I was sitting watching college football, just like you probably have many times, when the TV camera followed the running back after a fake handoff from the quarterback.
Completely unaware of the mistake, the camera stayed on the player without the ball, the wrong offensive threat. I yelled at the dumb TV as I listened to the play develop outside of the viewing area. I share this with you, because in a recent interview with ThinkAdvisor, Stan “the annuity man” Haithcock, like the camera in the story, follows the wrong offensive play.
He favors single premium immediate annuities (SPIAs) and QLACs (a subject for a different day.) On his website, Stan says SPIA’s with a cash refund (I’ll define those later) are like having your cake and eating it too. I may not have the self-proclaimed title of Annuity Man, but Stan has missed the play.
(Related: Wake Up, Dave Ramsey: Your Math Is Flawed)
For the sake of newcomers to this topic, let’s get the financial gobbledygook taken care of first. Jump past if you have been distributing annuities since mood rings were new and it’s too sophomoric.
What’s a single premium immediate annuity?
A SPIA is where you send an insurance company a pile of dough (not literally) and they send you a smaller pile of dough each month as long as you’re alive. Pretty cool unless you die few days later, then it’s not so pretty. To overcome this, the income can be modified to include a spouse’s life, or a set number of years, or inflation protection, or many other circumstances. But every little option adds up, and every additional guarantee reduces the monthly income.
What’s a fixed index annuity?
An FIA is where you send an insurance company some moolah (not the donkey variety) and they put a smaller pile of moolah into your account each year based on how a specified market index performed. Simply, when the index goes up, they give you some moohlah, but it’s much lower than what the index went up by. You agree to take a much smaller share of the gains, in exchange for none of the losses when the index goes down. You are not invested directly in any stock, bond, or market index.
What’s a variable annuity?
A variable annuity is where you send an insurance company some clams* and they use those clams to buy mutual funds you specify, in exchange for you giving them some clams each month, quarter, or year for building the product.
* The Flintstones used clams for money. One wonders: What did the Jetsons use?
Both FIAs and VAs can have a lifetime income benefit rider (LIBR) attached. A LIBR guarantees a monthly income even after your account value is reduced to zero.
Here’s the problem: FIA growth is often overstated, VA fee/internal costs is often understated, and LIBR is often misrepresented as guaranteed interest, or growth, rather than income.
Here’s a very basic way to view an annuity.
Have you ever owned a business? No? Okay, then imagine you own lawnmowing company. You charge $35 per cut for a standard lawn. A condo association contacts you, and tells you they have 100 standard lawns, and want you to mow regularly, but will only pay you $2,500 per cut ($25 each lawn). It’s a reduced amount, but you would still be making money.
Would you take the reduced income per cut? You shouldn’t because you’d be lowering your profit on a lot of cuts. Yet, many businesses will offer a discount for larger and repeat customers. Why? The consistent income gives the business security and assurance they can pay their monthly overhead, even with unexpected fluctuations in sales. Isn’t this reasonable? In essence, this is an annuity.
“The annuity man,” Stan says a SPIA with a cash refund is like having your cake and eating it too. A cash refund simply means the insurance company sends the rest of the dough, moolah, or clams you sent them to your beneficiaries (the lucky bloats who financially benefit from your death).
Here’s an example:
- You send the insurance company $100,000.
- The insurance company sends you $1,000 per month for life.
- After 20 months and 20 payments, you die (sorry).
- The insurance company makes a final payment of $80,000 ($100,000 minus $20,000) to your beneficiaries.
Notice the amount paid to your beneficiaries is exactly $80,000, not $80,000 plus interest. In other words, a SPIA with a cash refund is basically an FIA or VA with a LIBR which hasn’t earned more interest than its fees. Thus, a SPIA with a cash refund is simply a cruddy, crappy FIA or VA.
Before I go any further, let me say this. I agree with Stan that annuity marketing is often misleading. Income benefits are overstated, growth is overpromised, and fees are often mispresented. This is akin to saying anyone with a British accent is a genius, while anyone with a Southern accent is cross-eyed and will marry their sister. Absolutely stupid, and so is the argument that misleading annuity advertising negates the many positive features of an annuity used correctly.
Further, if commissions were the only thing persuading producers to sell annuities, then why wouldn’t the carriers who offer the highest commissions, like National Western Life, have the top-selling annuities? Since they don’t, and rarely if ever do, then this argument is fundamentally flawed.
So is his argument that higher commissions are at the detriment of the consumer. They can be, but this isn’t universally true. Compensation is necessary to provide services. If the only service a client needed was help filling out an application, or understanding standard insurance lingo, then compensation should be reduced. However, clients require much more. They lean on advisors, planners, and insurance agents for help with issues like taxes, income planning, long-term care issues, and even bona fide counseling at times. In other words, Stan’s argument should be how do we ensure advisors, planners, or insurance agents provide the services they’re compensated for, that they promised they’d provide, and that the client expects?
Okay, and deep breath, I’m ready now…moving on.
So how is a SPIA with a cash refund a crappy FIA? Here’s how.
This is fun. I promise. I used immediateannuities.com for the SPIA quote which would presumably spit out a competitive income. For the FIA I used an insurance company who calculates their LIBR charge on the account value. I personally believe this is a better fee format, but the argument is irrelevant to this argument, so we will not travel down that rabbit trail.
Here’s the details:
- 65-year-old male
- $150,000 premium
- Income to start after 3 years
Here’s the guaranteed income:
- SPIA: $863 per month
- FIA(1): $804 per month (actually $803.94 but I think we’re splitting hairs here.)
- FIA(2): $863 per month but $161,000 deposited rather than $150,000.
To get the same income as the SPIA, the purchaser could also just defer the income from FIA(1) for one additional year.
Too many numbers? NO! But just in case let’s make this easier.
Here’s how they compare.
Death Benefit after five years of receiving income:
- SPIA: $98,220
- FIA(1): $138,600*
- FIA(2): $148,786*
*2% compounded annual growth rate net of LIBR fee.
Since the monthly income was lower, the FIA did pay out $3,540 less than the SPIA over the 60 months. Would you give up $3,540 of income to have $40,380 more? Who wouldn’t!
Similarly, to keep the same monthly income, and to take income at the same starting point, you could deposit about $11,000 more and receiving about $50,000 in additional benefits. Easy as pie… I too can make bakery related similes.
Account value after five years of receiving income:
- SPIA: 0
- FIA(1): $138,600*
- FIA(2): $148,786*
*This doesn’t include any surrender charges.
At 10 years, the gap increases. Death benefits are as follows.
- SPIA: $46,440
- FIA(1): $101,817*
- FIA(2): $109,300*
*2% compounded annual growth rate net of LIBR fee.
The only time the SPIA with a cash refund is better, is when the account value and death benefit of FIA(1) and (2) is reduced to zero. This occurs between the client’s 88th and 89th birthday.
Here’s what Stan the self-proclaimed annuity man hasn’t considered: Maybe the reason SPIAs aren’t popular has nothing to do with low commissions.
Maybe consumers don’t buy SPIAs because of the way it makes them feel. People don’t like going from $400,000 in assets, to $250,000, after they put $150,000 into a SPIA.
Maybe, just maybe, people buy other annuities with LIBRs not because of snazzy sales-pitches (although this does happen) but rather because of the sense of security they have knowing they’ve got growth potential along with guaranteed income they can’t outlive. Quite frankly, the latter sounds more like having your cake and eating it too.
— Read 8 More Dave Ramsey Myths Debunked on ThinkAdvisor.
Michael Jay Markey Jr. is a co-founder and owner of Legacy Financial Network and its associated companies. He has been a member of the Million Dollar Round Table member and a winner of Court of the Table and Top of the Table honors.