What is the annuity salesperson not telling me?

[Vapors]

Hi all. I posted a few days ago about an annuity my father-n-law was considering. Well I talked to the salesperson myself to get as much info as I could. Here is what he told me. I know he must be leaving something out.

You invest in a fund group, say an 80 equity/20 bond group. A fund manager who oversees that group invests the monies in funds that he likes from say Fidelity, Vanguard, etc. The total expense ratio for the fund, including the fund group manager is 0.55%.

For an additional 0.4% John Hancock will guarentee a 5% return. This doesn't protect the principle.

So if he invests $100,000 he is guarenteed to make $5,000 per year. If he makes more great, if he loses money he still gets the $5,000. And that $5,000 never goes down, even if the principle falls to $50,000. If his principle gains money, every 2 years they recalculate the 5%.

So why would they offer this. By talking with the salesperson they are only making around 1%. If the market falls or goes stagnant for a period of time, John Hancock would be out a lot of money that would take a long time to recoup at 1% a year.

The guy claims there are no other fees or expenses and the money will go to my father-n-law's heirs when he dies.

Has anyone heard of this type of annuity before? The bells in my mind are ringing loudly that there is a major catch that I am missing. I just don't know what it is.

[mom-from-missouri]

What I don't like about them is your money is tied up. If you have an emergency and need it-you can't get it. All you get is a check monthly or however often it is set up for. If you need say, transplant surgery and have to come up with $100,000 and you have it in an annunity, you still only get a monthly check. You can't get back out of it.

[Hypersion]

Why not just buy an annuity directly from Fidelity or Vanguard and cut out the middle man. They offer dozens of low fee annuities.

[jIM_Ohio]

Hi all. I posted a few days ago about an annuity my father-n-law was considering. Well I talked to the salesperson myself to get as much info as I could. Here is what he told me. I know he must be leaving something out.

You invest in a fund group, say an 80 equity/20 bond group. A fund manager who oversees that group invests the monies in funds that he likes from say Fidelity, Vanguard, etc. The total expense ratio for the fund, including the fund group manager is 0.55%.

For an additional 0.4% John Hancock will guarentee a 5% return. This doesn't protect the principle.

So if he invests $100,000 he is guarenteed to make $5,000 per year. If he makes more great, if he loses money he still gets the $5,000. And that $5,000 never goes down, even if the principle falls to $50,000. If his principle gains money, every 2 years they recalculate the 5%.

So why would they offer this. By talking with the salesperson they are only making around 1%. If the market falls or goes stagnant for a period of time, John Hancock would be out a lot of money that would take a long time to recoup at 1% a year.

The guy claims there are no other fees or expenses and the money will go to my father-n-law's heirs when he dies.

Has anyone heard of this type of annuity before? The bells in my mind are ringing loudly that there is a major catch that I am missing. I just don't know what it is.

Vocabulary. Ask the salesman how HE is being compensated. It might be called a fee or an expense.

The $5000 guarantee protects against a loss of 5%. If the fund loses 6%, then overall portfolio still lost 1% in value. Explain this to your dad- is this what he understands (I am still not sure I understand, but I'm not the one buying it).

What is the purpose of the annuity?

[poundwise]

Fees.

Believe it.

[Scanner]

Give me $100,000 and I'll guarantee you 5% year.

Seriously.

[mom-from-missouri]

?? I would think that as you start getting your payments, your $100000 "investment/deposit" will start to go down each month . Thus, you then would have less money to earn that 5% (or whatever % you are getting). Taking that into consideration, I'd think there would be a better way to invest it and something higher than 5% so that wouldn't go down as fast.

I understood it that annunities will come to an end. Most are good for x amount of payments or a certain topped out dollar amount whichever comes first??? At least that is how it is worded in mine (which I hate, but had no choice it was a court awarded settlement and thats how they did it-I had no say in it, but at least I got it)

[Vapors]

Vocabulary. Ask the salesman how HE is being compensated. It might be called a fee or an expense.

The $5000 guarantee protects against a loss of 5%. If the fund loses 6%, then overall portfolio still lost 1% in value. Explain this to your dad- is this what he understands (I am still not sure I understand, but I'm not the one buying it).

What is the purpose of the annuity?

I think he understands that now. He definitely did not at first though.

The purpose is to gain as much money as he can without risking his principle. His financial advisor is the one pushing this on him. He called my father-n-law again this morning. My father-n-law has the money in a money market account and the advisor told him this was a way to make more money guarenteed. What he didn't tell him was that the principle would be at risk.

[Vapors]

Give me $100,000 and I'll guarantee you 5% year.

Seriously.

That's pretty much what the advisor told him. Sounds good when you are only making 3% on it currently.

I know he can make more money in the long run investing himself. He doesn't feel at all comfortable doing that. And I do not want to be the one to invest for him because the year the market drops 20% he will blame me (this could be the year).

[Scanner]

The purpose is to gain as much money as he can without risking his principle.

If that's the case, products with no principal risk:

1. Savings account
2. CD's (you can find CD's for 5+%)
3. Treasury Bills/Series EE savings bonds (well. . .not exactly true. . .you are depending on the US Gov't to pay you back so in effect your principal is at a very small risk)
4. Insured municipal bonds

I don't recall an annuity being an "insured" product but then again those things are complex.

You should only invest in what you understand and if you can't explain a product in a couple of sentences, I'm highly suspicious.

[jIM_Ohio]

I will chime in that the person doing the investing needs to define a risk tolerance. There are NO risk free investments. Completely eliminating one risk (principal risk), creeps in another (like inflation risk).

Risks to consider

1) principal risk- the idea that if 100k is invested, the 100k is always there.
2) interest rate risk- the idea that changing interest rates will affect the return of the investment. 100k at 5% makes $5000. If rates drop to 3%, the investor only made $3000.
3) market risk- the risk that the market(s) the investment is in collapse. Maybe the 100k is invested in a bank CD, and the bank goes bankrupt, or the 100k is invested in Enron stock and the company goes bankrupt.
4) inflation risk- the risk that 100k today can buy something, but when investor needs money, the 100k cannot purchase that good anymore. 100k in 1600 could have purchased most of Rhode Island. Today 100k would not even get you an acre. That is inflation. Cost of goods and services increase over time.
5) return risk- risk that the invesment will not generate the return the investor needs to achieve a given goal.
6) currency risk- risk that the currency being used for the investment collapses. This is primarily seen with investing in countries outside the USA.

Investing is NOT about eliminating risks, it is about managing them. If the investor is satisfied with all the risks of an investment, then that is a good investment.

For example, I am 34 yo, and investing for retirement. I invest in 98% equities, giving myself market risk, while at same time trying to maximize return. This is best hedge against inflation. I have an emergency fund in CDs. The EF needs to protect for 3 months of mortgage payments- which are not subject to inflation. I also do not need a high return on the money (making 1-2%) as there is enough in EF to fund the objective, and I need 100% certainty that the principal is retained. I do have interest rate risk, but I am not investing the money in CDs for the return on investment- I am investing for the return of my investment.

Make sure your father knows his risks and go over them with him.

He might be willing to subject 40% of his money to the market, knowing that 60% is safe. the 60% earns 5% (60k earning 5% is $3000). The 40% position is more aggressively invested, with hope of beating inflation. It's possible that 40k earning 7% ($2800) is a good return for the risk taken. Maybe it's a 30-70 split, maybe 20-80.

Your father should define his risk level. He needs to understand risks from many market forces (principal, inflation, interest rates) before making a final decision.

[Scanner]

JimOhio gives a good summary.

I just take it on face value that principal risk is the biggest concern.

I"m not there but someday I will be. People of SSI/Medicare age have a psychology about them and I can't blame them.

If you knew that you would never earn another dime again in your life, how much relevance would you assign principal risk? (food for thought) I think that's why Medicare/SSI people walk around constantly saying:

"I'm on a fixed income."

[Vapors]

Thanks the posts.

I have explained inflation risk to him. I have tried to warn him that he could easily outlive his savings. But he answers, 'Where will I be if I lose my principle'? I think this is the same coversation he had with the advisor and the advisor tried to sell him something he didn't fully understand. And that wasn't really his fault. When I talked to the advisor he always talked around losing principle.

I honestly don't know everything my father-n-law has saved. I think he does have other retirement accounts that still invest in the market. But if he does it's not a lot. I figure he is at most 25% still funds. And I know at least one of those funds is a balanced fund so he is even less in equities.

They don't live extragent. They don't take vacations. They own their home out right. They don't carrry credit card debt. So I can't fault him for not wanting to risk what he has.

This annuity vehicle sounded like a safer way to invest a portion of his savings in the market. Being a annuity, I assume there are things I haven't fully been told. But either way, I don't think he is going to do it at this point.

Thanks again for the posts everyone.

[Hypersion]

"For an additional 0.4% John Hancock will guarentee a 5% return. This doesn't protect the principle."

If your FIL want the principle protected at all cost he needs to get a Fixed Annuity.

Take a look at

https://personal.vanguard.com/us/accounttypes/retirement/ATSFixedDefAnnOverviewContent.jsp

Vanguard Fixed Annuity

[jIM_Ohio]

Thanks the posts.

I have explained inflation risk to him. I have tried to warn him that he could easily outlive his savings. But he answers, 'Where will I be if I lose my principle'? I think this is the same coversation he had with the advisor and the advisor tried to sell him something he didn't fully understand. And that wasn't really his fault. When I talked to the advisor he always talked around losing principle.

I honestly don't know everything my father-n-law has saved. I think he does have other retirement accounts that still invest in the market. But if he does it's not a lot. I figure he is at most 25% still funds. And I know at least one of those funds is a balanced fund so he is even less in equities.

They don't live extragent. They don't take vacations. They own their home out right. They don't carrry credit card debt. So I can't fault him for not wanting to risk what he has.

This annuity vehicle sounded like a safer way to invest a portion of his savings in the market. Being a annuity, I assume there are things I haven't fully been told. But either way, I don't think he is going to do it at this point.

Thanks again for the posts everyone.

This is where a complete plan will do better than just the concept of inflation eating away at the return of a CD.

Is the $100,000 mentioned in the OP the amount of the investment, or an example to show how the annuity worked?

Because 5% of 100k is only $5000. So the return we are talking about is hardly enough to live on, and the 100k would probably only last a retiree between 5-10 years anyway. If this is all he has, then leave it in cash.

If there is 200k or so in question to be considered, then how about a plan for how the whole 200k gets spent each year.

Yearly expenses =? I will use 20k for this example.
Total amount in savings =? I will use 200k for this example

Put 20k in savings (this is money spent for 2008)
Put 20k in an 11 month CD (this is money spent for 2009)
Put 20k in a 24 month CD (this is money spent for 2010)
Put 60k into I-bonds. I-bonds are indexed to inflation and have a nominal interest rate, plus an inflation adjustment component.

120k of the 200k is being marked as cash for next 6 years.
80k could then be invested. I suggest a mix of 30% equities and 70% bonds. Goal is about a 6% return.

Each year pull 20k from the 80k position. The goal would be to have this position large enough that it makes 20k each year.... obviously with only 80k left in this example, he would run out of principle in 3 years...

But with 200k to start with, he had only 10 years expenses to begin with.

The better plan would be to have the 80k increased to 200k or so (the invested portion) and remove 20k from this any year where the market went up.