Wednesday, September 21, 2011
The Good, the Bad, and the Ugly: Why Your Broker May Not Be Recommending The Most Competitive Annuity
There are over two thousand life insurance companies offering over fifteen thousand different annuities, and they run the gamut from horrific (I wouldn’t offer it to an enemy) to outstanding (I own it myself, and recommended it my parents). To make matters more confusing, annuities can be very complicated, with lots of different hard-to-understand variations. Enter the insurance agent / financial advisor / broker, to whom most annuity sales are outsourced, and who get paid a commission from the insurance company when they sell you an annuity. Let’s look at how they’re paid and how that can create a conflict of interest that can leave you, the investor, with an inferior annuity and less retirement dollars. When a broker sells you an annuity, the broker can typically select from a range of commission structures offered by the insurance company. Let’s say you invest $100,000 in a variable annuity. The insurance company might offer the broker a choice of three commission structures: a) 5% up front and nothing ever again in the future – so the broker dealer would be paid $5,000 on your $100,000 and nothing ever again; b) 4% up-front and 0.25% per year (called a “trail”) for however long you hold on to your annuity – so the broker would make $4,000 up-front and then 0.25% of your account value every year after the 15th month that you hold your annuity; or c) 2% up-front and a 1% trail beginning in the 15th month. These are just typical commission structures, and they vary from insurance company to insurance company, and from annuity to annuity, but you get the gist of it. You may say that option “b” or “c” in the above example – where the broker gets a lower up-front fee and an ongoing trail – is better for you because the broker will work harder knowing that he is actually being paid to service the contract year after year, and it may help the broker think longer term. Furthermore, a long-sighted broker might think, “I’ll take the lower 2% up front commission, and 1% each year thereafter, because if I do my job well and my client’s account doubles over a period of time, then I double my trail.” Then everybody wins, right? For the most part, yes. But enter greed. I’m going to give you two real-world examples that will help you understand why some brokers are not working in your best interest, but in their own. One typical example is when a broker offers an investor a standard annuity, and fails to mention that there is a “bonus” version of the same product that pays the investor an up-front bonus (and hence the broker a lower commission). Take two variable annuities offered by American Skandia: APEX II and XTra Credit SIX. Both have the same options and features, but the XTra Credit SIX pays the investor an immediate 6.5% bonus – meaning the minute you invest $100,000 in that annuity, your account value goes up to $106,500. Furthermore, both annuities have the same fees for the first ten years (1.65% at the time of this writing), but after 10 years the XTra Credit SIX fee drops to 0.65%. You may be asking, “Why wouldn’t my broker recommend the XTra Credit SIX with its bonus and lower overall fees? Well, at the time of this writing the APEX II pays the broker a 5.5% up-front commission and after four years 1.25% annually. But the XTra Credit SIX bonus annuity pays the broker just 4.75% up-front and a 0.25% trail annually after the first year. An unscrupulous broker may not tell you about these bonus products because, in effect, they benefit the investor at the expense of the broker’s commission. Let’s take a second example of how a broker’s greed can keep you from the most competitive annuity. Suppose your investment profile makes you a prime candidate for a variable annuity with a reasonable surrender period and a great living income benefit. Two annuities come to mind: the Allianz High Five and the Ohio National Value. Both are competitive annuities, but I’d typically recommend Ohio National’s Value because it gives has lower fees, a better living income benefit, and no trading restrictions. But guess what? The Allianz High Five pays the broker a whopping 7% up-front commission (no trail). Ohio National Value pays the broker a 5% up-front commission (no trail). An unscrupulous broker may not mention the Ohio National Value to net him or herself an extra 2% commission. The top variable annuities in the marketplace are among the best investment vehicles for helping people achieve their retirement goals, including financial independence and peace of mind. Finding the right people that can, and will, make the right recommendations is the ultimate challenge. How can you make sure your broker is recommending the most suitable and competitive annuity? A few simple guidelines: • Don’t buy an annuity that you don’t understand. If you invest in something you understand, you significantly reduce your chance of being taken advantage of. • Never buy an annuity from someone who cold-calls you. These strangers are the least likely to give you the best recommendation. • Make sure that if your financial advisor is recommending an annuity, they have a lot of experience in working with annuities. The average financial planner who deals mainly in stocks and mutual funds is quite likely to fall into the “trustworthy but unknowledgeable” camp. • Look up your financial advisor’s NASD record (including customer complaints and regulatory actions), free of charge, at http://pdpi.nasdr.com/PDPI. • Be leery of someone trying to sell you “non-registered” products like the now very popular Equity Index Annuities (EIA’s). Many of these so-called financial professionals only have an insurance license, and may bad-mouth variable annuities and mutual funds because they are not licensed to sell them. • Finally, take the annuity recommended by your financial advisor and call a free, independent annuity resource like Annuity FYI (www.annuityfyi.com) and see if you get the same recommendation. If not, ask why. This will start a dialog between you and your financial advisor that will help educate you and give you confidence in your advisor (or expose your advisor’s shortcomings).