More About Ric Edelman

When in my last post, I criticized some of Ric Edelman’s practices and fees, I felt a bit queasy.  Was I being unfair?

I reached my conclusions by reading the handout material and by what he said in a seminar.  I also studied his web site, which disclosed his fees.  But I did not have direct access to a client’s portfolio, so I felt somewhat tentative in my judgments.  But today’s post by Allan Roth An Interview with Ric Edelman – Is High Cost Indexing an Oxymoron? confirmed my suspicions.

Roth analyzed an Edeleman client’s portfolio, and he also spoke to Edeleman. Roth reached the same conclusions I had about the high fees, and he also questioned Edelman’s recommendation of not paying off a mortgage.  Finally he confirmed my belief that Edelman was not paying attention to asset location, since he found the same allocations in the IRA accounts as in the client’s taxable accounts.

But enough criticism.  The rest of this post is about Edelman’s book The Lies About Money, which I can recommend.  In the first two chapters he persuasively lays out the case for diversification and for not trying to time the market.  This is a very important message which many investors still do not get.  Then he explains the advantages of mutual funds.

But it in his fourth chapter, The Demise of the Retail Mutual Fund Industry, that he shines.  He essentially demolishes (active) retail mutual funds.  For starters, he discusses the frequent manager changes, the costs of active management, and the dangers of style drift.  And this is just the beginning; he discusses 25 reasons why you should not use a typical (active) retail mutual fund.

Not satisfied with that, Edelman actually put together A Mutual Fund Scandal Timeline outlining the abuses that have been alleged or proven from 2003 to 2007.  It takes him a “mere” 40 pages to summarize the questionnable practices and allegations of abuse.  If that is not enough to make you question whether your mutual fund or stockbroker is actually your friend, then nothing will.  So buy the book or get it out of the library simply for Chapter 4.

Conclusion

The financial services business is fraught with conflicts of interest, high fees, misleading ads, and general confusion for the typical investor.  Sorting through this mess is not easy.  As William Bernstein says, “Both mutual fund companies and brokerage houses know more ways than you can count of fleecing you without your knowing it.”

To be continued.

Brokers May Have to Change

“A report by Rand Corp. last year found that 63% of investors think brokers are legally required to act in the best interest of the client; 70% believe that brokers must disclose any conflicts of interest.  Advisers always have those duties, but brokers often don’t.  The confusion is understandable, because a lot of stock brokers these days call themselves financial planners.” – Jason Zweig.

If you are confused by the difference among these titles: Financial Planner, Stockbroker, and Registered Investment Advisor, you are not alone.  The “Name Game” in the financial services industry is downright confusing.  How does your financial advisor operate?  How does she get paid?  What are the advantages and disadvantages of each arrangement?

Many people believe that they are getting financial planning from a stockbroker, when in fact financial planning is usually only an incidental part of what a stockbroker does.  Similarly, many people are not aware that a stockbroker does not have to act in the client’s best interests.

A June 19th Wall Street Journal article Big Change in Store for Brokers in Obama’s Oversight Overhaul brings home this point.

According to the article, stockbrokers might have to change the way they do business; they might have to act in their client’s best interests, the way a Registered Investment Advisor already does.

Wow!  What a concept.

Here are the relevant quotes:

Buried in President Obama’s proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher “fiduciary” standard that would compel them to place their client’s interests ahead of their own.

Currently, brokers are only required to offer investments that are “suitable,” which means they can’t put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated.

Many investors don’t even know the difference between the two standards, believing their brokers already are acting in their best interests.

But requiring brokers to operate under a fiduciary standard could force them to offer products that are less costly and more tax-efficient. They will have to disclose any potential conflicts of interest, such as any fees they may get for favoring one product over another. That could mean clients will be offered fewer proprietary products if the broker can find a lower-cost option elsewhere.

For example, a broker couldn’t put you in a mutual fund with higher fees — or one he gets a bigger commission for selling — if he could get a comparable fund with lower fees elsewhere, says Tamar Frankel, an expert on fiduciary law at Boston University School of Law. (Emphasis added.)

The article implies that some stockbrokers sometimes put their interests above yours.  Hmm.   This might just be worth investigating.

Luckily, I’ve discussed this topic many times, and in fact I have a series called The Dark Side of Wall Street, which lists all of the relevant posts.  If you start with Choosing a Financial Advisor, Part 1 at the bottom of the page, you can read them in order by following the “To be continued” link at the end of each post.

Avoid Investment Scams, Part 2

“You don’t need 99.9 percent of what Wall Street is selling. It’s expensive, unsuitable, or stupid. Most investments are designed to profit the brokers, banks, and insurance companies, not you.” – Jane Bryant Quinn.

My last post discussed a recent Wall Street Journal article, Laws Take On Financial Scams against Seniors, which stated, “financial scams that target seniors are on the rise, and states are cracking down.”  According to the article, “The recession has spurred more scams that play off people’s fear of stocks. Some investments pitched as low-risk could instead be quite complex.”

The sidebar included advice on what questions to ask when you’re presented with an investment “opportunity.”

What are the risks of this investment?

How much does it cost initially to purchase this investment and what, if any, additional or ongoing costs will I have to pay?

How liquid is this investment?  If I need to sell or cash in the investment, how little he can I do so?

Will my investment be tied up? If so, for how long?

What happens if I decide to sell or cash in my investment?  Are there surrender charges or other fees?

For what type of person is this investment a good idea?  For what type of investor is this a bad idea?

Is this investment registered?  If so, with which regulator?

If the speaker can’t or won’t answer your questions to your satisfaction, and in writing, the investment is not right for you.

Understand Risks and Costs

All of these are good questions and arguably they apply to any type of investment.  Understanding the risk of your investment is very important. My advice is to shy away from any advisor who does not take the time to explain the risks of a particular investment.  If the presentation makes you feel extremely “lucky” that you have attended the session in the first place, it’s time to slow down.  And if all you hear in a presentation are the glorious benefits of an investment, and nothing about the risks, head straight for the door.

In my opinion, the questions above particularly apply to deferred annuities and mutual funds.  It’s important to understand what the costs and fees are of any investment you may make.  Keep in mind that Wall Street is very good at obfuscating, hiding fees, and using doublespeak to confuse consumers.

Regarding deferred annuities and mutual funds, under no circumstance should you accept the answer that “you do not pay any fees, because the insurance company or mutual fund firm pays me.”  This is an example of the “doublespeak” that I referred to in the previous paragraph. To put it simply, it’s a lie. Obviously, any fees that are paid out come from somewhere; in fact, they come from the returns that you could get in an investment product.

Beware of B sharers of mutual funds.

Mutual fund B shares are not a scam, but I have met prospective investors who assumed that they were not paying anything to buy their mutual funds.  Actually, they had been sold B shares of mutual funds.  To be kind, the investors were “misinformed,” and the advisor was paid handsomely for this “misunderstanding.”  You decide if this akin to a scam or not.

According to the Securities and Exchange Commission:

Class B shares might not have any front-end sales load, but might have a contingent deferred sales load (CDSL) (a type of fee that investors pay only when they redeem fund shares, and that typically decreases to zero if the investors hold their shares long enough) and a 12b-1 fee (an annual fee paid by the fund for distribution and/or shareholder services).  Class B shares also might convert automatically to a class of shares with a lower 12b-1 fee if held by investors long enough.

In other words, unless you wait for years to sell these shares, you will pay a contingent deferred sales load – in plain English, a commission – to get your money back.  In addition, that quote does not make clear that B shares typically have much higher annual expenses than true no-load funds.

If you read through the prospectus carefully and know enough to ask your “advisor” the “right” questions, you will reach the proper conclusion – that there are better investment alternatives for you.  Actually, there are plenty of better investment alternatives available.

Avoid Investment Scams, Part 1

“There’s no such thing as a free lunch.” – Milton Friedman.

“Fed up with purported financial advisers preying on unwitting older people, investigators from the Arkansas Securities Department last year staged an undercover sweep of one of the hucksters’ favorite showcases — free lunch seminars.”

That was the lead in today’s Wall Street Journal article Laws Take On Financial Scams Against Seniors.  According to the article, which is about some questionable and possibly illegal practices, “financial scams that target seniors are on the rise, and states are cracking down.”

“Besides Arkansas and Michigan, Idaho also passed a senior-victim law in recent months that will go into effect this year. Six other states, including Maryland, Minnesota, Missouri, New Jersey, Rhode Island and West Virginia, have similar bills pending in their current legislative session.”

Leaving aside whether seniors are in particular need of protection, and whether the site of the crime is only a lunch seminar, let’s take a look at the misleading products offered.  Here are some relevant quotes, with emphasis added.

The Arkansas sweep … uncovered …shady practices — misleading claims, underplayed risk.

The recession has spurred more scams that play off people’s fear of stocks.  Some investments pitched as low-risk could instead be quite complex.

The events are generally pitched as educational events, with a free meal thrown in. But in Arkansas, state agents instead found that the dozens of seminars they attended all featured hard-sell pitches for financial products, many of which weren’t appropriate for elderly investors. Presenters at about half of the seminars made misleading claims about potential investment returns, Arkansas regulators say. And at about a quarter of the events, products being pushed were ill-suited to older people, such as investments heavily exposed to swings in stock prices.

The frequency of scams is increasing in the recession, many financial experts say. Seizing on fear of stock-market turmoil, sales people and fraudsters are hawking investments that claim to be “low-risk,” or a supposedly safe way to invest in the stock market and earn back losses. In fact, the products may be complex and have significant downsides.

Firms that have been cited for violations range from big financial giants to single-person offices.  In October 2007, a unit of Allianz SE, the German financial company, agreed in a settlement with Minnesota’s attorney general to review sales practices and to give refunds to as many as 7,000 Minnesota seniors that the state said may have been sold unsuitable annuities since 2001.  Allianz also agreed to strengthen its process to determine suitability for customers over the age of 65.

There is nothing illegal about financial advisers pitching products at seminars, but under securities and investor-protection laws, there are lines that these salespeople can’t cross.  Brokers must follow “suitability” standards, meaning they can’t sell a product that doesn’t make sense given a person’s age, income, or liquidity needs.  They can’t misrepresent products. S ales materials and oral presentations must show a balanced picture, with both the risks and benefits of investing in the product.  Any statements to investors that an investment is “safe as cash” or that it carries no market or credit risk “would raise serious questions under FINRA’s advertising rules,” according to the regulatory group.

A number of products sold to seniors have triggered investigations in recent months, including reverse mortgages, which can help senior tap equity into the home and be beneficial, but which can also include hidden costs. Also popular are deferred annuities, which promise future payments to the investor but which can lock up money for a decade or more.

Conclusion

I am not surprised that one of the vehicles used by the scam artists are deferred annuities, as I have written about this before. Quite simply, variable annuities pay salespeople very high commissions. Annuities may be suitable for some people, but determining what is best for you should be done by someone who does not gain from the decision. In other words, your best option is to hire a fee-only planner to advise you on whether you really need a deferred annuity. Quite possibly, a fee-only planner will come up with a less expensive solution that achieves the same goals as an annuity.

The article lists several sites which will help you if you think you have been scammed. Of course it may be too late at that point.  Instead, I’d recommend one site that will help you find a fee-only planner, a fiduciary acting in your best interests – the NAPFA website.

As mentioned in the article, salespeople must only follow a “suitability standard” and do not have to tell you about the best option for you.  The difference between a “suitability standard” and a “fiduciary standard” may seem like a technicality, but the effect on your financial wellbeing can be huge.

Read Part 2.

Avoiding Financial Fraud

Ron Lieber’s New York Times column Even Vigilant Investors May Fall Victim to Fraud was quite disturbing and not a little worrying. It recounts how Matthew Weitzman, a founder and principal at AFW Wealth Advisors, a Registered Investment Advisor, and a fee-only firm, is no longer with AFW. The firm informed its clients of “certain irregularities in a limited number of client accounts.”

You can read Lieber’s article for the details. What is not clear, though, is how much money was involved nor how quickly the irregularities were discovered. Though, from my point of view, they are not the most worrying aspects. What concerns me most is that Mr. Weitzman was a member of the National Association of Personal Financial Advisors (NAPFA).

When a member of the advisory community violates the trust that clients place in him, all clients and advisors suffer. What this country does not need right now is any further deterioration in what little confidence we have left in the banking system, the federal government or our financial advisors.

I have been a fee-only planner since 2003, and whenever possible, I recommend that investors seek out financial planners who are compensated directly by their clients, rather than by commissions. In this way, you will avoid obvious conflicts of interest.

Members of NAPFA all practice a fee-only method of compensation and sign a Fiduciary Oath, which means that they swear to act only in their clients’ best interest. So it is with great discomfort that I heard that not one, but two, former members of NAPFA have been accused of bilking their clients.

What to do? As Ronald Reagan once said, “Trust but verify.” And of course, you should never write checks directly to your advisor, but only to an independent custodian. It is the independent custodian who should be providing you with confirmations of all transactions and trades, and a monthly statement. These are sensible precautions in the age of Madoff.

As Lieber says, “Open your mail. Confirm the accuracy of your trades and fund transfers. Read your account statements. Every month. Every number. Every single word.” I am not sure about reading every number, every word, but I get his drift.

Lieber further recommends that you handle all of your stock transactions yourself. I believe most investors will find this “solution” impracticable, inconvenient and unnecessary. I believe a better solution is for you to sign a limited power of attorney, allowing your advisor to enter transactions on your behalf, but which does not allow him to withdraw your funds. Only you should have the ability to withdraw funds from your account. I am not an attorney, but I believe that this provides adequate protection. (Attorneys, please weigh in.)

My mother always said “A promise is a promise.” Unfortunately, there are always people who will promise one thing and do another. It’s disappointing to have your expectations dashed.

I don’t know about you, but I expect firefighters to be brave, judges to be moral and rabbis and priests to comfort the troubled. Yet, there have been judges who, instead of upholding the law, bend it out of shape for personal gain. And there have been priests and rabbis who have preyed upon our young and betrayed our trust.

Lieber says, “I’ve always believed that advisers in the (NAPFA) association were plenty smart and morally upright, but it’s hard to recommend them now without at least including an asterisk.”

In my experience, NAPFA members have the highest standards in the profession. But like every profession, there may be individuals who choose to violate the trust of clients they serve.

It’s not easy to protect yourself against out and out theft, but you can take some small comfort from the fact that if financial advisors break the law, they are subject to prosecution by the regulatory authorities.

In my opinion, a great majority of investors will lose countless dollars because of the continuance of “Standard Operating Procedures” at Wall Street investment firms. Every day these firms peddle ill-conceived, hard-to-understand, expensive investments, because it is profitable for them to do so. Investors will lose more money in the ordinary course of business than they will ever lose due to outright fraud.

Unfortunately, what is legal on Wall Street is bad enough.

And so, I will continue to heartily recommend NAPFA members, because the fiduciary standard is the right way to do business.

And yes, monitor your accounts. Remember, “Trust but verify.”

Who Will Guard Your Nest Egg?

“Make no mistake about it, you are engaged in a brutal zero-sum contest with the financial industry — every penny of commissions, fees, and transactional cost they extract is irretrievably lost to you.” – William Bernstein.

Previous posts have discussed the advantages of using a fee-only financial planner and also the possible conflicts of interest that may arise when working with a commission compensated planner.

Certainly, Wall Street investment firms spend a lot of money on advertising, making it seem as though their interests are aligned with yours. So, it is understandable that the majority of consumers are unaware of the difference between a fee-only planner and someone who calls himself/herself a financial planner but who is actually a salesperson.

In Saturday’s Wall Street Journal, Jason Zweig delineates the nature and extent of the confusion.

Brokers must recommend only investments that are “suitable” for clients.

(Registered Investment) Advisers act out of “fiduciary duty,” or the obligation to put their clients’ interests first.

Most investors don’t understand this key distinction. A report by Rand Corp. last year found that 63% of investors think brokers are legally required to act in the best interest of the client; 70% believe that brokers must disclose any conflicts of interest. Advisers always have those duties, but brokers often don’t. The confusion is understandable, because a lot of stock brokers these days call themselves financial planners.

Brokers can sell you any investment they have “reasonable grounds for believing” is suitable for you. Only since 1990 have they been required to base that suitability judgment on your risk tolerance, investing objectives, tax status and financial position.

A key factor still is missing from FINRA’s (Financial Industry Regulatory Authority) suitability requirements: cost. Let’s say you tell your broker that you want to simplify your stock portfolio into an index fund. He then tells you that his firm manages an S&P-500 Index fund that is “suitable’ for you. He is under no obligation to tell you that the annual expenses that his firm charges on the fund are 10 times higher than an essentially identical fund from Vanguard. An adviser acting under fiduciary duty would have to disclose the conflict of interest and tell you that cheaper alternatives are available.

If brokers had to take cost and conflicts of interest into account in order to honor a fiduciary duty to their clients, their firms might hesitate before producing the kind of garbage that has blighted the portfolios of investors over the years. (Emphasis added.)

Conclusion

Panicking and pulling out of the stock market following a steep decline, concentrating your investments within a narrow range of options, and too much trading and too little long term holding are some of the more common mistakes investors make. Any and all of which will likely result in a reduction of your investment returns.

Understand, though, that high costs can absolutely kill your investment returns, whether from the high fees of a variable annuity or 403(b) plan, high (and often hidden) expenses and fees of some mutual funds, or the opaque mark-up on bonds sold to unsuspecting investors. Your best protection is to ask your financial advisor to sign a Fiduciary Oath. To find a fee-only planner near you, view the NAPFA (National Association of Personal Financial Advisors) web site.

It is encouraging that the issue of who is working in your best interests has been brought front and center by Jason Zweig, a respected author and columnist. Now, let’s see if the Securities and Exchange Commission Chairwoman, Mary Schapiro, proposes changes in legislation that will benefit consumers. The stakes are extremely high, as Wall Street firms make billions from unsuspecting customers.

Entrenched interests never give up power or lucrative business practices easily.

Don’t Put Your IRA in a Variable Annuity

I recently received an email from a couple in their 60s requesting advice regarding how to invest their IRA funds. They had been to a “financial planner” who recommended a variable annuity. Luckily they had read my posts on the subject and said in their email that they were “skeptical because of the costs and early withdrawal penalties.”

I heartily concur.

Jeffrie Voudrie’s article Don’t Put Your IRA in A Variable Annuity explains why.

Here’s a quick summary.

If you’ve talked to a broker or agent about rolling over your retirement account, there’s a good chance the advisor recommended you invest in a Variable Annuity. Don’t do it! I believe the only reason a variable annuity is recommended for an IRA is so the advisor can earn more money. Let me explain.

One of the main sales ‘hooks’ used in selling a variable annuity is that you don’t have to pay a commission. That can be very compelling when compared to a mutual fund in which you pay the all the commission up-front. Many advisors will even say that they get compensated by the insurance company, not you. Do you really believe that? Insurance companies are not charitable organizations. If they are paying the broker, they’ll recoup those costs from you—the costs are just hidden so you don’t think you’re paying a commission. The second main argument for using a variable annuity for an IRA is the death benefit (not offered with a mutual fund). “That way you’ll never have to worry about your beneficiary getting less than you invested”, the thoughtful advisor says. This feature may seem nice, but you end up paying through the nose for it.

The real reason that you are recommended a variable annuity for your IRA isn’t that it’s better for you. It’s because it’s better for the advisor. If you invest $500,000 in a commission-based mutual fund, the advisor’s gross commission will only be about $10,000. The same investment in a variable annuity would yield gross commission to the advisor of $30,000-$35,000 or more! If an advisor can earn 3 times more by getting you to invest in a variable annuity instead of a mutual fund, which do you think will be recommended? 

Don’t fall for the ‘put your IRA in a VA’ trap.

Conclusion

I am not sure which is more shameful (1) Wall Street titans who took outsized bonuses that turned out to be based on illusory profits or (2) the bad advice given to consumers every day by “financial advisors.” This self-serving advice costs consumers billions of dollars every year.

There is a better way - fee-only financial planners. To find one near you, consult this web site:

National Association of Personal Financial Advisors (NAPFA)

Stockbrokers in the Spotlight

You may recall a series of articles that I wrote not too long ago about the potential perils and pitfalls of working with stockbrokers, also occasionally referred to as “registered representatives.”

An article in the January 13, 2009 edition of The Wall Street Journal, Help Wanted: Wall Street Stockbrokers, No Joking, explains just how well some “high-producing” stockbrokers are compensated. (Note, in this case, the description “high-producing” refers to how much revenue they generate for their employers.)

For a somewhat jaundiced (and funny) post on this particular issue, see Milo Benningfield’s article, Stockbrokering: Who Said Retail Wasn’t Profitable?

Benningfield, by the way, is a fee-only financial advisor located in San Francisco. Here’s a summary of his post.

Now that investment bankers and traders have proven such great disappointments to the large Wall Street houses, they’ve taken renewed interest in their retail brokerage operations. And what lucrative operations they are.

Naturally, Wall Street wants to take care of these golden geese.

As ‘registered representatives’ of the brokerage firm, stockbrokers (as they are informally called) are legally bound to represent the interests of the firm, not the client, in any transaction. (Registered reps/stockbrokers should not be confused with ”registered investment advisers,” who have a statutory duty under the Investment Advisers Act of 1940 to put the client’s interests before their own.)

In other words, stockbrokers are a distribution channel for the brokerage firms, and it makes perfect sense that the firms would want to protect and support that channel by offering brokers huge financial incentives.

But all the largess heaped upon the brokers does raise a question: just how are the Wall Street firms, who apparently need a government bailout just to stay in business, expecting to recoup the “partner awards” and other incentives that they’re currently “doling” out to stockbrokers?

To answer that question, dear customer, all eyes are upon you. Caveat emptor, my friend.

Caveat emptor – buyer beware. As always, that’s very good advice. If you’d like to read more about this subject, read The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein. Pay particular attention to Chapter 9, entitled “Your Broker Is Not Your Buddy.”

Caveat emptor, indeed.

Financial Experts?

 

 

 

 

 

 

 

 

 

 

 

 

This cartoon is courtesy of Nick Anderson, the Editorial Cartoonist of the Houston Chronicle.

I think it captures beautifully the irony of banks and brokerage companies still holding themselves out to be “experts”even though they have imploded due to poor risk management.

Variable Annuities, Part 2

“It has always been said that annuities are ‘sold,’ not bought by investors. Over 90% of all annuity sales are through brokers or life agents… Why are so many people sold annuities? The answer is simple…. high commissions and great sounding stories.” – Scott Dauenhauer.

In a previous post, I outlined some of the disadvantages of variable annuities. Today’s post goes into this a bit more deeply.

A colleague of mine, Scott Dauenhauer of Meridian Wealth Management, is a former stockbroker and someone who is quite critical of the “so-called” advantages of variable annuities that are usually touted by salespeople. The following quotes from Secrets of the Wirehouse and How to Protect Your Best Interests emphasize the high (hidden) costs and lack of real benefits.

Annuities, Hazardous to Your Wealth?
Variable annuities performance is based on an underlying “sub-account,” basically a mutual fund. The major benefit to an annuity is the ability to defer taxes until the money is withdrawn. Another highly touted benefit is that an annuity can pay an income stream for life. Let me lay out a case for why variable annuities may be hazardous to your wealth.

The expenses inside an annuity are one of the main problems. There are several expenses involved. Today most annuities do not charge you an upfront commission, the fee is charged as an annual fee (which you don’t see). This fee is deducted daily from your balance, there are five possible costs. The costs are: The policy charge, Mortality & Expense, Rider charges, underlying sub-account expenses, & transaction costs associated with those sub-accounts. Below is a range of what these cost can add up to:

Policy Charges                                   $ 30-50

Mortality & Expense                        1.00 – 2.00%
Riders                                                .25 – 1.25%
Sub-Accounts                                   .25 – 1.50%
Turnover Costs                                 .06 – 1.00%

Total Costs                                     1.56 – 5.75%  Annually

These expenses take a toll on the ability of the portfolio to match, or even beat the market. The annuity has to earn 2.5-5% before it breaks even for the year.

Add the fact that gains in an annuity are taxed as ordinary income when withdrawn and the chances of your annuity beating your taxable account come close to zero. In addition, if you die with an annuity you do not receive any favorable tax consequences. You lose what the tax code refers to as the “step-up” in basis, meaning that if you die with a taxable account the entire account gets passed on to your heirs with no income or capital gains tax, not so with an annuity.

You may ask “what about the guaranteed death benefit?”

It is basically worthless in most circumstance. Annuities are long-term investments, they are not meant for periods of less than 10 years. If you end up being one of those poor unfortunate souls that bought at the top of the stock market and still have less money than you started with 10 years ago (extremely unlikely, but it happens, though usually due to idiot broker advice) then your loss exposure is likely minimal. An amount that will be less than what you probably paid for the insurance over that period. In any event, the death benefit is not a logical reason to purchase an annuity.

Now, of course, if you have loved ones that you want to provide for a death benefit may offer you some peace of mind. Keep in mind what you pay for that peace of mind and the likelihood of it ever being collected on. If you are insurable, purchase insurance; if you are not, perhaps a variable annuity with a death benefit makes sense (though I still highly doubt it). If in the extremely rare circumstance that a death benefit makes sense in a variable annuity my choice would be to purchase a variable annuity from the Vanguard Group, as they offer a low cost account with a death benefit.

Let’s recap the problems with Variable Annuities. High expense, high marketing costs, tax penalties if under 59 ½, loss of capital gains status, loss of step-up, limited choice of investment vehicles, & worthless death benefits. So why do people continue to be sold these products? High commissions and high profitability to the companies involved. Profit is the bottom line, not your interests. Variable annuities have become such a problem that the SEC (regulator) has issued a booklet available online through its website that lists the pros and cons of annuities.

Living Benefits

Variable Annuity providers knew that the death benefit just wasn’t enough to keep the sale of variable annuities going, so they came up with a whole new generation of benefits for variable annuity products dubbed Living Benefits. The four major living benefits that are offered are as follows:

Guaranteed Minimum Withdrawal Benefit (GMWB)

Guaranteed Minimum Withdrawal Benefit For Life

Guaranteed Minimum Income Benefit

Guaranteed Minimum Accumulation Benefit

These living benefits are sold with some really great stories and too good to be true promises. I can’t even begin to get into the inner workings of each of these so called benefits because it would bore you and take up a lot of space. Suffice it to say that these living benefits are expensive (despite what your broker will tell you) and are not all they are cracked up to be. If you are being told that you will be guaranteed 7% on your money, beware and read the small print. If you are being told that regardless of stock market performance you can withdraw 7% of your account annually, beware.

The stories that are used to sell these products are wonderful, they sound like an investors dream, but reality is much different. These products are costly and in most cases fixed against the possibility of a claim being made. Always read the fine print and hire a professional who has nothing to gain to review any variable annuities recommended to you.

The “Bonus” Annuity Scam
If you are an annuity holder, chances are you have been approached by an insurance agent trying to sell you an annuity that pays you an ‘upfront’ bonus. Whatever you do, do not succumb to the sales pitch for the new “bonus” annuities. This is a new and highly aggressive tactic of the industry, to keep investors “imprisoned” in a high cost product, and generate new and even larger commissions for the sales force. Annuity holders with a few years left in their surrender charge period are approached with the following “typical” story:

“I understand that you are unhappy with your current variable annuity because of poor performance, lack of investment choices & a fading death benefit. I also understand that you have a surrender charge left. We are going to “help” by giving you an up-front ‘bonus’ of 3-6% to cover the surrender charge. It will not cost you anything to switch.”

Unfortunately, the only “bonus” is to the salesperson. The new sale starts the surrender period all over again and the salesperson gets another commission. It is a great deal for the agents, they get two commissions from you.

To pay for the bonus and the commission and any extras, the insurance company raises the expenses on your investments. Since these expenses are buried in the prospectus and hidden from you on your statements, you never know that you are being taken advantage of. When all is said and done, everybody is making money except you! I have actually been in meetings and heard brokers laugh at how they duped another person into a “bonus” annuity.

They refer to the extra commission internally as the “Yield to Broker.” It appears that the SEC is coming down hard on this practice. On June 5th, 2000, they issued an “investor alert” and placed a brochure on its website to help investors understand the benefits, costs, and risks of variable annuities, which combine features of mutual funds and insurance.

Insurance companies have been hit with rounds of lawsuits stemming from churning and suitability. It seems that the real “bonus” will be new business for trial lawyers!!!

Conclusion

When someone, specifically a salesperson who is compensated by commissions, recommends a variable annuity or a “bonus” variable annuity, you should seriously question whether the recommendation is in your best interest (or his). Take it from an ex-stock broker; that recommendation may very well be prompted by the promise of a very high commission.

Read about IRAs and Variable Annuities.

photo credit: loop_oh

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