Helping a friend

[Scuba]

I have a friend who is 74 and is a retired teacher. Her pension covers all of her day-to-day living expenses, and she has great health insurance. She owns her waterfront condo outright, and has a few hundred thousand in CD's. She's conservative and has never really invested in equities apart from the annuity described below.

Her other major investment is an annuity through a group called Home - Confidence Wealth Management. She asked me to go with her to her appointment. It is one of those annuities where the value is guaranteed not to go down, and she can invest in equities through the annuity. She showed me her balance over the last few years, and it doesn't seem like she has gotten much benefit from market appreciation. She's been invested 50/50 in the S&P 500 and NASDAQ so it seems that she should have gotten appreciation.

I know this group is not a big fan of annuities, and we don't own any ourselves. If you were going with this person to her appointment with her annuity advisor, what questions would you ask? A few I've already thought of are:
- With the market having gone up substantially in the 2015-2017 time frame, why did the account balance not go up ... ie how much appreciation is credited to the annuity holder vs kept by the provider?
- If the value can never go down, why wouldn't the investments recommended be the most aggressive possible, with the best long-term growth potential?
- Obviously the benefit of this product is limiting her risk, but at what cost? What are all of the fees embedded in this annuity?
- What are the surrender charges if she decided this was no longer an appropriate investment for her? Is there a schedule of these available?

Since my friend is very risk-averse, and this is a guaranteed product, maybe it isn't too bad for her, but I'd appreciate any thoughts/additional questions you suggest I share with her and/or ask at the appointment. Thanks!

 

[pb4uski]

Do you have monthly/quarterly/annual statements for her account? If so, that may answer or provide insights to some of your questions.... that or looking at online transactions/activity. You should be able to rollforward the beginning of period balance to the end of period balance and see all the fees and charges.

If the annuity is a VA, you are correct in that if the underlying subaccounts are 50/50 S&P 500 and NASDAQ that I would think that the account should be increasing even after fees given the results of the past few years. On your second question, usually the insurer will provide limitations to prevent policyholders from gaming the situation as you suggest (you aren't the first one to think of that).

Alternatively, it might be some hybrid equity indexed annuity and the cap might be preventing growth.

I think your instincts are right and she would be better off in a CD or maybe some CDs and a little Wellesley to get some stock exposure.

 

[REWahoo]

- With the market having gone up substantially in the 2015-2017 time frame, why did the account balance not go up ... ie how much appreciation is credited to the annuity holder vs kept by the provider?
- If the value can never go down, why wouldn't the investments recommended be the most aggressive possible, with the best long-term growth potential?
- Obviously the benefit of this product is limiting her risk, but at what cost? What are all of the fees embedded in this annuity?
- What are the surrender charges if she decided this was no longer an appropriate investment for her? Is there a schedule of these available?

The best place to find answers to these questions is from a review of the annuity contract itself. Asking them to annuity advisor is likely to result in incomplete and/or inaccurate information. They are trained on selling the sizzle, often don't know the nitty-gritty details and are schooled on how to [-]obfuscate the negative aspects of an annuity agreement[/-] overcome objections.

When I did something similar for an elderly couple who were being heavily influenced by their "financial guy" to purchase an annuity, I was able to find the contract online. It didn't take more than an hour to wade through the fine print and work up a summary of the fees, commissions, caps on gains in an up market, etc. that showed the agreement insured only the insurance company and agent were guaranteed to come out ahead in the long run.

Good luck in assisting your friend.

 

[FreeBear]

The best place to find answers to these questions is from a review of the annuity contract itself. Asking them to annuity advisor is likely to result in incomplete and/or inaccurate information. They are trained on selling the sizzle, often don't know the nitty-gritty details and are schooled on how to [-]obfuscate the negative aspects of an annuity agreement[/-] overcome objections.

+1

Good to see someone looking out for a friend.

Agree that the contract is the best place to start. Be forewarned though, that these can be LONG. I did this for someone posting here a while ago. It was 72 pages long, and the cost and fee information was buried deep, around pages 25 and 50! The effective expense ratio was well over 2% and the holdings and setup so complex that it would take hours, at best, to calculate the total true cost. It didn't take a long time to realize this was a bad deal though. Don't forget that ongoing expenses have a negative compounding impact, gradually, but inexorably, transfering assets out of the investors account.

 

[travelover]

This is a tricky situation. Your intentions are the best, but it is all too easy to end up getting blamed for losing money for someone else that is unworldly and very risk averse. Even something as tame as Wellesley can go down and "the annuity was guaranteed never to go down".

 

[Scuba]

This is a tricky situation. Your intentions are the best, but it is all too easy to end up getting blamed for losing money for someone else that is unworldly and very risk averse. Even something as tame as Wellesley can go down and "the annuity was guaranteed never to go down".

Yes, I agree, especially since I’m much less risk-averse than she is. I’ll ask her if she has a copy of her original contract and see if I can read it before the appointment. I am not going to push her in one direction or another but will try to ask probing questions that she can think about.

 

[ncbill]

It's common in equity-indexed annuities for there to be a cap on annual appreciation (e.g. 7%) in addition to the insurance company keeping the dividends (so it's based on straight appreciation of the underlying index), so I'm not surprised "it doesn't seem like she has gotten much benefit from market appreciation."

 

[Sunset]

When would she be able to take $$ out of the annuity, the schedule, and what fee's if any for withdrawal over time.

On avg, she has 10 more years of lifetime.
What happens if she dies suddenly (is it all lost?) or while getting payouts from the annuity ?

 

[Scuba]

Good questions. She is bringing me her file tomorrow so I can read her contract.

 

[Jerry1]

It's common in equity-indexed annuities for there to be a cap on annual appreciation (e.g. 7%) in addition to the insurance company keeping the dividends (so it's based on straight appreciation of the underlying index), so I'm not surprised "it doesn't seem like she has gotten much benefit from market appreciation."

Plus, the index can take the measurement at various times (monthly, quarterly, annually). It’s not uncommon for the underlying index to be down on a month versus month basis enough times during the year to really impact the overall growth that you see in a year to year view of the index.

 

[Scrapr]

It's great that you are helping her. I help my MIL with her Edward Jones guy. But what is your ideal end game? Move the account to a lower cost provider but still in an annuity? Just going in & grilling the agent may not be particularly productive

I would be clear with your friend on outcomes. Has she expressed disappointment in the returns? Is the annuity a substantial portion of her portfolio? Since her expenses are covered by other money is this annuity "important" money to her later plans?

 

[Scuba]

It's great that you are helping her. I help my MIL with her Edward Jones guy. But what is your ideal end game? Move the account to a lower cost provider but still in an annuity? Just going in & grilling the agent may not be particularly productive

I would be clear with your friend on outcomes. Has she expressed disappointment in the returns? Is the annuity a substantial portion of her portfolio? Since her expenses are covered by other money is this annuity "important" money to her later plans?

Good questions. She expressed disappointment that the market had gone up a lot the last few years, but her account balance hasn’t. She asked me to come to her appointment with her so she can better understand the annuity and decide if it’s for her or not. I’m not planning to “grill” her advisor, but rather to ask questions to clarify my friend’s understanding of the product.

It is a reasonably significant portion of her financial assets, it I don’t think she needs it for living expenses. She has a son and two grandsons she wants to leave assets to.

If it were me, I’d probably cash it out and move the assets to a balanced ETF or MF, but my risk tolerance is much higher than hers is so I recognize that what I would do is not necessarily right for her. I am not an FA so would never want to persuade someone to do something different ... would just like to help her understand her options and then she will decide what is best for her.

 

[imoldernu]

DW has a small fixed rate annuity. We have no intentions of doing anything with it, so will keep it 'til it's needed.

But in line with the subject of the thread, wondered what would have happened if it were a variable annuity... I don't know how to calculate that. Guaranteed rate is 4%, but was more in the first 5 years.

The original value was $8K, and it's now worth $61K. Here's the inflation calculation as a basis for comparison.

Any way to calculate the market value to see what the current value might have been using the $8K as a market average investment at the same time?
I found this, but couldn't find a calculator.

What is the average investor's return on mutual funds?
The average investor greatly underperforms the stock market. Over the last 30 years, the average investor saw a return of 3.66%, whereas the S&P 500 had an average return of 6.73%.

 

[Scuba]

OMG! My friend brought over her contract and annual statements and I just spent a couple of hours analyzing them. I now understand why people think annuities aren't a good deal for anyone except the salesperson. I will summarize my findings here and ask that those more in the know than I am let me know your thoughts on how I should advise my friend. After looking at her numbers, I am thinking this is a really bad deal for her.

Basic terms of contract:
Entered into in Nov. 2013 with initial investment of $322K
Annuity date Nov. 2034
Surrender charge decreases by 0.0758% each month; takes until Year 11 to become zero.
Current surrender charge would be approximately 5.25%
Current cash surrender value is approx $320K
Contract has an "enhanced withdrawal benefit" but it cannot be accessed until after Year 11
Amount of enhanced w/d benefit is approx $80K; it cannot be accessed if contract is surrendered and can only be accessed by requesting higher distributions after Year 11
This annuity is held within an IRA
There is a death benefit, limited to $300K regardless of contract value, that could be taken by beneficiary either as lump sum or payments over no more than 5 years. Her son is the beneficiary.
There are a variety of investment options. Hers have varied over the years.

The only withdrawals she's taking from this are RMD's of about $13K/year. I will confirm with her, but it appears from her paperwork and what I know of her situation that her motivation to buy this was to leave it to her son. He is married with 2 kids, in his 40's, has a great very secure job. He will be inheriting her other assets of about $300K in bonds/CD's/money market funds as well as a waterfront condo currently worth around $750K, paid off.

As others noted, her contract caps the amount she can earn and while it claims to limit losses, it does so in a rather sneaky way that does not help the owner of the annuity. For example, if she invests in the S&P 500 monthly return, it is capped at just over 2% but monthly losses are NOT limited. So, if the market goes down 10% one month, her account loses the full 10% for that month, but if it goes back up 10% the next month, she only gets a 2% benefit. I did a calculation from 2013-2017 and compared the return she has earned from this contract vs what she would have earned just being in a similar market ETF or fund, and the difference was a whopping $131K which is over 40% of her initial investment. I was shocked!

The questions I have for members of this forum are:
- If the cash surrender value net of surrender charges is about what she put into this, do you think she'd be better off just cashing this out now?
- Since the death benefit of this product is limited to $300K regardless of the annuity contract value, is there some reason that getting a life insurance payout would be better for her beneficiary than just inheriting investments if she cancelled this contract and made her son the beneficiary of her investment portfolio?
- Is there anything I'm missing assuming my numbers are correct that she'd be better off in a low cost portfolio? I figured out that as long as she had made 4%/year on her beginning balance, she would have been at least as well off as she is now with this annuity. She isn't very computer savvy and I don't know that she would feel comfortable managing it online herself, but she could set up an account at Fidelity or Schwab and they'd probably be willing to meet with her annually to reallocate her assets.

And questions for her:
- How important is the life insurance component to her?
- How important is it to her to get the RMD's; ie is she relying on them for income or just re-investing them in a CD or other vehicle?

Thanks for any additional advice - the suggestion to read the actual contract and analyze her statements really helped me understand this product a lot better!

 

[imoldernu]

OMG... And I thought I was confused...

... Scuba you must be a saint to get into this. Not sure you mentioned the age of your friend, but the 2034 contract date... hmmm ?

We've decided to just leave the rest of ours, up to the kids. First in, last out.

 

[Souschef]

When DW's husband died, a "friend" sold her an annuity from his life insurance proceeds. He claimed it would protect her from creditors, which is not true. The proceeds were protected.
Fast forward 10 years, and her annuity was up for renewal.. They offered her a 9% bonus for renewing. BUT the admin charges were higher. I ran a spreadsheet, and found out that in year 6 she would start going in the hole!
The salesperson claimed he did not realize that. DW was grateful I took the time to review the terms.

 

[Scrapr]

so the salesman sold her a 21 year annuity at her age of 69 years old? And in an IRA? Did she get a bonus at time of signing? 11 years is a long time for the surrender period. Aren't the more common ones 6 or 7 years? Any idea on the fees?

that downside protection & upside lock is enough for me to get out of it. I would probably do it out of spite. Not sure I would help her into though

 

[target2019]

Scuba,
Since her intent is to pass this on to child, it is best to cash in now, and simply put it into an IRA with one balanced, or target fund. She would not have to worry about re-balancing anything. Simply reinvest dividends and gains for new shares.

I'm sure the insurance authority in your state would be interested in hearing about this.

 

[pb4uski]

I don't think it is quite as bad as you think.

If the original surrender charge was 10% (11*12*0.0758%) and it decays at 0.0758% per month and the contract has been in force for 5 years (Nov 2013-Nov 2018) then the current surrender charge would be 5.45%... right? If the CSV is $320k, then the account value is ~$338k ($320k/(1-5.45%)... right? A 10% initial surrender charge grading off over 11 years isn't particularly unusual for annuities.

So she put in $320k in 2014 and took RMDs of $13k in 2015, 2016 and 2017 and the current account value is $338k? If so, then that is a IRR of 4.43%... while that sounds bad, Wellesley's average annual return from Nov 2013 to Nov 2018 was 5.65%. OTOH, the IRR using the CSV is 3.09%... not great, but better than CDs (except the PedFed 3% deal). You may want to compute the IRRs since you ve more of the details.

So while I wouldn't characterize it as a keeper, I'm not sure that it is a disaster either... unless I have significantly mis-interpreted what you wrote.

If this money is earmarked for her son, then there is a school of thought to invested it more along the lines of how her son would invest it, but it is also her SHTF money too... I would probably cash it out and put it in Wellesley or another conservative balanced fund.

 

[Scuba]

I don't think it is quite as bad as you think.

If the original surrender charge was 10% (11*12*0.0758%) and it decays at 0.0758% per month and the contract has been in force for 5 years (Nov 2013-Nov 2018) then the current surrender charge would be 5.45%... right? If the CSV is $320k, then the account value is ~$338k ($320k/(1-5.45%)... right? A 10% initial surrender charge grading off over 11 years isn't particularly unusual for annuities.

So she put in $320k in 2014 and took RMDs of $13k in 2016 and 2017 and the current account value is $338k? If so, then that is a IRR of 4.43%... while that sounds bad, Wellesley's average annual return from Nov 2013 to Nov 2018 was 5.65%. OTOH, the IRR using the CSV is 3.09%... not great, but better than CDs.

So while I wouldn't characterize it as a keeper, I'm not sure that it is a disaster either... unless I have significantly mis-interpreted what you wrote.

Well she’s been invested in the S&P 500 and NASDAQ, so what I’ve compared is what her balance would have been if she had just invested in the indices without even counting dividends, vs what her balance actually is. I accounted for her RMD’s in both scenarios and her account balance would have been $131K more if she had just invested in SPY and QQQ for example, plus she’d have gotten some dividends. I’d say that’s a huge discrepancy.

 

[Scuba]

so the salesman sold her a 21 year annuity at her age of 69 years old? And in an IRA? Did she get a bonus at time of signing? 11 years is a long time for the surrender period. Aren't the more common ones 6 or 7 years? Any idea on the fees?

that downside protection & upside lock is enough for me to get out of it. I would probably do it out of spite. Not sure I would help her into though

Yes she got a 20% bonus, but it can’t be accessed until Year 11 Nd only then through higher annual distributions.

 

[Scuba]

Scuba,
Since her intent is to pass this on to child, it is best to cash in now, and simply put it into an IRA with one balanced, or target fund. She would not have to worry about re-balancing anything. Simply reinvest dividends and gains for new shares.

I'm sure the insurance authority in your state would be interested in hearing about this.

Thanks, that is what I’m thinking too. I’m sure it’s legal as it was sold by a reputable company and the disclosures are documented. It’s just unfortunate that people with limited financial acumen buy these products, not really understanding the way they really work.

 

[pb4uski]

When DW's husband died....

Are you a ghost? The phrasing just caught me off-guard.

 

[Souschef]

Are you a ghost? The phrasing just caught me off-guard.

Sorry, I could have phrased that a little better. DW's husband passed away in 2005, the same as my late wife. I married my present wife (DW) some years later

 

[pb4uski]

Well she’s been invested in the S&P 500 and NASDAQ, so what I’ve compared is what her balance would have been if she had just invested in the indices without even counting dividends, vs what her balance actually is. I accounted for her RMD’s in both scenarios and her account balance would have been $131K more if she had just invested in SPY and QQQ for example, plus she’d have gotten some dividends. I’d say that’s a huge discrepancy.

In order to make your comparison valid, you would need to include hedging costs since her contract puts a floor on losses and what you are using doesn't... and those hedging costs would likely be very significant.

Also, from what you wrote this person would never have invested in SPY or QQQ without some or of floor... so since the floor was an important aspect of her investment decision then you need to proide for it in your analysis.