CNCB, Jeff Rose
Not too long ago, a new client visited my office with a variable annuity illustration obtained from another financial advisor. The illustration itself used some fairly fuzzy math to paint a perfect picture for this client’s retirement. But once I dug into the details, I could see this annuity illustration showed a potential lifetime payment of $22,000 per year and a guaranteed payment of $17,000.
An annuity illustration is a graphic way to show a client the benefits and features of a fixed annuity. A majority of the population learns and understands by visual aid. With an illustration, many financial advisors believe they are able to reinforce the guarantee and safety of this investment. As for the new client I was meeting, the huge disparity was due to the way this annuity’s projected returns were laid out. Using a fairly moderate portfolio as an example, this annuity illustration projected an average return of 7.68 percent — but 11.5 percent for the first four years.
Andrew Rogers, the director of financial planning here at Alliance Wealth Management, noticed it immediately. “The high initial return was simply a projection or a ‘guess,’ yet it made this illustration look much better than it really was, he explained. “Worse, this client left the initial meeting with the other advisor feeling as if they were definitely getting $22,000 per year if they pulled the trigger,” he said.
These annuity illustrations are used by financial advisors because they help show on paper what kind of returns a particular annuity might offer over the long haul. And for the most part, this is a good thing. As financial advisors, it’s our job to make sure our clients understand the type of returns to expect, depending on the level of risk they accept when they invest.
But things do get tricky quickly with certain investments — and especially annuities. With a variable annuity in particular, these illustrations sometimes offer projections that don’t fit well with reality. Most of the financial advisors I’ve discussed this issue with agree that you have to be careful with illustrations that seem too good to be true. And it’s not always a dishonest advisor that misleads their clients; at times it’s more of a miscommunication.
“Annuity illustrations can be misleading because they can be very complex products,” said Jamie Pomeroy, a financial advisor in Winona, Minnesota. “There are so many moving parts that often brokers have a difficult time fully understanding the product, let alone illustrating it properly.” Whether your financial advisor might lead you astray or simply doesn’t understand the products he or she is selling doesn’t matter. At the end of the day, it’s your job to understand how your advisor is investing your money, why you chose this path and the fees you’re paying.
After speaking to several others about this issue, here’s a quick list of things to be aware of when it comes to annuity illustrations and buying annuities in general.
● Hidden fees: Annuity illustrations might show great returns but obfuscate the fees you’re paying for those potential returns. “The type of hidden fees annuity investors should pay attention to are separate account [investment funds] expense ratios; back-end sales charges; annual administration fees; mortality and expense costs; any rider fees, such as guaranteed income rider, death benefit riders [and] principal protection riders, to name a few,” says financial planner Joseph Carbone of Focus Planning Group.
● Misleading returns: Some advisors will do anything to sell an annuity, even if that means letting you believe you can’t lose. “The annuity salesperson will usually only show you the best case scenario of the potential returns you will receive,” says David G. Niggel, a financial advisor at KeyWealthPartners.com. If you believe you’re getting one amount and end up with something else, this can throw a real wrench in your retirement planning – but usually only once it’s too late.
● Opportunity costs: One hidden cost that is not talked about enough is opportunity costs — when too much money goes into an annuity. “Too often, agents and consumers talk about the return of the investment and too little on when you will get your money back, the return of your investment,” says financial advisor Jose Sanchez of LifeInsuranceToolkit.com. For example, a 65-year-old might buy an annuity and defer income until age 70. At age 70, she gets lifetime income guaranteed for the rest of her life. It isn’t until age 85, 20 years into the policy, that income received becomes greater than her initial deposit. “Placing too much money in an annuity might have a bigger opportunity cost than most people realize,” Sanchez said.
Not only that, but a variable annuity just isn’t right for certain customers. And often times, investors can earn more by choosing other, more flexible, options. “If you aren’t absolutely certain that you want to use this money to fund your retirement, you should look at other investment options,” says financial advisor Taylor Schulte, founder and CEO of Define Financial. “For example, if you think you might want this money to start a business or buy a home in the future, a taxable brokerage account or a high yield savings account would likely be a better fit.” If you didn’t know what an annuity illustration was before, you should be painfully aware by now how important it is to approach them with caution and an ounce of skepticism. What you see isn’t always what you get, and illustrations can be deceiving.