A referral from a trusted adviser like one’s CPA usually helps to take some risk out of the selection decision. However, just because a CPA works with numbers and is tax savvy doesn’t mean they are fully aware of the investment landscape nor motives that may work against your goals.

The Facts

Patrick was referred to a broker/advisor by his friend and CPA. He had a taxable account and two IRAs. In all three accounts his broker had sold him variable annuities (VA’s); VA’s pay very high commission rates. VA’s are mutual funds with insurance riders (except it’s not true insurance as explained below); and they’re tax deferred instruments. I asked Patrick why he the owned the riders and why he owned tax deferred instruments inside tax deferred accounts. He had no idea.

The Bottom Line

Every annuity contribution Patrick made cost 5% in upfront commission; annual 3% costs were eating up 50% of his expected return. A reasonable conservative estimate showed 30%-50% in lost account value over the next 20-30 years. There are lower cost ways to achieve tax deferral with better investment options. In addition, Patrick as a small business owner there are several superior retirement plan options to achieve significant savings and tax deferral.

What We Found Out

The annuities were invested in approximately 40% stocks, 60% bonds; the expected long-term return for this mix is 5%-6%. Patrick believed he was getting a guaranteed 7% growth on his principal. I assured him that while I hadn’t yet read the cryptic legalese in the annuity contract, that wasn’t the case. He got angry with me, insisting that he knew what he owned. I took an unusual step and offered to review the accounts with him and his broker, so he could be clear on what he owned. Knowing what you own is good starting point, right?

Motives: Whose Money is This?

Ever try to read an annuity contract? After 5 iterations, I deciphered its cryptic terminology, dissected the fine print, and concluded the annuities “all-in” annual investment and insurance rider costs ranged between 2.5%-3.0%. That means fees reduce expected returns by 50% or more! And every new contribution got hit with a 5% sales commission – an immediate reduction in principal that will never have the chance to grow.  

We met with the broker. He wasn’t comfortable with my questions. He needed to call the annuity desk to get answers. A guy selling something he doesn’t understand. Not as uncommon as you might think. He got outright nervous when I asked him why he sold Patrick a second annuity in one of the IRAs. Nervous for good reason. This egregious practice has come under FINRA’s regulatory fire because it has one self-serving purpose: to renew the broker’s commission and surrender cycle which locks the client into an expensive long-term commitment. Who does that make sense for?

Cautionary Buyer Beware: Seduced by the Pleasing Sales Personality

Variable annuities get sold, not bought. Sales claims often appeal to emotions and misrepresent reality. SALES CLAIMS ARE NOT FACTS. Some of the prominent selling claims tout tax-deferred growth without IRA/401k income limitations; guarantees against capital losses; death benefit; stepped-up death benefit; minimum income guarantees.

These sophisticated contracts are filled with mind-numbing, poorly-disclosed details. They’re written by the issuer’s attorneys to protect the corporation’s interest. There is nothing standard about them, so they need to be read. Yet a typical investor doesn’t want to read them and can’t understand them; many sales people don’t either (as was the case here) – though you can be sure they understand their commission cycles very well. They’ll never tell you the all-in costs, while hyping the dubious merits of the benefit. Without clear, understandable facts, how can you verify cost vs. benefit?

The Claims, The Facts, and Patrick’s Circumstances

Tax deferred growth: annuities do offer tax-deferred growth without the income limitations in an IRA or 401k. However, there’s no tax deduction for your annuity contributions; hence, it’s best to max out your contributions to the IRA or 401k first. Patrick hadn’t done this. In addition, he’s self-employed and there are various retirement plan options to create significant savings, tax deductions, and tax-deferred growth without the excess annuity fees.

Guarantee against capital loss: is only good if you die and if your investments have lost money. Patrick didn’t care about this and didn’t need to; 60% of his assets were investment grade bonds which don’t need capital loss protection! He was paying for protection he didn’t want, and his portfolio didn’t need. In addition, he had substantial cash savings in another account if emergency funds were needed. With plenty of short-term liquidity to ride out market fluctuations, there was no need to pay for this weak form of questionable protection.

Death Benefit: your beneficiary is guaranteed the amount invested. It’s only good if you die, and if your investments don’t perform! This wasn’t part of Patrick’s concern.

Stepped up death benefit: as investment returns increase, you can lock in a higher death benefit. Patrick didn’t care about this either. In truth, if investments are allocated for liquidity and growth, the long-term trend in capital markets is up. The odds are that over time annuity death benefit is more a marketing gimmick. Realistically, it offers a benefit only in rare circumstances.

Minimum income guarantees: these are popular because they are the perfect sales pitch to the safety minded. They offer an income stream for life, albeit very pricey (i.e. hefty commissions). Recall Patrick insisted he had 7% guaranteed growth on his investments. It’s a common point of confusion for consumers. In fact, he had an income guarantee of 5% on his “income base,” which is very different than account value. The income would begin at age 65; the 5% income and the rider fees get paid from the actual portfolio value. If the portfolio was ever depleted, the insurance guarantees the 5%. In addition, riders often have various stipulations and “gotcha” clauses. Confusing.

What Change Did We Make?

This was a mess. Several steps were needed to clean it up. First, we helped Patrick understand what he truly owned. He was then able to see what he had wasn’t what he needed or wanted. Second, we eliminated over 50% in annual excess costs that were severely limiting asset growth while not protecting anything he cared about. Third, we aligned his investment risk with his comfort level.  Fourth, improved tax efficiency and showed him ways to significantly increase his retirement plan savings. More specifically:

  • We reviewed the options with two annuity specialists. We liquidated one of the IRA annuities; did a 1035 exchange on another to avoid penalties and taxation (into a lower cost annuity without the gimmicky, unwanted, costly riders); the other one we had to wait a couple years because the surrender fee was prohibitively expensive (that was why the broker sold the second annuity to him, so he could lock in new 8-year surrender period).
  • We lost no benefit that he cared about or needed, and showed him you can always annuitize to create a guaranteed income stream with “fixed annuities” – if and when he wanted at a much lower cost than the VA.
  • We showed him two superior retirement plan options: a solo 401k plan that would allow him to save and deduct up to $50,000 per year; or a more advanced plan that would allow him to save and deduct $100,000-$250,000 depending on his income. He kept $700,000 in the business and personal savings as a buffer (we’ve begun to conservatively invest some of these assets).
  • By conservative estimate, we reduced total costs over 50% (about 1.5%) on $475,000 in invested annuity assets. The chart below illustrates the estimated compound savings benefit.


 Compound Savings Advantage


By focusing on what was important to Patrick we eliminated the unnecessary. The underlying investment assets are the same; the investment mix is the same. The difference is a right thinking, competent adviser who cares about the result. That’s work that matters.

Jerry Matecun helps business owners and individuals discover key planning and investment considerations vital to build and protect the value of your business and personal assets.  For a no cost, confidential conversation regarding your situation call or email Jerry at 949-273-4200, or jerry@compoundvalue.com.