Beware of Annuity Rip-Offs
By Bob Moeller
WEAC Member Benefits
April 2005
Financial
Planning Seminars
Achieving
Financial Independence
By pure coincidence, I had three individual meetings in
a row recently with members who were subjected to rip-off products.
It always distresses me when I have to show a member how they have bought
products that essentially resulted in them being robbed of thousands
of dollars. In one case, the member paid a total of $14,400 into a universal
variable life policy over the past six years. His total withdrawal value
when we met? $48.60. Yes, you read that right. Unfortunately. Those
meetings got me in the mood to write this article.
You do not want to invest in a variable annuity. I am
not talking about tax-sheltered annuities you have through your employment.
I am talking about annuities you purchase with after-tax dollars. Because
there is a life insurance element in each of them, you get to defer
taxes on any gains you might have until you withdraw funds.
First, a simple explanation of what these are. You invest
after-tax money with a life insurance company. You invest it in a selection
of sub-accounts that seem like mutual funds although technically they
aren’t. You are not taxed on any growth until you take out funds.
Sounds good doesn't it? But it’s awful, and here’s why.
- I'm looking at a Wall Street Journal table of variable annuity
charges. Equitable EquiVest, Hartford, Merrill Lynch Life, Nationwide,
etc., all have total expenses averaging more than 2% per year. According
to Smart Money Magazine, the average is 2.3% per year. Note, the average
mutual fund fee is 1.44%, and some like Vanguard have fees less than
½% per year. Paying excessive fees every year is not justifiable
considering what you get.
- Assuming you have gains in your investments, they aren’t
taxed until you withdraw funds, but once you do withdraw, you get
none of the advantages of long-term capital gains rates. Instead of
paying a maximum of 15% tax on your gains, or any dividends received,
you will pay regular tax rates, which for most will be 25%.
- Even though you used after-tax dollars to buy this, the first money
out is considered your profits. If you take money out before age 59½,
you will be charged taxes plus a 10% tax penalty.
- In a regular stock investment, if you die, your heirs get a stepped-up
basis for tax purposes. That means that the value of the account on
the date of death is used by heirs as their “cost” when
they later sell. Example: you invest $10,000, it grows to $15,000,
you die and heirs sell it a year later for $20,000. Their gain, again
in a regular stock investment, is $5,000. In an annuity, same example,
there is no step-up in basis to $15,000. Your heirs pay taxes on the
entire $10,000 gain. Not a good deal.
- Should you decide you want to transfer or withdraw the money within
the first several years, you pay a steep withdrawal charge.
All in all, you do not want to buy individual variable annuities with
your after-tax dollars. I should note that some no-load mutual funds
with life insurance company connections also offer variable annuities.
The only way they are somewhat better is the annual fees might be lower.
For example, Vanguard lists fees between 1.25% and 1.6%. Fidelity Investment
life is around 1.5%. Are they good deals? If you do have a variable
annuity and don’t want to take it out because of taxes, it might
make good sense to roll it over to Fidelity or Vanguard, assuming you
are at a point where you have no withdrawal or transfer penalties.
Variable universal life is even worse; the fees are usually much, much
higher. Yes, you do have an amount of life insurance involved, but generally
it is overpriced. Reread the example in paragraph #1.
Experts who generally write on the side of the consumer sometimes suggest
that if you have maxed out on your TSA, 401k, and IRA contributions,
then maybe variable annuities might be acceptable. I’m not so
sure, but considering that maxing out on a TSA for 2005 will take $14,000
or more ($18,000 or more if you are 50 or older), and that a Roth IRA
will absorb $4,000 if under 50 and $4,500 if 50 or older, you probably
do not have to worry about maxing out your limit.
If you have either a variable annuity, or a variable universal life,
get out your December 31 statement. Ask yourself how much you have invested
and how much it is worth now. Make the sales agent analyze what the
future value might be assuming the market doesn’t go up. Review
just what fees you are paying to the insurance company including insurance
company fees and sub- account (mutual fund) fees. Don’t just accept
a crummy product because you have been in it a few years.
Posted April 1, 2005