Friday, August 1, 2014

Why We Don’t Sell or Suggest Annuities…

Recently we have been inundated with clients questioning our opinion on annuities or requesting an analysis of an existing annuity contract. Annuities come in various forms, but the most popular versions are either a variable annuity or a fixed annuity. Variable annuities typically include mutual fund investments combined with an insurance or guaranteed income component which, incidentally, comes at a significant cost.


These days, when an advisor or sales agent proposes that someone buy an annuity, the motivation could be the significant sales commission he or she will receive for selling these products. By convincing a consumer to purchase one of these products, a sales agent can receive a payment of almost 10% of the contract value. Perhaps this is why the penalties for cashing in an annuity contract early are so severe.

Rollins Financial is a fee-only advisory firm, which means we are only compensated by our clients and do not receive a commission for selling particular financial products like annuities or loaded mutual funds. We feel it is a direct conflict of interest as an easy upfront payoff for selling a commission product is likely to inspire salespersons to suggest products that may not actually be in the best interest of the consumer. As a registered investment advisor(RIA), Rollins Financial Inc. is held to a higher standard and has a fiduciary obligation to suggest solutions which we believe are in our clients’ best interest, not just what might be suitable.

Beyond our fiduciary duty, we are strong believers in financial flexibility while pursuing efficient and cost effective solutions for our clients. Annuities are neither flexible nor cost efficient, and in many ways constitute a transfer of wealth into the coffers of the insurance company and their agents, and away from individuals and families. Conversely, our objective is based on preserving and growing our clients’ assets as they prepare for important milestones and expenditures such as sending their children to college or embarking on retirement. We trust this objective is shared by our clients.

Annuities are often referred to as products that are sold, not bought. Probably because not many investors would find that they fit into their long term financial plan unless a sales person approached them about buying one. Annuities often offer a guarantee of some kind. While these guarantees can be comforting to investors, they come at a very high cost, and over the course of 10 or 20 years are likely to provide little benefit. For instance, many of the annuities with riders can carry expenses upwards of 3.5% annually for providing a fixed benefit that won’t be received for another 20 years.

Over the course of 20 years, or longer, we believe it’s highly likely that an investor would be better off participating fully in the returns generated by their investments and avoiding the extra fees associated with annuity products. Examining the markets since 1950, the worst 20 year period for stocks would still have resulted in a 6% annualized gain. Of course this data would include the periods ending with the tech bubble and the financial crisis in 2008. U.S. stocks have returned an average gain of 11% since 1950.

Annuities are a tax deferred product, which in our analysis used to make some sense, but that was before capital gains and dividends were given such advantageous tax rates. Long term gains and qualified dividends are taxed at 15 or 20% for most individuals, while deferred income in an annuity is taxed at earned income rates, which could be as high as 43% at the federal level. While there is definitely a benefit to tax deferral, the cost of an annuity and the potential differential in tax rates is too large of a hurdle to overcome for current investors.

And please remember, annuities are only as good as the company backing them. The products and guarantees are dependent on the viability of the insurance company selling them.

I hope the foregoing has given our readers some useful information regarding annuities and the costs involved. Please contact us if we can provide more guidance and evaluate your particular situation.

Sincerely,

Edward J. Wilcox, CFA, CFP®

No comments: