Contractual vs. Hypothetical Income
06/21/2012 9:00 am EST
Never buy an annuity for what it might do in often-unrealistic projections, but what it is required to do for you even if the larger market falls, writes Stan The Annuity Man of Stantheannuityman.com.
In every conversation I have concerning annuities, I always include the following statement: “Own annuities for what they will do, not what they might do.” Will do are the contractual guarantees. Might do are the hypothetical and theoretical projections that most advisors use to sell their income plans.
Because I want my clients to live in Realityville and be ensured that they have the income they need when they need it, I base all of my projections on the worst-case scenario. The income plan in place needs to be judged and accepted on the contractual guarantees only, not projected pie in the sky possibilities.
Remember that an annuity is a contract between you and the issuing carrier. So the only thing that is important from an income planning standpoint is what the annuity contract will do. Period!
Consumers need to understand that the vast majority of annuity software programs that carriers use to show projected accumulation value returns can only show ascending growth projections. In English, this means that they only show it going up every year!
We all know that market returns do not work that way. Markets will always be volatile. There will be up years and down years. But when an advisor shows hypothetical returns for an annuity, they typically illustrate annual compounding gains. Heck, if we could accomplish those type of consistent returns with our accounts, we wouldn’t need the “transfer of risk” aspect of annuities.
Let’s go over the top three categories of annuities (Immediate, Fixed Index, and Variable) for which advisors utilize specific annuity carrier software programs to project returns. Then I will tell you how you should request your advisor run the proposal in order for you to make an appropriate and informed buying decision.
These are also called Single Premium Immediate Annuities (or Income Annuities). The software that is used for Immediate Annuity proposals show pure contractual guarantees.
There’s no “juicing” the numbers here. What you see on your proposal is what you are contractually going to get. Even if you attach an annual COLA (Cost Of Living Adjustment) Rider to the Immediate Annuity, the numbers shown for increasing income are contractual.
You can probably guess that I love this type of annuity for many reasons, including the pureness and truthfulness of the proposal process. Agents and advisors cannot manipulate these numbers!
Fixed Index Annuities
Also called Equity Indexed Annuities, this product is the one that is typically jammed down your throat at a too good to be true "bad chicken dinner" seminar. The accumulation value of this type of annuity is based on a call option attached to the S&P 500 (or other indices), and the gains are locked in.
The good news is that your money is protected on the downside. But the reality of the upside is that you will share in only a portion of the gains. But the software used to show returns for this type of annuity usually shows annual compounding upside numbers.
Some morally challenged agents do their own creative math by verbally saying if you can make 2% per month on a monthly index option calculation, then you can make 24% in a year. Yeah, right! It doesn’t work that way, but it sure is a good story!
Tell your advisor to run the accumulation value at 0% return (the worst-case scenario) for the life of the contract, so that you can make your decision on the contractual guarantees of the policy and any riders (attached benefits) that you have decided to add to the contract. Most agents will try to convince you not to run it at 0% because it reveals what the policy actually does. Make them do it!
This is where the projected return malpractice is really taking place. Let me pause and take a sedative here before I continue.
OK, I’m back. The next round of lawsuits (my prediction) will be concerning variable annuities. With annual fees averaging close to 3%, advisors and agents always “juice” the return numbers on the accumulation value side to cover these monster charges.
If you currently own a variable annuity, or are considering buying the dream, ask your advisor to run the accumulation value at 0% or at the Money Market equivalent. Advisors will fight you to the death on this because doing so fully reveals the absurd charges of the variable annuity.
What this really means from an investor’s standpoint is that if you own a variable annuity and want to move your money to the safest place within the annuity structure (i.e. Money Markets), you will lose money to accomplish this strategy. That makes no sense!
For example, if your variable annuity has 3% in annual fees, then you will lose money trying to protect your principal because the Money Market percentage will not exceed the annual fees. Hello! What? In what scenario does this make sense? Only if your goal is to buy your advisor a new car with the commissions he makes selling you the variable annuity!
FYI, over 80% of all annuities sold in this country every year are variable annuities. When the poo finally hits the fan on this, it will be ugly for the industry…and remember that Stan The Annuity Man predicted this!
In conclusion, always “let zero (0% projections) be your hero.” Make your advisor show you only the contractual guarantees during the recommendation process. If he refuses to do that, then walk (possibly run) away immediately, because you have revealed that advisor to be what I call a dream-slinger.
You want your income plan to live in Realityville. Remember that when considering annuities, base all of your buying decision on what the annuity will do (contractual guarantees), not what it might do (hypotheticals and theoreticals).
Preparing for the worst-case scenario is the only way to plan for your lifetime income needs, and is the true foundation of my annuity "transfer of risk" strategies.
A reporter recently called me the National "Annuity Consumer Advocate" in the same vein as Ralph Nader and Clark Howard are for other products and services. My goal as Stan The Annuity Man is to be that person, and I hope to continually educate the public on the complex and sometimes ugly world of annuities and become the go-to resource for "all things annuity."
I recently published The Annuity Stanifesto, fully explaining in an easy-to-read format how these misunderstood and misrepresented products actually can work within your portfolio. You can get a free copy of The Annuity Stanifesto by going to my Web site and downloading your copy.