Annuity Scare Tactics and Propaganda
Let me start this article by saying that I use both fixed and variable annuities for clients. I am not against annuities. They are a wonderful tool that is quite useful in many situations. However,
They are not the answer in most cases.There are two areas concerning the misuse of annuities that I’d like to cover:
There is a current push by the NASD (the self-regulatory body for brokers) to crack down on brokers who resort to scare tactics and misinformation when pitching variable annuities, particularly to senior citizens. Variable annuities are complex products, often times with high commissions. Those commissions can attract some shady dealings. While they are in the early stages of their investigations it seems that common tactics are used. In one they tout that these annuties protect investors from losing their money in a lawsuit (it might, depending on the state of residence). They then talk about people slipping and falling on their porch, the neighborhood kid getting bit by their dog, or other scenarios where they might be sued, lose, and owe millions. That this is rather unlikely is not the issue—it works in getting people to put their money into the annuities.
Why is this suddenly a problem? After the prolonged drop in stock prices, many folks were looking for something…anything that promised a better way. At the same time, sales were down and brokers’ incomes were dropping. Well, variable annuities are new to most folks and they pay brokers a pretty good commission. My Bible tells me that the love of money is the root of all evil. Because of this, fines and sanctions have already been levied against representatives of Banc of America, Edward Jones, Raymond James, American Express, Lutheran Brotherhood, Prudential, and other firms. This does not mean that the firms are evil…quite the contrary; most of their representatives are doing a good job. It does, however, point out that this is a problem across the entire financial community.
This does not mean that you should avoid variable annuities (remember, I use them in specific cases), rather that you should be careful to investigate what someone is trying to sell you. It may be a great addition to your investment portfolio or just a great addition to the broker’s wallet.
There is a lot of marketing of a particular type of annuity. These go by many names but the most popular seems to be an indexed annuity.
The neat thing about them is that they promise to give you the upward return of the stock market and the protection of a minimum return in a down market. What could be better than that? If the market goes up you make lots of money. If the market goes down you make a little money. You never lose. Sound too good to be true? Yes and no.
These types of annuities work exactly how they say they are going to. However, most people don’t look at the paperwork that goes with their annuity. If you examine how most of these work you will see that the annuity isn’t all it’s cracked up to be. (Note that every insurance company customizes these annuities so this discussion is general in nature.) For instance there are two limits to the upside of this type of annuity:
Dividends Returns from the stock market take on two forms: dividends and capital gains. Indexed annuities give you the capital gains but not the dividend return. Is this important? You bet! Over the two decades from 1983 to 2002 dividends (and the resulting reinvestments) accounted for over 45% of the total return of the S&P 500.
Cap Most of these annuities have an annual cap (maximum) as to how much return they will give you. For instance if the market goes up 30% in one year your annuity might be limited to only 15 or 20%.
Does this mean that these annuities are no good? Nope. It can be a good fit for some investors. Just make sure that if you are interested in one that you understand how they truly operate.