Why Index Annuities Are Targeted at High Net Worth Households
True Life Story of a Couple Duped by a ‘Guaranteed’ Annuity”
Every good heist has a red herring. If you don’t know that term, it’s a common story element in mysteries and film noir, where a clue or insight turns out to be misleading, hiding the true culprit in a crime. For our most in-depth book for those of you looking to invest between $5 million and $500 million we recommend you request your copy by clicking here.
You’re about to see how one high net worth couple fell for a red herring in a pitch from an insurance company, and as a result, got $725,000 of their money locked up in a guaranteed 6.75% annuity that would earn them almost nothing for ten years.
Are guaranteed annuities a good deal for high net worth households? Let’s take a look. First, imagine you’re in a room with a broker or financial advisor who offers you the following deal:
“I can get you a 10-year annuity with a guaranteed 6.75% annual rate of return. Even if the market goes down, you still get the 6.75%. And if the market goes up, your rate goes up. So you can’t lose, but you can win big.”
Table of Contents
- There’s Something Fishy with Your Guaranteed Annuity
- The Rider – Making the Deal that Gives Away Your Freedom
- The Shocking Truth about the Annuity Rider Revealed
- Why Ultra High Net Worth Households Make Good Targets for Annuities
- But Wait, There’s More Horrible News For This Family
- What Should This High Net Worth Couple Do with Their Guaranteed Annuity?
- Pillar Can Answer Tough Questions Like This One
It sounds amazing, but you hedge a bit. So then the broker hits you one more time to seal the deal during the very low interest rate environment we’ve been in for years. “In addition to the guaranteed 6.75% for 10 years, you get a 5% account bonus. For you, that’s over $36,000.”
Pretty alluring right? Like the muse in a film noir. How can you say no? On one hand, it sounds too good to be true, yet you can’t turn away.
Turns out, it IS too good to be true. Here’s a story of one of our clients (some details have been changed to protect privacy) who fell for the pitch you just read. Before going on, read the pitch again, because on the surface, it really does seem like a can’t-lose proposition. It’s hard to see any holes in it, right?
Let’s dive in and expose the cover-up.
There’s Something Fishy with Your Guaranteed Annuity
A fiduciary financial advisor, such as Pillar Wealth Management, would not recommend a deal like this, because we can smell its deception from miles away. What’s the first thing that doesn’t smell right?
It is impossible in the interest rate environment of the last few years for a bank to guarantee a rate of 6.75% using their conventional interest savings and money market accounts. Right now, the top 5-year CDs are paying 2-3%. And, five years ago when this story began rates were even lower. However, with the high risk of the stock market it is conceivable to earn a lot more than 6%.
Why is this important? Because the bank (or insurance company in this case) actually indexes your annuity value of $725,000 to certain markets. This means, if a particular index earns 14.81% (Euro STOXX Index), or 24.16% (Nasdaq 100), like they did in this particular annuity for the previous policy year, you’re not going to see most of that growth.
“But wait,” you’re probably wondering, “Didn’t you say I don’t lose if the market goes down but I win if the market goes up?”
Yes – but buried in the fine print is an Annual Cap on your gains. Other annuity products might call this a Monthly Cap, a Spread, or a Participation Rate. In this case, the cap was 2% per year, that’s right, they capped the return to 2% per year!
Or in other words, your annuity value, other than the Guaranteed Minimum Withdrawal Benefit (GMWB) value which you can’t benefit from unless you annuitize, cannot grow at a rate better than 2% in any one policy year!!!
So the truth is, hidden behind those red herrings of 6.75% and the 5% bonus, is that the MOST you can gain with this annuity is 2% annually (assuming you don’t give up full control of your principal to the insurance company, which we’ll discuss shortly).
With the market earning double digit growth, you’re locked out of hundreds of thousands in gains by investing in this annuity. Now do you see why they happily offer you that 5% bonus?But don’t stop here. It gets worse. Much worse.
The Rider – Making the Deal that Gives Away Your Freedom
This annuity product came with a rider, and it was actually the rider that guaranteed the 6.75% annual rate for 10 years. But the rider was optional. You have to buy into it. And the only way to do that is to sell your soul to the insurance company.
Here’s what we mean:
The policy guarantees 6.75% per year. But the only way to keep those gains is ‘annuitize’ the principal. In this case, the insurance company called that a Guaranteed Minimum Withdrawal Benefit (GMWB).
If you don’t annuitize, you can only make 2% each year, and no more. You’ll be earning 2% on $725,000. Meanwhile, the insurance company has earned well over 10%, just in the last policy year, in this market. Again, do you see why they offer you that 5% bonus?
What does it mean to annuitize? It means you give up control of your $725,000 by giving the annuity company full rights to your principal, and with that any chance your heirs will ever receive this principal.
So if you sign up for the GMWB and then die six years later, your heirs will not receive the $725,000 nor what it has grown to! You’ll have earned a minimum of 6.75% per year for ten years. But remember – you gave up any rights to the full principal of $725,000. In six years, you’ll have been paid back a fraction of that. Meanwhile, the insurance company might be earning more than 10% per year in the markets.
Plus, the GMWB is not indexed to inflation. Supposing you live 20 years after annuitizing. You’ll still be living on the same fixed income 20 years from now. At 3% inflation your GMWB income will buy you just over 55% of what you can buy with it today.
This means that, at 3% inflation, your purchasing power will be cut in half (or in other words your income will be cut in half) in just 20 years.
Even more alarming – this rider comes with its own separate fee of 0.95%. So in addition to giving up nearly three quarters of a million dollars that your heirs will never see, you also get to pay over $7000 per year for 10 years for the privilege.
The Shocking Truth about the Annuity Rider Revealed
Everything you’ve seen until this point is just window dressing, hiding the most diabolical stratagem of this particular guaranteed annuity product.
Let’s recap what we know so far:
- You are guaranteed 6.75% per year, for ten years, through a rider, but you have to annuitize to get it
- If you do this, your heirs will not get the principal, no matter when you die
- If you don’t do this, you don’t earn the 6.75%. You earn 2% at best!
- Your future income if you annuitize is not indexed to inflation
- You have to pay 0.95% for the rider
That’s a terrible deal. But here’s the shocker. Even if you don’t annuitize, you still have to pay for the rider! This means you won’t even earn 2%. You can earn a maximum of 1.05%.Clearly, the insurance company wants to make it extremely desirable to accept the Guaranteed Minimum Withdrawal Benefit. They want you to annuitize.
Why? Because they know that enough people who buy these products won’t live long enough to collect it all back in addition to the investment growth the money earns for the insurance company. And when you die, your heirs don’t get the principal.
On one hand, it’s understandable why the insurance company sets it up like this. They are taking a risk by guaranteeing 6.75%. In a down economy, that will cost them. But this is why they charge the 0.95% fee. Even if you do annuitize, you still don’t make 6.75%. You make 5.8%. The insurance company is making a bet that in the long term the markets will pay them handsomely.
They’re covering their bases, reducing their risk, and maximizing their chances of a big payoff.But what are they doing for you? Isn’t this supposed to be a good deal for you? It’s your money, after all.
Again – a fiduciary wealth manager like Pillar would almost never propose an investment plan like this. You can almost universally do better using other methods. This type of guaranteed annuity isn’t created for your best interests or long term benefit. It’s created for the insurance company.
It traps your money.
Limits your monthly payouts.
Locks out your heirs.
Costs you even more in fees.
And doesn’t adjust for inflation.
Why Ultra High Net Worth Households Make Good Targets for Annuities
We haven’t yet precisely answered this question for this particular couple’s annuity. But in general, you probably can already guess the answer. Annuities win the agent a big commission check. And when you get a high net worth or ultra-high net worth family to hand you $3 million for an annuity, how much will that be worth in commissions?
Suppose the commission is just 8%. It’s probably higher, but let’s assume a low number. 8% of $3 million is $240,000. It is easy to see how a commission-based broker or financial advisor who could earn $240,000 from a single client in a single transaction, would go for that. However, the reality of the particular policy we are discussing here is that the commission is probably closer to 10%; yes a whopping 10% to the broker/agent.
All these agents have to do is sign up a handful of high net worth clients each year, and they’re making huge commissions. They do not offer these products to clients because it’s in the client’s best interests. They offer them because it means big money for them.
What this means for you:
If you are a high net worth household, the guaranteed annuity salesmen are targeting you. They are coming for your hard-earned savings and IRA investments. They’re offering sweet-sounding deals with guaranteed payouts and signing bonuses.
It’s all a ruse.
The real goal is to lock up your money so they can earn big commissions and then scrape off huge chunks of the investment growth your money is making. It becomes clear why it is better to work with a fiduciary wealth advisor, where fees are fully disclosed and you could keep the growth for yourself. No caps. No empty-handed heirs left with nothing when you die. No hidden rider fees.
But Wait, There’s More Horrible News For This Family
In this couple’s situation, they had not chosen to annuitize yet, even though they had owned the policy for several years. They didn’t realize they were only crediting them only about 1% growth on their $725,000.
But even without annuitizing, they were still locked in the policy for 10 years. The insurance company was raking in the money and giving them about 1%. So why not just get out of the deal?
Because the policy also includes a surrender charge, a whopping 15% the first year, and reducing a bit each year until the 10th year concludes. At that point, if they don’t annuitize, they can get their money, which would have only earned about 1% per year, back.
Their question was, should we get out now and pay the surrender charges? Is that worth it, since we can earn much higher growth using other methods?
What Should This High Net Worth Couple Do with Their Guaranteed Annuity?
As part of our wealth management and investment process, we run 1000 stress tests on your lifestyle to evaluate the confidence of achieving your lifestyle goals over your lifetime. These stress tests use investment performance data going back nearly 100 years.
Having seen how the markets have performed through wars, depressions, recessions, inflation run amok, and so many other finance-stressing world and national events, we are able to use that data to evaluate how much confidence you can have in achieving your lifetime desired lifestyle, even in highly volatile environments.
There’s a lot more to this, and we don’t have room for too many details here. To see how your portfolio would perform against the 1000 stress tests, sign up for a free Wealth Management Analysis meeting, and get all your investment questions answered.
For this high net worth couple, we applied our 1000 stress tests to their complete portfolio, including their real estate. We also discussed their plans and desires for their money, and learned they wanted to leave money to their heirs.
Our process determined they would have a higher confidence of achieving all these goals if they did not annuitize this insurance product. Further, we found it made more sense to pull the money out now – even including paying the surrender charges – because they would likely recover that and much more over their lifetime.
Pillar Can Answer Tough Questions Like This One
This article is not meant in any way as a recommendation to those owning an annuity. Annuity contracts are very diverse and complex. Each instance requires a unique and deep evaluation, not only based on the terms of the contract, but also based on your goals.
Should I annuitize or not? That’s a very specific question. Do you want hard data to help you answer tough financial questions that will affect your life for decades, or would you prefer to settle for the smart-sounding commission-based financial advisor or broker/agent?
We prefer hard data. That’s what our process provided for this couple, and it will provide the same certainty for you, in whatever tough financial questions or situations you’re currently facing.
If you’re a high net worth household and a broker pitches you, or has already sold you, an annuity you don’t fully understand or that seems too good to be true, here’s our advice: Run or seek advice. Schedule a Wealth Management Analysis meeting with a fiduciary wealth advisor.
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