No, You Don’t Need a Variable Annuity for Retirement Guarantees
One of the products that has been stung in the retirement product race are variable annuities with benefits for retirement income. Here are reasons why you don’t need an annuity, and some ideas to create a safer portfolio.
As baby boomers are beginning to look for investment ideas to replace income in retirement, Wall Street has come up with ‘must have’ products over the last several years to meet their desires. One of the more interesting pitches belongs to the income benefits of variable annuities. These products claim to offer guaranteed growth, and then income, at rates that catch the income investor’s eye.
I’ve written against these products in publications in the past, and suggested there is more than meets the eye. Let me now give some uncensored thoughts on why variable annuities should not be the backbone of your retirement income strategy.
-These annuities were marketed to investors as being underpriced. Experts spoke for years about how insurers were underpricing their benefits, thereby making them a ‘deal.’ Annuity companies paraded these experts to financial advisors to make sure they knew what a great deal this was for their clients.
Advisors that passed this pitch onto their clients contradicted what is most critical about insurance – that the insurer charges enough to pay your benefits when called upon.
It’s mind-boggling to me that companies and advisors used this as a reason to sell annuities. What were insurers up to?
I believe insurers wanted back in the action of the boomer retirement wave, and in order to make their product palatable, they underpriced it. After all, who would buy a guaranteed growth of 5%, when their fees approach 5%? They made sure to include future increases in fees that so payday would come eventually. But, to start, they needed to be in the game.
Today’s annuity holder, with the market value of their account down, is faced with their insurer raising costs, hurting their ability to recover. Many insurers are on shaky financial ground themselves, making that increased cost less attractive to the retiree seeking true guarantees.
-Funny money. When you think 6% guaranteed growth, is it the same if you can only buy 3 or 4% more income? The guaranteed growth number is deceiving when looking at an apples-to-apples amount of income that can be purchased.
Payouts under income benefits are not equal to the income you can receive from other guaranteed income strategies, including other annuity products. Yes, they give you a ‘guaranteed’ increase in a hypothetical value. But, if that value buys less income than your portfolio would have even if it only increased 0-4% per year, would you pay the insurer as much as when you are told you’re buying a 6% increase?
I equate the income payouts to be like giving your retirement savings to Disney in exchange for guaranteed growth… and by doing so, you agree that everything you buy in the future is done with Disney dollars at their theme parks where the cost is 30-40% more. You might get so-called guaranteed growth, but you also get less real income for the money.
-You need to ‘just believe’ that the annuity will work. Let’s face it, you won’t understand how these products operate. Not because you aren’t capable (if you spent your summer studying the details that aren’t disclosed in the sales materials), but because you won’t be told.
The investing and ‘hedging’ that each company uses to protect your benefit is not disclosed (and reportedly more expensive than in prior years). With all the confusion, even in professional journals, about these benefits, don’t be sure your advisor has any more idea than you do if these benefits will pay out in the future.
We’re not told how the black boxes of these products work, which in addition to all the other negatives, violates a principal of investing to understand what you invest in. It’s not hard to believe that an insurer that needs to make good on its promises will invest in the next Madoff.
And once you’re in, the benefits are structured to make sure you are punished heavily if you want to leave. In addition to long-surrender periods, the costs make you captive to this policy and insurer, as the fees increase and drive your real savings dollars lower. What if your insurer becomes the next AIG?
-The investments are horrible. First, you need to understand you aren’t investing in the annuity promise; that’s just what you are paying fees for. You invest in investment managers. Like mutual funds. Your account will increase or decrease based on the investment performance (and yes, your real dollars do decrease, which is a common misconception of ‘guaranteed growth’).
In an annuity, the insurer picks and can change the investment providers. You have some say, but only some.
What are the qualifications for an insurer when picking an investment manager? Certainly some managers might be chosen for their expertise. But mostly the choices are affiliated companies with the insurer, or managers that share revenue they collect from your savings. These managers necessarily charge you more than those that don’t give kick-backs to the insurer, which, in addition to being a horrible practice of the annuity industry, also hurts your performance (insurers also share revenue with brokers, so there is also reason to question why a broker selects a certain annuity product to sell its clients).
Investors generally ignore the investment choices within an annuity when making a purchase and focus only on the guarantee. The guarantee though is only as good as the growth you will get, which is necessarily less when you have bad, and expensive, investments.
-Advisors paid more to do less. On top of this, advisors are overwhelmingly turning the investment management they used to be paid for over to the insurer. Advisors like this because the investment is on auto-pilot, no need for them to watch over the investments. How will you know if your advisor is watching over the portfolio you are invested in if they aren’t responsible for managing it?
Annuities also generally pay higher commissions, without break points for higher dollars, than advisors charge for their investment management services.
So, you’re locked into an investment for the rest of your life, get less income than strategies you can implement on your own, create less work for your advisor, and pay them more.
You’re probably thinking, if these products are so awful, wouldn’t all advisors run from them? Why did mine recommend an annuity for my rollover and retirement dollars?
Trust. They’ve seen past variable annuities pay death benefits to widows, and they trust the annuity company. They trust the company so much, an advocate recently responded to my criticism in a professional journal that an annuity with expenses of 3+% can match the performance of a S&P 500 index fund. Talk about trust!
But, these annuities are not your father’s annuity. The companies are not treating their policy owners like owners, which is a common problem in the financial services industry today that John Bogle covers masterfully in his book, Enough. Financial services companies aren’t living up to their duty to their clients; they’re focused today on short-term profits rather than long-term stability. That’s evident enough in their language about their business being an ‘arms race’ to get higher risk products on the market before the next company.
So, what can you do to protect your portfolio without a variable annuity? We all need ‘guarantees’, retirees seeking stable income more than most. What some prudent ways to insure your income needs, without leaving your retirement at risk in a variable annuity?
-Diversify. The surest and most proven investment strategy. Yes, the market was down significantly in 2008. But, if you were diversified, you likely didn’t suffer as much as the market.
-Find out how much risk you need to take. Many advisors still invest retirement assets by measuring your ‘risk tolerance’ level. What they are ‘measuring’ is how much pain they can expose you to. Find an advisor that can measure how much pain you need to expose yourself to.
-Replace gimmick strategies with real guarantee strategies. The word “guarantee” is the annuity’s greatest marketing pitch. However, you won’t hear about other guaranteed options from your annuity salesperson. In fact, before these new annuities allowed them to make money on offering a guaranteed retirement income product, many advisors had no interest in selling you guaranteed income strategies because it didn’t pay.
One of those strategies we prefer is laddering safe investments like FDIC-insured CDs and US Treasury bonds, to where the amount of income needed comes due every year. Our clients that created a bond ladder over the past several years are enjoying rates on risk-free assets of 5+% on many of their investments. Those assets didn’t stop paying, and didn’t decrease in value with their stock and bond mutual funds.
In an April 6th, 2009 article in the Wall Street Journal, an insurer’s CEO stated they were in an “arms race” and should have “had pulled back” on their benefit offerings. A company whose sole marketing pitch is you have a ‘guarantee’ with them, felt they risked that guarantee because they wanted to sell more annuities than the next company? They weren’t performing their duty to their policyholders then, and there is no reason to believe this won’t happen again in the future.
So, my advice has been and will continue to be, avoid investing in variable annuity benefits until you understand the risks, and research all of your options for securing retirement income.