Q. Recently, my wife and I met with our financial adviser. He notified us that our portfolio had lost over 6 percent of its value in the last quarter. As usual he explained that we are still beating the performance of the S&P 500. We believe he's honest, hard-working, and doing his best for us.
In the evening we attended a "retirement" presentation about annuities with guaranteed annual growth of 8 percent. A one-time bonus was also promised for signing a contract. We have received several of these dinner retirement seminar solicitations in the last few months. When I asked for additional information the presenter provided materials for three insurance companies (Aviva, Allianz and American Equity Investment) behind these programs.
How can there be such a discrepancy between what is promised by annuities and our portfolio's performance? —E.P., Austin, TX
A. The most immediate reason is that one is real money— your portfolio. The annuity offer isn’t real money, at least not real money you can get your hands on. The most charitable thing I can say, given the number of reader letters asking the same question, is that the insurance industry does a lousy job of explaining its products. Strangely, they are only inept in ways that make their product look better than it is.
In the quarter ending June 30, the S&P 500 Index lost just more than 11 percent. That’s a good deal more than the 6 percent loss your portfolio suffered. During that same period the average moderate allocation mutual fund (a mixture of about 60 percent equities and 40 percent fixed income) lost 6.63 percent. So it is a reasonable bet that your adviser is doing OK by you.
Many people get confused by these retirement dinner presentations. The dinners regularly offer either a variable annuity with a “living benefit” or an index annuity with a “living benefit.” In both contracts you are told that your living benefit value will rise by a guaranteed annual rate, in simple interest. So if you invest $100,000 with the intention of leaving it alone for 10 years, your account will have a living benefit value of $180,000.
It looks really nice on the hypothetical sheet the salesperson provides, particularly when you compare it to the wretched yields offered on most CDs or the losses in your equity funds.
That $180,000 figure, however, is NOT the actual cash value of your account. You can’t take that money out of the account. The actual cash value of your account will be what your $100,000 earns over the ten years in a variable annuity sub account, or in an index annuity account. In most instances the actual account value will be significantly less than the living benefit account value.
The only utility of the living benefit account value is that it is the number used to determine your guaranteed lifetime income. Multiply it by 5 to 7 percent, depending on your age, and that is the annual income you can withdraw for life. Whatever the percentage rate, the actual cash you receive will be far less than you would receive from a traditional life annuity which also guarantees lifetime income benefits.
Meanwhile, those guaranteed lifetime income payments are subtracted from your actual cash value account— your real money. Barring incredible investment performance, it is likely that the actual cash value of your account— the amount of money you would receive if you liquidated the account— will diminish each year. There is a significant chance that it will disappear altogether well before you die.
If that happens, you’ll still get the guaranteed living benefit, in spite of having no principal. But if you had simply purchased a life annuity, you would have enjoyed a higher income, for life.
A benefit of the living benefit contracts compared to a regular life annuity is that you can access your principal, if necessary. You can’t do this with a life annuity— once you buy it; all you can get is a lifetime monthly income.
Those who sell these products say this is a substantial advantage over a life annuity, and it is.
The question is: Exactly how much is it worth? I doubt that many people would buy the living benefit deals if they were told, up front, that the cost of having access to their diminishing investment was a reduction in their retirement income as high as 40 percent.
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