Annuity salespeople may soon be facing a new, huge hurdle. The WSJ reported last week that the Department of Labor has proposed that advisers working with retirement savings be held to a “fiduciary” standard. We’re all for it. A fiduciary standard means that an adviser must work in the best interests of the client and avoid conflicts of interest, such as commissions and other sales-based compensation. Registered Investment Advisers, such as DWM, on the other hand, are required to always be fiduciaries for the clients. Sales representatives and brokers for banks, insurance companies and broker-dealers, are not. They are held to a “suitability” standard based upon a prospect’s financial objectives, current income level and age in suggesting various products for which they are paid commissions and fees.
Our regular readers know that annuities and fiduciary standards have been topics in past blogs. In our June 24, 2014 blog (http://www.dwmgmt.com/annuities-buy-hold-or-surrender/) we discussed variable annuities. As a product, they do enjoy tax-free growth, which can be helpful. However, the problem is cost. According to Barron’s, the average contract cost is 1.5% per year. In addition, VAs generally use high-cost actively managed funds within, adding 1% or more. As a result, there can be a 2.5% or more drag on performance each year. These days, that may represent 50% or more of the gross return.
Insurance companies, which issue annuities, along with the brokerages and individual financial advisers who sell them, are not happy. Right now, many of these annuities pay an 8% upfront commission, most of which goes to the salesperson (who has been deciding for many prospects that these products are indeed quite suitable.) Variable annuity sales totaled $98 billion in the first nine months of 2015. Think of the upfront commissions- perhaps $7 billion to $8 billion per year. This is paid by the consumer through ongoing charges and surrender charges if the policyholder drops the contract within a certain time period, such as 7 years.
Furthermore, over 50% of the sales are made to retirement accounts. It’s amazing; retirement accounts grow tax-free, just as annuities do. So, there is no tax benefit to purchasing an annuity within a qualified account. However, as we know, there are trillions of dollars in retirement accounts which makes them perfect targets for annuity salespeople. It reminds us of Willie Sutton, the prolific American bank robber, who when asked why he robbed banks, he replied “Because that’s where the money is.”
The proposed DOL rule is expected to be finalized as soon as next month. This will likely lead to a change in upfront commissions and likely a big reduction in sales, at least in the beginning. Fiduciaries, like DWM, applaud this change. We want clients to do well, not the salespeople.
Regarding fiduciaries, perhaps some of our readers remember our blog from November 18, 2014 (http://www.dwmgmt.com/door-number-one-door-number-two-or-door-number-three/) where “Money Hall” asked readers to pick from three financial advisers standing behind doors 1, 2 and 3. Adviser #1 was a broker, whose products likely included variable annuities as we discussed above. Behind Door #2 was an RIA who was a “fee-only” fiduciary. Adviser #3 was both an RIA “fee-only” fiduciary and a value-added wealth manager, with a quality management system to organize, formalize, implement and monitor all investment management and financial planning activity for clients.
It’s amazing what some advisers, such as those behind Door #1, will do to sell their products. They try to tell prospects they always put their clients’ interests first, though their industry fights tooth and nail to try to avoid being covered by a blanket fiduciary responsibility. They tell prospects they are “fee-based”, which we have come to understand as “fee-plus” meaning that they may take up-front fees, part of fund operating expenses as well as a fee based on assets. No surprise that they are not interested in becoming fiduciaries. Their standard of living would likely take a big drop. If this keeps up, they may need to change their focus from selling “suitable products” to actually helping families increase their wealth by adding value. What a novel idea!