When a columnist on LifeHealthPro.com recently spoke out against indexed annuities (IAs), IA proponents fiercely defended the product, stirring up a heated debate over what is essentially an insurance contract—a complex one, but an insurance contract nonetheless. In baseball terms, the debate may not be hot as the rivalry between fans of the Yankees and Red Sox, but it's pretty close.
The FOES
Coming out against IAs are financial planners (mostly registered reps) who rail against the product's high fees that cut into the investor's return.
"If I had to give a number-one bottom-line critique of annuities in general, it's that costs are very high," said Jeff Feldman, Ph.D., CFP, owner of Rochester Financial Services in Pittsford, N.Y. Feldman is a fee-only, independent RIA.
"With the indexed annuity, they are guaranteeing you are not going to lose money or your losses will be minimized," Feldman said. "[But] there is no such thing as a free lunch. You are paying for that."
Feldman further maintained that the major selling point of an IA—a guaranteed rate of return—is something of a mirage.
"They are not really guaranteeing 5 percent on your principal, they are guaranteeing 5 percent on what they call an income base," he said. "The income base is what in 10 to 15 years you can draw on. They bring in life expectancy and other factors to be able to promise a certain payout in retirement. So they are not really guaranteeing your principal, they are guaranteeing an income stream at retirement. People don't realize because they have a limited life expectancy you don't have to have your principal grow in order to promise a certain amount of a payout."
Complexity, illiquidity and lack of upside potential are Michael J. Hardy's main objections to indexed annuities. Hardy, a CFP, is a partner at Mollot & Hardy, Inc., which has offices in Buffalo, N.Y. and New York City.
"My hang up with indexed annuities is that they are awfully complicated for the average person to understand," Hardy said. "If you have an investor going into one of these products, are they truly going to understand what they have five to 10 years later? It's also the illiquidity, the fees and penalty issues. And also a lack of upside that one has in the contract. I'm not against annuities. I think they certainly have their place for certain people and I do use them for clients. But I've never been able to fully find the reason to use indexed annuities."
The FANS
Sheryl Moore, president of Annuity Specs.com, in Des Moines, Iowa, said the primary reason for the negative reaction against indexed annuities is a misunderstanding about how insurance-only agents, who sell IAs, and registered reps, who sell securities like variable annuities, are compensated. Insurance agents get an upfront, one-time-only commission for an IA, while registered reps are paid yearly on how well a client's portfolio performs.
Consequently, a registered rep sees the commission on an IA and assumes it's too high a price for a policyholder to pay, Moore said. However, when spread over the life of an IA contract, that one-time commission equates to what a registered rep would get on an annual basis. "You're comparing 1.5 percent a year every year for four years to 6 percent upfront on a four-year product which is exactly the same," she said. "They don't understand the commission works different than theirs, so automatically it's a high commission product and that means it's not good for the client."