The top 10 reasons why people shy away from fixed indexed annuities -- and the answers that will change their thinking
By Karlan Tucker
Let's face it -- fixed indexed annuities seldom get good press, and selling doesn't always come easy for everyone, even if it's their occupation. Combine the two, and you've got your work cut out for you. It's always helpful to be a natural salesman, but it's more important to be able to provide products that offer solutions to problems and to be able to respond to concerns and questions.
Let's address the issues that cause many to shy away from fixed indexed annuities and provide the answers that will change their minds:
No. 1 -- They believe their money will be tied up.
Ask them: "Where is the most liquid place you can think of to put your money? Money market accounts? Checking? Savings? Your mattress?" Why don't people put of all their money in these locations? Because they need a return that will grow their money and fight inflation. They often also need an income that these low- or no-yield accounts can't give.
"By the way, where is your money now?" I'm in the market. "Then you're violating your own principle. I realize you can sell anytime you want. If you called your broker now, how much of what you gave him could he send you? 50 percent? On $100,000 let's say he sent you $50,000 (which is all that's left due to the market's volatility). You call him up to tell him you received the $50,000 and ask how long it will be before you get the other $50,000. He informs you that if you want the second $50,000, you have to return the first $50,000 and then wait a long time. In other words, you may have little or no liquidity.
With a fixed indexed annuity, the worst your liquidity could be damaged would be to return all but 20 percent, due to the surrender charge. However, you have the opportunity to take 10 percent annually, adding up to taking back all of your original premium in 10 years or a little longer, depending on your return and whether the 10 percent is calculated on the original premium every year or the new account value. Let me ask you, do you have a plan in place to spend all of your principal in 10 years?"
No. 2 -- They don't get all the up -- par rates, caps and asset fees are limiting.
My response: It's true that you don't get all the up with an FIA; however it is not a disadvantage to get some of the up and none of the down, compared to what most people get. Actually, with your diversified portfolio, not only are you not getting all the up, but you are participating in some of the down. Personally, I would rather get some of the up and none of the down than to get some of the up and some of the down.
Warren Buffett thinks diversified portfolios reduce your return. If you had put all your money in just the winner, you would have made more, but because we can't know that in advance, we diversify, allowing the losers to offset the winners, resulting in an averaged return which is less than the broad market's performance in most years, as represented by the S&P 500.
According to Dalbar, from 1984 to 2004, the S&P 500 has averaged returns of 13.2 percent. This return would have doubled your money almost four times over that same period. In other words, if you started with $100,000, you would have $1.6 million at the end of that period. If you started with just $50,000, you would have $800,000, and if you started with $25,000, your account would have grown to $400,000. If these amounts are more than what you actually received, then you know you've not been getting all the up. I find the simplest way to describe a cap, asset fee or participation rate is to say that as a result of these features, you don't get all the up, and that shouldn't bother you because you aren't getting all the up now.
No. 3 -- They don't like surrender charges.
Surrender charges are voluntary and self-imposed if more than a 10 percent penalty-free withdrawal is made in a given year. Let's say you had a charge as high as 20 percent for an amount taken above the 10 percent penalty-free withdrawal. Let's use the example of a $100,000 account. The first $10,000 is penalty free. The second 10 percent withdrawal would incur a 20 percent charge, or $2,000. This is 2 percent of your $100,000 account. Let's also assume that you made 8 percent on your account's growth in the same year. Effectively, what you have now done is withdraw 20 percent of the account and reduced your 8 percent interest to 6 percent, as a result of the fee. I tell people if they need more than 10 percent, go ahead and take it. It's not the end of the world.
Also, printed surrender charges which are disclosed before people buy an annuity can seem scary. They're likely thinking, "What if I need my money and I have to pay a fee to get it?" I remind them that they have signed many prospectuses that basically say you can lose your shirt, but because there is not a printed schedule of the market's volatility charges and because they think everybody else is doing it, it must be okay. I have had many people come into my office and show me statements with losses of as much as 50 percent, but because it was not in print in the form of a penalty schedule before they bought, they bought anyway. I have never seen an annuity with a 50 percent surrender charge. Remind your client that surrender charges are in their control and that they don't come into play unless the client makes that choice. Further, remind them that the market's volatility charges happen to them involuntarily.
No. 4 -- Their broker doesn't like annuities.
Typically, brokers don't sell the safe stuff, other than variable annuities that can lose principal. It shouldn't surprise your clients that their broker doesn't like anything he views as having the possibility of taking away accounts. I have not met many brokers who don't sell FIAs who actually understand them, much less have the ability to be able to fairly and accurately explain them to their clients. Not many people would recommend that you get your advice from someone who doesn't offer or understand the product you are considering. I always ask my clients if their broker owns the same products he recommends to them. I tell them I own FIAs and that I have experienced firsthand their tremendous ability to credit competitive returns as well as above-average double digit interest -- all without risk to my principal and without having to worry about the next downturn that otherwise would take back the gains.
No. 5 -- They are concerned that the advisor gets a high commission.
I don't mind telling my clients that the longest, highest-paying FIA I sell has a term of 16 years and a street level commission of 8 percent. When I divide 8 percent by 16 years, I get 0.5 percent per year in compensation. I also tell them that the broker who is telling them not to buy because of high commissions is in all likelihood being paid 1 percent per year, which over 16 years would be 16 percent, or twice what I get paid.
No. 6 -- They don't like the fact that the index calculations don't include dividends.
Once again, it's true that they don't get all the up. I ask them if they can give me an example of something that includes or pays dividends that has no risk to their principal and previously-earned gains. It's not a perfect world, and I admit I'm not offering perfection; but I remind them again that they don't already own a perfect strategy, either.
No. 7 -- Their broker says FIAs aren't appropriate for qualified funds such as IRAs and 401(k)s.
Since when is tax treatment the only consideration when one is considering buying a product or making an investment? It's true that from a tax standpoint it's a wash, but what about safety, opportunity and liquidity? All of these should be considered, as well. When looking at the complete picture most people agree that it makes sense to have some money in an FIA. This product is not likely to duplicate any other investment they have. We are all taught to diversify, and an FIA is a great way to do it. Think about safely linking to the horsepower of 500 stocks represented in the S&P 500, as compared to owning a couple of stocks directly. This is much greater diversification.
No. 8 -- They are concerned about trusting an insurance company with their money.
I find it interesting that people trust insurance companies with insuring their homes, cars, health and life, but not their nest eggs and income. If we can feel okay about trusting them with all of this, then we ought to be okay with having them insure our nest eggs and income. No owner of an FIA has suffered any losses due to a company failure, even in these unprecedented times when many banks and brokerage firms have failed.
No. 9 -- They don't believe there is enough horsepower in an FIA, and feel they can make more in mutual funds.
We already know that the best way to grow money is to never have to make up for a loss, even for one year. Annually adding interest that has been generated from stock market indices, a bond index or the fixed account to the highest amount you have ever had minus voluntary withdrawals over time will compete very favorably with a volatile market that continuously takes back previously-earned gains.
I call the last 10 years the Lost Decade(TM) because many put up the capital, took the risk and have nothing to show for it. If you had been in an FIA for the same period of time, the story would have been much different and vastly better.
No. 10 -- They think the fees are high.
Actually, there are no fees, unless an income rider is added on, in which case the fees range from .30 basis points to .65 basis points annually. The insurance company makes a spread between the gross of the bond portfolio's yield which they manage and the net credited to the client's account. This spread is not unlike how banks make their money, and typically ranges from 2 percent to 3 percent annually. From this spread, the insurance company pays the agent, covers the insurance company's expenses and returns a profit to its shareholders.
The difference is that a spread is not taken from the contract owner's existing account balance. So, in a year where the annuity credits zero growth due to a flat or declining market, the FIA owner gets a true zero -- not zero minus 2 percent to 3 percent in management fees, which is what happens on brokerage accounts, adding insult to injury.
I know these answers work to change the thinking of prospects, as I have personally used them in over 5,000 interviews, spending approximately 10,000 hours understanding how people think when it comes to investing and making a commitment. Make these answers your own!
I wish you great selling!