Fiduciary Standard Closing in on Reps and Brokers

willie sutton3Annuity 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 ( 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 ( 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!

Annuities: Buy, Hold, or Surrender?

annuitymapAnnuities are big business: $142 billion sold last year. The hottest ones are deferred income annuities (“DIAs”), an old concept with a tweaked name and sales pitch and lots of new customers. Is an annuity right for you? Sorry, the answer isn’t as simple as the sales pitch.

DIAs were featured in a NYT article on June 6th. Invest now, in a lump sum or periodic payments, in exchange for a guaranteed paycheck for life that starts some years later. Sales man Matthew Grove of New York Life sees it this way, “It’s people realizing that, ‘I can invest in bonds, but I won’t get as much juice. I can buy equities, but I am taking more risk.’ This is kind of right in the middle, where I am driving income, but I am basically doing it with no risk to myself.”

Au contraire, Mr. Grove. Like any investment, annuities come with risk, and often with more risk than a managed investment portfolio.

Here’s an example: a 55 year old man invests $200,000 in a fixed annuity. In 10 years, at age 65, he starts drawing monthly income of $1,750 for life. Actuarial tables tell us he is expected to live to age 85, so an average individual would receive $420,000. The return on his $200,000 would be roughly 3.85% per year. Not a great return, particularly if you are in the 50% of investors who die before age 85. Furthermore, with inflation appearing to be ramping up, how much will $1,750/mo. buy in 30 years? Annuities are illiquid; you can’t tap into the principal. Also, annuity buyers are relying on the financial security of the insurer, for decades into the future.

What about variable annuities (“VAs”) that invest in equities? The concept again is to grow assets tax-free, like an IRA or 401(k), and then withdraw in the future. The problem is the cost. Barron’s annual report on annuities, published Saturday, identified 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 could be a 2.5% annual drag on performance. As our DWM clients know, passive funds and ETFs outperform actively managed funds over time, primarily due to cost. A 1% annual additional cost over decades can take a huge bite out of your investment.

How about a VA with guaranteed benefits? Before the financial crisis of 2008, a number of large insurance companies sold a decent product. It was a VA with a guaranteed annual 7% growth factor. An individual could invest $100,000, for example, with a 10+ year guaranteed annual net return of 7%. Yes, the contract was expensive, 2.5% in fees plus the operating expenses of the funds. But, here is the good part- at the end of 12 years, e.g., an investor could take either the account value (net of the fees) or the guaranteed value of $225,000 and annuitize it (that is, start taking monthly payments). It was a good deal.  In fact, it was so good that insurers aren’t offering them anymore.

Lastly, how about a single premium immediate annuity (“SPIA”)? A 60 year old can invest $200,000 and get a 6% annual return ($1,000 monthly check) for life (roughly 24 years are expected). The return on investment would be 3.24% per year on average. Roughly ½ of each payment is return of principal and ½ is interest.


BUY? In today’s marketplace, we do not think annuities are generally a good investment for clients with investment assets exceeding $500,000. Of course, there are exceptions.

HOLD? If you own annuities, you should review them with an experienced, independent financial adviser such as DWM. You may have a good one (like the 7% program above) or you may not. However, you may be able to exchange them tax-free into a vehicle with lower fees and better investment choices. Jefferson National, for example, has a contract with a low monthly fee and a wide-range of passive investment funds.

SURRENDER? Don’t surrender an annuity before getting advice from an expert. Income taxes are not paid on annuities until distributions begin. So, there may be significant tax consequences and surrender charges. However, if the accumulated earnings are low or the contract is held in an IRA, for example, it may make sense to surrender the contract even if you have to pay a small amount of income tax in order to emancipate your funds.

Contact us to discuss your individual situation.