The Harsh Truth About Annuities!

everything you ever want to know about annuities and more it's Bryan Preston the money guy yep so this is one I think is an interesting one bride because annuities are it's a it's a polarizing word out there in the financial industry when you even start throwing it out there either people's ears kind of perk up or they immediately turn a 180 and move in the opposite direction as fast as they can well I mean there's several things going on we talked about this in pre-tape laning I don't tell people when I meet new neighbors or even people if you go to like an entrepreneur luncheon or something like that I said what do you do for a living I always pause because I never know what to say because when you tell somebody you're a financial planner they naturally social distance from you because they assume it's a matter of time before you either pitch them a life insurance policy an annuity and that's and that's so unfortunate to me that that's become synonymous with what financial planners use in their toolbox so we want to kind of explain because we've had here's what's going on beau we've gone through a weird Tom I mean because we've had stock markets that have crashed we've had all of us go under where we're essentially locked down in our house nationwide I mean really worldwide so these are things that you haven't seen so it's very realistic that fear is peaking now two levels we have not seen and typically when you start having fear elements panic that's when the insurance guys come out and start pitching guarantees or you know lack of volatility all the type of things so I want it look that we're gonna try to do this in a way that even if you're an insurance person you're watching go yeah hey they they at least laid out the way things really work and wins the good times to use these type of products but what's the reality and what's not necessarily in the sales brochure it the thing we want to equip you with today is if fear is at an all-time high it means that the folks are gonna be out ready to start pitching you so likely if you haven't heard it yet you'll start hearing it all we want to do is equip you with the right vocabulary the right knowledge so that you can approach those decisions well now I do feel like about to put a disclaimer out there because every time we ever do a show covering a specific investment product or hyper products the haters come out of the Woodworks we are not saying in this show that all annuities are bad or that all annuity salesmen are bad or that all insurance is bad do not miss here so we're just gonna try to lay out the facts of what you need to know the different types of products and how they work fair enough fair enough yeah yeah but I'll be the bad I'll be the Simon Cowell here and share that unfortunately the lion's share people that are being put into annuities don't fit completely so let's jump into this and let's go a little deeper so basically there are two types of annuities yes there's your fixed annuities and then there's your investment annuities and I want to kind of do a deeper dive into each one of sort of topics and first we had fixed annuities both so talk give us give us an overview of what we're talking about when we say fixed annuity yeah so when you think about a fixed annuity there are really two main varieties that we're gonna touch on there are immediate fixed annuities which essentially says I'm going to trade lump sum of cash today for an income stream since I'm gonna take you know X dollars and I'm gonna start receiving an income stream for that or the second variety of fixed annuity is a deferred fixed annuity we're essentially I'm gonna take that chunk of money and I'm gonna put it somewhere and it's gonna earn a guaranteed stated rate of return over some special period so it's not creating income for me yet it actually is a growth mechanism with a fixed rate over a fixed period so when we see the words fixed we know we're either talking about a cash stream you know essentially paying you income for a stated period of time or we're talking about a guaranteed rate of return that's when we're talking about fixed so let's first just jump into immediate fixed annuities because what I think is interesting about these we don't see as many pensions but if you really boil down what is a pension it really is an immediate fixed annuity because what it is promising you is it's somewhere there is a basket of holdings that is getting handed over to an insurance company or a pension pension administrator where they're saying for the rest of your life or for a stated period of time they're gonna pay you this level of income for that stated period yeah and a lot of times if you're someone who's approaching retirement or you've recently gone through retirement you probably recognize you had a choice you could either receive that lump sum that big check that you would be in charge of managing for the rest of your life or you could receive that income stream you're essentially making the decision to annuitize those dollars or to not annuitize those dollars yeah and this one's useful like I said if you want to have a personal pinch maybe you didn't work for a company it had a pension this is probably the cleanest way to create your own personal pension situations that's right and then deferred fixed annuities but you kind of laid this out this is where you're basically saying for a stated period of time we're gonna have a guarantee interest rate a rate of return and what we found just to kind of let everybody know if temperature of the market right now they're paying between two and a half to three and a half percent the difference on a deferred fixed annuity is that two and a half is like a five-year sure you know anything two two three four years guaranteed on that term and then if you see something that's paying three and a half percent that's you have to go out as far as 10 years yeah we were talking with Matt you know doing some pre show up revenue said really you know when you think about a deferred fixed annuity it's a lot kind of like a CD if you think about the way a CD at a bank works it's very very similar the reason that most people would opt for an annuity over a certificate of deposit is the rate tends to be slightly higher now and most people aren't getting excited about two to three percent especially when you come out of the year like 2019 where the markets you know even conservative portfolios may double digits but all of a sudden we go through a bear market you're like wait a minute guaranteed you know you start getting excited about that so that's why these products come out when people start getting nervous and realized that markets do have volatility typically two out of every ten years you're going to have downturns and people rose I don't really like that say they they kind of jump into it so I want to kind of talk about what's left out of the sales presentation what are the risk of fixed annuities yeah so you know when you hear things like guarantees just like you said people get excited but it's not all sunshine and rainbows there are some things you need to be aware of I think this is the part with insurance that I want to make sure people understand I think insurance design is made up of they say okay what are things that from a component of human nature that people are scared of and how can we create a product that kind of checks the bottom so when you come through fearful times like we just came through this pandemic people say man I will guaranteed sounds really good so the insurance company has to figure out how do they design a product that is guaranteed typically when they do that when you're willing because guarantee is a slow poison to long term returns risk and reward going the same boat together it's right so when you say the word guarantee they don't it doesn't fit naturally with that because you're not you're losing all of the risk element which is equates to return so you know you're giving up a lot so there definitely some limitations and we talked about it so let's talk about some of these limitations because it's not only on ready to return it's also inflation yeah that's right so one of the biggest risks that we see with fixed-rate annuities we have this guaranteed lowest rate is inflation the cost of goods rising over time could potentially be greater than the return those dollars are earning and so we just said let's look at a quick study of how prices have changed and we wouldn't looked at three common goods we looked at a gallon of milk we looked at a new house and we looked at a new car and the price those things were in 1970 when some of us were around and then looking all the way to today I wasn't around in 1970 you were getting close how was close my parents I don't even know if they knew each other in 1970 but but it is one of those things what's funny is I look at these prices like gallon of milk okay that is what it is but house my parents houses they built in 1978 that was I was five years old when we moved I still remember they built that house for $60,000 the house my mom lives in what I think is interesting is then you look at the new car I still remember in the sometimes 76 78 somewhere in there my parents bought an Oldsmobile for around two grant two to three grand so that was probably somewhere in those low 70s so because you can see a new car was $3500 what I find interesting is that new cars cost more than what houses cost in 1970 it's insane and so why does this matter most of us when we enter in to retirement or when we think about long-term planning we're planning for a 20 30 40 year time horizon well if we only plan for what things costs today and we're not thinking about what things cost 20 or 30 years in the future there's a really good chance that we could you know cut ourselves off by not having the resources nestled in turist rates are in the basement right now and it's one of those things where I think if you walked in for an extended period of time you you really could get yourself in a pickle of a situation because it is no doubt that one dollar today 30 years from now probably is only the equivalent of 30 cents yes because it the purchasing power will go down over time so you definitely need to be aware of inflation and what that means a special when you're in such a low interest rate environment short now and that leads to kind of the next thing that we talked about is legacy is limited yeah so one of the things that often especially if you have children or family members one of the things you really think about is I want to make sure I leave a legacy for my kids so I want to build up to financial independence so they can provide for me over that 20 30 40 year financial independence period but then I'd like to have something that I leave behind to the next generation most people kind of have that thought with annuities you don't always get to do that thing well and that it's the big part this is the thing we've looked at it because you can go to websites and type in like immediate annuities thing you see because a lot of us if you could daydream about what you want we'd all love to have a pension you know but they've gone extinct you just don't see as many pensions as you used to unless you work for a government entity right but so we all look in like man it would be great if I could stack my Social Security plus a pension so then you have the thought well I'll just go create my own pension system and when you look and here's something I want to people to understand cash flow or payout rate is not the same thing as a safe withdrawal rate and you can go because we did this for show prep if you went right now and looked for a 65 year old male what the you know guaranteed for life what your payout would be on an immediate annuity it has a stated cash flow or payout rate that is like 5.9 percent it's immediately when you're here that you're like Oh 5.9 guaranteed sign me up all day long why wouldn't I want to have that in my butt it's played a little bit of a mind trick on you because like I said we're so used to you if you've watched enough shows we talked about wait you're trying to build up your financial assets so that when you get to retirement you can pull out between three and a half to six percent depending upon what age you retire you can pull out that's called a safe withdrawal rate with the thought that you'll live off the money the portfolio's generating but then when you pass away there's probably gonna be a large portion of that principle that you'll pass on to your heirs so when you hear that there's a cash flow or payout rate a 5.9 percent it immediately ding-ding-ding-ding that's a high that's on the high end of where the safe withdrawal rate was but there's a catch because let's take that same example of 65 year old realistically they're probably gonna live I did I just did a quick calculation with the financial calculator to age 85 even if you don't pass away at age 85 your living expenses go down significantly once you get into your later 80s anyway so if you take that twenty-year period all of a sudden that 5.9 percent once you take into account the principal that's also being degraded because once you pass away this is why we say it's a legacy risk once you pass away your heirs don't get this money this goes to the insurance company that's the deal you make with them that you give them this chunk of money they give you this cash flow for the rest of your life but then after that it kind of goes away once you take an account that principle degradation that rate of return of 5.9 which sounds like a really good safe withdrawal rate goes down to 1.7 percent because realize that 5.9 is primarily made up of you spending the money you say you're essentially getting your principal paid back to you now before you guys start writing so yeah you can go buy life insurance riders or things like that to protect the value but then you're only really doing two things you're either increasing the cost of the product or you're lowering that rate of return the inherit rate of return you have so I don't know that that's the best solution if legacy building is something that's on your list of goals to do and but that's that's ultimately where the two sides of this discussion go is because most people say I won't guaranteed safety but then when you ask them Oh several questions like so you're okay with not leaving anything to the kiddos and they're like no I want to leave something over here to the kiddos II like well those two don't go too well together so they're there they're definitely in conflict with each other so be aware that because those are the biggest concerns with the the fixed annuities is that you are going to see some inflation risk you're also going to see some legacy risk and those things go into play but I want to pivot now because more than likely when I talked about insurance people when you hear somebody's a financial planner you always naturally social distance yourself because you know they're gonna start pitching you stuff they're not pitching immediate annuities they're not pitching fixed deferred annuities them they're pitching an investment annuity and buh give them the sales bill what do people typically say when they go and they pitch an investment in ooha t-this is an exciting opportunity for tax deferred growth you can actually legally hide money from the government inside of annuity structure you don't have to do the 401k you don't do the 403 B you can actually set up your own tax deferred vehicle and you can allow it to grow into the future and not pay any tax on it sounds pretty good yeah because well it also once again remember when insurance products are designed they apply they appeal to some type of central thing to being human that we like well we know on the fixed side we like guarantees yes safety is good but we also on the other side we like growth remember that whole theory they're ingredients that we're always fighting and they're in battle with each other so we've got the fear taken care of with the fixed annuities that greed part is what comes in over here so we know investing is naturally something that we ought to be doing with our money we ought to make our army of dollar bills do something for us so it's not uncommon that we have a product that's put together that should mimic these things and then what gets them in trouble is that they usually the promise is very simple but when you look under the hood they get very complicated on the fees the structures and I kind of wanna walk talk walk through because you said something tax deferred growth is how they say you get the best of both worlds you're not gonna pay any income taxes on the growth and it's also you'll get investment products when I hear that I'm like that sounds familiar I'm really familiar and it what it is is what is the large largest asset class that most people have when they talk about their investments what is the when people cross into seven-figure millionaire status it usually happens first with their retirement ok actually moving like 401ks IRAs Roth IRAs those type of all those things have tax benefits but guess what and look if you were trying to do a financial order of operation on where investment annuities fit into it it would be after you maximized your 401k after you maximize all of your IRA savings options including Roth IRAs that's when you would even consider this because you go find out these things by their sheer design are somewhat expensive they're of complexity so all that stuff comes into place so don't even consider this unless you're first checking the box on paying yourself first and saving in those retirement accounts so personal finance check point number one if you are someone who's thinking about investing in an investment annuity you have to ask yourself a question have I exhausted all other tax deferred savings because am i maxing out my 401k not not just getting the employer match am I actually hitting the IRS limit max that I'm a maximum IRAs only after that point should you begin to think about looking at investment annuities now this is a quick I don't to go into much of a side here but we talked about this one of the most frustrating things that we see is when a new prospect comes to us a new client wants to start working with it so we look at their investment portfolio and we start seeing annuities housed inside of IRAs inside of an IRA rollover or inside of a Roth IRA I mean that's almost unmentionable I mean it here's the real why does that upset us why does that make the hair and arm stand up is that the design the legislation that created 401ks for three B's 457 s and IRAs the design of the legislation that the government put together to give these things tax-favored status is automatically free granted to them meaning that you didn't have to pay extra to put an inch pterence product or anything they're just by the sheer design and the way that was written into law you get to have this benefit so when you stack an insurance product like an annuity inside of a already by its sheer creation tax-deferred product you're double paying for something to make that for the benefit that's already just innately been given to this yep this this savings vehicle so when you do that you know you're over paying for something that was already inherently given and then his boa said it's almost like a cuss word right here and we have seen it unfortunately if you're putting tax that you know if you're putting an annuity products inside of a Roth IRA which grows tax-free that's a travesty yep I mean it turns my stomach just even thinking about it but you see this type of stuff and it gives me all kind of heartburn so maybe you just heard that you're like oh no I'm one of those people I have an annuity inside of an IRA or I have an annuity inside of a Roth here's one silver lining that we have found generally speaking once you get past the surrender period we'll talk about certain periods in a second it is a little bit easier to exit annuities if they're inside of the irh structure so if you have one that you've had it's much much less costly from a tax perspective to surrender that annuity inside of the IRA than if you were to do it outside of the IRA so again you have some options they're likely but if you can avoid it you want to make sure that you avoid them just you can't unwind them I mean we'll talk about it later in the show if you have been sold one of these products you're going to have to unfortunately figure out where you are we'll get into the fee structure remember where you're on the cells and the deferred sales charges and other things there is some plans of actions you can do to fix the wrong that was done and but last thing just before I move on to the two different types of investment annuities is that realize financial order of operations I know I've already mentioned this face but you got to respect the food and make sure you are maxing out not just maximizing the match maxing out exactly what bo said earlier you're fully filling up those retirement accounts before you even consider something like this love it so let's go a little deeper and let's talk about now investment annuities in general because there's two type of investment annuities that you're going to have your brother-in-law and others you may be a neighbor - let's kind of go ahead and educate you on what those are yes so the two we're gonna focus on are one the variable annuity just a regular variable annuity and then the other that we've seen more prevalence on in the last ten to fifteen years are what are known as equity indexed annuities both of these are pitched with tax deferred growth market participation and then likely some sort of potential for limited downside risk that's the way these things get sold so in it bosz exactly right so when you talk about like a variable annuity it's going to be it's what's crazy is it has sub accounts which look very similar to mutual funds they have a lot of the components of you can I've even seen where you might have a brand name to it that you think you're buying into this investment but it's actually a sub account where it's got additional layers of fees on top of it but it does look very similar to a mutual fund but there's some things that are left out of the cells presentation let's kind of cover you know what that is is that these things can be expensive yep and they also I can tell you because we have this discussion it's gonna say I appreciate breath on this came up is that they can be a headache for you for your kids you know cuz these things when you inherit annuities it's a little different it's not it's not as easy as some of the other things that you can pass on to the kids yes people so often get caught up in this idea of oh well I really like tax deferred growth tax deferred growth taxed of her growth which is true we love text to for growth that's why it's higher up on the food but there's nothing wrong with growing ass that's inside of an after-tax account because we do know once they've been held long-term even they are subject to long-term capital gains rates but from a legacy planning perspective one of the beautiful things it's available to after tax assets is you do get a step-up in basis for your air so if you have a taxable account that you had half a million dollars in and when you pass away it's worth a million dollars all of that gain gets evaporated if your heirs and here at that because it gets that step-up in basis so I said we'll talk about that with the negatives in a minute but no doubt there's okay we talked about tax diversification all time it's okay to have a basket of after-tax money that's your your taxable savings tax deferred like your 401 K is your IRAs and then tax-free which you're a Roth you want to kind of have a nice healthy mix of all those things but that's variable annuities they look like mutual funds they just have a sum expenses that we'll get into in a minute but they try to mimic a lot of the investment components and that leads to the second one which is the other investment annuity is equity indexed annuities now run I've heard you explain these a thousand times over the years and one of the one of the best ways I've heard you explain it is like a ratchet and what's so funny or even I think I mention this show from I've never actually seen you explain it without doing the arm motion and so I feel like explain how an equity indexed annuity works but you got into the arm motion well this this is not my design because this is the way it's pitched the reason I know about this is because I've had prospects been bunch this yeah by the way we have rescued I don't know if you remember big case this is years and years and years ago is that a 401 K a person inherited a very closest seven-figure portfolio was right below it it was like $800,000 met at a their favorite breakfast restaurant and insurance agent okay that put her into an equity index annuity and that was like what you know unfortunately we were within the halo period of the state of Georgia has a look back buying period we were able to unwind it because like I said this was a 401 K already tax deferred you know tax favored that you know she rolled into an IRA and then bought into this product it was a bad deal but the way it was pitched to her was that this thing's gonna invest just like you did in in your deceased husband's 401k where it's like a ratchet it can always go up but it can't go down there's no negative you can't lose money with this type of investment and again as investors who recognize fear and greed what is better than an investment that only goes up and protects you when you go down that sounds like that absolute best thing tied to the market I mean you're telling me this thing's gonna be tied to the S&P 500 whew how'd it get me in there I want some of this so but you know when somebody guarantees or they protect you there has to be a trade-off there's no free lunch you know there's a reason we tell when you invest don't invest anything in the financial markets that you can't be a long-term investor five to seven years is how long you have to be willing to let that money work well guess what insurance companies know that rule as well so that's why what they do is the way they can offer you these guarantees and these protections is they will control your behavior they will put a surrender period on here that could last 10 years 12 years 15 years I mean so let's kind of break into how these things and the limitations of an equity indexed annuity yeah so the very first one Brian you just hit it high surrender charges and cancellation fees they control your behavior they say hey sign on the dotted line and you're gonna get this great thing but if you want your money in the next 7 10 12 15 years you cannot touch it or you got to pay the piper now so I mean that that's a big catch that's a big if that can control your behavior think about if I could have a client come in and I say look you give me this because we can't use the word guarantee but I tell people historically if you could leave the investments alone for five to seven years we'll make it through the downturns but I can't guarantee it these guys can guarantee it because they're walking you down for four ten years and there hasn't been a time that the markets been invested on it like a 60/40 diversified portfolio that there's not a decade that you really lose money so that's how they can make promises like that the next one is hi this is why I I don't mean to laugh high commission fees so oftentimes with these types of products they are incredibly lucrative yeah for the person selling that um that case I told you about this as many years ago but it was a 401k that was inherited rolled into an IRA put into an equity indexed annuity I found out later that the Commission on that product was 8% so you think about somebody who has eight hundred thousand dollars invested eight percent Commission I'm sure that guy he definitely cut ear and his beer after I pulled that Commission back because that was that was that's that's pretty that's crazy how high the Commission's are on some of these products the next limitation that we see is that we have expenses of the underlying investments that they can be slow if somewhere around half a percent but some can even be greater than two percent this is on an annualized ongoing basis not that initial Commission these are ongoing expenses inside the underlying sub accounts well it's the structure what they the way they will pay themselves these these high expenses is they'll be built into the participation rate in the cap rate because they you won't see an actual cost on these equity index annuities is primarily going to be through the underperformance of the limitations that they built into the asterisk and you'll explain more on that in just a second and you actually said that your return typically can't go below zero that's that ratchet and they protect but it's capped usually or we'll talk about a few different ways that they manipulate you return to where you can only make I don't know three seven percent well if you've ever watched our shows we talked about what the market does if you look at it on like a year by your basis it's like up here down here up here down here up here down here but the average is fairly consistent over long periods of time it just doesn't hit that average quite often well if you are capping it at zero that's great but you're also losing a lot of that upside so maybe what you're giving up might not be worth it well a lot of people now see that part you can't go below 0% so you can't can I not lose money on these investments yes you can't lose money because what happens if you have to get a medical issue now a lot of these products will be written where you can get access to 5% per year potentially but you might forfeit some bonuses and other things if you do that but it's it's still they go limit your behavior and if you do pull out above what they allow you to pull out in a year typically like 5% you go pay a large surrender fees right that you can actually lose money on these investments when you take into account this or under fee now one of the things that as we were kind of diving into this I thought it was a little interesting these fees are I mean these these products are so easy to explain when you talk about the ratchet but the way that they actually and I'm gonna use the word manipulate your return is far from simple it's not exactly easy so we wanted to explain some vocabulary for you guys to be aware of to understand okay if I'm being pitched a product what does that thing actually mean how are they affecting the performance that I can truly earn inside of these products well I think there's a clue in how they're designed to is realize when we're talking about equity index annuities these are not products that are regulated by the Securities and Exchange Commission because they're not necessarily buying the sp500 what you're the dirty little secret that most people don't talk about these things are regulated by your insurance commissioner not the SEC and then they perform after we go through this list of all the fees and limitations you'll find out they perform more like a fixed income guaranteed type product than they do the equity that they're tied to that's more of a marketing ploy than it is on an actual performance and we'll explain more so the first one is just a cap this is exactly what it sounds like there's an upper limit on the return you can experience over a period of time so hey you get market performance up until 7% yeah and then you don't get any more pretty pretty straightforward the next one is a participation rate this is you get a percentage of the indexes returned credit to your new ities so maybe you get 60% of the returns so if the market makes 10% you only make 6% so what I think is interesting because a lot of people are watching us and go okay so it must be an either/or so I either get you know 7% cap or I get an 80% participation so those years that like last year where the stock markets up well over 20% you're thinking okay well that means that product will be capped at 7% but if there's participation maybe I just want the one that has participation it's 80% of you know 20 Wow I'd be great no these things are stat huh so what happens is think about this if you had a cap of what 7% but then a participation of 80% they stack these things on top of each other you'll have a year like we had last year where the market makes over 20% and you're going to look at your returning go that doesn't look anything like what happened you have the stock market because I hit the cap and the participation rate got employed and then there's another fee the spread margin asset fees some products are written where they'll say we're automatically every year going to take three percent off of the performance of whatever index is listed these things get stacked on top of each other and here's the other thing that's a dirty little secret you would think okay if they get crushed on something if we hit a downturn can they change the rules after they've already designed this product the answer is yes absolutely all they have to do is they can go to the State Insurance Commissioner it's easy for them to change participation rates and other things after you've already had the contract written which is usually not the greatest thing you're talking about negotiations when somebody has all the cards and you're left holding the bag with what's left over this next one this one kind of frustrates me because what I found in my experience this is the hardest one to end up explaining to clients or potential clients is this bonus it's a percentage the first year premiums received that's added the contract value so let's say that you you buy $100,000 equity indexed annuity well they say you don't have sweetener in there I'm gonna go ahead and give you a 10% bonus so it's actually worth a hundred and ten thousand dollars well what they don't tell you is it's actually in most cases only worth that if you annuitize that benefit at some point in the future you don't ever actually get that money back at least for the policies that I've looked at the most it's not really real it kind of it's another one of those things that handcuffs you to where you feel like you can't get out of they usually have a vesting schedule and the vesting schedule typically will be even longer than the surrender period and you've already heard us talk about surrender periods can be 7 to 15 years so if they put a vesting schedule on these bonuses you have to look once again it's great from the marketing as you hear I'm gonna get a guaranteed 10% sweeteners stacked on top of this as a bonus but then when you find out that's overextended over the life of this product and it's got a huge vesting period like that's not as good I mean if you started dividing that by the years that I have to keep this all of a sudden I mean and when you take that into coordination with the caps and the participation right you're all is is it's not really sweetening the deal as much as you thought but it sounded good emotionally when you first heard the sales pitch and then the last are just riders these are extra features that can be added to an annuity for additional cost so you could have life insurance riders or cost-of-living riders or fill in the blank once again they do one of two things either increase the cost of the product or they decrease your potential return so I know a lot of our audience is probably listening oh man these guys it sounded more like professors and you know to textbook salesmen than they are the typical entertaining guys they are so it can at least show me something so can I get an illustration for that I'm not just going off of these tables when when we have slides with tables and lines and columns and rows you're like oh gosh this is just like I'm in high school again or college no we want to show you we actually put together an illustration to kind of teach this in a way that actually visually I think will make more sense so let's see how they actually stack up let's see how equity indexed annuities stack up two index funds so let's assume you bought an equity indexed annuity in 1990 that just tracks the S&P 500 500 biggest companies in the United States and let's say that that particular product has a cap of 7% right you know cap is usually somewhere between 3 to 7 but let's be generous say it has a cap of 7 but you can't go below 0 so dot-com bubble bursts don't go below 0 Great Recession don't go below 0 kovin 19 don't go below 0 but there's something we didn't even put an error because I want people to know we try to give the benefit of the doubt here we put it at 7% which is pretty generous you don't see any participation rate remember these things get stacked on top of each other the fees gettext Act we didn't put participation right in we're just going to assume you get that first 7% is all yours to keep even though we know in reels villes that's not actually how things work reels fill like a real bill how about a another t-shirt put down on the list I love it we live in real veil so ok so let's actually look at what the numbers look like ok so the blue line on the chart and if you're out there listening on itunes iHeartRadio stitcher Spotify we're actually just showing the performance of the SNP and just like we said it's kind of all over the place some years that's as high as 30 per second EKGs yeah it actually doesn't look exactly like an EKG well in the middle that kind of orange-ish line yeah it goes up to as high as 7 but it never goes below zero so it's a nice steady band through time so it's a much smoother walk you're getting rid of the large palpitations of the sp500 and realize once again this is an annuity that the money got team designed that has not half of the limitations that you see typically with a normal product design but we just wanted to use this as a teachable illustration so the question is all right well which one came out better because I don't know about you but when I look at that coms newett is looking pretty good look it's a Great Recession I mean that thing it fell off a cliff I mean you look at those returns you know Wow by the way this is you know diversified investing you're not just buying the sp500 you'd like it more of a probably a 60/40 or some type of diversification mix but this does make a great example it's hard to tell what the long-term performance is when you just look at the ups and downs of that S&P 500 and ekgs there so when we actually look at this what's that 20 year period 19 year period nope that's bad math 30-year portable math all right thirty year period right so we're talking a long time period on average the annualized return of the S&P 500 nine point nine six percent how much did the guaranteed safety of that equity index annuity cost you the annualized return was only four point nine percent over that 30-year period but wait there's more I mean this is think as real as we didn't cook participation rate in there but there's another catch that people don't talk about when they're selling equity index annuities is that dividends make up a large portion of your long-term performance when you're buying into the equity market case dividends you know come from you think about all the big companies a lot of them issued dividends to their investors those get reinvested when they get reinvested that's essentially sweetening up some long-term performance well there's actually been research on that and this is not just picking on the equity index it's just thinking about how powerful are dividends to your long term performance fidelity actually did some research on this they looked at a period this was for 20 years they said okay now realize this ended as of 2018 so it does not have the outsized performance of 29th - sure does not have the volatility of 2020 with the Cova 19 but this does show you kind of an interesting thing here is that the 20 years as of December 31st end of 2018 fidelity found that it was twenty one thousand five hundred and seventy seven dollars is the sp500 return without dividends and then if you look at it with total returns meaning with dividends the number bounces up to $31,000 so broad enough confuse we were just talking about equity indexed and and then you went on the sidebar where you're talking about dividends connect those two dots for me well equity index annuities just go off of price changes and it depends upon how your contracts written some look at them from month-to-month price changes you know there's also annual price changes it all depends upon how the contract was written but they don't take into account dividends it's only the price changes of the index that they're saying that they're tied to and that's what I think there's a little astrid down at the bottom of this slide this is an important point - this is not only just a recent effect if you look at this since 1930 dividends have made up approximately 40% of the sp500 average annual total return so if you're just going off price changes no matter whether you're looking at monthly annually you're still shortchanging yourself on a lot of the long-term performance here yep so that leads to you know because we kind of picked on equity index annuities but let's kind of bring it back to talk about what are the risk associated with all investment into a sure yeah so the first thing we've already talked about you you lose a little bit of your flexibility most annuities annuity products that you see have some sort of surrender charge so if you want to take that money and change and go buy a house or do whatever oftentimes you're gonna be locked up for a surrender for a surrender period amount of time you lose the flexibility of what you actually get to do with your dollars so exactly what you're talking about you're on lockdown yep typically you could have fees as high as 10% yep and 7 to 15 years think about that you have a medical emergency in year 2 that exceeds the 5% that they let you do in the plan you're like oh my goodness I just lost 10% on this investment or you know what if you got the chance of a lifetime on an investment deal on buying an office building or something like that so sorry you don't we lose a lot of your flexibility so lots of flexibility is a legitimate thing the next part is we have higher taxes what do we mean by higher taxes yeah so this one is a little surprising right so the way that annuities get pitched is because of tax deferred growth tax deferred growth tax deferred growth which gets people excited well they never talk about the D cumulation phase I never talk about what about when you actually want to spend the money cuz I don't know about you Brian the reason I save all this money is so that I can spend it one day right well one thing with annuities is they're not taxed the same way that after-tax assets are they don't get subjected to his long-term capital gains rates when you go to pull money out of your an annuity it's gonna be ordinary income on the earnings yeah and typically because remember you're funding a lot of times you're funding these if it's done right with after-tax money and so they're going to point you pull out the income component before you guess right principle so you're going to pay ordinary income tax rates on all of it and check this out losses are not deductible so there's no ability to harvest losses so we're primarily talking about with that statement variable annuities of you if you're buying the straight-up investment products and they go down there's bad years you could have losses and they're not going to be deductible you're not able to donate if you have appreciated holding a sling because that's when you're doing after-tax investing normally you could use this if you're charitably minded you can donate appreciated mutual funds appreciated stocks you take a tax benefit you get a full deduction for the market value but you never pay income taxes on the capital gains that is a great planning tool if you are charitable minded you can do that with annuities right and then you'd also bow mention this earlier today you don't and this was a big one you invest like Bose talked about you have a portfolio that you put in five hundred thousand dollars into the portfolio it's now worth seven figures like a million dollars you pass away your heirs are going to get a step-up in basis meaning they're going to that $500,000 investment now becomes after tax to a million dollars for your beneficiaries because he got the step-up in basis annuities don't get that they they you have to pass this on to your children where somebody's got to pay the tax man the taxes on all those deferred gains and then the last and we've already talked about this just these quirky limitations cap rates participation rates all these different things make investment it's maybe not as attractive of a thing as they were when they originally pitched to you so I kind of want to I want to bring this thing in for landing I think it's important for anybody who's considering annuities because they do have a component if somebody wanted to create a private pension a fixed annuity might be something they want to look at you know the investment side that's a it's a little different equation but you ought to at a minimum educate yourself on the the primary fee structures of all annuities so we kind of want to give you a God to understanding annuity fees in general and again and I'm sorry Brian because this is a team prep we did another table with a chart and so sorry is about ADHD there is in is we we are running a virtual classroom here to a degree but and people need to know this information but I like it when we get to kind of be goofy silly and make these things teachable but I think it's so important that people ought to we ought it warrants a table well and I want you to rest assured you've still been goofy I want you to know you haven't lost that that's good so okay so let's talk about some of the common fees and expenses that you see across annuity annuity contracts the first one are what they call insurance charges these are what known as emoney fees mortality expense fees remember annuities most often are associated with some type of insurance that's what makes them their insurance based products well these expenses these mortality expensive spent more tality and expense costs pay for the insurance guarantees associate with a product or the administrative expenses to actually design and run the product to get that tax deferred status they have to be wrapped inside of an insurance product so exactly right but then they go on and talk about how when the investment they they're going to have some costs associated with that yes so if if you're participating in equity indexed annuity or variable annuity there's gonna be some underlying sub-account feed costs that you're paying so those investment options have a feeder with it well here's what's really really frustrating Brian you mentioned one time that you had a client I still remember this and they were so excited because I had a 401k plan but their 401k had Vanguard investment options so so excited about that it was a dentist she was very excited that they had Vanguard investments inside theirs but when I looked at their 401k I was like the these aren't true Vanguard investments they are more like Frankenstein because they had sub-account fees so all the logos was Vanguard known for his low cost yeah and then all of a sudden you go and look at the Vanguard S&P 500 and some of the other funds that are in there near as they have internal expenses well over one percent and it's like because the sub-account fees so that's not uncommon those investment management fees are real so you need to pay attention to that stuff the next one surrender charges we've already talked about this when you buy an annuity when you enter into one these contracts generally you lock your money up five seven ten twelve fifteen years if you want to get out of it you're gonna pay the price so just be aware of what the surrender period is and what the surrender charge is and even if you've made a mistake in the past like I want to get out of this you guys I've changed my mind sometimes we tell folks how you as much as we want to get you out of this thing the surrender charge is just too great we have to let time pass before we exit it yeah we will we'll get into them we get to that flat contract but it's not uncommon when somebody comes to us a prospect comes to us with an annuity we look at where they are on the cycle sometimes you have to love the one you're with because it is so detrimental to pay those surrender charges if you've already been there for a few years it makes sense just kind of love the one you're with which is unfortunate because it limits our planning ability in some ways but we'd rather measure twice cut once to do the right planning for the client and just let it be a teachable moment that they got sold a bad product yep the next one rider fees again these are optional riders these benefits come with an additional cost this could be cost of living protection or spousal addition or life insurance or you know wear a blue shirt on Tuesday whatever the thing is you can add just about anything you want but it's gonna cost money and it's gonna either increase the total cost of product or decrease your overall return so you need to be aware of what we're and you're the thing I think it's really I don't say frustrating but a lot of annuity salesmen I feel like we'll add riders without ever even talking to the con saying oh no you need this one and this one and well if you get disabled you want the premiums to still be paid in the product so we're gonna add just make sure you understand what are all the costs are so said with a product that you might be well it's kind of that's why variable annuities are hard to shop when you're when somebody shows up with a variable annuity they want us to look at it we it's hard to know because every product is designed with additional riders added to them so it's hard to do an apples apples analysis when you take into account all the additional riders that are stacked on top of it now we don't like any fees I think that's okay to say we generally don't like fees but the flight contract fees an interest and this is a baseline charge that allows you to maintain ownership of the annuity now sometimes depending on the type of new Prada if it's large enough they'll waive this fee where we normally see flat contract fees or if we're doing something like a rescue identity rescue annuities there's some players out there in the insurance marketplace now that know that there's a whole broad group of people that have been sold some annuities that may be long-term aren't great products so what they've done is they've designed these rescue annuities where they're very low-cost but they will charge you a flat contract fee to help offset so they can the insurance charges are minuscule right that that's how they make up the difference and then we've had to do that for close yes so it is these things you'll pay these fees just so you can not pay income tax because what happens is if you have somebody who's had an annuity for 710 years they might have a pretty large gain built into it the only way you can get access to it is to pay a lot of income taxes so you don't want to do that and it you know you don't want to trigger the taxability of it so you'll do these rescue type annuities where you'll you'll exchange it do a white count exchange you don't pay income taxes on the light come exchange and then you love the one you're with with a better design process exactly right so let's kind of talk about because we how can you tell because a lot of you guys where we're now that we're hopefully getting out of the house in the next few weeks as we're ending this quarantine you're probably gonna come into you know your neighborhood you know financial planner that it's gonna try to sell you an insurance product how do you know that you know don't get lured into the bad investment what some things that you can do to protect yourself well I think it's so interesting we doing a pre-show prep we're talking about all well and you know we've been doing this for long if I remember back in the day when you could go sell one of these things you get pitched on how much you make but that was way back then and you were we were talkin you're like wrong yeah this hasn't stopped because we had you know rust we have associates here that have worked on the Commission side and we called em one of them yes now I think with the new fiduciary rules that they'd quit charging 8% commissions I think they've pushed those like three or four percent said no that is not true and I said because I just got an email I did a quick search all you do is go into your email if you're a financial adviser it's just funny to me is because we're fiduciary financial advisors it's not hard to see that we are not your typical firm where we're doing commissions but these guys just throw everybody in the in the pot and shake it up and send out these emails and what here's here's a radish that you need to understand the higher the Commission on a product probably the worse the product it is because you know we hear the adage does it sell itself if you have to put an 8 percent commission on a product it definitely is not selling itself it must mean it's ugly it's got some warts on it and your lipstick in the heck out of that thing trying to make this product sell so you have to go empower a sales force and pay them a lot of muku bucks you're going to push it but here's an email I got this is came to me on April 1st and maybe this was not a job but look at the subject line by the way was what's in boldface right there don't miss out on a 10% bonus and an 8 percent commission opportunity they're pushing insurance annuity type products and this stuff's still going on so we're not done with it look I'm not picking on this company I don't even I'm not even really familiar familiar with this company but this one I think is so interesting it doesn't talk a whole lot about the client it's only talking to us as the advisor hey here's what you get hey here's what you get a here's what you get star we talking about the client if the products are designed to really benefit the person selling it not the person buying it immediate red flag so let's with that that's probably a great segue thanks for keeping me on track two signs you might be making a bad investment the first one is you don't understand the why of why the investment is a good fit for you so I say this all the time to someone Brian if I recommend to you a strategy or an investment or a solution or a fill-in-the-blank and you couldn't go to your local grocery store and to the person standing six feet away from you explain to them what I just explained to you maybe you shouldn't buy it and it's it's one of those things when you're asking the question of because you said one I like when people say the why because as we've heard earlier in the show a lot of times people's desires are in con because you will have people that say the Y might be I want to guaranteed income stream for the rest of my life but then when they find out I can't pass it on to my kids those things are in conflict lijo so you better make sure you understand the Y and know if this is truly a good fit for you the next one the investment is complex and you don't really know how it works again six foot gross for example still works if you can't explain how the product works to someone else maybe you don't need to invest in that we tell all of our clients all the time if you don't understand what we're recommending why we're recommending and why it makes sense for you ask us and we'll try to tell it a different way and ask us again and we'll tell you a different way ask because you really need to make sure you understand it don't ever just sign on the dotted line because I just they have a nice suit and they seem like they know what they're talking about well we said this earlier in their show too is that the sales brochure seems incredibly simple come to me I'll give you this product that gives you this guaranteed performance for you know you're like wow that's so simple that's what I'm looking for is a guaranteed performance take away the risk but then they show up with an Austin in our pre-show meeting he's working that the boards while Daniels at home also in the chat room is he goes have you ever seen an insurance contract it's like a hundred and thirty pages so it's a very simple promise with a very complex back-end and that's where you have to be very careful on how you you reconcile those two things you know the third sign that you might be making a bad investment if there's a structure that doesn't make sense and we were talking about structure doesn't make sense we're really talking about is do you have an annuity inside of an IRA why would you be doing that if there's not like a really really esoteric unique specific purpose for doing that probably is not what makes them well and respect the FEU we talked about these type of products should if you're looking at financial order of operation where do they fall even if you're doing it right it's after you've maxed out fully to the legal limit of what the IRS lets you do into your 401 K your 403 B your 457 your RA sit there should not be any tax deferred boxes that have not been checked that's where so if somebody's coming to you and they know that you're only putting in to get the maximum match from your employer but you haven't Mack doubt and they're still recommending an annuity to you that structure doesn't necessarily make sense and then the last one and we laugh at this cuz we've seen we just seen bad advisers who do this they tell you that insurance is the answer for everything and this is a you know I think back to my career I've been doing this over two decades now is that when I first started being a financial planner you had and we use the analogy of it was a stool is that you had the financial plan or we're kind of the quarterback for this whole process but you got your CPA you got your your life insurance salesmen because people do need life insurance I don't want to mitigate that I mean I have tons of life insurance you have tons of life insurance there is a need while you're still working you need to replace that income there might be a need for certain things and then you'd have your estate attorney so you'd have all these professionals that were kind of coordinated and working together well then the insurance agents kind of realized we don't like that guy being the quarterback will just start selling everything so that's why you saw insurance companies start buying mutual fund companies so that they could get creative with rolling these things up so now you see insurance agents they'll tell you if you need to save for college I've got the product for you if you need to pay off your mortgage early I've got an insurance product you I mean there's all kind of things that instead of and this is one of the things when I worked in financial planning at the first firm we sold a lot of insurance and it used to bother me that we go sell these products that yes we'd go put five hours in and then have a huge Commission check and I was like man we could do the exact same thing if we put them in touch with a estate planning attorney they structured a trust that gave the same protection and save them a lot of money on that insurance premium that they're paying but it was just different that's what I'm telling you that it's it's the same way why you still want that stool approach you still want to have a good attorney an estate attorney you want to have a good CPA once your assets get to a certain level but you also want to have a financial planner that kind of can coordinate all those things and bring in that insurance agent cuz we still do a lot of insurance it's just that when you think you have a one-size-fit-all you get in some gray area there you know at the end of the day when we said this to start with we'll repeat it again annuities aren't inherently a bad thing insurance products aren't inherently a bad thing unfortunately and if you haven't had a chance to listen to us during our live stream the chat has just been wonderful I mean the people are saying oh well yeah the reason advisors pitched those is because they are so profitable and they get paid the most and so it's really unfortunately its kind of true we just want you guys to be well aware and well equipped that when someone does approach you with this you can say okay yes this does make sense for me or no this does not make sense for me and this is why and send the intern salesman a link to this show and we'd be happy to explain it soon well our like status on this show is probably going to be substantially lower than the channel average I just can go ahead and see how the thumbs downs that are gonna be pushed well probably the the insurance guys will be rolling in here in no time but guys seriously go to our website money guy calm love for you to sign up for the resource page yep I mean that's something that's very powerful a lot of people are taking advantage of that all we ask for is your email address and then we load you up with free advice and that's all part of the abundant sykes right we've been talking about this that we have been creating content since 2006 creating an online platform where you come learn apply grow and it's free you're like holy cow these guys are literally just giving this away what is the catch because you heard today well we're talking about investing when we're talking about I'm planning there's usually a catch when somebody's giving you something will the catch for us is we do have an objective that lies underneath the abundance cycle is that when you reach a level of success you're going to get to it we want you to come learn apply grow but you're gonna reach a level that you just don't feel comfortable you've got so much success your assets have reached such a level that you're like I need a co-pilot I need somebody to help me make decisions you'll remember who helped you build that foundation and you'll come and we'll work together professionally as well because we work with clients all across the country you guys mentioned the beginning we've crossed over 60,000 subscribers on YouTube that is so so thanks to you guys if you were out there listening and you're just renting your seat to this show go ahead and take some ownership make sure you subscribe on youtube click the belts and get notifications we have new information coming out you will be notified make sure that you do that yeah join the family quick coming to the buffet dinners and eating the food without actually joining the family if your showing up don't rent your seat as Bo said I want you to subscribe and ring the bell for good service so that you can also get the notifications guys we're having a blast money got eehm out

Channel: The Money Guy Show

Views: 167,939

Keywords: money guy show, debt, budget, cash, real estate, insurance, how to make money, save, credit card, compound interest, buying house, buy stock, success, personal finance, The Harsh Truth About Annuities

Id: 4LQjFyklEhM

Length: 58min 20sec (3500 seconds)

Published: Fri May 01 2020