Annuities-Suze Orman, Jane Bryant Quinn, John Biggs & AARP HATE Them – Why?

by Randall Luebke RMA, RFC on August 1, 2011

Randall A Luebke RMA, RFC

Annuities, fixed indexed annuities I refer to as 3rd Generation Annuities, are almost always one of the core tools I recommend in my retirement planning arsenal when structuring a safe, conservative, guaranteed retirement plan for my clients.  Unfortunately, many of my clients leave my office and research annuities on their own only to come to the conclusion that annuities are AWFUL investments.

Why?  The Internet is loaded with articles from some very well known financial celebrities like Suze Orman, Jane Bryant Quinn, John Biggs and even/especially the AARP supporting that position.  The problem with these folks is that they lump ALL ANNUITIES into one group.  This is just plain wrong, misleading, and it’s causing millions of people who would otherwise benefit greatly from annuities to avoid them all together.

That said, I just came upon a very well written article on annuities written by financial advisor, Josh Mellberg.  So well written, in fact, that I’ve decided to include it in this blog and give him full credit.

His article speaks specifically about variable annuities.  I refer to variable annuities as 2nd Generation Annuities.  Personally, I don’t like them either. Josh, however, is somewhat open to them as you will see in this article.  He believes that they can be considered as an investment.  That said, I don’t.  Yes, it’s true!  Suze Orman and I actually agree on something. As for Jane Bryant Quinn, John Biggs ad AARP, they are all on this band wagon too.  They all hate variable annuities.

I will setup a link here to my previous article written about 1st, 2nd and 3rd Generation Annuities.  That article is a great overview (if I do say so myself) of how these annuities evolved and who they differ.  I firmly believe that annuities, especially 3rd Generation Annuities, should be an integral part of everyone’s retirement planning.  3rd Generation Annuities work like a pension.  (In fact, many pension plans purchase these annuities for their retirees upon their retirement.) They are safe.  They have minimal to no fees associated with them and, they can provide a guaranteed income for life and the life of a surviving spouse.

I hope that Josh’s article will provide you with some beneficial insights.  As always, thank you for taking your time reading this article and please, leave your comments and pass the article on to your family, friends and co-workers.

It’s a good life!


 

 

Randall A. Luebke RMA, RFC

Randy@LifetimeParadigm.com

www.LifetimeParadigm.com

 

What is a Variable Annuity and Should I Consider It? – By Josh Mellberg
A variable annuity is invested in what are called sub accounts, which are similar to mutual funds but have extra insurance fees attached to them, so the value will go up and down with the market. Many financial experts do not recommend them, especially as part of a retirement portfolio.

In fact, Suze Orman lists them as #1 on her hate list, particularly when touted as part of a retirement account. Jane Bryant Quinn says that she’d like to take all variable annuities and smash them to smithereens. John Biggs from TIA-CREF says that it’s never suitable to buy a variable annuity. Even AARP has spoken out on the topic, discouraging its members from ever including a variable annuity in their considerations for retirement funding.

Capital Gains Problem with Variable Annuities:
Of the several problems that experts see with the variable annuity, the one that hits many consumers the hardest is the capital gains problem. When variable annuities became popular in the 1990s, capital gains were taxed differently than they are now.

Since you do not have to pay taxes on capital gains earned under the umbrella of a variable annuity–or money earned through interest in investments–until you take money out of the account, it can sound like a good deal. And it is – until you want to remove your money.

At that point, you will be required to remove the gains first. Since this is the part that is taxable, you will be paying taxes when you begin to rely on the funds for income. On top of that, you will be subject to taxation on that money at your ordinary income tax rate, instead of at the long-term capital gains tax rate. This is almost always a higher rate, so you’ll have to pay even more money to the government.

The bottom line is, you may pay more in taxes with variable annuities now than when they were popular in the 1990s.

Fees Problem with Variable Annuities:
There are potentially seven types of fees associated with a variable annuity, depending on the company and the particular fund. We will cover the most common. The first of these is an Administrative Fee. Every year, fees can be deducted from the account for record keeping, paperwork, and administrative costs. This may be charged as a flat account maintenance fee or, as a percentage of your account value. Typically, but not in all situations, this usually comes in around .25% to .50% each year. While this doesn’t sound like very much, it’s $2,500 on a $500,000 investment. Over time, that can add up.

Most sub-accounts which are similar to mutual funds held in variable annuities also carry a Mortality and Expense Fee. This fee guarantees that your heirs will be paid at least a certain amount if you pass away before taking money out of the fund, even if the fund’s current value is below that amount. So let’s say that you buy a mutual fund in a variable annuity for $500,000 and the value of the annuity at your death is only $300,000. Your heirs will still get $500,000 if you paid a Mortality and Expense Fee.

This fee is can pose several problems however.  First of all, any gains that your heirs receive from a variable annuity are 100% taxable, even though most life insurance is tax-free. Secondly, the fee is equal to a certain percentage of your account value, typically in the range of 1-2% per year. For a fund with a value of $500,000, you’ll pay $5,000-$10,000 in annual fees.

A third common type of fee is the Mutual Fund Fee. Mutual fund expenses are made up of sales charges and fees. While they often sound low, typically between .25% – 4% annually, depending on the type of fund, they can add up quickly. These fees generate major income for the companies that hold mutual funds. In 2006 alone, Wall Street made over $80 billion in Mutual Fund Fees.

Finally, there are fees for bells and whistles also referred to as rider charges. These rider fees are usually attached to your account contract, and they can add up quickly.

In fact, all of these fees can add up. One gentleman purchased a $1 million variable annuity and found that, after 5 years, the value had shrunk to $800,000. Since a rider on the fund said that it had to increase by at least 5% a year, the value should have been $1.25 million. Upon further investigation, the gentleman found that the fund did in fact have that value, but he would have to die to access the full amount. His only other option was to annuitize it, or turn it into a pension. But if he did that, he would lose control of his money.

If that wasn’t bad enough, he also discovered that he was paying $32,667 annually in fees for the fund. It was advertised as only carrying $10,000 in fees, but that only covered the Admin Fees. Once all of the fees he was not aware of were added up, the gentleman discovered that he had paid over $160,000 in fees in the five years that he had that fund.

Is a Variable Annuity Ever an Appropriate Investment?
With all this discussion of the negative aspects of variable annuities, many people wonder why they exist at all. The truth is, in some situations, they can be a good investment. If you’re looking for aggressive growth and can find one with low fees, it might be a good option for you.

Josh Mellberg

{ 19 comments… read them below or add one }

Roxanne Cecala August 30, 2011 at 6:53 pm

Dear Josh,
I have just spoken to a financial advisor with MetLife. I am a single and disabled, due to a very bad car accident not at my fault. I am only recieving 815.00 dollars a month from disability and being allowed to work on disability I earn an extra 700.00 dollars a month. My monthly bills come to 1300.00 dollars a month , not counting any luxuries. However, I was told today that a variable annuity GMIB MAX/ EDB MAX (whatever that means) is suggested for me to invest my money. I am barely making my financial responsibilities each month and may need to supplement with this kind of annuity. I have listened to your videos and lectures and I am trying to educate myself the best I can. Could you please , please tell me your opinion that I highly respect, I am lost.
Respectfully,
Roxanne Cecala

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randylue August 31, 2011 at 6:24 am

Roxanne

In general I am not a fan of variable annuities. I refer to them as 2nd Generation annuities. The “Promise” is that you will receive professional management of your money, which is invested in the stock market. While in theory, this could work, in practice it doesn’t. Between the losses experienced due to the volatility of the stock market and the fees built into these contracts it’s difficult to realize a significant profit needed to fulfill that promise.

Annuities, in general fall into 3 categories. I’ve just described the 2nd Generation annuity. The 1st Generation annuity is also referred to as a “fixed” annuity. These annuities are very safe. Think of them as a CD (certificate of deposit) on steroids. Why? 1st Generation annuities pay yields that are generally 100-400% about the typical CD rate. Moreover, the interest you receive from CD’s is taxed immediately, whereas the interest you receive from the 1st Generation annuity is taxed deferred. As a result, your earn money in 3 ways: 1) The interest paid by the annuity. 2) The compounded growth of those earnings 3) The compounded growth of the tax-deferred earnings. Ultimately you will pay taxes on the earning, of course, but only when you start to withdraw your money. Even then these annuities are taxed in a tax favored manner. We don’t hear much about 1st Generation annuities today. I like to say that these are the annuities your Grandparents owned. That said, with baby boomers nearing their retirement and those already in retirement looking for safe, solid tax favored placed to invest, I predict that you will hear a lot more about these products in the very near future.

The 3rd Generation annuity takes the idea of a 1st Generation annuity (safety, tax deferral, good tax-deferred earnings) and super-charges the potential earnings by incorporating indexing strategies into the mix. What this means is that with a 3rd Generation annuity can actually experience significant returns/growth without being subjected to the potential risks and losses associated with 2nd Generation annuities. It is like having your cake and eating it too; potential growth with no risk of loss.

Finally, you referenced GMIB MAX / EDB MAX. While I’ve not researched the specific product that’s been recommended to you, I’m going to guess that these acronyms mean – Guaranteed Minimum Income Benefit / Enhanced Death Benefit and the “Max” is “maximum”. Let’s break this down for you. The GMIB is similar to a pension meaning, once activated you would receive a check from the insurance company every month for the rest of your life. In reality, you can receive that check once a year, a quarter and a number of other variations. What’s important is that this feature will provide a continuous source of income. Today this feature is available to both 2nd and 3rd Generation annuities and it CAN be an incredible opportunity to create pension-like income for the millions and millions of us who won’t have pensions provided to us through our employers when we retire.

The Enhanced Death Benefit could me a number of things. In general, however, it means that when you die, the entire annuity is available to your heirs without early termination fees reducing its value. Early termination fees are imposed when you withdraw money from your annuity before it matures. Like a CD, if you try to cash it in early you will be assessed penalties. Most 3rd Generation annuities will allow you to withdraw 10% of the annuity’s value each year without any penalty. However, if you tried to cash in the entire annuity you could be subjected to early withdrawal penalties ranging from 10-20%. If you die, however, those penalties are waived. There are also 3rd Generation annuities with waivers for terminal illness or if you were required to receive medical assistance related to long-term care (Nursing homes, in-home health care, etc.).

As you can see, annuities have many, many features and restrictions and choosing the right set of options for your particular situation requires 3 things: 1) You doing your homework, learning about the choices and options that are available to you. 2) Finding a Financial Advisor who will take the time to understand your particular needs and issues. 3) Finding a Financial Advisor who has all the product choices available in the market to choose from, so that he/she can provide you with both objective advice and be able to deliver the best solutions.

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jeff o. September 16, 2011 at 1:58 pm

Randy, where are links to the two articles you referenced; i.e., yours and Josh Mellberg’s. I obviously am missing something.

Jeff

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Randall Luebke RMA, RFC January 24, 2012 at 2:32 pm

Sorry for taking so……long to reply to your post Jeff, but I do not have the links for Mellberg. That said, was there anything specific that you wanted to know? I would be happy to research it for you to compensate for my very belated response to your question.

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Donna S March 5, 2012 at 9:54 pm

Several “experts” have spoken with me about variable annuities/indexed annuities,but I have an idea that since I have no children to worry about, perhaps at 66 years old planning to buy a home I could enjoy living in forever with my husband who is 63, that buying into that property with a reverse mortgage, and I know the fees are high, but based on a 30 year additional life span, the net gain on a 1000.00 a month mortgage is a savings of $360,000.00. While most advisors do not have a way to make a commission on this product, do you think this could be a viable planning strategy, not for all our funds, of course, but as part of planning???

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Randall Luebke RMA, RFC January 10, 2013 at 3:01 pm

You hit the nail on the head Donna when you wrote “…most Advisors do not have a way to make a commission on this product”. Let’s give the Advisor community the benefit of the doubt and assume that just because they won’t earn a commission, that they would not direct you to a better solution. We will give them that. However, the fact is that if they are not going to earn a commission then it is very likely they are also not going to take the time needed to learn about the product. The result is that they are likely not qualified to give you advice either for or against a reverse mortgage.

The problem goes deeper, however. Did you know that most financial advisors are actually prohibited, by their employers, from giving clients any advice about real estate and/or mortgages. PROHIBITED! I think that, at best, this is crazy. At worst it’s somewhere between unfortunate and terrible because clients come to their advisors expecting to receive objective and comprehensive advice. The believe that is what they are receiving, because they don’t know the truth. They don’t know what limitations the Advisor has in terms of knowledge, experience, licensing or other restrictions.

The bottom line is that I believe that reverse mortgage can be a wonderful financial tool. More and more my colleagues agree with me.

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carol mettler June 7, 2012 at 12:29 pm

our financial advisor at jp morgan wants to sell us a variable annunity through Sun America. We would put 182,000. Annual fee is 1.6 taken out quarterly. Annual rider fee is 2.90 % Withdrawal rate is5.50%. Protected rate is 4.00%. M &E expense is 1.55 for five years then goes to 1.30. No commision to get in. I have a lot of concerns about this plan. We have additional income for retirement worth about 320,000. I do like the guaranteed income for life even though this is invested in mutual funds. I worry about the stock market causing us to lose more money if another recession comes.

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Randall Luebke RMA, RFC January 10, 2013 at 2:39 pm

I think you have zeroed-in on all the right issues and concerns. In general, the problem with 2nd Generation/variable annuities is that they are LOADED with fees. Even if the market goes up “the house” is going to take the first cut of your profits. If the market goes down, you principle takes the hit. Yes, they do provide an income guarantee. Yes, they do have the potential of increasing in value. That said, for most people the priority should be safety of principle first, then return on investment and not the other way around.

One of my 12 Principles of Money is called The Principle of Regeneration. It’s really a math formula, however, the essence of the Principle is it takes a multiple in gains to make up for a loss. In other words, if you experience a 50% loss and then receive a 50% gain you still only have 75% of the money you started with. To make up for a 50% loss you need 2 x 50% or 100% just to break-even. For the entire post on this Principle go to http://www.thebankofyou.com/the-12-principles-of-money/

Thank you for your comments!

Randy

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carol mettler June 7, 2012 at 2:10 pm

i think that 2.9 % was annual market return. but not sure.
i said rider fee but that may not be correct.

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Charvak Karpe July 19, 2012 at 9:59 am

Randall,

What do you think of allocating the fixed income, commodity, and actively traded portions of a high net worth individual’s portfolio to the Jefferson National Monument Advisor annuity? It only costs $240 per year. Those assets are subject to ordinary income taxes anyway, so the deferring the payment of the ordinary income taxes seems to be very valuable.

You said it’s wrong to lump all annuities into one group. Isn’t it wrong to lump all variable annuities into one group as well? How is the Monument Advisor annuity not just an extension to qualified retirement plans like 401(k)’s and IRA’s, with lesser tax advantages in exchange for no contribution limits?

Charvak

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Randall Luebke RMA, RFC January 10, 2013 at 2:30 pm

You know, Charvak, you are “right”. It’s really unfair to lump all variable annuities into one group. I will be more thoughtful in the future. I am very familiar with the Jefferson National annuity. I think that it is a great program and plan to offer it to my clients. Why? Because unlike most (see I’m getting better already) other variable annuities the Jefferson National program is 100% liquid. The $240 fee is significant for a small investor ($240/$00,000 = .24%). However, with a $200,000 investment or more that fee is pretty insignificant. Of course, your investments are not provided any principle protection as they are inside a fixed or fixed-indexed/3rd Generation annuity. That said, if you are going to own mutual funds outside of a 401k or other tax-deferred vehicle, then Jefferson is a great option as you do gain the tax-deferred benefits of the annuity.

Thank you for your comments!

Randy

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Betty Ann July 26, 2013 at 8:08 am

Randall,
Do you have any thoughts on Jackson Perspective II Fixed and Variable Annuity?

Thanks,
Betty Ann

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Randall Luebke RMA, RFC July 28, 2013 at 4:33 pm

I am sorry, Betty Ann, but I am not familiar with the Jackson products you are inquiring about. As I have previously written, however, I am just not a fan of variable annuities in general mainly due the the high fees associated with them as well as the risks of loss to your principle. I much prefer fixed indexed annuities (FIA’s) which I refer to as 3rd Generation Annuities. They are safe. They have low or even no fees. They have excellent earnings potential. They really are a better, smarter, safer way to protect and grow your money.

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Bob Solomon August 17, 2013 at 3:13 pm

Dear Randall: Thank you so very much for your candid and unbiased opinions on this topic. I can’t seem to locate ANYONE who is so unbiased, and deeply appreciate you.

Just having entered retirement, and learning just how pitiful, dangerous and difficult fixed income investing is at this time, there are few options to consider. I am single, and would like to leave some of my worldy savings to my nieces and Godson. But I am willing to place 200K out of 610K in savings/stocks/bonds into an annuity. But which one??

I am a Schwab client, and they are trying to sell me a Income Variable Annuity with a Guaranteed Lifetime Withdrawal Benefit (GWLB) rider. They have sent me multiple “illustrations” of different stock market scenarios. It is offered through Pac Life.

I can see for myself the multitude of fees and stipulations. It seems outrageous. Do you have an opinion on this?

Would I be better off in the AARP NYL annuity with the 20 year guarantee that my heirs would receive the balance of my payments up to 20 years if I died before the 20 years was reached? While I am 60 now, no male in my family has lived beyond 72, and I have all the congenital issues they had – diabetes, high BP, bad cholesterol, arthitis, etc., so I don’t really expect to do much better than the men that came before me.

Would you consider the AARP/NYL annuity a variable or fixed annuity? I have been cautioned relentlessly about variable annuities (I watch Suzy religiously), and the Schwab annuity is a variable one, although softened by the GLWB.

This is all so confusing and nerve-racking. What would be your recommendation between the Schwab variable annuity with the GLWB or the AARP/NYL annuity (is it considered fixed income??)? I am ready to move on this now, and would so deeply value your opinion.

Many thanks!!! Bob

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Randall Luebke RMA, RFC January 25, 2014 at 9:24 am

Bob, please accept my sincerest apologies for not responding to your comments until now. That said, thank you for your kind words. As so much time has passed since you added your comment have you found the answers to your questions? If not, please let me know and I will respond to them right away.

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DIANE HARDY November 4, 2013 at 4:10 pm

I HAVE A GROUP ANNUITY THAT I HAD NO IDEA THAT I HAD IT. WHEN I FOUND OUT ABOUT IT I HAVE HAD ALL THESE YEARS UNTIL I FOUND OUT I HAVE HAD SINCE 1991 NEVER RECEIVED ANYTHING ON INTEREST RATE BUT IT MATURES IN 2017. I NEED DOWN PAYMENT ON A HOME DENTAL WORK AND I NEED SOME OF THIS MONIES THEY WON’T TELL ME ANYTHING ABOUT IT. WHAT DO I DO GET A LETTER ON SOMETHING I CANT ASK ANYONE ELSE ONLINE ABOUT THIS WHAT IS THIS ARE YOU ALL MONTORING MY ACCOUNT

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Randall Luebke RMA, RFC January 25, 2014 at 9:27 am

My first question is, how do you know that you have a group annuity and the maturity date? Can I assume that you don’t have a copy of the policy? Other than the maturity date, what information do you have; the name of the insurance company, a policy numbers, any other information that would help you to track down the details?

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Pat January 25, 2014 at 8:38 am

What do you think about a hybrid fixed annuity vs. a fixed annuity? I have retirement money that has been taxed and am 66 yrs old and just retired. I have no knowledge about what options are out there. One advisor says stock market ; another says the Jackson ,with some in Cion and Allied; and the last says ING fixed annuity which gives you $5,000 for signing up. I probably will not need the money for awhile so it can sit until govt requirements have to be meet when I am 70. Due to mixed advice I have started to research and writing down questions to ask. None of them have suggested a Hybrid Fixed Annunity that Mr. Mellberg talks about. What do think about his Hybrid model? What about something else I should look into? Also who do you go to for advice that can help educate you but doesn’t have any commission to gain? Would that be an accountant?

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Randall Luebke RMA, RFC January 25, 2014 at 9:20 am

Thank you for your inquiry Pat. I know that understanding the wide variety of choices and options among annuities can be confusing. The fact can be exacerbated when the persons you question don’t know all of the details of each and every product as well. Moreover, often an advisor will have a limited number of options to offer. Rather than “lose the sale” they will often do their best to convince you that what they do offer is THE best option. There is a bigger question that needs to be answered, however. That is, what is the right strategy for Pat? Is it an annuity? Is it stocks? Is it both or something different altogether. The answer is that it depends on the details of your specific situation. How much income do you need? What are your other sources of guaranteed income during your retirement like Social Security or pension income. What this boils down to, Pat, is someone needs to help you access what you have to work with, what your needs are, understand you personal concerns and issues, then one could recommend an appropriate solution for you.

I hope that this was helpful. Please let me know if there is other information or insights that I can provide you.

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