that’s $13,616 more!

For younger investors, the annuity is pushed as a tax deferral investment program. A variable annuity will give you that at a cost. For those investors who are maxing out their 401k and IRAs and looking for tax sheltered retirement savings, I have determined that the best vehicle is a taxable, tax efficient portfolio. With the growing popularity of Exchange Traded Funds (ETFs), an investor can build a very tax friendly portfolio at an investment cost less than 0.30%.

Why do consumers fall for the annuity bait and switch? It comes down to the persuasion of the salesperson and the bank playing to the consumer’s fears of investing. Many bank-going consumers would probably never invest in the market at all, deeming it too risky. The annuity appears to have the safeguards that the consumer wants. Just remember that there is no such thing as a free lunch. If it sounds too good to be true, it is. There are many alternatives to managing investment risk that will cost you one tenth of the average annuity. A fiduciary fee only advisor can help you explore these options.

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2 Responses to Why do they keep trying to sell you that annuity?

  1. Andy Smith says:

    Your article mentions VA fees, but it doesn’t mention any of the other features. Tell the whole story. I am a 37 year old CFP and use these for my own financial plan. No other product offers the benefits of today’s VA product. I don’t think it is the only answer, but I do think it is part of the solution for most people who want a plan for retirement income. What other advanatage does an ETF have besides being inexpensive? Most people don’t even know what ETF stands for, much less how to build a properly diversified portfolio using them. Not to mention, most people will buy the wrong investments at the wrong time. For the conservative investor/retiree, buying small caps and emerging markets in an ETF is a difficult hurdle to jump. I was able to buy these asset classes in the VA in March 2009 and have done great. I won’t buy these asset classes in large percentages for retirees unless inside of the VA. If the asset class tanks, at least they have an income for life, which is rising each year, if they don’t touch the money until they decide to use it.

    Don’t knock something if you only point out one issue with the product. I can do the same with an ETF or any investment. List the cons…and the PROS. You get the point. Andy in Charlotte, NC

  2. Thanks for the note Andy…. This short blog is part of a series for the Dallas New Era Paper (limited to 500 words). I have also posted other peoples blog on this site concerning annuities like here:http://www.wiserinvestor.com/run-run-from-the-salesman-with-the-annuity/

    I will agree that there are times that an annuity could be beneficial, usually of the fixed variety, but I rarely see it. The math on the longterm use of annuities just does not add up. Clark Howard and Dave Ramsey are the two biggest spokespeople for this. The concept of the annuity is a great selling point. It’s like a free lunch….. The potential for risk free gains….. but there is no such thing as a free lunch! It is the fees that will erode your rate of return vs. my ETF portfolio invested in 12 global asset classes taking on moderate risk with over 6700 companies all costing .25%. Why would you want a guarantee that you make money 20 or 25 years from now. The market has never lost money over that time. With proper asset allocation (a conservative allocation) prior to retirement, years like 08 would not even be an issue.

    Fiduciary responsibility in the brokerage business will clean up a lot of the annuity sales, especially from the weak (most expensive) players.

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