# The Investment Scientist

Posted on: June 5, 2014

Recently I was approached by two prospective clients. The husband is a very successful entrepreneur and they are also very frugal. As the result of that, they have accumulated substantial wealth – north of \$5mm.

The only problem? all of that money is in about 28 variable annuities they purchased over the years. In examining these variable annuities, I turned up the following problems:

1. Horrible returns

For each variable annuity, I was able to calculate its annualized return.

Out of the 28 variable annuities, only two have annualized returns above 4%. Seven have annualized returns between 3% and 4%. Six have annualized returns between 2% and 3%. The rest (13 of them) have returns less than 2% including a few that have negative returns.  The average annualized return? 2.12%. Not enough to beat inflation!

2. Horrible surrender charges

There is this one annuity they purchased from Jackson National Life in 2007 for \$200k; today it has grown to a “value” of \$245k, but if they should cash it out, they would only get \$221k since there is a surrender charge of \$24k. After seven years, there is still a surrender charge of 12%! This is just horrible!

3. Horrible taxes

Let’s say they cash out the aforementioned annuity, they should still be able to pocket about \$31k in gains right? Wrong! Unlike a mutual fund, where gains are taxed at the 20% capital gain rate, annuity gains are taxed as ordinary incomes. Since they are in the highest tax bracket, their combined federal and state marginal rate is about 50%. After tax, all they get from the annuity is about \$16k in profit. This is a lot less than the insurance company took from them. Based on the size of the annuity and the lock period, it could be a lot less than commission the agent got as well!

How could they have put all of their money in such horrible products? Does it come as a surprise that they have a “good” friend working in the banking industry? These products are never bought, they are sold by people who have no qualm abusing your trust.

These guarantees are not what they crack up to be! If you pay \$100k in premiums, you are guaranteed to get \$64k back. How does that sound? That’s exactly what’s in an annuity contract after I did the math.

You may not even get that, since insurance companies’ guarantees are as good as their balance sheets, which you should pray they don’t ruin like AIG did

If you want to find out how I can help you, schedule a Discovery review with me. If you are not ready, you can still get my white paper for freeThe Informed Investor: 5 Key Concepts for Financial Success.

### 2 Responses to "Variable Annuity: Bad Investment!"

Getting ripped off by annuities does not only affect the wealthy. The husband of a coworker runs a small family business. He invests with an adviser who he considers a friend. I tried to tell him how little annuities return for him versus costs, and how much cheaper it is to invest in index funds. He thought I was trying to sell him something and got mad at me. I gave up at that point.
My wife, a public school teacher, has the option to put money into a 403b account (like a 401k, if your readers don’t know). She saves as much as she can, because she certainly will not get much from her pension. I helped her select an index fund that charges almost 1%, but even that was better than the other options. Most of the available options were lousy annuities with loads (commissions) and surrender charges. The HR department in her school system would not even talk to me about those high costs or about getting a lower cost index fund. Neither would the school system administration or the school board. (Would it surprise you that many people in those groups share the same last names? But most likely none of them could spell nepotism.) The administrators trust the HR people to make decisions about complex financial investments about which they are completely untrained. This is most likely true for many businesses as well.

It’s always a good friend. I am pretty much resigned to the fact that there are unscrupulous people and there are undiscerning people. They will make friends, and the unscrupulous will take advantage of the undiscerning. It’s just the fact of life.

### Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.

You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.