The Annuity Con Game 2/29/2001 Many prospective clients that call us to discuss working with us have already met with a financial planner or insurance agent that recommends the purchase of a large annuity for tax benefits. What these people fail to realize really how lucrative the commissions are on these products. Annuities may add up for you in some cases, but normally they don't unless you happen to own shares in a company pushing them. The most common type is the tax deferred annuity. In the case of a deferred annuity, you pay up front or with a whole series of installments, and then your investment will increase without the IRS taking its pound of flesh until you withdraw. You can then look forward to regular income to tide you over in your old age. Does much of this sound familiar? Of course. Retirement plans like an ordinary IRA can postpone the day of reckoning with the IRS until long after your investments have compounded mightily. You might say that tax-deferred annuities are redundant since other plans are already posting the payments. Why buy them, then? In fact, with some important exceptions, we believe that you normally should pass on annuities unless you wish to live the good life vicariously through the broker or life insurance rep whom you put in that multimillion-dollar mansion. Forbes' latest advice, offered in an article mentioning an SEC examination of the practices of some leading annuity marketers, does not even come with a qualifier: "Don't buy an annuity." The magazine passes on the horror story of a retired couple in Potomac, Maryland, who lost many thousands of dollars by following the suggestion of a Certified Financial Planner peddling annuities on commission. Not all CFPs, alas, are Fee-Only. Here is the case that the Motley Fool, business magazines and Fee-Only investment advisors have made against annuities: 1. Tax-related arguments exist beyond those already given. Remember, capital gains that you make in the market are taxed at a lower rate if you hold your stocks long enough before selling. On the other hand, Uncle treats annuity payouts as ordinary income (minus the amount you've paid for the annuity). 2. Most annuities cost too much. With everything added in, you do not enjoy the same low fees over time that you would through a Fee-Only planner or Vanguard-style index fund. You're hit with all kinds of bizarre charges such as "mortality and expenses charges." Certain annuities are not so bad (some of the better possibilities come from Vanguard, T. Rowe Price and TD Waterhouse and have low yearly expenses). But Fortune says most are "still sold by commission-paid insurance agents, stockbrokers, and financial planners. These folks earn more selling annuities than they could selling virtually any other investments." Fortune says that the sales commissions on variable annuities--discussed later in this article--"average six to seven percent and go as high as 15 percent. Commissions on load mutual funds average more like three to four percent." On top of other outrages, you may pay surrender charges as high as seven percent the first year if you cash your annuity in ahead of time. Plus, you'll pay management fees, just as with a mutual fund. Normally they will be lower--but not as small as those that an index fund charges. When all's said and done, your annual fees may approach two percent--or just about twice as what a Fee-Only planner would charge. 3. The insurance coverage that annuities offer isn't that great a deal. They don't even work out well as death benefits. Fortune has said that annuities are "an inefficient way to buy life insurance, and almost no one collects on it anyway." 4. To grow your investment, the annuity providers will often rely on means that are less than stellar in yields. Fixed annuities mean assure you a certain return ahead of time, but then it's so low that inflation could pose a real threat to you in retirement. Within a variable annuity, you can indeed decide to an extent how to invest your money. But it will have to end up in the equivalent of in-house mutual funds. Some choice, eh? Does this not sound a little like the incestuous dealings of brokerages where not-so-objective planners direct you to their own dogs? Another choice might be a equity-index annuities. Yes, you'll be guaranteed a return of perhaps several percent, but then your upside from the stock market would be limited, too. If you're a long-term investor, why not simply invest in the funds yourself--perhaps in an index without the handicap? 5. Annuities tie up your money so you can't invest it more profitably. In fairness to annuities, there are occasions when they might make sense. According to the Motley Fool, they "are desirable only (if ever) for those who: * "Have contributed the maximum to their 401(k) plans and IRAs and desire further tax deferral on investment gains." * "Prefer investing in mutual funds as opposed to individual securities. * "Will keep the annuity for at least 15 to 20 years." But, let us add here at ElderAdo, that argument is rather irrelevant to most people who are retired or close to it. * "Are in a 28 percent or higher income tax bracket today, but expect to be in a lower income tax bracket in retirement." * "Don't need the annuity proceeds prior to age 59 1/2. * "Are unconcerned that heirs must pay ordinary income taxes on any appreciation. * "Desire a 'guaranteed' income for life in retirement." The later argument can be powerful. But remember the tradeoff. If history repeats itself, the "guaranteed income will most likely be much smaller than the rewards of investing regularly and prudently in the market. A outrageous example of the risk of trusting annuity-pushers comes from our own back yard in Potomac, Maryland, where a CFP urged an elderly couple to trade in an annuity he had sold them four years before. He said they would get a $50,000 reward for making the switch. He said it would more than cover the old model's $25,200 surrender charge, which was 1/25 of the original investment ($630,000). They would enjoy a $24,800 profit. But as Forbes revealed, there was a catch: "The annual expense was 1.7 percent compared with 1.25 percent on the old account, and the surrender charge, which started out at an exorbitant eight percent, would take nine years to go away. If the couple had kept their original annuity for three more years, they could have surrender it with no penalty. "Sadly, the husband then was diagnosed with terminal cancer, and he needed cash for estate tax purposes and medical expenses. "But getting out meant paying a surrender fee of $80,000 plus reimbursing the insurer the entire $50,000 bonus. The market's 2000 slump eroded the annuity's value, so they walked away with a paltry $605,000. Now they're suing their planner for deceptive sales practices." Did this happen to financially naive people? Hardly. The couple had gotten well off through ownership of apartment buildings. With such cases in mind, the SEC is examining the marketing materials of the biggest underwriters of annuities, including, says Forbes, ING Golden American, American Skandia and Allianz Life. It quotes Paul Roye, director of the agency's Divsion of Investment Management: "The industry is on notice." Enough said. If you feel you must buy an annuity, just be certain that the person recommending it is not on commission. Do not shy away from asking how he or she will benefit directly or indirectly from a sale, and watch out not just for present fees but for those down the road. Links that might be useful: www.prestigeadvisors.com/The_Annuity_Con_Game.htm Annuity Gratuity Carrie Coolidge-Forbes.com 02.19.01 www.forbes.com/global/2001/0219/064.html

Experts are baffled that investors and regulators did not wise up to the ruse sooner. "I'm shocked investors turned a blind eye to returns that were too good to be true, constant, steady, small, positive returns," said Jim Vos, of the hedge-fund consulting firm Aksia LLC. But Madoff apparently made them an offer that was too good to be scrutinized. Madoff was single-handedly managing billions of dollars in offices he kept separate from the rest of his firm, said Vos, who steered clients away from the fund. The only oversight was conducted in a Rockland County accounting office only slightly larger than a cubicle. And Madoff, who made his fortune embracing the latest and best technology, forbade investors to get online access to their accounts, insisting instead on paper printouts. "When something is too good to be true, it probably is," Vos said. For well over a decade, competitors and experts said they found Madoff's track record suspicious. He seemed immune to any volatility in the market and, no matter what was happening in the economy at large, managed to finish each month with almost identical profits. Markopolos, who worked for a Madoff competitor when he made the charge of fraud, continued to cry foul for years, to little avail. Madoff dismissed these attacks as envy and said critics simply did not understand the complexities of his strategies. Some 11 to 25 investors at a time, it seems, were willing to play along - at least before the economic meltdown in recent months persuaded them to pull out. They told Madoff they wanted to liquidate their assets, not realizing Madoff had already vaporized them. Aksia LLC was hired to investigate Madoff several years ago, said principal Jake Walthour. The probe only increased the concerns about the fund. Madoff's returns were "abnormally smooth" from month to month, and it seemed impossible to replicate his investment strategy or verify his track record. Madoff claimed to be moving as much as $13 billion in and out of the market every month, but "no one on the street could verify it or even see his footprints," Walthour said. "That organization was incredibly secretive." When they staked out the tiny accounting firm no one had ever heard of, investigators concluded something was amiss. "We decided there are several scenarios here, one of which is, this could be a Ponzi scheme," Walthour said. "None of our clients invested." Those who have invested in the fund have told investigators that withdrawing cash from it was an arduous process that involved faxes and inexplicable delays. That's because in a Ponzi scheme, money from new investors is used to pay those seeking to withdraw their money Keep drinking the kool-aid, investors who turn a blind eye on the shenanigans because of unusually high/constant rates of return deserve SOME blame,perhaps,lol

Berniek is right: Much of the blame here falls upon the shoulders of the politicians (led by then-President Clinton), who forced banks to begin some rather foolish lending practices. Alan Greenspan certainly did his share to push this concept of "everyone can borrow" during his time as Fed chairman. Between creative financing, no money down offers, and other such options, the government has given people plenty of rope with which to hang themselves. We Americans haven't proven ourselves to be particularly strong in the moderation and self-discipline categories over the last 30-40 years. Also, remember the climate that existed in the 90s, when I bought my first house: Spurred on by the soaring housing prices, people were convinced that buying "as much house as you can afford" was a good move. Housing was considered an investment that couldn't fail. Yes, the experts began preaching about "the housing bubble" long before it hit, but the masses couldn't grasp how this sure-thing could ever fall. And there's always been a (faulty) basic belief that "If I couldn't afford it, the bank wouldn't lend it to me." I fully agree with those who say that Real Estate agents will push buyers to their upper limits and beyond, and banks will lend what they can -- it's all about profits for them. Yet, the home owner DOES also bear the brunt of personal responsibility. After all, who cares most about whether I can afford my mortgage -- and still buy groceries and other things I need? Clearly, it's ME! I reap the rewards or punishments of my decisions, so I should do the math and know whether I can comfortably afford a house (or anything else) before I buy it. However, we've sort of left that thinking behind in today's buy-now-pay-later society. We're constantly told that "we deserve" this or that thing. That if we're going to finance it, we deserve to have exactly what we want. That "everyone" has debt. We've got to get past that.

chisue wrote: "Did you mean to look at the CD yields by deducting the percentage of our tax bracket, or something else?" I'm not a financial planner (and wouldn't want to steer you in the wrong direction) so I would suggest asking your broker or CPA this question. Martin Weiss (Weiss ratings) talked about treasuries in April 06'. Here is what he had to say. "I can put my keep-safe money in 3-month Treasury bills or in a Treasury-only money market fund. The advantages are many: Advantage #1. Safety. As long as I wait the 13 weeks until my T-bills mature, the Treasury Department guarantees zero risk of loss. And even in the very rare event that I sell them on the secondary market at a loss, the loss would be so tiny I'd need a microscope to see it. Is the U.S. Treasury really a good credit risk? Some people are so concerned about the government's bulging debts and run-away deficits they're beginning to wonder, and I don't blame them. But it's still the highest rated borrower on the planet. So until someone offers me a better alternative, that's where my keep-safe money is staying. Advantage #2. Rising yield. A couple of years ago, the yield on short-term Treasury bills was hovering so close to the zero line it felt like I was paying the government for the privilege of loaning it my money. Plus, at that time, there was a big gap between the ultra-low yield on 3-month T-bills and the still-decent yield on 30-year Treasury bonds. But now T-bills yields have mostly caught up, and the gap has narrowed tremendously. Every time the Fed hikes interest rates by a quarter point, the yield on my T-bills promptly rises by about a quarter point. And every time Wall Street trumpets no more rate hikes coming, the Fed sends not-so-subtle hints that it's going to raise them some more. That's what happened after the last Fed meeting. And from everything I can see, that's what's going to continue happening after the next Fed meetings for as far as the eye can see. Good. My T-bill yield, although still not high enough to give me any thrills, just keeps moving up and up. Advantage #3. Liquidity. With a Treasury-only money fund, I can get my money out so quickly it's like having the cold cash in my night table when I wake up every morning. I can write checks on the fund to immediately pay my bills. Or I can call the fund and have them wire the money to my local bank within 24 hours. Advantage #4. One Account. Some people have bank accounts coming out of their ears. They've got checking accounts, savings accounts, money market accounts and various CDs under the $100,000 FDIC limit. I don't. Except for a local checking account I use for small monthly bills, I have just one single, multi-purpose Treasury-only money market account that does it all. It's not FDIC insured. But that doesn't bother me because the U.S. Treasury Department guarantees all the securities that the fund buys on my behalf. Advantage #5. Exempt from local income taxes. On the surface, the yields on CDs and Treasuries are similar. But there's a significant difference: The Treasuries and Treasury-only money funds are exempt from local and state income taxes. Bank CDs and money funds invested in CDs are not. This isn't an issue for us now because we live in Florida, and Florida has no state income taxes. But it certainly would have made a difference when we lived in New York. Ditto for states like California or Massachussets. Advantage #6. Inflation protection. People ask: Suppose inflation surges or the dollar falls in value? What good are your dollar-denominated Treasury bills going to do you then? Answer: I get most of my protection from the rising yield: The higher inflation goes, the better my yield is going to get. Will the higher yield always be enough to cover the loss in the dollar's purchasing power? Probably not. But in any case, I can get the rest of my protection elsewhere." This story is archived at www.moneyandmarkets.com/press.asp?cat_id=25 "The Big Picture" by Martin Weiss-April 17, 2006 He offers a free newsletter as well as other services. A link that might be useful: SafeMoney.com