Let's go to Ken from San Diego.
He goes, "Being considerably risk-averse.
I'm curious about your opinions related to FIAs," which stand for fixed index annuities
- or some people call them equity-indexed annuities.
But I think the S.E.C. or someone got upset and they said, "no, you can't put the word
equity into it."
Yeah they used to be called EIAs.
I remember that.
"Specifically the growth options where you just park cash and let it grow.
I'm considering parking a million dollars from my recently retired wife's 401(k) for
about five years while I'm still working.
I'm looking at a fund that will give a percentage bonus on the initial balance, but it's seeming
a bit like too good to be true.
I realize I have to pick the index and the upside is clipped, but...
Appreciate your thoughts."
Okay, Ken.
Wow, I'm just going to sit back and listen.
It sounds great.
Well - this is how it's sold.
So all right let's talk about it.
It's a fixed annuity.
So let's start there.
Let's just start really basic.
What a fixed annuity is, is that you are giving your dollars to an insurance company and what
you receive from that insurance company is a fixed rate of return.
Fair enough?
Like a CD, Al.
You have CDs.
I do.
Most people don't know how this stuff works.
So let's say you go to the bank and you want to purchase an FDIC insured CD.
So you give U.S. Bank - whatever - $100,000.
They're going to pay you 2%.
What do they do with that $100,000?
They're not putting it in the vault and waiting for you to come back in 6-8 months or 12 months
or whatever the term of your CD is.
They're investing it.
Yeah they're trying to make more than the 2% that they're paying you.
And they're making a lot more than that most cases, because --
They're loaning money out for whatever.
Yeah.
Boats.
Boat loan, car loan, credit cards, house loan.
4.5%.
Right.
Credit cards, 24%, a boat loan, 12%.
Whatever.
So they're lending the money out.
And so they're trying to reach higher than that 2%.
That's called a spread.
And so when people hear that with the banks, they go, "OK, that makes sense."
Insurance companies, when it comes to fixed annuities, do the exact same thing.
They've got a reserve.
So you give your money to the big insurance company, they're going to give you a fixed
rate of return.
So I could buy a fixed annuity.
The difference between a fixed annuity and a CD, in layman's terms, is that the interest
on a CD that I receive is taxable each year that I receive it.
In a fixed annuity, it grows tax-deferred.
So let's say I get a five year, 2% fixed annuity.
That 2% on my principal I'm not paying taxes on until I take the income out of the annuity.
Annuities also have special terms that you have to be 59 and a half to get the money
out or there's a 10% penalty.
Every interest is taxed at ordinary income rates.
Now that's a fixed annuity.
They're like, "OK well, that's great, but that's boring."
I want a better return.
I want something cooler.
I want something more like market returns.
But I don't want to lose money.
Yes.
Right.
And so how it's sold and how it works are two different things.
I'm not opposed to how it works as long as it's disclosed appropriately.
But like right here, Ken.
He's saying "I'm getting a bonus."
So what he's getting himself into is a fixed indexed annuity.
So it's a fixed annuity and they're going to promise him a bonus.
"Give us $100,000, we'll give you 5% right up front.
Now no questions asked."
Yeah, you got $105,000.
Yep, all of a sudden, $105,000.
Or it could be even a bigger bonus - maybe it's 10%.
Now you got $110,000.
18%!
Day one.
We've seen that before.
$18,000 right up front.
Yes we have.
How do they do this??
This is great!
It's like a free toaster when I open up a checking account!
Expensive toaster.
Yes.
So how the fixed indexed annuity works - and there are all sorts of different flavors.
I have no idea, Ken, what you're buying.
If you want to show me the contract I'll be more than happy to dive in a little bit deeper
for you.
Not me, but someone in my firm.
(laughs) Let's be clear.
You're buying into... how do I say this in layman's terms - like a zero-coupon bond with
a call option on whatever index that he chooses.
Okay.
That's in layman's terms?
(laughs)
Kind of.
(laughs) That's why I had to think about it for a second.
Because l on your fixed index annuity it says, "how about you can invest in the S&P 500?
Or how about the Russell 2000?
How about the Wilshire 5000?"
"Oh, well now I'm a stock market investor.
But I'm never going to lose money."
Because how it's sold is that "you can get stock market-like returns with no downside
risk.
So if the stock market does 6%, you'll get 6%.
The market does 8%, you'll get 8% but if it goes down 20, you don't lose a dime."
Yeah.
Now that sounds great.
That sounds perfect.
Who doesn't want that?
Yeah.
Now, what's the problem?
Of course it doesn't work that way because you have to look at the fine print on these
products.
Most of them, they'll have a participation rate.
So let's say the market does 10% but what is your participation in it?
Maybe you only have a 50% participation.
So now the market does 10%, but my participation is only 50% so I'm getting 5.
Then there's also caps with how much that you can make.
Maybe it's a point to point on a month to month basis or year to year basis or things
like that - so you have to look at that.
Maybe I can only get 2% per month on a 50% participation contract.
Right.
And the market goes up in one month...
Yeah it goes up 8% in one month.
Well, I've got a 50%, so that's 4% plus the cap on it, well it's 2%.
You're like, "well, what the hell, the market's up 10, I only got 2!"
Right!
That's how the insurance companies make all the money!
Because he got a bunch of guys out there saying, "stock market-like returns with no downside
risk.
Oh, and by the way, I'm gonna give you a 10% upfront to boot!
And a free toaster.
What do you think?"
(laughs) Where do I sign?
Yeah!
Because you get all these conservative investors that are now retired, they're looking at their
statements because they need to live off this stuff.
He's retiring in five years - and I like how Ken goes, "Well I want to take my wife's money
and put it in this thing.
I'm not going to put my money to it."
(laughs) So if they would say, "Would you like a fixed annuity that will probably tie
you up into this product for 10 years?"
You have to look at, "how long how long am I going to be in the contract?"
If they're giving me an upfront bonus, you know it's longer than 10 years in most cases.
7 to 15 years.
So now I'm stuck in this product.
Now I try to take the money out, I've got huge surrender charges because they're lending
that money out - the insurance companies are doing all sorts of stuff with it.
Now you can take 10% per year.
Oh yeah!
That's what the brokers are telling them or the insurance agents: "Why would you want
to take it all out?
Come on Ken.
You only want to take 4% out per year.
Don't you know the 4% rule?
Why are you taking out 10?
You know - we'll give you 10!"
So there's a lot of really bad sales practices behind it.
But if it was like, "OK, here's my commission you give me -" He's gonna get a million bucks.
Guarantee the commission on that product, at a bare minimum, is what?
I was going to say $70,000 to $100,000.
It could, very easily.
I don't know what a minimum is but that's what I've seen.
Seven to 10%.
We've seen higher.
Right.
So you've got 10% and gonna put a million bucks?
You're paying the commission on that is $100,000.
We've seen a little bit higher than that too.
18% commissions, we've seen.
We tried to go help - this guy comes in, 90-some years old, or 87 year old, right?
He was in his mid-80s, yeah.
Mid 80s, couple million dollars in, like, seven different contracts.
And I was like, "well why do you have all these?"
"Well, it's diversification."
No bull-- it's all different breakpoints and stuff like that.
And every contract with 17 years.
Yes.
And this broker went to like different types of -- because one insurance company is going
to be like, "you're putting this in this gentlemen's entire net worth in this annuity?"
This is illegal, sir.
" That's why he's breaking it up and he's putting it all over the place.
I mean there's a lot of crooked s-it out there.
Right.
OK.
Got it.
Anyway, so what's the advice?
I guess just be really careful, know what you're getting into.
Yeah.
Because you're right, if it sounds too good to be true, Ken, what do you think?
It is.
If you want the skinny and just say, "OK, I'm willing to tie up my money for it anywhere
from let's say 10 to 15 - or let's say 7 to 14 years.
I don't know what contract he's getting sold here.
It's a million bucks.
Or maybe it could be annual liquidity.
If that's the case, well then that's a totally different story.
Maybe there's no commission in the overall FIA, but if there's a bonus involved?
I'm guessing.
I'm just guessing.
It's a pretty good hunch, so I would agree with you.
So without me knowing anything about what product you're thinking about going into,
that was kind of with a broad brush.
Just buyer beware.
Think about the pros and cons of everything, because it sounds to me that he only knows
the pros.
Ken does not necessarily know the cons.
Well he knows the upside is clipped.
He is aware of that.
And he knows that it sounds too good to be true.
"I realize I have to pick the index and upside is clipped," but here's how it sold.
"If the market does 12, I could get you 11.
What do you think?"
(laughs)
(laughs) That sounds pretty good.
"We can't get you the full upside of the market but almost, almost."
So I don't know hopefully that helps, Ken.
But if you're a conservative investor - but to be honest with you we've seen just straight
fixed annuities performed better than some of these indexed annuities or fixed indexed
annuities.
It depends on, again, participation rate, your points and caps, and all that other stuff.
So all right.
Let's see, Ross from Los Angeles.
He writes in too, the same type of question that we did from Ken.
He goes, "boys, I need your intelligent thoughts.
What do you think of a fixed annuity within your IRA that pays an average of 3 to 6% with
no loss ever and a cap of 10% when the market does well.
No fees.
Really value your opinion since it appears so many financial advisors don't like annuities."
Okay, well this is just another way to explain what we just went through.
So on average 3 to 6%.
Which means 3.2%.
Well look at this, Alan.
If I'm looking at the expected rate of return - let's say if Ross here - let me put my little
Larry Swedroe hat on.
Okay.
Can you talk like Larry?
(imitating Larry Swedroe) "Hello! (laughs) hold on a second, gotta shut the door, get
the dog out."
(laughs)
(laughs) Every time we call him, that's what we get.
I love Larry.
It's wonderful.
But if you think about it - so he's getting sold this now.
Average 3 to 6% in a fixed annuity!
Averaging 3 or 6%.
Come on!
Where are interest rates right now, what's a 10 year Treasury at?
Two??
Two and change.
Okay.
So of course, the insurance companies are going to pay you 3 to 6.
And it depends on what index you select, because it's like, "when the market does well."
Well, what market are you referring to Ross?
Is it the S&P 500?
Is it the Russell 2000?
Is it the international?
There are so many different types of indexes.
But let's just assume he's going to select the S&P.
S&P price-earnings ratio is pretty high.
You look at the earnings yield on that, the future expected return of the S&P is probably
around 3%.
It's lower than usual because it's so high right now.
Right.
So when you have prices that are high your expected returns are going to be lower.
Yeah.
I think a lot of people don't understand that - when prices are low, future expected returns
are higher.
It's kind of almost the opposite of what you might think.
So he's saying 3 to 6%.
If that were the case, if you could get an average 3 to 6% with zero loss and a cap of
10, why the hell wouldn't you?
Yeah that sounds great.
I would do it.
But it's not true.
It's not going to happen.
It's not like financial advisors don't like annuities.
Financial advisors that are fee-only fiduciaries don't like how annuities are sold.
If they said, "here's a fixed product that you're stuck in and here's how it works, and
you're probably going to get 2%"-- I mean, what's a fixed annuity?
Can we look it up on FixedAnnuity.com or something like that?
What's a standard fixed annuity paying?
I would guess, what, two and a half?
Three?
Well they don't say it that way.
No no no, this is a fixed indexed annuity - I'm just saying if I wanted to buy a straight
fixed annuity.
No, but I'm saying they talk about the distribution rate, which is also getting your own money
back.
That's where I'm going.
Oh yeah.
No that's an immediate annuity.
Right.
So that might be 4% or even 5, 7, but they're giving you your own money back.
Principal back.
Right.
So if that was the case, Ross, then yeah by all means.
But I just don't think you can average over the next, let's say, 10 years, 3 to 6% in
a fixed annuity.
Why would they cap it?
So the caps at 10?
So if the market does 9?
If the market does 11, you get 10?
So again, you gotta always look at the fine print.
Yeah.
So we don't know the details here.
But wouldn't it be safe to say, Joe, that we've looked at a lot of these and have you
found one that you would recommend?
A fixed indexed annuity?
Yeah.
No.
Ever.
There are things that I hear it's like, "OK well here, there's you no surrender charges."
They say "no fees."
It's BS.
Lots of fees.
It's not a fee.
It's something else, it's called a spread.
It's different.
It's just different terminology.
They're making a ton of money.
You're not giving any dividends from the stocks because they're buying options on the stuff.
And it's not like in a per se "fee" that you see it's a spread and there's commission.
It's just all it's just word games anyway.