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Don’t let this annuity horror story happen to you

Reprinted courtesy of MarketWatch.com.

To read the original article click here

Millions of American investors are at risk of falling prey to a financial industry that often exploits their trust and lack of sophistication.

I want you to know the story of how one woman was led down a potentially ruinous dead-end path just so a hotshot salesman could augment his million-dollar-plus annual income.

That’s a harsh indictment. Once you know the facts, you can decide if it’s warranted.

The story starts with a woman I’ve known for 10 years, I’ll call her Doris, who was laid off by her employer, one of largest companies in the northwest. The other main character, who will in this story be known as Sam, is a successful insurance salesman posing as a trustworthy adviser.

When Doris was laid off, her company recommended that she and others who were being let go attend a workshop about some of the financial decisions they faced and about various options for their 401(k) retirement assets. Doris gratefully attended the workshop, making notes and keeping the handout materials.

Later, she shared this material with me and recalled details of the presentation. In her mind, what stood out was a strong focus on “10 reasons you should get your money out of your 401(k) NOW!”

(A cynic might argue that from Sam’s point of view there was only one reason these people should get their money out of the 401(k) plan — so he could earn sales commissions. Sam’s promotional material, which is widely circulated in the industry, says he earns more than $1 million a year as one of this insurance company’s top national agents.)

Sam impressed Doris as being understanding and trustworthy as well as very sympathetic to participants who were undergoing a major life change they hadn’t asked for. In addition, he had been endorsed by Doris’s former employer.

In his presentation, Doris said Sam was particularly eager to get people into his office for personal consultations, which of course were free.

In his office, Sam spent their first meeting asking Doris a lot of questions about her investing experience, her retirement plans and her financial goals. He listened intently and appeared to be taking notes as Doris emphasized that she favored low-cost mutual funds with broad diversification among many kinds of stocks. She told him that she didn’t want to buy an insurance product.

In their second meeting, Sam said he had been thinking about the things Doris had told him. He said he had found something even better for her than normal mutual funds: A variable annuity. Sam didn’t bother telling Doris that the annuity would earn him a very large sales commission or that it would significantly increase Doris’s investment expenses for the rest of her life.

Nor did he tell her it could cost her as much as $64,000 if she later changed her mind and “prematurely” wanted her money back. (Does that figure seem high? It’s 8% of the $800,000 she had in her 401(k).)

He didn’t tell her that the annuity was what Doris had specifically said she didn’t want — an insurance product that included an expensive life insurance component. Instead, Sam focused on other supposed advantages of this variable annuity, including access to many funds run by multiple management companies. He said her investments in the annuity could be rebalanced automatically every six months without cost. He made these services sound free, which of course they weren’t.

Doris should have walked out on him. But she didn’t have enough knowledge, experience and understanding to properly evaluate his sales pitch.

Sam scheduled a subsequent meeting for her to sign paperwork. She was entirely out of her league, facing many pages of documentation with multiple boxes that he had checked (and she needed to initial each one to indicate her understanding). Doris initialed a box saying she was an “experienced investor.” (She wasn’t.) She initialed another box indicating she had been given a prospectus. (She had not).

By the end of this meeting, Doris told me later, she didn’t really know what had hit her. Only later did she start to understand that this charming, persuasive man had sold her an expensive product that wasn’t what she wanted.

Worse, Sam had persuaded her to roll over her perfectly good 401(k) account into an IRA, which unlike the 401(k), could hold a variable annuity. I know lots of competent advisors who recommend low cost immediate life or longevity annuities, as well as variable annuities in taxable accounts, but I don’t know a disinterested financial advisor who would recommend placing a variable annuity in an IRA.

Tax-deferred earnings, the main rationale for variable annuities and the main justification for their high expenses (2% or more a year), would do Doris no good inside an IRA, which already was tax-deferred.

Inexcusably, the annuity was far different from what Doris had explicitly told Sam she wanted. Instead of low-cost index funds, her money was suddenly invested in high-cost actively managed funds, many of which were owned by the insurance company that issued the annuity.

The result: Doris could expect to earn at least two percentage points less, for the rest of her life, than if she had her money in the investments she had told Sam she wanted.

The annuity would leave her with significantly less retirement income. Should she die before her husband, it would leave him with less to live on. And when they were both gone, it would leave their heirs with less.

Once this started to sink in, Doris called me. It looked as if it would be almost impossible to undo this damage without forfeiting 8% of the money she had paid for the annuity.

But, with the help of fellow RetireMentor Stan the Annuity Man (and after talking with the Washington State Insurance Commissioner and the Securities and Exchange Commission), I did help get Doris out of it.

Doris asked for a follow-up meeting with Sam. I coached her in advance on questions any investor should ask — questions a competent adviser should be obligated to answer truthfully.

I wasn’t at the meeting, but Doris took voluminous notes. Nearly every time she asked a question that touched on the unfavorable attributes of what he had sold her, Sam either flat-out lied or changed the subject with half-truths.

For example, Doris asked if Sam was a fiduciary, somebody who is legally obligated to put the client’s interests ahead of his own.

Three times, in response to pointed questions, Sam swore that he is a fiduciary. That was technically true because he is dually licensed and can sell other products through a separate company.

But in Doris’s case, Sam wasn’t acting as a fiduciary and didn’t have that level of responsibility to her.

In the end, Doris asked for her money back. At my prompting she told Sam that if she didn’t get it, she would go to the S.E.C., the state insurance commissioner and other regulatory bodies as well as her former employer, which had sent her to his workshop. In most cases, annuity purchasers won’t have to go to such extremes to get out of their contracts — if they act quickly. Most annuities have a “free-look” period of 10 to 30 days, during which time you can revoke the contract.

Fortunately, this was resolved without the need for arbitration. But as part of the settlement, Doris had to agree not to disclose what happened or say anything negative about Sam or the insurance company.

Doris told me the details before she made that agreement, and I am free to relate them here.

Three pieces of investment advice leap out at me from this story:

Don’t deal with any financial adviser who is paid by commissions or is licensed to earn sales commissions in any capacity.
If a disinterested tax adviser such as a CPA recommends you buy a variable annuity, shop for one at Vanguard, where costs are low and there are no conflicts of interest.
Don’t move your life savings into a new vehicle such as a rollover IRA until you are certain that you know what you’re doing. If you have any doubt, hire a CPA to review what you are considering.
If Doris had stuck with the variable annuity, it’s very probable her retirement income would have been diminished. In fact, I can make the case that her retirement income would have been cut in half — and she would likely have left less than half as much to her heirs. Last year I wrote on how an extra half percent adds millions to a $200,000 ($5,000 a year for 40 years) investment. Imagine the extra kick by adding 2% to the return. That’s the impact of not having to pay the extra expense.

As John Bogle says, ““We investors as a group get exactly what we don’t pay for.”

Sam, on the other hand, would have pocketed a sales commission of at least $30,000.

For more on this topic, including details of these numbers, check out my podcast entitled: “100,000 ways to lose half your money.”

Richard Buck contributed to this article.