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EIA Salesman

Typical Salesman’s Chart for EIA

Financial author Allan Roth once wrote an article called “Investment Trick – Annuity Style” where he asks a rhetorical question, “If the S&P 500’s total return is 12% in a given year, what do you think your equity index annuity (that is supposed to track the S&P 500) would return”?

  1. 10%
  2. 8%
  3. 5.4%
  4. 3.4%

Allan Roth goes on to explain why the correct answer is 3.4%. Boy, was he wrong! Read the rest of this entry »

images-65 A client of mine bought a fixed rate annuity a few years ago. She was told by the agent that it’s just like a savings account, only with a higher interest rate of 3%.

Recently, we took the money out in favor of a better investment, and boy was she in for a shock! There was a $17k surrender charge and nearly $3.6k in tax withholdings. All the interest she supposedly earned in the annuity went to the surrender charges, and now she has to pay income taxes on that interest!

Here is why a fixed rate annuity is nothing like a savings account.

1. A savings account is FDIC guaranteed, in other words, it has the full faith and credit of the US government behind it. A fixed rate annuity is NOT FDIC guaranteed, it only has the credit of the issuing company behind it. Think AIG! Read the rest of this entry »

Sunk-shipMany people keep their bad annuity investment because it imposes a stiff surrender charge. This is a stereotypical example of sunk cost fallacy, an academic term which describes people throwing good money after bad.

Why surrender charges are sunk costs?

Imagine you were sold a $100k variable annuity with a ten year surrender period. The agent who sold you the contract collected a 10% commission, or $10,000. Where do you think this money came from?

Bingo! Your pocket. I hate to break it to you, but insurance companies are not in the charity business and they sure as heck aren’t gonna tell you that 10 of the 100Gs you just handed over to them are going to pay the agent’s commission! If they did that you’d pull your money out and rightly avoid them like the plague in the future.

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images-38Recently 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! Read the rest of this entry »

ImageI am not a fan of permanent life insurance. Over the years, I have helped many people extricate themselves from costly life insurance policies. Invariably, they were sweet talked into buying these products without any real need.

But recently, I’ve actually had to help a client shop for a permanent life insurance policy. They have a child with a potentially permanent medical condition. Of course we hope and pray that he will outgrow his medical problem, as many kids do, but as parents, they must prepare for the worst.

This is one of the few legitimate reasons for using permanent insurance. Other legitimate reasons include to pay for estate taxes, or to facilitate business succession.

Here is the decision process I employed to help my client, bearing in mind that insurance products are not under the purview of the SEC and are usually chock full of hidden costs.

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ImageA few days ago, I interviewed Jim Ludwick using Google+ Hangout On Air (HOA.) This is the first time I’ve interviewed an expert live on air! Feel free to laugh as you watch me stutter and trip over my words left and right.

Jim is the owner of MainStreet Financial, he used to be an agent at NY Life. Now he is a licensed insurance advisor.

I did not waste his appearance and got right down to the nitty gritty. I asked about a client case during the interview. Specifically, this client of mine was talked into 1) buying a universal life insurance inside her defined benefit plan, 2) buying a whole life insurance policy for her young daughter, because “it’s a great investment” according to the agent’s illustration of 8% growth.

I asked Jim three questions:

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Old AgeRecently, a client of mine fell, broke his hip and ended up lying on the floor for 20 hours before he was rescued. I went to visit him in the hospital a couple of times. The good news is: he is out of immediate life-threatening danger. The bad news is: he may be wheelchair bound for the rest of his life.

When John first came to me to seek my help with his personal finance, I looked at his overall financial big picture and was pleased overall. He worked at federal and state jobs and enjoyed good pensions. On top of that, he had a decent investment account.

But there was a gaping hole in his retirement security: he was turning 70 then, was divorced, and his children lived far away. That meant if he were to get sick, nobody would be there to take care of him; he would need to hire caregivers. Right then, I insisted that he buy long-term care insurance.

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My friend Dan is in the life insurance business. Recently, he shared with me a case in which he helped a client of his (let’s call him John) get $600k out of his term life insurance with life settlement.

In case you don’t know what life settlement is, it’s the sale of an insurance policy by the owner to a third party for a price higher than the policy surrender value.

How does this work?

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Annuities and Life Insurance

I recently met with a physician couple who became clients of mine.

Their investment portfolio is chock-full of annuities and life insurance; even their qualified retirement plans are not exempt.

They told me that they went to financial seminars and were convinced that these products were good wealth accumulation vehicles. In fact, they are anything but.

These insurance products have nothing with do with wealth accumulation (except for insurance agents).

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I was called a “wing nut” by a commenter for pointing out all the malpractices of insurance companies. Indeed, I could go nuts seeing how they mislead their customers into financial peril. They know full well that their customers are not going to read beyond the first few pages of their hundred-page contract, so they put all the goodies on the first page and keep the disclaimers on the back pages.

The following is an actual annuity contract a client of mine purchased a few years ago, much to his regret now.

On the first page of the contract, all the warm and fuzzy keywords are used: “GUARANTEE”, “fixed”, “annualized interest rate of 5.75%”. Pay attention to the following line though: This rate is subject to change each month.

Annuity Contract Front Page

Annuity Contract Front Page

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I recently met an entrepreneur friend of mine. I was pleasantly surprised to learn that he had sold his business and was now looking forward to retirement. He has about $1mm in his 401k plan. As any shameless financial advisor would do, I asked him if he had someone helping him manage his money.

“As a matter of fact, yes!” he answered. “A friend of mine is also a financial advisor, and he helped me create a balanced portfolio.”

He related that “50% of the money will be in safe investment—a (deferred) annuity that has a guaranteed yield of 5%; the other 50% will be in alternative investments for higher performance.”

To say that I was flabbergasted is a serious understatement. With a friend like that, who needs enemies?

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Watch the show and you’ll know what I meant.

Listen to an insurance agent's financial advice

Invest in a Variable Annuity

Recently, a client of mine brought me the variable annuity he bought a few years ago.

Prominently displayed on the first page are the benefits of the annuity:

Death Benefit: Enhanced Guaranteed Minimum Death Benefit

Living Benefit: Lincoln Lifetime Income Advantage

as well as the fact that the money will earn an fixed annualized rate of 5.75%. Under the bold ACCOUNT FEE subtitle, it states: Account fee is $35 per contract year.

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Annuity without Risk

Annuity without Risk

Recently, I was approached by a prospective client named John, who has all of his retirement in one annuity.

I have always been intrigued by how annuities and life insurance are sold. Listening to John explain his decision-making process and reading through the annuity contract is like turning on the light bulb in my head.

It turns out that the unique selling point of this product is the “200% Step-Up of the Guarantee Amount (GA).” The way John puts in, if he just keeps the annuity for 10 years, he will get back 200% of what he put in. What is there not to like about that! After all, he gets guaranteed upside with absolutely no downside risk.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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