How to evaluate an annuity

Question

My mother wants to gift annuities for me and each of my siblings. Great...uh, maybe.

I'm concerned that she may be purchasing some expensive crappy investment she doesn't need to achieve what she wants to achieve.

She says, "I will be buying you a tax deferred annuity with an income rider. In effect, I am buying you a very nice pension for your retirement years as the income value will be growing at 8.2% per year until you begin to take income in your 60s or early 70s." (I am currently in my early 40s. She is in her late 60s.) "This annuity gift is tax-deferred so there are no taxes due until you begin taking your pension payments."

The two things that make me suspicious that this may not be the best way to do what she wants to do:

• Guaranteed 8.2% annual return sounds too good to be true. Am I right? Are there likely high fees, etc.?

• Her financial advisor doesn't charge by the hour--he takes a commission. So there's obviously some incentive to sell her things, even if she may not need them.

Is there a good, reputable checklist of things I should look for to determine if this annuity is a rip-off or not?

Answer 1

Guaranteed 8.2% annual return sounds too good to be true. Am I right? Are there likely high fees, etc.?

You're right. Guaranteed annual return is impossible, especially when you're talking about investments for such a long period of time. Ponzi (and Madoff) schemed their investors using promises of guaranteed return (see this note in Wikipedia: In some cases returns were allegedly determined before the account was even opened.[72]).

Her financial advisor doesn't charge by the hour--he takes a commission. So there's obviously some incentive to sell her things, even if she may not need them.

Definitely not a good sign, if the advisor gets a commission from the sale then he's obviously not an advisor but a sales person.

The problem with this kind of investment is that it is very complex, and it is very hard to track. The commission to the broker makes it hard to evaluate returns (you pay 10% upfront, and it takes awhile to just get that money back, before even getting any profits), and since you're only able to withdraw in 20 years or so - there's no real way to know if something wrong, until you get there and discover that oops- no money!

Also, many annuity funds (if not all) limit withdrawals to a long period, i.e.: you cannot touch money for like 10 years from investment (regardless of the tax issues, the tax deferred investment can be rolled over to another tax deferred account, but in this case - you can't).

I suggest you getting your own financial advisor (that will work for you) to look over the details, and talk to your mother if it is really a scam.

Answer 2

Annuities are usually not good deals. Commissions to the salesman can be as high as 9% of the initial premium. They're not scams, just not the best deals for most circumstances.

Basically, these things are a combination of an investment vehicle and multiple insurance policies, including permanent insurance. The 8.2% "return" is the total cash value of the account, which your heirs get if you die.

Answer 3

You can get no load annuities through some no-load financial companies like Vanguard so to start with I'd see how what she is being offered compares with something that comes free of a sales load.

I'd also question that fixed rate, seems pretty impossible to me, which makes me think there is some catch or 'gotcha' that we are not seeing that either brings down that rate, or makes it delusional (they are kidding themselves) or deceptive in some way. In any case it's setting off my 'too good to be true' alarm at full volume, along with the 'shark attack' alarm as well. (I would strongly suspect the 'advisor' is advising the product that makes the most money for him, NOT what is in your mother's best interest)

A fixed annuity is an insurance product, not a security, because the insurance company must credit the annuity holder’s account with the specified interest rate for the contractually-stipulated time period, regardless of market fluctuations in actual interest rates. It is the insurance company that bears the investment risk, which it does by investing the annuity holder’s purchase proceeds in fixed-income instruments that the company hopes will provide sufficient return to fulfill its contractual representations to the holder. THIS is why there is no prospectus (it's not a 'security' they are not required to provide one by SEC) because the risk is entirely with the company. Obviously as pointed out in the comments, the company could easily go out of business (especially of they sell a lot of these and can't find a way to get that kind of return on the invested money). Now, ask yourself, if I was the insurance company, would I be comfortable guaranteeing that level of return over that much time if I intend to make a profit from it, pay sales comissions, and stay in business?

In terms of 'will they stay in business' I'd have a hard look at their ratings, and go compare where that is on the total range for AM Best (they are lowest 'secure' rating, next thing down is in the 'vulnerable' category) and Standard and Poors (4 places down from their best rating, next thing down is 'marginal' followed by 'poor') You might also want to see if you can get any idea of historical ratings, is this company's ratings falling, or rising? Personally, for the amount of money involved, I'd want a company with MUCH higher ratings than these guys.. THEN maybe someone could say 'no risk', but with those ratings? an no, I don't think so!

BTW I'd check over what this bozo (um sorry, that's not fair to clowns) is recommending she do with her own funds as well. For example is he recommending she take something that is already tax sheltered such as an IRA and investing the stuff inside that in an annuity (kind of pointless to 'double shelter' the money, or lock it up for a period of time when she may be required to make withdrawals) make sure you don't see something there that is actually against what is in her best interest and is only done to make him a comission.

Answer 4

You need to see that prospectus. I just met with some potential new clients today that wanted me to take a look at their investments. Turns out they had two separate annuities. One was a variable annuity with Allianz. The other was with some company named Midland Insurance (can't remember the whole name).

Turns out the Allianz VA has a 10 year surrender contract and the Midland has a 14 year contract. 14 years!!!

They are currently in year 7 and if they need any money (I'm hoping they at least have a 10% free withdrawal) they will pay 6% surrender on the Allianz and a 15% surrender on the other.

Ironically enough, they guy who sold this to them is now in jail. No joke.