7 Reasons I’m Not Fond Of Annuities

December 1, 2015 • Page 2 of 2

4. Lack of Liquidity
Once clients place money in an annuity, they often face limitations in getting it back—at the least, they may experience surrender charges. In other cases, they face taxes and IRS penalties. Even worse, some contracts limit the amount they can withdraw per year, even of their own principal. And this lack of liquidity applies in virtually every case once annuitization starts. I wonder how many clients fully understand these restrictions or their implications. And by the time they become apparent, the advisor who sold the product may be long gone.

5. Low Returns
The low interest rates offered by fixed annuities don’t even require elaboration. And the returns of variable annuity subaccounts are reduced by the fees mentioned earlier.

6. Early Death Risk
Any annuitant who wants money to go to a spouse, children, charity or other heirs might be called insane to annuitize an annuity contract: Get your first monthly payment today, get hit by a bus tomorrow, and watch the rest of your account evaporate. Clients who want to protect a spouse have to accept lower monthly incomes, and kids and charities can’t be protected. Oh, wait, yes they can: You can sell the client a life insurance policy in addition to the annuity policy. Why settle for one commission when you can earn two?

7. Longer Life Expectancy
According to the Society of Actuaries, women now live to about age 88 on average, men to about 86. Imagine how long people will be living when today’s 65-year-old annuity buyer reaches age 85! My research into exponential technologies has led me to worry that the actuarial assumptions that insurance and annuity companies use are flawed, and that the companies simply will not be able to honor the promises they are making to today’s annuity holders.

The industry seems to know it has a problem. Why else would so many insurance and annuity companies be quitting the business, altering their products, initiating buyout offers to current policyholders and selling their books of business to private equity firms that are too dumb to realize what’s happening?

Shortly after the Society of Actuaries added two years to everyone’s life expectancies, General Motors had to add $2 billion to its pension plan. The workers’ rising life expectancy, from age 84 to age 86, cost GM $2 billion! What will happen to the carmaker when mortality tables increase by 20 years? Will GM be willing and able to pay? I shudder to think about what happens to all those retirees if GM doesn’t honor its promises, or if the thousands of other companies that have made similar promises don’t.

When clients invest in a globally diversified portfolio consisting of low-cost ETFs and index funds, they maintain control over their money. They
can make investment changes anytime, and they can withdraw their money whenever they want. But when they put money into an annuity, they face higher costs and often severe restrictions, sometimes permanent ones.

No wonder the SEC, Finra and NASAA have issued so many investor alerts regarding the sales practices of annuity products.

Now you know seven of the concerns we have with many of the annuity products on the market these days. If you routinely recommend them, you might want to reconsider which products you use, why you use them and how much your clients truly understand the risks associated with them.

Ric Edelman is chairman and CEO of Edelman Financial Services LLC, a registered investment advisor. He is an investment advisor representative who offers advisory services through EFS and a registered principal of (offering securities through) Sanders Morris Harris Inc., an affiliated broker-dealer, member FINRA/SIPC . You can connect with him on LinkedIn at linkedin.com/in/RicEdelman or on Facebook at facebook.com/RicEdelman. Or follow him on Twitter at @RicEdelman.

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10 Comments

Comments

Annuity Advisor 8 years ago

Talk the only tool being a hammer when everything looks like a nail. It sounds like a lot of these guys blasting Edelman think the answer to every clients' financial life is an annuity, probably a high-commission one. Annuities have some purposes. I recommend them to retired clients who have spending problems. It's something like a diet and with a no-load annuity they have quite a bit more to spend. It is also a way to protect clients from longevity risk and allow them to take more risk with the rest of their assets. No-load annuities again are better. But I suspect some of the people yapping out here are far more worried about their own current income than clients' future income
Evan 8 years ago

I know annuities are a controversial subject, but I'd like to ask everyone who wants to voice their opinion to be civil out here. Like Ric says, annuities have some features that turn off many advisors and clients. On the other hand, I think many middle-class Americans with $300,000 to say $600,000 in life savings may find that making that money stretch over a 30-year retirement is challenging if not futile. Maybe that's my problem because I live in New Jersey. I've talked with Nobel laureates in economics who have studied this issue and have no vested interest who believe that putting a portion of their assets in fixed annuities, not variable or fixed index annuities, are the best option for millions or Americans and others around the world. When I raised the issue that Ric mentioned, that of locking into a fixed annuity at a time when interest rates are at or near historical lows, they told me that was the wrong way to look at the problem. No doubt they are smarter than me and it is true a 70-year-old can get close to double-digit income on a fixed annuity. But as someone who came of age in the early 1980s when triple A-rated 30-year bonds from AT&T were selling at 35 cents on the dollar, maybe that's just my phobia like Depression-era who were spooked by equities. The problem is most Americans today don't have pensions so they need a substitute. As I wrote in August 2014, they are afflicted by Annuity Aversion and Pension Envy, http://www.fa-mag.com/news/annuity-aversion--pension-envy-18693.html?issue=231.
SteveLewit 8 years ago

Ric. Please. Do yourself a favor and stop embarrassing yourself by commenting on things you don't really understand - Fixed Index Annuities. It is clear why you get so many replies when you make absurd and naive statements about a product category that had a 22% increase in volume and a banner year. I guess all those people just happen to succumb unknowingly to all the commission breath advisers out there who will be quitting the business soon and don't really care about their clients. Of course, in your role as a Fiduciary, to put the best interest of your clients first, you think that eliminating the insurance and principle guaranteed side of the equation is worthless and that investing in the market is the only answer. Hmmmmm. Sounds like one hammer and one nail scenario to me. I always thought Fiduciary meant something else, more holistic, more, how shall I say it, client focused on what they need. And, oh, by the way Ric, take a look at all the current research which clearly has proven that the best way of protecting principle and providing income is a combination of mutual funds and FIAs with income riders. That would, of course, require time and effort on your part and take you away from promoting AUM. So, if you're not up to getting up to speed as a legit financial professional would, you could, of course, always show us your research that says otherwise. I've been looking for it but just can't seem to find it anywhere. And, just one last thing, why FA magazine would promote your biased point of view is beyond me. Well, maybe I do understand. In another article the headlines is, "Annuity Sales are Soft" but in the body copy it's clear that Fixed Index Annuity business is strong. It is clear FA looks at the 'annuity business' as Variable Annuities, with FIAs taking a big back seat. Article should have been titled, "Fixed Index Annuities Have Record Year". Youi know that ole 'birds of a feather' thing. Well, if it looks like a duck, walks like a duck and quacks like a duck, guess what? FA needs to take a hard look at what message and which messengers its promoting for sure.
8 years ago

Edleman and his likes are disingenuous to be against annuities so steadfastly. They know they will lose that annual fee based income (much higher over time than an annuity pays the agent selling it) for the life of the business relationship with the client. They also know when they sell their businesses (which Edelman has a couple times and Fisher is retiring), their practice is worth more if the clients are fee based instead of having purchased an annuity. They also know that they will not still be in the business to sue when their former clients run out of money late in retirement because they did not have some protection for portfolio value or lifetime income. The industry is making a serious mistake for allowing these ego maniac fee based advisers to be on a pedestal to peddle their biased commentary on the minds of younger advisers who can be similarly influenced by the charlatans.
t6891raf 8 years ago

7 opposite views regarding the 7 Reasons I'm not Fond of Annuities: 1. Tax rates at retirement are usually lower even if you don't get the capital gain rates. Nothing can be passed tax-free except life insurance proceeds. 2.Inflation risk is the problem for fixed annuity. Variable annuities would allow the continuing investing in the market and not losing the growth potential. 3.Is the author saying all the promises in the annuity contract are deceptive and will be broken when it's the time to make payments? You got to be kidding me. This is an executed legal binding contract. 4. This is the well known disadvantage of all annuity products. But plenty of products with shorter surrender charge periods are available on the market today. 5. Does the author know about today's market? How many people are still buying the outdated, fixed annuities today? 6.That's why most of the annuity products go with the systematic withdraw and never go annuitization. 7. Longer life expectancy is one of the most important reason to let an annuity to provide lifetime income. The author is again saying the promises in the annuity contract can not be kept eventually and the insurance companies will have a hard time stay in business if these promises are kept. Is the author too dumb or everybody else? No body should put all their money in the annuity. I hope the author would not suggest his clients to put all their money in the ETFS and index funds. The author's knowledge about annuities are so outdated and is very much lack of knowledge of today's annuity products on the market. If the title of the article changes to 7 Reasons I'm Not Fond of FIXED Annuities, I would mostly agree with his/her point of view.
vconnor 8 years ago

Although I see typo's in my comment below, I cannot correct them. I don't see any "edit" option. Take the comment for its substance, not my proof reading ability before hitting post!
vconnor 8 years ago

Ric- you do your firm a disservice by presented such a half baked argument full of substantial inaccuracies. I do full planning and build retirement income plans. I use annuities as part of the plans as they are literally the only think you can guarantee a life income. In the 1990's, the accepted underlying ROR of the market for planning was 7%-10%. Today its more 4% - 6%. With negative interest rates in Europe and Japan, all return levels are likely to be lower, so who knows what equity ROR will be going forward. I've be doing this for 35 years and there's only one thing for sure - there is no single right answer. From 2000 to 2010, the markets ROR was basically 0. And "rates can never go below 0%". Well short rates are under 0% in Europe and Japan today. So to have your clients depend on just equities or just bonds, provides very little true security. You don't know where market ROR are going and you don't know where interest rates are going. As in managing a stock portfolio, a key is diversification. That applies to products as well. As to annuities, it's like cars - there are terrible cars and wonderful cars. There are Yugo's and Mercedes. Both get you from point A to point B, but one has substantially more crash protection. That's what annuities do. You don't buy them for superior ROR. You buy them for crash protection. Insurance is something you pay for that you hope you never use. Like car insurance or home insurance. But when disaster strikes, you'll wish you had more. Same with annuities. Your ego is punishing your clients. Put your clients well being in front of your ego. I like stocks better myself. But I know the pitfalls and know to build a diversified portfolio - both in names and in products.
8 years ago

Does Edelman guarantee his fee based account clients that they will never run out of money if they live a long time. Naturally he does not like them as they would lose all that fee based asset income for many years if one buys a lifetime income rider variable annuity. In a perfect world, we don't need to insure our portfolios. He would charge his big fee forever (until client runs out of money) where the annuity advisor likely only makes 6 or 7% over life of the contract. Much of Edelman complaints are for fixed / SPIA type contracts or higher cost variable annuities with no lifetime riders. We don't recommend either of those very often as they don't justify the costs. Annuities are not right for all clients but they help insure part of a portfolio (either principal on an index annuity or income stream from a variable contract). If advisers don't believe in insuring part of a portfolio, they should tell all their clients to cancel their extra auto or homeowners insurance. I suspect it is more likely one will lose money in their portfolio over a given time frame than their house burning down. The holier than thou advisors such as Edelman and Ken Fisher are dangerous for their clients as they simply want fee income knowing that their clients money might last until the advisor retires and then the client is left holding the (money) bag which might not be enough to carry them through retirement. Shameful for these type advisors to be put on a pedestal as if they don't have a conflict of interest to taint their recommendations.
jmraft 8 years ago

Hmmm, annuities in wrap accounts, transaction charges, 12b1? Why would you need a disclaimer if you don't use them? BTW pretty steep starting fee, but I guess small clients are not of interest to his firm. Found on websites FAQ, must be an error. "Edelman Financial Services" What is your fee? Our clients pay no commissions, trading costs, or brokerage fees.* Instead, Edelman Managed Asset ProgramÂ® (EMAP) features a single annual fee. It is calculated quarterly and debited from your account in arrears, based on the beginning and ending values of all the accounts in your household (adjusted for any money you deposit or withdraw during the quarter). Your quarterly statement will show the management fee for the quarter; you will also receive a year-end summary. The fee is based on the value of your account. So the more you invest, and the higher your account value grows, the lower your rate â€“ potentially providing valuable savings to you. The fee schedule for Traditional EMAP is: First $150,000 2.00% Next $250,000 1.65% Next $350,000 1.25% Next $250,000 1.00% Next $2 million 0.75% Next $7 million 0.60% Next $15 million 0.50% Amounts above $25 million are negotiable *The wrap fee does not include certain account and securities-related costs including the fees and expenses embedded in the mutual funds (including management fees, transaction charges incurred for fund-level asset allocation model trades, custody of fund assets and other fund expenses), ETFs or annuities in which wrap fee accounts invest. Depending on your situation you may incur a debit balance fee, margin interest, an IRA or retirement plan fee, transfer fees, SEC fees, 12b-1 fees for certain money market funds, wire transfer fees, overnight check fees, account closing fees, transaction charges incurred for fund level asset allocation model trades, or other fees or taxes as required by law.
ThomasRSchwebach 8 years ago

Ric Edeleman's commentary on annuities is seriously flawed and requires clarification on many levels. Life time income annuities provide just that, a guarantee of income which simply cannot be outlived. Such an income stream, in tandem with a robust equity portfolio, provides a complementary negatively correlated portfolio which research clearly demonstrates, is the optimal approach for long-term retirement success. Stated differently, when a lifetime annuity income floor is included into a Retirement Plan (RP), retirement success probability improves dramatically. RP failure rates for longer duration retirements (20-30 years), become significantly reduced. I would invite Mr Edeleman to research the work of Dr Pfau and Dr Finke, both professors in retirement income planning, to broaden his knowledge of annuities in retirement planning. Guaranteed lifetime income annuities also provide the opportunity for the retiree to receive mortality credits-and thus a rising stream of income during retirement. Mortality credits are unique to lifetime annuities-no other asset class offers these credits. Rising annuity income during retirement is also, in fact, a meaningful hedge against inflation. Certain mutual insurance companies also pays annual dividends on their lifetime income annuities, which can be used to purchase incremental increases in guaranteed annual income. Call it a laddered annuity income floor. Lifetime income annuities also address and mitigate longevity risk. As retirees live longer, their base floor income can never disappear. Lifetime annuity income also helps guard against elderly decision-making error risk, their annuity income is on "auto-pilot". Lifetime annuity income also avoids expensive advisory fee risk. Paying an additional 1% fee on assets, increases portfolio withdrawal rate drag, adding to significantly increased probability of RP failure. Speaking candidly, many advisors dislike lifetime income annuities, and have an inherent conflict of interest when it comes to annuities because they lose their asset advisory management fees. Don't touch my AUM cheese/fees. High PE valuation equity exposure at retirement time exposes cusp and early retirees to adverse sequence of return risk. Adverse sequence risk is thee paramount risk a retiree faces as he approaches, or, enters into retirement. Acquiring a lifetime income annuity helps reduce and mitigate equity risk exposure, reducing sequence risk. Retirees also will not lose any of their principal invested into a lifetime income annuity, as they are always made whole via the refund of premium feature. If they receive minimal income during the distribution phase, any remaining unspent original principal is refunded to their beneficiary. Liquidity? Should not be a real issue for retirees, as only a portion of their retirement portfolio is allocated towards their annuity income. Finally, studies show that retirees who own guaranteed lifetime income are happier retirees. Yes, they are happier in their retirements-come what may, their floor of lifetime income, will never die before they do. In fact, myriad streams of guaranteed lifetime income, help relieve equity performance pressure. Come what may, the retirees enjoy a monthly guaranteed income which covers all their core monthly expenses, for life. When properly framed? Guaranteed lifetime annuity income, is an integral element, to any thoughtful and thoroughly conceived Retirement Plan.

7 Reasons I’m Not Fond Of Annuities

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