Eve Kaplan, CFP®
Eve Kaplan
Kaplan Financial Advisors
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Berkeley Heights, NJ 07922 USA
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Caveat Emptor (Buyer Beware) When It Comes to Complex Annuities!

March 13th, 2013

Do you own an annuity — or have you been approached about buying one? Be aware that annuities are under increasing scrutiny, with the State of Florida leading the charge. Florida put suitability standards on the books in January 2011 to protect its senior citizens from fraudulent annuity sales that are unsuitable for a person’s age or economic status. Florida now is considering extending these protections to Floridians of all ages. It seems to be working —annuity sales complaints in Florida have declined since January 2011.

Here’s an example of an unsuitable annuity sales attempt close to home: one of my close relatives (now age 83). This relative lives out of state (not Florida). A financial advisor tried to pitch an annuity to her when she was 79. Fortunately she turned to me for a 2nd opinion and I recommended she stop taking calls from this advisor. Why? The fine print on this annuity proposal indicated underlying expenses were over 3% per year and the money would be locked up for 10 years until she was 89 – otherwise she would incur stiff surrender penalties. Did my relative need this annuity? Absolutely not. The advisor, however, needed the commission and was annoyed when my relative said “no thanks.”

Having a stream of income in retirement (like Social Security) can offer significant benefits over tapping a lump sum in retirement. Some annuities can provide this in a transparent and low cost manner  — e.g. fixed annuities (if purchased when interest rates are relatively high).  However, consumer advocates can be critical of complex variable annuities. But don’t take my word for it – here’s what  Barbara Roper (Director of Investor Protection at the Consumer Federation of America)* has to say about “complex annuities”:

1. Putting annuities in IRAs is “not appropriate.” Roper observes “A huge percentage of annuities…actually are held inside tax-advantaged retirement accounts, so you’re buying a product whose primary benefits are tax-advantages inside a plan that already provides those tax advantages.” (this is what I call “a refrigerator inside a refrigerator”). Roper points out that the SEC has deemed this “not appropriate” [for a retirement product].

2. They’re too complex.  Roper says  “When you buy an investment, they say you shouldn’t buy it unless you understand what would have to happen to you to make money and lose money…too often annuities – at least the more complex exotic annuities […] fail that test.” Roper says it’s extremely difficult to compare annuity products since they have different features. Withdrawal penalties, for example, often are presented in the form of an equation instead of disclosing dollar amounts of surrender penalty losses.

3. Fees are high, disclosure is not transparent.  According to Roper, “The complexity, the less-than-transparent disclosures about key features, the very high costs associated with these products make them highly suspect….”

4. Salespeople plugging them can put their interests before yours.    Roper observes “…they’re [annuities] disproportionately sold by salespeople who don’t have to act in your best interests…[annuities] compete based on paying the salesperson. That to me is a market I want to avoid.”

What should you do if you own an annuity? If your annuity is non-qualified (purchased with after-tax money), a fee-only advisor can provider an objective assessment of a product. It may be possible to roll this annuity over to a far less expensive annuity. If your annuity is qualified (in a tax-deferred account – e.g. an IRA), it may be dismantled altogether if it serves no purpose and is out of surrender penalty.

*Roper was quoted in an article about “Complex Annuities” by Marlene Y. Satter in “Investment Advisor” March 2013 http://www.advisorone.com/2013/02/25/top-5-retirement-issues?t=the-retiree&page=2

 

 

Copyright (C) Eve Kaplan, 2013. All rights reserved.

 

 

Variable Annuities – Uses and Abuses: Part 2

October 1st, 2009

Variable Annuities – Uses and Abuses: Part 2

By Eve Kaplan CFP®

Last month we fired an opening shot at Variable Annuities to highlight their uses and abuses. We’ll continue this discussion this month by looking at them in greater detail.

To summarize, I mentioned last month why so many annuities get sold (very profitable, for one) and why so many people buy them without understanding them well. Annuitants (annuity holders) I meet never seem to know they’re getting their hands tied to an expensive investment that unnecessarily restricts their freedom of choice and doesn’t protect them as much from the market as they think.
Variable annuities just aren’t the “quick fix” for retirement some annuitants think they are.

Let’s review in detail some of the pros and cons re: variable annuities:
Pros:

1. Any annuity takes taxable income and converts it to tax-deferred income (note: this is redundant if the IRA is put into an annuity). This is good if you’re in a high tax bracket now, don’t need the money now and expect a lower tax bracket when you draw your annuity.

2. Some variable annuities (expensive ones with bells and whistles) provide downside protection in stock markets. This certainly was helpful this past year. However, the underlying expenses are quite high for this type of “portfolio insurance” (and a lot steeper than they used to be since September 2008). Insurers got burned by the market collapse that began last September, so the protection is less generous and/or costs have risen for protection.

Cons:

1. Converting money to a tax-deferred status means you lose the ability to make use of a loss by offsetting it against gains in your taxable portfolio. Further, you lose the right to deduct an additional 3K/year of excess losses each year.   If you’re in a 33% tax bracket, that’s like losing an extra 1K per year.

2.  The present value of the annuity (a stream of payments for the rest of your life) is higher if you live longer. But variable annuities invest in unpredictable things (stock markets) so the stream of income is unpredictable, too (unless you previously bought the ‘bells and whistles’ annuity). The annuity may have no value if you pass away unless you purchase additional features that pass initial investments to your estate.

3. Locking up money in any annuity means you can’t readily tap the funds if you suddenly need your funds in a hurry.

4. Variable annuities can confine you to an unattractive, expensive investment selection. You’d lost the freedom to roam widely and find the best and most cost-effective investments.

5. School teachers are thrown to the wolves in many 403b plans – these annuities confusingly are billed as “tax-sheltered” investments (giving the impression tax is avoided altogether).

6. One of the worst offenses is putting IRA (already tax-deferred money) into an annuity. Putting IRA into an annuity can be likened to putting a refrigerator inside another refrigerator.

As you can see, the “cons” outweigh the “pros.”

I use annuities sparingly through a network of annuity providers I trust. I prefer fixed annuities – especially inflation-protected annuities that retain purchasing power. And charitable annuities (typically fixed) bestow tremendous tax benefits, secure some income for life and allow the annuitant to gift the balance to a charity of choice.

Financial planning should encompass all aspects of a person’s financial world: insurance, estate planning, education planning (if relevant), investments and tax planning. When done right -without the intrusion of product sales compensating the planner – clients have powerful plans to the end of their lives. The alternative is a quick fix annuity sale by an advisor or broker who usually bypasses a detailed, in-depth analysis of the person’s financial needs.

Again – the expression Caveat Emptor (“buyer beware”) is a good adage when you purchase anything —including a variable annuity.

Copyright © 2009 by Eve Kaplan

Eve Kaplan is a Fee-Only (no products sold) Certified Financial Planner. Kaplan Financial Advisors, LLC is a Registered Investment Advisor in NY and NJ. She can be reached at 908-898-0549 or www.kaplanfinancialadvisors.com

Variable Annuities – Uses and Abuses: Part 1

September 1st, 2009

Variable Annuities – Uses and Abuses: Part 1

By Eve Kaplan CFP®

It’s true some variable annuities redeemed themselves this past year. Holders of annuities with expensive (but generous) contracts came out smelling like roses because insurers promised to pay those clients lifetime retirement income based upon past market gains, along with some protection against down or flat markets.
This has given us critics of variable annuities some pause for thought. Meanwhile, insurers are clamping down on promises to new annuity clients because they paid heavily to insure against a very unlikely event (the catastrophic market collapse we witnessed this past year).

So why do I still have a beef with many or most variable annuities? Two reasons: 1) clients often don’t need them and 2) they don’t understand them. There can be good reasons – at times — to invest in a low-cost fixed annuity but there are fewer compelling reasons to invest in a variable annuity.
In another article we’ll discuss the “better” annuities: fixed annuities (immediate or deferred) and charitable gift annuities.
Why do so many people buy variable annuities? People often mistakenly think they’re getting a guaranteed product that can solve their retirement funding problems. They’re attracted to the “insurance” element (in fact, just a guarantee your heirs will receive the sum of your initial invested amounts if you die). But another reason is they’re incredibly lucrative to sell because they generate whopping commissions of up to 8%. On a 300K annuity, that’s as much as 24K in commissions! (the broker or seller may have to split this with his or her firm – but that’s still a nice 12K commission on a 300K annuity).

Sadly, people who buy variable annuities usually don’t know it can cost them 2% to 4% per year in underlying expenses to maintain. That’s approx. 6K – 10K per year in unseen underlying expenses on a 300K annuity (6K to 10K less to the bottom line return each year). And then there are the surrender penalties on some annuities – as high as 12% on the value of the annuity It takes years (sometimes 10 or more) to phase the penalty out.
One of the worst offenses is annuity sales on money that’s already tax-deferred because it’s part of an IRA. Putting IRA into an annuity can be likened to putting a refrigerator inside another refrigerator.
When an annuity is expensive and inappropriate for a client, all is not lost. By using a 1035 Exchange, annuitants roll out of expensive, unattractive annuities (baring any surrender penalties) and into better, less expensive ones. Costs can be slashed by 75% to less than 1% per year. The annuity provider doesn’t pay Fee-Only advisors (who can facilitate this process) a commission, so they can pass on savings to the annuity holder.
Here are some pros and cons to having a variable annuity:

Pros:
1. Any annuity takes taxable income and converts it to tax-deferred income (note: this is redundant if the IRA is put into an annuity). This is good if you’re in a high tax bracket now, don’t need the money now and expect a lower tax bracket when you draw your annuity.
2. Some variable annuities (expensive ones with bells and whistles) provide downside protection in stock markets. This certainly was helpful this past year. However, the underlying expenses are quite high for this type of “portfolio insurance” (and a lot steeper than they used to be since September 2008).
Cons:
1. Converting money to a tax-deferred status means you lose the ability to make use of a loss by offsetting it against gains in your taxable portfolio. Further, you lose the right to deduct an additional 3K/year of excess losses each year.   If you’re in a 33% tax bracket, that’s like losing an extra 1K per year.
2  The present value of the annuity (a stream of payments for the rest of your life) is higher if you live longer. But variable annuities invest in unpredictable things (stock markets) so the stream of income is unpredictable, too (unless you previously bought the ‘bells and whistles’ annuity). The annuity may have no value in your estate unless you have additional riders (that cost money.

3. Locking up money in any annuity means you can’t readily tap the funds if you suddenly need your funds in a hurry.

4. Variable annuities can confine you to an unattractive, expensive investment selection. You’d lost the freedom to roam widely and find the best and most cost-effective investments.

5. School teachers are thrown to the wolves in many 403b plans – these annuities confusingly are billed as “tax-sheltered” investments (giving the impression tax is avoided altogether).

I use annuities sparingly through a network of annuity providers I trust. I prefer fixed annuities – especially inflation-protected annuities that retain purchasing power. Most of the variable annuities I see are unnecessary and expensive.  Financial planning should encompass all aspects of a person’s financial world: insurance, estate planning, education planning (if relevant), investments and tax planning. When done right – without the intrusion of product sales compensating the planner – clients have powerful plans to the end of their lives. The alternative is an easy annuity sale by an advisor or broker who usually bypasses a detailed, in-depth analysis of the person’s financial needs.

I apologize if I’ve offended professionals who diligently identify the right annuity for their clients, do the necessary research and have a Fiduciary Responsibility toward their clients (putting their clients’ needs before their own). It’s just that clients who come to me armed with annuities never relate that kind of experience. They invariably are confused when I ask them “Why did your previous advisor/broker recommend you buy an annuity?” And they’re horrified when they realize how much their annuity really cost them.

Caveat Emptor – or “buyer beware” is a good adage when you purchase anything —including a variable annuity.

Copyright © 2009 by Eve Kaplan

Eve Kaplan is a Fee-Only (no products sold) Certified Financial Planner. Kaplan Financial Advisors, LLC is a Registered Investment Advisor in NY and NJ. She can be reached at 908-898-0549 or www.kaplanfinancialadvisors.com

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