Investors Beware: Devil May be in Details of Annuities

Recently MetLife agreed to pay $25 million to settle allegations it misled and misrepresented investors with the sale of annuities. Financial planners say annuities pay out some of the highest commission structures in the business, offering some bad apples more incentive to sell them to unsophisticated investors.

James Sanford, CFA, founder and portfolio manager of Sag Harbor Advisors discussed with the hidden secrets that retirement planners sometimes conveniently forget to tell annuity investors. Here is what you need to know:

Boomer:  What makes variable annuities such a complicated investment?

Sanford: There is a huge library of features and terminology an investor must plow through. The complicated web seems almost intentional to force the investor into the Advisors hands, by throwing in the towel and just trusting their advice. The Advisor has major conflicts of interest, as annuities offer some of the largest commissions available to advisors.

Calculating what your account is really worth in the future may require understanding of present value accounting and bond math, as well as life expectancy analysis. Not only do layperson investors lack these skills, but trained actuaries may only be suited for such analysis.

Boomer: Can salespeople mask annuity fees from investors?

Sanford: As for commissions, a salesman has no legal obligation to reveal the commissions he earns both upfront and on an annual basis.

When it comes to annuity fees, don’t rely only on the sales guide, which may obscure an annuity’s costs and restrictions. The devil is in the details, and the details are in the contract, prospectus and prospectuses for any subaccount funds, which can amount to many hundreds of pages of information and disclosures.

Boomer: What can investors do to identify loopholes that can potentially steal their retirement years down the road?

Sanford: The fees and commissions in annuities are really the retirement killer here. Ask your Advisor outright to reveal what commissions he is earning upfront on the product. Typical upfront commissions can range from 6-8% and the client also pays annual fees that can run as high as 3.5-4%. These fees can make a drastic hit to your nest egg in the future. Since 1997, if you invested $100,000 in a 70/30 Blended investment comprised of 70% MSCI World Index/30% Merrill US Treasury Index, your nest egg in 2014 would be $299,000. If you applied a typical annuity annual fee structure of 3.95% over that period, your nest egg would be only $152,000.  (source: “Annuity Insights”, Ken Fischer)

The bottom line is never sign what you haven’t read.

Annuity providers also often reserve the right to change terms, which can have a significant impact on your investing goals. For example, suppose you plan on contributing regularly to the annuity in order to receive higher income benefits. Some annuity providers reserve the right to limit future contributions in order to avoid paying more in benefits. If this happens to you, you may not be able to receive the income stream you’re counting on today. Fees, participation rates, and performance floors and caps may also be subject to change on an annual basis in most cases.

Some indexed annuities are based on benchmarks that don’t include dividends, which can limit your total return. Avoid these.

Boomer: With the recent passing of the DOL's Fiduciary Rule, can investors expect to be better protected against misleading annuity sales?

Sanford: The new DOL rule is absolutely a step in the right direction but it only protects investors ERISA regulated retirement accounts like 401k, IRAs and pensions. The key part of this rule is that it requires Advisors to disclose commission arrangements to clients in an attempt to shed light on hidden backdoor fees and compensation schemes for Advisors. If you’re buying an annuity with your general savings and investments accounts you’re not protected by the DOL rule, and it’s important for investors to demand upfront disclosure of commissions  on all products and in ALL of their investment accounts, not just their 401Ks and IRAs.