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The Retirement Ripoff You Can't Afford

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As the stock market sinks, many people turn to safer investments to protect their capital. Unfortunately, that also means investors are more prone to buy costly variable annuities that are sold as a safe alternative to stocks. And now, insurance companies are making changes to those annuities that will make them an even worse deal for investors.

Earlier this week, The Wall Street Journal reported that insurance companies are planning to make adjustments to variable annuities they offer to investors. Those changes will reportedly increase charges for some popular features of these annuities, while making those features less beneficial to investors.

The ABCs of annuities
As a way of guaranteeing a steady income for life, annuities serve a useful purpose for some investors. But the variable annuity market, which is led by companies like MetLife (NYSE: MET  ) , AXA Equitable (NYSE: AXA  ) , and ING (NYSE: ING  ) , typically appeals to investors for a much different reason: the prospect of protecting their income and principal.

To provide protection, variable annuities often come with special features that offer guarantees against some event happening. Some of them include:

  • A guaranteed death benefit that your heirs will receive, even if investment losses have cut your annuity's value below the benefit level.
  • Protection against losses in your accounts, as long as you own the annuity for a certain number of years.
  • Minimum income payments once you decide to start taking distributions from your annuity, even if your annuity balance has fallen to levels that wouldn't normally support that level of payments.

All that sounds great. So what's the catch?

There's no such thing as a free lunch
The problem comes from the fees you pay. When you consider just the costs of investment management and insurance, variable annuities charge a hefty price -- nearly 2.5% annually, according to Morningstar. Each guarantee you decide to add on usually comes with an additional charge. The average death benefit guarantee, for instance, adds another 0.4% to that annual cost.

When the market goes up, those guarantees go unused, adding to the insurance company's profits. But the recent troubles in the markets have caused problems for insurers. Hartford Financial (NYSE: HIG  ) , for example, posted more than $100 million in losses in the third quarter tied to the fact that the company hadn't adequately hedged its exposure to the financial markets.

With the cost of hedge protection increasing as the result of market volatility, insurers have to pay more to cover themselves -- and they want to pass on those costs to their customers. Manulife Financial (NYSE: MFC  ) officials specifically cite trying to increase profitability as the motivation for cutting benefits and increasing charges.

The best move for your portfolio
As attractive as variable annuities may sound, the latest actions from insurers should remind you that variable annuities are designed to ensure profits for the companies that sell them. Right away, that should tell you that you're paying a premium for whatever protection you're getting. Otherwise, the company wouldn't sell annuities to you -- or would try to cut back on those benefits, as the industry is doing now.

More importantly, buying variable annuities with principal protection now is like taking out an auto insurance policy after your car has been stolen. With the market already down so far, the odds that you'll ever collect on those guarantees -- which you'll pay for year in and year out -- are incredibly low.

Even if variable annuities that customers bought last year turn out to have been a good investment -- something that's far from certain, given the long-term nature of the guarantees -- buying them for the guarantee protection now just doesn't make sense. You're far better off assessing your risk tolerance and buying a good portfolio of blue chips like Johnson & Johnson (NYSE: JNJ  ) or Procter & Gamble (NYSE: PG  ) . That way, you'll save on high fees and pocket more of the profits for yourself.

For more on avoiding bad investments, read about:

To learn more about the perks and pitfalls of annuities, take a look at our Motley Fool Rule Your Retirement newsletter. It has tips on protecting your money and finding great investments, even with the market down. It's free with a 30-day trial, so don't wait -- try it out today!

Fool contributor Dan Caplinger may buy an annuity someday -- but only an immediate annuity. He doesn't own shares of the companies mentioned in this article. Johnson & Johnson is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy won't rip you off.

Read/Post Comments (16) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 28, 2008, at 3:07 PM, patrickdonald wrote:

    I am baffled by this article? The author would make me believe I should by an annuity from an Insurance company who's fees are so low they go out of business as a profitable Insurance company is a rip off. Hartford wasn't charging enough? I guess that's good for all the people that own one then as along as Hartford stays in business.

    I should put ALL my retirement dollars in two stocks,PG, and JNJ and hope for the best? Let the author live his life without health insurance, car insurance, life insurance, homeowners insurance, disabilty, liability, and yes, some kind of income or portfolio insurance, (which btw is worth more than my home and car). If the Insurance companies are pricing my risk insurance too high I'll shop around. If too low....buyer beware. Which is it? With the markets down 45% .....18 years worth of Insurance fees seem cheap to me, especially with the huge amount of risk I would be taking by owning a couple of stocks. Nice perfect hindsight BTW on your 2 picks. Chances are your portfolio before the crack wanted me to own FNM and WB. I understand that with the insurance charges I won't and can't get market averages. Something TRADING won't get me either. But I think if I own a professionally managed portfolio and HOLD on I should get a reasonable return and less the fees, should still be adequate to provide me with more than enough income I need in retirement. I do know that if the markets DON'T perform and the insurance company has hedged properly and charged the right amount, that my retiremnet is still secure, something I don't see the author GUARANTEEING. I want to go golfing and play with my grandchildren.....NOT trade stocks and worry about markets. I'll pay a reasonable amount for that and do so with reputable insurance companies that have been managing risk longer than the author's family tree has been around. Also, if I NOW have to assess my risk tolerance and I find it to be lower than I previously thought does that not mean I should be reallocating to less stocks (sell) and more bonds (buy)? Buy high sell low?

    His analogy about buying car insurance after the car has been stolen makes no sense. My car was stolen and I had no insurance? Too bad you should have. Now I'm buying another car and he once again is suggesting NO insurance!!!

  • Report this Comment On November 28, 2008, at 4:31 PM, rbrandau wrote:

    I agree with the first comment. Perhaps the author of the article was too lazy to really understand the benefits of the products.

  • Report this Comment On November 28, 2008, at 6:17 PM, kamuirei wrote:

    In the author's defense, I'm sure he'd acknowledge that there are some cases where an annuity makes sense. But others where it certainly does not. For example, I am a new teacher, and less than a month into the beginning of school an AXA representative came by. The majority of the teachers in the school use AXA for their 403b plans because they simply do not know they have any other option. (Many falsely assume that the district has picked AXA as their 403b provider) Thus, you end up with my friend down the hall who at 25 is paying 2.75% annually to insure her portfolio when she could be paying .10% via Fidelity without the insurance.

    He never suggested buying 2 companies. He suggested buying a basket of blue-chips. You can use VLACX, VUVLX or whatever blue chip fund you prefer as a proxy and see that his advice isn't all that bad.

    Another note. I find it suspicious that the first comment was made the same day patrickdonald's account was created.

  • Report this Comment On November 29, 2008, at 12:22 PM, gr8optimist wrote:

    As a financial advisor who has a choice of putting clients in any registered investment, I am appalled at your lack of knowledge and would recommend that you read up on why people buy Variable Annuities. In addition, I would recommend that you dissect an annuity from each of the carriers that you mentioned and count all the fees based upon what types of guarantees you would like. In fact, some of the annuities that are offered in the marketplace today cannot be purchased with the guarantees that you are talking about unless you are 45 or 50 years old. And for those people that are nearing retirement who are worried about preservation of capital with upside potential, an annuity makes all the sense in the world.

    Would you buy term insurance to protect your family and invest the difference? If so, then an annuity with guarantees is your insurance contract. If you don’t need insurance, then you wouldn’t need or want to buy the annuity. BUT, if you would like an “autopilot” to take the risk out of the market and not actively manage your accounts (like many of your readers), then an annuity makes sense.

    The same argument can be made for permanent insurance versus term insurance but in most circumstances, the tax deferred growth and tax free access to the cash outweighs the fees in most permanent products over annual taxes.

    Your article is misleading and borders on criminal because it does not give the whole truth. Moshe Milevsky, a rocket scientist who was asked to analyze these investments, gives a thorough analysis in an article done by Kelly Greene in the Wall Street Journal called, "How to Bullet Proof your Nest Egg" on June 14, 2008 that every person should read. In contrast, you don't discuss both sides of these annuities and have fallen victim to the herd mentality that the insurance carriers can't afford to provide the guarantees. Do you know how an insurance company has to reserve for the guarantees? Do you know whether the investor can self direct the investments or does it have to be asset allocated? How does each carrier manage the underlying investments and do they do anything that pulls cash out of the market to preserve capital on a non-elective basis when the "protected value" (i.e. the benefit) is increasing and the assets are decreasing?

    Before your write another article Mr Caplinger, I suggest that you find out these answers and include them in your article for your readers. Until then, you should banned from writing for the masses.

  • Report this Comment On November 29, 2008, at 4:32 PM, bgelldawg wrote:

    gr8optimist, would you please post a link to the June 14 WSJ article, "How to Bullet Proof Your Nest Egg"?

    The WSJ web site only contains article from the last three months.

    Thank you.

  • Report this Comment On November 29, 2008, at 5:08 PM, lsnickerson wrote:

    Mr. Caplinger should do a little more homework before his next article. His assumptions reveal his lack of understanding of variable annuities. I was shocked to hear his blanket investment advice to just buy blue chip stocks. I am sure there are plenty of retirees out there pulling money out of these investments that would also take exception with this embarrassing analysis...

  • Report this Comment On November 29, 2008, at 8:19 PM, lovingliving94 wrote:

    I couldn’t help myself but to comment. I retired about 3yr’s ago now when the market was said to be pretty good, according to my accountant who at the time was looking after about $700k of mine and my wife’s money. He had us in a 60/40 split that’s 60% stocks and 40% fixed income. He told us “you’ll be just fine congrats on your retirement and please go relax and enjoy”. My wife and I also keep about $500k with a finical advisor at UBS who at the time we were thinking about retiring said you should be in a variable annuity. At first my wife and I didn’t know what to think so we asked our friends and more importantly our accountant, he told us that a variable annuity would not be a good move for us as did our closest friends. After about three weeks of thinking about it and meeting with our finical advisor and a rep from AXA we decided to go ahead with the annuity. The point of my story is this, the money which my accountant was looking after, is today worth about 40% less only because about 3 months ago we forced him to pull us out of the market and into CD’s, which we will be out of in 3 months at that time I will most likely get back into the market. The annuity that everybody other than my advisor thought was the worst idea is the only thing keeping my retirement a retirement many of my friends have gone back to work part time or sold whatever they could to avoid going back to work. As you can see annuities are not what some critic’s say they are please take it from me trust yourself and always do what feels right to you not what other people feel is right for you.

  • Report this Comment On December 01, 2008, at 11:10 AM, theo67 wrote:

    As an advisor as well, I believe the comment is too one sided. For younger people, willing to ride out market ups an downs, the fees COULD be wasted.

    For those that retired last year, they are pretty happy they have those riders.

    As for this point forward, I suppose Mr. Caplinger can see the future, as he thinks now is not the time to use a VA with a guarantee. The S&P 500 is down 5.45% right now as I type.

    But for those who are concerned about the fees associated with the income guarantees, buy the contract that has no surrender period or charges. Sit there for a year, and if you feel that you no longer need the insurance that the VA company is offering, you can move your money easily.

    And seriously, what kind of stupid comment is it to suggest you should not buy these riders because the companies want to make money? What company do you want to be involved with that does NOT want to make money? Following that thought process, you should own NO insurance products ever.

    Get real. It is an insurance companies job to study risk, and sell you a vehicle to reduce it. And yes, you pay for it.

    I am suprised he did not suggest that all homeowners that have no mortgage stop paying for homeowners insurance, since those greedy buggers are probably making money on that, too!

  • Report this Comment On December 01, 2008, at 12:24 PM, RyanHinchey wrote:

    I have spent the last 5+ years advising insurance companies around the world on designing and hedging variable annuity guarantees and can add a unique perspective.

    A few points:

    1) Annuity guarantees (specifically lifetime guaranteed minimum withdrawal benefits) are a unique product that offer:

    - Guaranteed market downside protection so the owner never loses their initial investment

    - Ability to participate in market upside and lock in market gains

    - Guaranteed income for life that the owner will never outlive

    - Guaranteed to pay heirs benefit if the money outlives the owner

    All this equals the ability to invest in the market with piece of mind

    2) A basic principal of investing is that each investment option has a risk / return profile. This means that the more risk one takes, the higher expected return that one expects to achieve – in investing there is no free lunch (as the author pointed out). For example one can put their entire savings in a single stock (very risky) and hope that this stock is going to outperform the market. Or one can invest in a diversified portfolio of stocks (less risky) and earn the market average. Now applying this principal to annuity guarantees, one can invest in say the same market portfolio. In this case, their risk will be further reduced such that their minimum return has a floor of 0% and their expected return will be reduced by the fees paid for the product (and technically, increased due to the floor). There are other pros and cons that can be factored in, but lets assume those net to zero for now. So in principal, these products fit in with the basic investing paradigm of the risk / return payoff. Figure out how much risk the investor wants their retirement savings to be exposed to, and then invest in an optimal portfolio that gives them the best expected return for that risk profile. Many financial advisors who sell variable annuities say that this translates to investing 15%-25% of a retirement portfolio in VA's for those at or near retirement.

    3) The reason there is an increase in the price of these guarantees is simple. The price of the raw materials of creating these guarantees has gone up. This is no different than any other industry that depends on raw materials to create their product. If gold goes up then gold watches goes up. When oil goes up then price of gas goes up. And in the case of annuity guarantees, when market volatility goes up then the price of creating market guarantees go up.

    Insurance companies figure out the price to charge for their guarantees by determining how much it costs to “hedge” the product (i.e. neutralize their risk) plus hold capital, and perhaps even a profit margin (they are a business after all).

    What happened over the past six months is that they were selling guarantees that were priced appropriately at the time, then the the price of the raw materials began to rise because they are sensitive to market volatility (which had increased substantially). As can be sen by the low stock prices of insurers, their profits took a huge hit because they were selling products that were likely below what it costs to manufacture them. Therefore, they are now redesigning the products such that they can cover the costs of the raw materials.

    So draw your own conclusions, but I don't believe its appropriate to call these products a “ripoff you can't afford” as they 1) offer a unique combination of features to the customer that no other commonly sold product offers, 2) fits in with the basic investing principal that there is a trade off between the risk the investor is willing to take and the expected return, and 3) the reason the price of these products will be increasing is because the value of creating and offering these products has increased. For anyone at or near retirement, please do your homework and work with an unbiased financial advisor before making a decision on investing your nest egg.


    Ryan Hinchey

  • Report this Comment On December 02, 2008, at 12:02 AM, retirementyoda wrote:

    I too am a financial advisor. The most interesting comment I see here is the one from the gentleman who retired a few years ago. I can just see the smug accountant saying "don't worry about it, it'll come back". Just like on the financial blogs and tv shows, this article is written by someone who doesn't sit in front of clients day in and day out. I do. The clients that put at least a portion of their money into annuities are sleeping well. The insurance companies are well positioned to weather the storm(s) even if they invested in the toxic derivatives.

    I love the fee conversation. How about stocks, etf's, no loads, low cost funds, uit's? Rock on cowboy! Works fine until you start dealing with clients 50+.

    Shop a few advisors, get written proposals including fees, expectations, past performance, read the prospectuses, look the guy in the eye and ask yourself if you trust him, sleep on it, think on it, don't get in a hurry. Then, be sure to put some of your money into something that is guaranteed. FDIC is guranteed. Insurance is guaranteed.

    I don't fault this writer that wrote the article. He obviously isn't trying to help clients, he is trying to promote himself so "fools" will be sure to read his blog or next article. That's the world we live in...beware.

  • Report this Comment On December 02, 2008, at 1:17 PM, tropaz wrote:

    What rip off????

    Sounds like the people who bought these protections that you claim are "expensive" wound up with the best deal in the world.

    For the people who lost tens or hundreds of thousands of dollars in value in their portfolios, probably wished they had a product for 0.4% protected against account losses. (even if there is a time frame you need to hold it for)

    I wish I had bought that product. I wouldn't feel so bad about being down 40% if I had a variable annuity with a guarantee like that.

  • Report this Comment On December 02, 2008, at 2:35 PM, nofool862 wrote:

    Dan has the usual one sided day trader perspective of hawking on fees without any look at the market history or investment value. Forget the fees and look at the numbers. A 20 year study of market performance by Lipper concluded that the average stock mutual fund grew in that time period by an average of over 12% at the same time the average investor who put money in those same mutual funds saw a return in the same time period of 3.9% according to a Dalbar study. Why the big difference? Investor behavior. Too many people have listened to people like Dan that would have you buy index funds and move in and out of the market. That advice ignores the fact that people sell when they are scared (market lows), buy when they feel safe (market highs), ignore bonds and cash, and overestimate their tolerance for risk.

    So here are the options:

    1. Have a well diversified and insured portfolio that guarantees a pension income that you can't outlive.


    2. Trade back and forth worrying about the market everyday all while getting a smaller return than the historical average 6 month CD rate. But hey at least you saved on fees.

  • Report this Comment On December 05, 2008, at 9:19 AM, gr8optimist wrote:

    For those that want to see the Wall Street Journal Article by Kelly Greene, here you go.

    If the link doesn't work, copy it and it will. You may need a subscription to go back past 3 months though.

  • Report this Comment On December 05, 2008, at 8:53 PM, Hongkongexpat wrote:

    nofool, why do you conclude that the author is a day-trader? The whole point of this article is based on the premise-- which is pretty consistent throughout ALL Motley Fool articles-- that one buys stocks for the long-term and rides out volatility. When prices on good companies drop, one adds to one's positions; the only reason to sell is if the stock price has gone up above the company's realistic value or if the company's fundamentals have deteriorated. The holding period is measured in years or decades, not minutes and days. Dismissing someone who advocates holding specific stocks for years at a time as a day-trader is not only unfair it's frankly very weird.

    And to retirementyoda, it sounds as if you don't "get" Motley Fool. OF COURSE this author isn't trying to "help clients". None of us here are Dan Caplinger's clients. The assumption is that people who are reading Motley Fool articles are interested in taking charge of our own investment portfolios-- again, for the long-term. Whether or not YOUR own clients would be comfortable taking Caplinger's advice is hardly his problem!

    I personally take the view that any money I need within 10-15 years isn't in the stock market anyway, so short-term principal protection is hardly the most important thing to me. And if I buy a stock at $50 and it drops to $10 before finally rebounding to $30, then that $50 to $30 unrealized loss is offset by the $10 to $30 unrealized gain on even more shares (because OF COURSE I bought at $10; if I liked it at $50 I loved it at $10). Meanwhile, the dividends keep rolling in.

    Of course, I realize variable annuity salesmen have to eat, too.

  • Report this Comment On February 09, 2009, at 10:25 PM, matoia wrote:

    Written like someone who is not taking the risk. There is no insurance ever bought that an honest person would wish to collect (especially life insurance!) However, the recipients of insurance proceeds are usually glad they spent the money. So go the features and benefits of variable annuities, just in case the stock market doesn't turn out quite the way we expected when we need the money.

  • Report this Comment On February 10, 2009, at 5:34 PM, kramdawg wrote:

    You people are clueless if you think for one second that every insurance company that offers VA's w/ LB's has a snowballs chance of being able to pay these off. NEVER happen...

    These "benefits" (nice wordsmithing) are completely and totally UPSIDE DOWN and MOST IMPORTANTLY- they are SOLD not bought with "pitch" that this living benefit is a "WALK AWAY" number,,,just watch the headlines on insurance company earnings the next few weeks and HOLD ON 2 YOUR SHORTS!!!

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