Annuities: The Trojan Horse of Retirement

HUNT VALLEY, Md. (TheStreet) -- I am a fee-only financial adviser, which means I can lead my clients to any investment on the planet if it is best for them. In addition, I am a fiduciary and must lead my clients to the best possible investment -- again, for them. Yet, despite opportunities to invest in some of the cheapest, commission-free annuities, I rarely recommend a client ever invest in them. In fact, I think it's a safe bet none of my colleagues who are also fee-only, fiduciary advisers would consider an annuity a wise investment.

Annuities are little ticking time bombs of taxable income that will either blow up in the hands of the owner or definitely in the hands of the heirs. In only slightly less violent imagery, annuities are like the Trojan horse, rolled inside your camp without understanding what's inside.
Annuities are like the Trojan horse, rolled inside your camp without understanding what's inside.

Annuities are typically sold with high fees to compensate for commissions to sell the investment. These commissions normally come with 4- to 15-year deferred sales charges, in essence handcuffing the client into the contract. It's a safe assumption that at least 90% of all annuity sales come with a commission -- the reason people buy them is because they are sold by a seller who is compensated for the sale.

Annuities are an easy sell because insurance companies are marketing wizards. They conduct enough focus groups and do enough market research to know what causes investor fear, grief and anxiety. They then attach a product feature dealing with each investor concern to lure the person to the product. For example:

"Tax deferral for everyone wanting to minimize taxes": Annuities are, for the most part, the only tax-deferred savings vehicle that is a benefit given only to the insurance annuity industry. There are far better overall planning ways to minimize taxes during your life and at death. (Municipal bonds are tax free and capital gains and dividends are also taxed at a flat 15% rate, unlike the ordinary income tax rates of the annuity.)

"Guaranteed so I can sleep at night": Guarantee is a word used in many annuities, but you must read the fine print to know what is guaranteed and who is the guarantor. As you will see in the following examples, the word "guarantee" is not always as wonderful as it sounds (the italicized words are the fine print):
  • Insurance companies are guaranteeing a return of your investment at the time of death.
  • Guaranteed accumulation account that really is not your money, so do not ask for it -- but you can use your guaranteed withdrawal based on this fictitious guaranteed accumulation account.
  • Guaranteed withdraw rate that can either be principal or return and only your heirs will know for sure.

Finally, the "High rate of return without loss": A sure way to get all of the upside in the stock market is for the insurance companies to magically make the downside of the market disappear. This is all smoke and mirrors, and some of the most complex features to try to understand. In addition, the expenses of the insurance product will devour your return -- even in good years!

This is the triumvirate of financial sales: to tell someone it is tax deferred, guaranteed and high yielding. No other product -- even if it could use the same tricks to make those three claims -- can compete legally on the same field with the marketing protection of the insurance annuity industry.

Brokers love the product because they are an easy sell. Clients love them, becauser they think they have a worry-free product with a lot of great benefits. Many times a client will own an annuity for years and, as long as it never shows a decline, they are happy even if the increase is well below average.

Unfortunately, like at the Battle of Troy, the client does not understand the product they bought until it's too late. Insurance companies have never been a benevolent bunch, nor are they known for devising products solely in the best interest of the client.

Remember to always be wary of any investment that looks to good to be true.

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Andrew Tignanelli, CFP, CPA, is president of Financial Consulate, based in Hunt Valley, Md., and a member of NAPFA, the National Association of Personal Financial Advisors.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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