Annuities: Ask hard questions about those promises
Somewhere in the blogosphere, a salesman is at this very moment posting an outrageous claim about an annuity that "has some AWESOME benefits for YOU!"
I know because I see those statements regularly. And somewhere in this country, a 75-year-old widow is being asked to put her life savings into an annuity. I know because it happened to a relative.
So I spoke to some experts — including Moshe Milevsky, a finance professor at York University's Schulich School of Business, and Peng Chen, a chartered financial analyst and president of Ibbotson Associates — to find out what questions to ask before buying an annuity. Before you get pitched an annuity, arm yourself with the following list of questions to ask the person doing the selling. (The following apply mostly to variable annuities with guaranteed living benefits, but some apply for fixed annuities also.)
Is this right for me? How does this product fit my needs and objectives?
Often agents sell the sizzle before the steak. Consider, for instance, this pitch for a fixed index annuity that appeared on an online discussion group: "Get a 5 percent bonus on the initial premium; get an ADDITIONAL 25 percent bonus added to the income rider to boost your income amount; liquidity for nursing care and terminal illness; guaranteed death benefit; guaranteed NO LOSS; 10 percent free withdrawal through year 10 then 100 percent; seven fixed payment options guaranteed for life; and you get all that with only a 10-year surrender schedule."
Now all that might be true. Then again given the comments on the discussion group from actuaries and others, it's possible those claims stretch the truth.
Some critics say selling annuities this way is really the equivalent of handing out prescriptions in the absence of a diagnosis. It should be the other way around — first the diagnosis, then the prescription — said Rick Miller of Sensible Financial Planning, a financial advisory firm.
With annuities with guaranteed living benefits, ask the following:
— How much does this cost?
— What are the fees charged against the investment? What does each fee pay for?
— Which fees are optional? What do they pay for?
— What are the surrender (or early withdraw) penalties? This should always be revealed.
— What are the fee ranges? Many variable annuity contracts allow providers to modify their fees in the future. According to the experts, most annuities with guaranteed living benefits have maximum rates, but many can rise to whatever the rate is at the time the triggering event, which typically invokes a step-up provision, occurs.
— How do you get paid?
— I have heard that insurance companies offer many series (or share classes) of the same annuity chassis, based on the surrender-charge schedule selected. Can you please walk me through my options here? You might not want this much detail. Then again, if you are buying an annuity, you just might want this much detail, not to mention a second opinion.
— I understand that it only makes sense to pay for a guarantee on a portfolio or collection of subaccounts that need protection. Can you confirm that this variable annuity allows for ample risk exposure? In other words, can I allocate 60 percent or 80 percent or 100 percent to equities? According to one expert, no variable annuity issued today allows 100 percent allocation to equities when a guaranteed living benefit is chosen.
— What are the options for the underlying investments? Sometimes it's good to invest more aggressively inside the variable annuity, since you already have the guarantee protections. According to one expert, it's always better to invest aggressively when you have elected a guaranteed living benefit.
— What exactly is the guarantee? Is it a withdrawal stream or an actual dollar value I can withdraw?
— What if I need more than the guaranteed withdrawal amount? For example, ask the adviser to run an illustration of what happens if you don't touch the money for 10 years, then begin minimum withdrawal amounts and then, three years later, you need to withdraw a one-time amount of $10,000. This presumes that the agent's software can model that scenario.
— In some cases, you can choose a living benefit for one life or two. What's the withdrawal amount for both lives? And the cost of that benefit? Sometimes you pay more for two lives and get the same withdrawal amount; sometimes you pay the same for two lives and the insurer reduces the withdrawal percent — understand which it is.
— If I don't buy the annuity with the guarantee, how much higher would my account value be in 10 years? This is the real cost of the benefit. Of note, the answer to this requires modeling that may not be available to the agent.
— What if I have an IRA? What if I just deposited the money there? Often you have to decide whether to invest money in an IRA or a variable annuity.
— What is the best investment option for growing a true "walk-away" value? Why would you recommend a variable annuity if the money is already in a tax-qualified account, such as an IRA? The answer to this question depends upon the assumptions made and the tax treatment of an annuity. The tax deferral enjoyed by a nonqualified annuity flows from a tax provision that never applies to IRAs, and the tax treatment of IRAs flows from a provision that never applies to non-qualified investments.
— I have heard that the yield or income on payout annuities is better than the rates guaranteed on a variable annuity with guaranteed living benefit. Can you please walk me through the pros and cons of a payout annuity instead of this variable annuity? Now, some consider this an apples-to-oranges comparison. Still, it's worth asking with this caveat in mind: Any such reckoning would have to assume whether the guaranteed living benefit is or is not triggered. And ultimately it's a guess whether the benefit is triggered or not.
Are you comfortable with the credit risk and hedging program of this company? Can you explain to me how the company can afford to make these promises?
For what it's worth, you're unlikely to get the answers to these questions. Most hedging strategies are proprietary and are not revealed in detail by the insurer.
To be sure, there are plenty of other questions to ask. But this is a good start. Especially, given the sentiment expressed by Steve Cooperstein, president of Steve Cooperstein & Affiliates.
"I doubt that most agents will be able to correctly or accurately answer most questions about annuities," he said, "especially the deeper ones posed."
Robert Powell is editor of Retirement Weekly, published by MarketWatch.