Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, March 4, 1991 TAG: 9103020302
SECTION: BUSINESS PAGE: A7 EDITION: METRO
SOURCE: MAG POFF BUSINESS WRITER
DATELINE: LENGTH: Long
Buy one, and you are virtually wed to it for a lifetime.
The serious message behind the joke is that it's imperative to investigate in advance before entrusting money to this type of financial product.
In addition, buyers must look behind inflated claims to find the actual return on their money.
Annuities, especially variable annuities, are enjoying a boom in popularity. Forbes magazine recently estimated that Americans sank $8.8 billion into variable annuities just during the first nine months of 1990.
It's not hard to understand why because annuities are one of the few surviving tax shelters. Like IRAs and 401(k) plans, earnings are taxed only when money is withdrawn at retirement. Unlike them, there's no ceiling on the amount you can salt away.
Investors can choose between a fixed or variable return, the latter depending on the market and type of investment chosen. They can finance the annuity with a single payment or in periodic installments.
Another reason for the popularity is a heavy sales push by insurance agents, banks and other purveyors of financial products. They earn high commissions, which come from your investment along with sizable annual fees.
You can't bail out if you don't like the terms or the level of interest earnings. Virtually all annuities come with hefty surrender charges that start as high as 10 percent and decline slowly over a period of years.
The surrender charges help to cover the commissions. And they are in addition to the 10 percent penalty and tax bill if you withdraw prior to the age of 59 1/2.
Andrew M. Hudick of Fee-Only Financial Planning in Roanoke said the commissions range from 5 to 10 percent, but typically equal 8 percent of the investment.
Annuities, which are usually sold as substitutes for bank certificates or IRAs, "have been misrepresented to many consumers," Hudick said.
Insurance companies charge annual investment management fees along with service fees and overhead charges related to marketing the product, he said. The charges average 2 percent of the investment each year, but Hudick said he's seen deductions as high as 3 percent.
The charges are deducted directly from the quoted return.
When a bank advertises an 8 percent return on a certificate of deposit, Hudick said, that's the amount the investor earns over a year's time.
When an annuity advertises an 8 percent return, he said, the fees lower a depositor's net to 6 percent.
"So, while tax deferral would always be beneficial if there were no overhead involved," Hudick said, "the costs of managing these investments often offers a much reduced return."
Hudick said he recently reviewed four tax-deferred proposals for a client, and the fixed-rate returns ranged from 6.34 percent to 7.76 percent. Yet each had quoted an 8 percent rate on its cover sheet and two were no-load companies.
He figured it would take 17 years for his client to break even on the 6.34 percent proposal.
"The caution for most consumers is to perform a calculation of the true rate of return," Hudick said. "The advertised return is rarely the actual return."
He said the same is true of taking distributions from any plan in the form of an annuitized payout.
Many retirees have annuitized insurance policies, IRAs and retirement plans, Hudick said, but they are not receiving the advertised rate of return.
Gregory Tinaglia of Investment Management Corp. in Roanoke believes that annuities "can be a very valuable savings vehicle for long-term savings."
Because of withdrawal taxes and penalties prior to the age of 59 1/2, he said, they are not for short-term needs.
Tinaglia said variable annuities offer an additional advantage of allowing diversification into different types of assets such as stocks, bonds and money funds. Capital gains are sheltered along with earnings until retirement.
He has developed a list of questions to help his clients shop for a policy.
He also had two warnings for potential investors.
Because investors commit their money for a lifetime to a private insurance company, he said, they must be careful in selecting the company.
People should check the company's rating by a service such as Best's Insurance Reports, which is available in the reference rooms of many public libraries. He said the company should have an A+ or superior rating: "There is no reason to drop to the A category."
The other caveat is that the insurance company can drop the interest rate sharply after the initial period.
Investors should ask to see rates paid to older customers who have had their policies for several years. An honest company will pay them no more than a point less than its initial rate for new customers.
Tinaglia said investors may want a "bail-out" provision allowing withdrawal if the interest rate falls below a certain point.
A few companies offer annuities without a commission charge, Tinaglia said. Two of them are Allstate (owned by Sears) and Lincoln Benefit Life.
He suggested approaching a company with an A+ rating on that basis or going through an agent or financial planner.
Take your list of questions on every shopping trip to help find the best overall annuity, Tinaglia said.
And don't be seduced by the tax break.
by CNB