Should my parents get an annuity as advised?

[TennisFan]

First of all, this is my first time posting, although I've been actively reading this site for a good 2-3 years. Thanks to all of you who provide such great analysis and posts. While I've been a "silent participant," its great having a forum such as this to enjoy a shared passion of living beneath one's means, and focusing on a FIRE lifestyle.

Anyway, this first post isn't about me, but rather my parents. I will try to give as much detail and if there are blanks, please let me know.

My parents work with an independent financial advisor who I believe is doing a pretty good job with their money. I actually met her for the first time last night as my parents want her to get to know my sister and me just to build a better working family relationship.

My parents recently sold some investment farm land in which they are netting about $300K. This brings their overall portfolio to about $1MM (a combination of 401K, IRAs, a balanced portfolio of American Funds, and stock in Exxon and Center Point Energy). Right now this $300K is sitting in a short term CD earning a modest 2.5% awaiting distribution.

The advisor is recommending they put the $300K into a joint annuity Shareholders Advantage Variable Annuity through Lincoln Financial, with the funds invested in American Funds. The advisor says that there is a 2% upfront fee and she gets a standard 1% of the portfolio. She claims that this annuity has a guarantee payout of 5% per year, and that if one of my parents were to die, the other keeps moving forward with the same terms, and if both my parents were to die, we (my sister and I - their heirs) would receive the current value of the sum (whatever the $300K has turned in to). If the fund returns more than 5% a year, they'd get the additional sum as well, but are guaranteed 5%.

My Dad is 61 and my Mom is 57 - and both hope to work 5 more years.

In doing some retirement forecast, my parents believe they may need some of the guarantee to maintain their current lifestyle, so they expect to need to draw upon some of this. My questions are as follows:

- Does this annuity and its terms as I laid them out make sense?
- Is it more advantageous to take this $300K, dollar cost average in to the market over the next 12-16 months in a diversified and risk appropriate portfolio?
- What am I missing?

Thanks so much for any insight.

[73ss454]

The only person the annuity will be good for is the person selling it. Tell them to run as fast as they can.

[haha]

Quote:

Originally Posted by TennisFan My parents work with an independent financial advisor who I believe is doing a pretty good job with their money.

Quote:

The advisor is recommending they put the $300K into a joint annuity Shareholders Advantage Variable Annuity through Lincoln Financial, with the funds invested in American Funds. The advisor says that there is a 2% upfront fee and she gets a standard 1% of the portfolio.

These two statements conflict with one another. Since you know that she is in fact recommending the VA, it follows that she is not doing a good job with their money.

The $300,000 cash became a stress test for the advisor and she failed it.

Ha

[TennisFan]

Quote:

Originally Posted by haha These two statements conflict with one another. Since you know that she is in fact recommending the VA, it follows that she is not doing a good job with their money. The $300,000 cash became a stress test for the advisor and she failed it. Ha

I appreciate the feedback, but any more detail you can give? Is there ever a situation where an annuity makes sense? Should we go with a balanced portfolio of mutual funds? Thanks for any depth you can give to why its not a good idea.

[73ss454]

For what ever reason your parents think they need an annuity and if they have to have one then look into a low cost one with a place like Vanguard.

As far as I'm concerned the only time it makes sense is if your selling it.

You should look around on the forum a bit and learn. Also get a few books and have them and maybe yourself read them. Start with maybe the Bogleheads Guide to investing.

[haha]

Quote:

Originally Posted by TennisFan I appreciate the feedback, but any more detail you can give? Is there ever a situation where an annuity makes sense? Should we go with a balanced portfolio of mutual funds? Thanks for any depth you can give to why its not a good idea.

My response above I think is reasonable for most people most of the time, but there may be exceptions. My own brother swears by VAs, and he is otherwise rational.

You say you have read this board for several years. During this time there have been countless posts on this topic. I don't read them, so I can't really say too much about it. Perhaps a search of the board would turn up some more data?

I suppose it is possible that there are circumstances under which a VA might be a good choice. I think I can say that this would not be commonly found.

I should stress that my information is limited and certainly faulty.

Ha

[TennisFan]

Thanks 73 and haha, I appreciate your responses.

I haven't had a reason to read any of the other annuity threads in the past (at 30, this isn't an option, obviously) but I I'll scour through the search tool.

I have read Boggleheads' book and will dig it up this weekend as a refresher.

[REWahoo]

There are some situations where a SPIA (Single Payment Immediate Annuity) may make sense. I'm not aware of any circumstance where a Variable Annuity make sense to the purchaser once they understand the true costs and marketing hype behind the product.

Example: The fine print probably shows that the "guarantee payout of 5% per year" is really a guarantee of an average payout over the life of the annuity. And when you understand that part of the payout is coming from the $300k your parents are giving the insurance company, that 5% guaranteed payout doesn't sound so hot.

[Marquette]

Get details on the riders, surrender charges, all that. Is the free look period 10 days?

What about options for a SPIA?

At the very least, shop around. Look at the annuities Vanguard is selling. Look at Vanguard's managed payout fund. Look at the other American Fund options.

Personally, I would look at the portfolio in aggregate and consider risk tolerance. I know you mentioned risk-appropriate redeployment of the funds, but it should be to get the entire portfolio to a desired AA and not looked at independantly.

[FinanceDude]

Quote:

Originally Posted by Marquette Get details on the riders, surrender charges, all that. Is the free look period 10 days?

Generally all annuities have a 10-day free look........

Quote:

What about options for a SPIA?

I'm not sure an SPIA is needed now,since the parents want to work another 5 years, so their current income needs are being met........

Quote:

At the very least, shop around. Look at the annuities Vanguard is selling. Look at Vanguard's managed payout fund. Look at the other American Fund options.

A lot depends on if they want THIS money at risk in the market........

[Marquette]

Quote:

Originally Posted by FinanceDude Generally all annuities have a 10-day free look........

Yes, VAs typically have a 10 day free look, which is why it might be good to see if your VA is typical before you commit.

[Bestwifeever]

TennisFan, why not introduce this site to your parents? They might have concerns you're not aware of, or that they might not want to discuss with you. Tell them they're more than welcome to join us!

PS--re your statement, "The advisor says that there is a 2% upfront fee and she gets a standard 1% of the portfolio." Does this mean every year the advisor "earns" $3,000 against the $300K annuity besides whatever portion she gets of the "2% upfront fee"?

[crazy connie]

Get yourself a bunch of pencils and a lot of paper. Do the math based on the contract NOT WHAT A COMMISSIONED SALES PERSON SAYS.

You can read and do math. If you can not understand it, then be assured their lawyers do not want you to know how little the returns are in reality and how much they make every year off of fees.

Shopping around for a few weeks will get CD's with 5% ROR I bet and no downside risk or upfront fees of 6 to 9K.

You all need to do what is called "DUE DILIGENCE".

[calmloki]

Quote:

Originally Posted by crazy connie Get yourself a bunch of pencils and a lot of paper. Do the math based on the contract NOT WHAT A COMMISSIONED SALES PERSON SAYS. You can read and do math. If you can not understand it, then be assured their lawyers do not want you to know how little the returns are in reality and how much they make every year off of fees. Shopping around for a few weeks will get CD's with 5% ROR I bet and no downside risk or upfront fees of 6 to 9K. You all need to do what is called "DUE DILIGENCE".

In fact, here you go - 60 month, 5.28%. Bank Deals - Best Rates and Deals

[eridanus]

From the prospectus (H):

Sales charge (as a percentage of gross purchase payments):5.75%

It costs .75% to guarantee the principal.

There are also a lot more rider charges, including the death benefit, etc.

Oh, that doesn't include the fund expenses, which range from .52 to 1.07%.


They'd be fools to buy this annuity.


Edit: My mistake. I found an SEC supplement and the sales charge for $250,000-$499,999 is only 2.5%.

[clifp]

Quote:

Originally Posted by eridanus They'd be fools to buy this annuity. Edit: My mistake. I found an SEC supplement and the sales charge for $250,000-$499,999 is only 2.5%.

Doesn't change the correctness of your conclusion especially if there nice FA charges a 1% wrap fee on assets under "management" including this VA.

Regarding annuities it sometimes makes sense for people to buy an annuity, it almost never makes sense for someone to buy an annuity sold to them by a salesman and that is almost certainly what is going on.

By way of analogy imagine two folks walking into the car dealer, with 50K one says I really don't know anything about cars what do I need, the other says I want a Honda Accord with AC, Options A, B the internet says dealer invoice is 19,600 , which one walks out with money?

If your parents had no kids, AND all 4 of their parents were still alive a vigorous in their 80s and 90s, AND your parents were super healthy, AND they were terrified of investing in the stock market AND THEY WERE ALREADY RETIRED, THEN and probably ONLY then would it make sense to buy a SPIA,. There maybe a case for a variable annuity but in the absence of holding a PHd in statistics and/or finance most folks will never see it.

I was prepared to put out a bunch of reasons why this is bad but instead I'd just recommend looking at page 7 of the prospectus.
The expenses associated with this VA are pretty mind boggling.
After 1 year $936 per $10,000 after 10 years $4,860 in expenses!!.

So if investment (in the market generally) grow at 5% on the $300,000, the insurance company and financial adviser will generate almost $150,000 in fees and commissions. Put another away if your parents god forbid die in 10 years,your parents will have adopted their financial advisers, since you him and your sister will share equally in the estate, he just gets his share quicker.

Take a look at the prospectus of any Vanguard fund let use the infamous pst Wellesly Admiral as an example. Wellelsy while it doesn't have "guarantee of 5%" has a many year track record of way better than that. What do you think the the same SEC mandated expense pages says 1/2 the $4860? 1/4 as much. Naw way way too high $192 per $10,000 invested. Now the lower sales charge for the annuity the Eridanus found will decrease the expense by perhaps $200-300/$10,000 but not even close to being in the same ball park.

[OAG]

You say they are 5 years from "retirement". I suspect the VA looks good to them because the FA says "it will grow for the next 5 years and then when you retire you can start taking that 5% as income", or words to that effect. Of course from your numbers SHE (the FA) will get about $17K in HER income. TODAY you can get a 5 year CD paying 5% or a 7 year CD paying 5.35% from CAPITAL ONE (and I am sure you can find others at like periods) FDIC insured with options to either take the interest monthly, quarterly, SA or annually OR just allow it the stay in the CD and earn interest on the interest and roughly the 300K will be about 360K in 5 years for them to buy a SPIA with (if they REALLY like an annuity). And there are ways to ensure the full 300K would be FDIC insured - use the EDIE calculator at the FDIC.Gov site to see how.

[plsprius]

In addition to the high expenses and the loss of access to the principal in the event of a financial emergency, another reason this annuity is likely to be a poor investment:

Using today's risk-free return of 4.5% (for example, 30 year treasuries) produces a 5% payout ($1,250 per month, $15,000per year) for (drum roll):

615 months (or 51 YEARS!)

So, what, exactly, is the annuity providing?

Of course a variable annuity offers the potential for inflation protection, but the outrageous expenses will probably offset that.

Other than the need to remove all financial stress (e.g., an incompetent beneficiary) I can't think of any reason to purchase such an annuity.

These types of financial "products" really bug me. If I had to buy one, I'd look first to Vanguard and then Berkshire to compare prices.

- plsprius

[cute fuzzy bunny]

My wife had a VA with Lincoln for her 403b at her former employer.

After reading all 500-something pages of the prospectus to accurately determine the actual terms, conditions and expenses, we paid a couple of grand in surrender fees to get the money the hell out of there. We'll recoup the surrender fees in about 2 years. Well worth it.

Here's the simple math. In an average balanced portfolio your money will make about 8%. After taxes and inflation, somewhere between 4 and 5%. Lincoln takes about 2%. You're left with 2-3%. You can do better than that with a CD, zero risk, and no 500 page prospecti... :

Fees up front, fees in the middle, expenses, all sorts of extra and hard to find costs. You pretty much need to compare balances from one statement to the next over a year or so to see exactly how much you've been charged and when.

If none of that worked, look up the location of your local Lincoln Financial building and have a drive by. Theres your money in action. Or better still, flip on the tv and tune to a Philadelphia Eagles game at "The Link", also known as Lincoln Financial Field.

[brewer12345]

Tell them to run away from this product and consider firing this advisor for even pitching it to them. These contracts typically have expense ratios in the ballpark of 3% a year (10X what a Vanguard portfolio would cost) in addition to the up-front commission and the other account fees the advisor charges. There is just about no investment on the planet I would be interested in with these kids of expenses.