The Bad Reputation of Annuities¹ – the Rosenthal Family’s foundation lost money, despite stock markets doubling, while the salesperson got rich
Marcus Schafer (00:05)
Hey, this is Marcus Schafer, Director of Growth at Greenspring Advisors alongside Pat Collins, our CEO. And we are here today to talk about why annuities get a deservedly bad rap. There are some good aspects about annuities. We’ll talk about those, but what we’re really going to focus on is the research around why annuities are very, very difficult for retail investors to come out ahead on.
So maybe to start this, we’ll start with, think, a sensational story, but something that’s really well grounded that a lot of people experience, maybe to different dollar sums. So there’s a story in the Wall Street Journal in 2014 about a family called the Rosenthal’s. And they’re in Minnesota. They had some tragedy in their life, and then they got this unexpected windfall. They won a lottery. Almost $60 million was the after-tax payout of this lottery.
And because they’re good people trying to do the right thing and they experienced tragedy in their family, they set up a foundation. Foundation was about $30 million. Small town America, how to think about how to set up this foundation. They went to their local insurance provider, advisor, kind of difficult to tell sometimes in between the two, but they go to this guy and he flies him out on a private jet to an insurance company and they invest in
variable annuities for their portfolio. Something like $2 million of fees just on the front end of $25 million foundation, $2 million of commissions. Turns out it’s closer to 6 % commissions on the front end, 2 % ongoing fees. And they look back at this portfolio like a decade later and it’s lost money, which is pretty tough to do because the S &P doubled in value.
over that time period. And so they naturally had a lot of questions. We know about the story because there’s a court case and the people involved had to settle and it’s very expensive. But wow, what a crazy outcome. Not the use case for annuities really fit it in. Just terrible. Just terrible.
Patrick Collins (02:16)
I read the same story. Obviously, we were chatting about this. I had a few takeaways that I thought were worth mentioning. First is, if someone ever flies you on a private jet to talk about investments, you should probably be concerned. Most people don’t do that in our industry. So I think they smell blood in the water when these insurance agents flew them to wherever they flew them to to talk about the annuity and insurance products they sold them.
You know, the other things that were in my mind really telling in the article was that they not only bought the annuities one time, which I think we’ll get into, has all sorts of problems. But the other part of it is they, after probably a surrender period, which we’ll talk about what that means, they bought them again. They went and sold them and bought a new set of annuities and got a whole new set of commissions associated with it. So there was all sorts of problems.
with this advisor and what was going on here. The author of the paper estimated that the account should have been between $12 and $25 million more than what it actually was. So you put that in real terms, this was a foundation to support a disease or the research on a disease that had taken the life of their daughter.
And you think about all of the support that could have gone towards and instead it went to an insurance company. So I’m looking forward to getting into this. Hopefully people will take away some lessons from this podcast because we’ve just seen so many abuse or bad cases of how these things are sold. So like you said in the beginning, there are really great uses for annuities and we’re going to talk about what those are, but there’s also times where they have been missold.
And that’s probably more the majority. And so I think that’s what we really want to get into.
Insurance Isn’t Bought, It’s Sold – how simple sales pitches mask 500+ pages of legalese even Pat struggles to understand
Marcus Schafer (4:03)
It’s situations like this that just are so infuriating, right? Because you have somebody trying to do all the right things and you just have a system set up to take advantage of them. It’s not right. And it really sucks, especially when you consider how well the other investment options have progressed, right? It’s like…
over the course of this time period, hey, you could have invested in these really low cost index solutions, maybe done a little better, but you could have had much different outcomes and it’s bad advice you’re getting. You know, you have to wonder in a situation like this, are you getting advice or are you getting products? And I think that’s a really, really big difference. But one of the things you mentioned is like, why do annuities get a bad rep? One of the reasons is they’re often a fear-based
sell, right? So somebody’s looking for some sort of peace of mind and, hey, I have this great thing that checks all these boxes. So maybe talk a little bit about how you’ve seen clients or people that have come in and asked us for help. Why did they first kind of get these annuities?
Patrick Collins (05:14)
I think there’s the old adage that insurance is never bought, sold. And I think that’s true and annuities fall into that camp, they’re an insurance product. at face value, when you hear the pitch of an annuity, it sounds too good to be true in a lot of ways. And obviously, again, an old adage, that usually is the case. But the way it’s typically sold is you can get the upside of the market with no real downside.
And, know, that sounds pretty good, especially for someone who’s afraid of where the market might go or just the volatility in the stock market. So to your point around fear, I think it does prey upon the fear that many people have around volatility in the stock market. A lot of people view the stock market as gambling or as this risky type thing. And if someone comes along and says, I can take the risk out of this equation.
that really does prey upon the fears of people. And it sounds like a really, really good deal. And I just think that people probably don’t dig in enough to understand what they’re actually buying. I think that’s probably the first part of why they’re missold and how they’re missold is through the use of just maybe touting some very high level details, just the things that they know will really resonate with the client. And then maybe leaving out some of the things that
Marcus Schafer (06:30) Yeah.
Patrick Collins (06:35)
aren’t so good about them.
Marcus Schafer (06:37)
Yeah, and it’s this other thing that’s really challenging, and I think why they get a bit of bad rap too is they’re incredibly difficult to understand. There’s all these terminologies. You’re hearing them for the first time. They throw around the word guarantee.
And then you have to unpack exactly what’s being guaranteed. What’s the dollar amount that’s being guaranteed? What’s not being guaranteed? There’s all these moving pieces. hopefully today we’ll get into what are some of those different things and just an educational aspect so people can learn a little bit more about, Hey, what does this cover? What does this not cover? So hopefully we’ll, we’ll talk about that. And you know, the other, the other challenge is obviously high fees.
Right. It’s, Hey, you take the fees of an investment account in many situations, and then you start just adding layers and layers of fees. Some of those fees are optional. You add them on depending on what you select. Some are just embedded. Hey, the nature of the business is there’s going to be more fees because this is actually kind of an insurance product. It’s not just an investment, not just an investment vehicle.
Patrick Collins (07:43)
Yeah, about 10 years ago, it was longer than that, that we started really seeing clients come to us that were thinking about buying them or actually had bought them and were kind of upset five years later and said, what did I get myself into? But I decided to take a look at one of these products and I looked for the year of what the highest grossing annuity product was and I went and pulled the prospectus on that. So this is the legal document that they technically have to provide to anyone that buys these things.
And it was over 500 pages long. As I read through it, the complexity of these products, I was convinced. I mean, I do this for a living and I had a really hard time, nearly impossible, trying to figure out exactly the mechanics of these products because you would read sentences and they would go on for a half of a page, a sentence, and they would reference things that was unclear.
Marcus Schafer (08:21) Yeah.
Patrick Collins (08:37) I was kind of convinced that the people that are selling these things probably don’t fully understand what they’re selling either. And whenever you have complexity as a client, that’s just something that you have to be really careful of. You should be able to articulate why you’re doing what you’re doing and how the product works. And if you only know at a surface level, I think it goes up and doesn’t go down kind of thing. That probably is a very, very small element of how this annuity works.
Marcus Schafer (08:51) Yeah.
Patrick Collins (09:02)
That’s an element of it. The fees are, like you said, extremely difficult to even figure out to some degree. You don’t know exactly what these annuity companies are making on these. You don’t know exactly what the agent is making a lot of times. I looked up prior to the podcast here, just curious. I went to one of the largest insurance companies that sells annuities, and they also were in all sorts of other financial services, business lines, retirement plan consulting, group benefits.
What was interesting to me was that annuities were the, by far, the highest part of their net incomes as a business line. If you added up every other business line that they had, it still didn’t make more money than just the annuity line item. So that tells you something, that these companies make a lot of money on these annuity. Making money is not a bad thing. But obviously, when you make really high margins, this is the net income that they were making.
that creates incentives. they want people to go sell these things. And so you have to be mindful of that when you’re the end user is, are these things good for me or is it good for the insurance company?
Annuities’ Intended Purpose² ³ ⁴ ⁵ – longevity insurance has a role and has existed since Ancient Rome
Marcus Schafer (10:04)
Yeah, well let’s, you know, we keep talking about annuities. Let’s maybe define what they are and that definition has maybe kind of evolved a little bit over time, so we’ll talk about that. But highest level, what an annuity is, you take dollar amount, what they call premiums. I view this as maybe like a deposit and you’re exchanging that deposit for payouts in the future. It’s kind of like, hey, I’m going to give you $100,000 and you agree to give me a salary every year.
And what’s really difficult is that’s an insurance contract, which means there’s different terms for everything. So it can be an annuity until I die. There could be additional benefits. It could say, hey, I want to set term for how long this exists. But annuities have been around for a super long time. They go back to ancient Rome, new eye. They go into Middle Ages France, tontines. I think I said that right. I could barely speak English sometimes. I’m not sure if I can cover French.
They’ve been in America since the 1750s, so these are really long running solutions. And at the just that, I’m going to give you some money right now, and in exchange for that, I would like you to give me a fixed stream of payoffs. And the real theoretical benefit to this is an insurance provider can pool mortality risk to help hedge against longevity. So what it’s saying is…
By getting everybody together, we think that your expected value can be more than whatever you deposit with us. And we can maybe talk a little bit about what the research shows around is that true? What are some major other benefits? It’s insurance, so there’s another benefit to just certainty and peace of mind. But that’s what an annuity is. Pat, correct me or add on as appropriate.
Patrick Collins (11:52)
You’re absolutely right. the only thing I would add on to that is that there’s a real benefit to what you’re talking about, which is kind of in its purest form, an annuity, what you really are getting is longevity insurance. You think about it’s the opposite of life insurance. Life insurance protects me if I die early. Annuities protect me if I live a long time because I can’t live this, you know, can’t outlive this income stream. So for a lot of people,
Marcus Schafer (12:00) Yeah.
Patrick Collins (12:16) This is like a pension or social security. It’s a very, very similar type of product. So it can add a tremendous amount of value and peace of mind for someone who is getting into those retirement ages because you know that you can’t outlive this asset. And that is different from an index fund. It’s different than a bond. It’s different than a traditional financial product. So that’s why I said in the beginning that these are good products. They do serve a purpose.
And we’ll talk about maybe where it makes sense to consider annuity as if you’re an investor or you’re a retiree, when do you think about buying an annuity and maybe when does it make sense to not? But the longevity component of it is really compelling. Now, over the years, and especially probably over the last 30 to 40 years, the insurance companies have realized that one, people don’t
buy a lot of annuities in the traditional sense that we’re talking about for a lot of reasons. If I’m a client and I put my money into an annuity, I put, to your example, $100,000 in the annuity, there was a couple of downsides to that. One is I no longer have access to that $100,000. I’ve exchanged it for an income stream. So that’s problematic for some people because they like to know they have flexibility with their money. The other part of it is that if I die a year later,
maybe I’ve only collected $6,000 of income and I gave up $100,000 for it. So it’s not a great deal from that perspective. So there are some downsides that people don’t like about annuities. And what the insurance companies started to look at is, is maybe we can add another layer to this to make it appealing. And that’s where kind of the deferred annuity comes in, which basically is the same thing as an annuity. But what they say is, that
in the beginning part of it, instead of turning it into an income stream, we’re going to let you defer for some period of time. And during that period of time, we’re going to hopefully have you accumulate more so that at the time that when you do it, you turn it into this annuity or income stream, you have a higher value. And this is the vast majority of annuities that are being sold today are these deferred annuities. And there’s all sorts of different flavors that we’re going to get into, but that’s really where kind of the insurance companies have taken it.
Marcus Schafer (14:36)
Yeah, it’s a what I defined is what’s called a SPIA. So it’s a Single Premium Immediate Annuity. That’s in 2024. I looked it up according to trade associations that represent this group. the numbers coming from them, 3 % of the dollar value of annuities sold. So you’re sitting there thinking, hey, this is what I’m being told an annuity is. Nobody’s selling it. Well, why aren’t they selling it?
It’s because it’s a lot more competitive, right? You can go across and say, what do I really care about? I care about the premium I’m paying and how much I’m getting every month. And that’s a very competitive market because you could go through there. We’ll talk about maybe nuances to credit quality of the insurer, but that’s pretty competitive. And where all the real fees are, all the monies to be made is something where you can have
a lot more opaqueness, which is the deferred annuity market. And maybe I’ll just talk a little bit about the math that goes into this, because we talked, I mentioned the theory is that if you pool a bunch of people buying annuities, you can all get better outcomes than you could individually. And what you could do is you can look at the price of the annuity, how much premium you have to get.
What’s the price of that? What’s your expected payoffs? How long you expect to live? And what else could you get if you invested in something with maybe a similar risk type tolerance, right? Like go buy a treasury bond or go buy a corporate bond and ladder it out. And when you do this math, you don’t get an expected value of one, which means you’re trading certainty of those payoffs for lower expected value.
And that number changes and a lot of the research is going into, well, why do we think that? And there could be some sort of adverse selection going on, right? Which is if I know I’m going to live a really long time, that annuity is a better deal for me than if I know I’m not going to live for that long. So who goes and buys annuities? It’s people that think they’re going to live for a really long time and are confident on that because they know they can get much more value out of it than someone.
someone else. If you look at the research, have gotten better. 70s, 80s, 90s, dramatic increase in improvement in terms of the value consumers are getting. Since then, maybe not so much improvement, probably a little bit. But you’re looking at saying, if you spend $100,000 on a premium, it’s somewhere between you’re getting $70,000 and $90,000 of expected value. So there is a trade-off there.
The good economists will tell you there’s no solutions, just trade-offs. So that’s kind of the state of the market today.
Patrick Collins (17:34)
Yeah, and I think it’s always important to think about incentives too for people in our industry if they’re being paid on some sort of commission type schedule. And when you think about an annuity, well, let’s go back to our story in the very beginning of this agent who sold a bunch of deferred annuities to this foundation. And then after a period of time, it didn’t mention in the article, but I’m gonna guess seven to 10 years when the surrender period started to
to burn off, they probably went back to the client and said, we need a new set of annuities that you need to buy. So when you put it in deferred annuities, you can come back and sell more stuff to those people. Whereas an immediate annuity, that money, once it’s in the immediate annuity, there’s nothing to sell them anymore. They’re just getting an income stream. So you don’t get a double dip on your commissions or whatnot. So I think that’s important as far as the standpoint of incentives to think about.
from the agent standpoint is that money now is no longer accessible to buy other types of investment products. So again, I don’t want to assume that everybody is greedy and evil, but you also do need to understand the incentive structures that are in place.
Marcus Schafer (18:42)
Yeah.
Yeah, you have to understand the incentive structures. I think there’s this term in the research of annuities called the annuity puzzle, is people, obviously you’re retiring. What do you want? You need to replace the salary that you’re no longer getting. And the more certainty you have over that replacement.
The more confident you can go live your life, that’s a really, really good thing. So annuities should be a really, really good thing. But then you just go and you start to look at the research rates. Well, only 3 % are being sold for that purpose. Well, if you look at the deferred annuities, the variable annuities, it’s really tough to understand what’s actually annuitized. So somebody says, I’m using this to build up my value, and now I want to convert into that SPIA
Maybe 5 to 20 % of those, it’s really tough for me to understand exactly, is actually being converted. So there’s a lot of research trying to figure out if this is a really good thing, why aren’t people taking advantage of it? And a lot of it is costs, adverse selection. And then there’s also some fixed payments where you look at the payments you’re getting and you still have to beat inflation. And do you have the proper inflation hedges?
attracted to that. There’s a lot of confusion. So again, think SPIAs, they have a purpose. They’re much clearer. The trade off is better than deferred annuities. I kind of mentioned you for $100,000 of premiums, you get 70 to $90,000 of value, decent trade off. Now, once you get to the deferred annuities, that value starts to be at the lower end where sometimes it can be as low as, you know, $50,000 of value for $100,000.
of premiums. So let’s maybe just talk a little bit more about these deferred annuities, variable annuities. There’s all these terms. Let’s just get into it, Pat.
Patrick Collins (20:40)
Yes, I think the comments you’re making around the annuitization and the rate at which people annuitize is important. So one, we know that only about 3 % of policies are actually immediate annuities, meaning that they’re going to provide an income source. And then the remainder, 95, 97 % of policies, only a small fraction of those are actually being turned into an income stream that you can’t outlive. And so what does that mean? That means the vast majority of annuities being
Deferred Annuities as Accumulation Products – most annuities sold today are hybrids of costly, complex investment/insurance vehicles
purchased today are A, deferred annuities and B, are being used for accumulation purposes. So if that’s truly the case, then you’re going to want to compare that. if that’s, and again, if that’s what you’re buying an annuity for is the thought of, want to accumulate more assets, not necessarily because I want to turn it into an income stream. You’re going to want to compare those options with other options you have to accumulate assets.
And I think that’s where, you know, kind of diving into these deferred annuities makes some sense because that’s really how they’re being sold and how they’re being used by the end investor. So there’s really a few different flavors of deferred annuities. And I think we’ll probably touch on, you know, three or so of them. The first one is going to be really simple. And it actually is one of the higher, you know, kind of grossing areas of the market. And that’s just fixed annuities. And you’ll see these a lot of times at banks.
some insurance agents will sell them. I would put them on the same kind of line item as CDs, or treasury bills or things like that. It is a, it’s the length of period. There’s a contract term and you get a set interest rate guaranteed by the insurance company. They tend to be in that same ballpark of whatever the, you know, whatever, like a CD might be, might be paying. So, you know, with those, I don’t think
Clients can get in too much trouble with those. There’s some benefits. Annuities do have a tax deferral nature to them. So meaning that if I buy an annuity, all of my growth is tax free until I pull the money out or tax deferred until I pull the money out. So similar to like an IRA or something like that. So fixed annuities are pretty straightforward. I don’t think clients can get in too much trouble. You’re not gonna have a much upside with those, but you’re gonna have something similar to a fixed product that you might buy somewhere else.
Then you get into kind of the other more complex products that are out there. So you will find equity indexed annuities. So these are annuities that are going to be tied to an index typically. So this is the ones that’ll say something like, you get some percentage of the upside of the S &P with the floor, you can’t go under this amount. And so it sounds pretty good. It’s like, wow, I could get
Marcus Schafer (23:19) Mm-hmm.
Patrick Collins (23:20)
80 % of the upside with no downside. That sounds really good when you end, but there’s nuances to those that we’ll talk about. Then you have variable annuities that are basically like you put your money into these products. Again, it’s deferred and it looks a lot like mutual funds. You are allocating your money across a bunch of different types of investments. It could be stocks, bonds. They usually have a menu of choices that you’re going to select from.
And there are all sorts of bells and whistles and riders, they call them, on what they kind of attach to those to figure out, you know, things like guarantee. And anytime you hear the word guarantee, that is a concern of mine when I hear that. And the reason why is to guarantee something, you should expect returns similar to what you would earn in another guaranteed investments. Nobody can guarantee a return twice as much
as what the true risk-free rate is. It’s just, you know, eventually something’s going to go wrong there. so whenever you see things like guaranteed withdrawal benefit, guaranteed death benefit, there is a cost that is bringing your expected returns down significantly. And again, we can start talking about some of the numbers, but those are kind of the flavors of the annuities. Again, I’d say fixed annuity, straightforward compared to a CD. The second is an equity index annuity.
Marcus Schafer (24:39) Yep.
Patrick Collins (24:43)
much less straightforward. It’s going to have things like participation rates, cap rates, floors. There’s all sorts of different things there. And then you’re going to have the variable annuity and that has all sorts of different riders. But essentially you are investing in investment products. Your results are going to be based on how those products perform, not where as a fixed annuity is just giving you a set interest rate each year.
Marcus Schafer (25:07)
Yeah. So fixed annuities, very straightforward. Let’s, let’s maybe talk about, these equity or these, fixed linked annuities because when I’m, when I’m doing research and I’m thinking about how is Wall Street bringing innovation to retail investors, there’s a lot that kind of fall under this classification of structured products, which means something to the effect of, we’re to cap your downside, but we’re going to cap your upside. And you’ll kind of end up.
with this average. And no matter what area of finance I see these, when they end up coming all the way to the retail investor, it’s like, hey, so we’re going to do exactly what we can do through a very simple stock bond mix, but we’re going to charge you 70 times the fees. We’re going to charge you 70 basis points in exchange for this protection when you can go out there and get an S &P 500.
and a bond fund for three basis points, get the right mix. And it’s not nearly as cool and it’s not nearly as confusing and simplicity sometimes is hard to stick with because you always think there might be something better. But 70 basis points is a massive amount when you think about what that means from a compounding perspective. And I see this all the time in kind of Wall Street products. You have structured products and structured notes and you have
these cover call ETFs and buffer ETFs and these situations and you unpack it and you say, let me just compare this. And the moment you remove some of the mystique.
It’s really, really disappointing because I think they’re really cool ideas. They just never end up coming to fruition to benefit people on the bottom. So maybe, I guess I say all that to get a little heated, but what are some of these terms that people should be looking out for? You mentioned things like participation rates. So what’s kind of some of the terminology that they might see that’ll help them understand, well, this is something that’s going to be confusing.
Patrick Collins (27:08)
So on the linked type products, the equity linked fixed index annuities, you’ll see participation rate. That’s probably one of the bigger ones. So that’s going to be that you get to participate in some percentage of the upside. So if it’s a 70 % participation rate, if the S &P goes up 10%, you would get 7 % returns. So that’s the first part.
Then you have a cap rate sometimes, and that will be that you cannot go over a certain amount. There’s a cap, it could be per month, it could be per year, but let’s say you have a cap of 3 % per month. If the S &P goes up 5 % in a month, you only get three. So even though you might be able to participate in a certain amount, then you also have the cap rate that could limit your returns there. There’s also a floor, which is gonna tell you what you can’t go under.
Oftentimes that might be a 0 % floor, meaning that you can’t lose money on this deal. Those are probably the big ones. One of the challenges on the fees, you mentioned 70 basis points, is, and we saw this in the article that we read, that the client after a few years kind of got wise and probably before they filed a lawsuit said, hey, can you tell me…
what the fees and commissions are of these products. guess he had never asked, when he actually bought them and the broker came back or the agent came back and said, there are no fees. And you will hear that from insurance agents from time to time and nobody works for free. We all know that that is not the case. The difference is, is that when they design these products, they will design it in such a way where you do not get to capture all of the returns in these products. They know.
The Hidden Costs of Annuities¹ – how one client underperformed the S&P by 7% per year over 18 years
that they are going to make money, but they don’t have to disclose that. That’s what’s so challenging about these things is you don’t know how much of the spread, you know, you it might be that this product earned 7%, but you on your statement, when you do all the calculations of your participate participation rate, your cap, your floor, you might see you only earn 4%. And so they might be charging really high fees and it probably depends on the market environment, but believe me, they’re not.
designing these things to lose money at any point, they’re going to figure out ways to make money one way or another. And so that’s the challenge is trying to if you are trying to figure out the fees, good luck, because I have not figured out a way to determine that for these equity linked type products. I have a we have a client here that this is anecdotal, because I will say that in preparation for this podcast,
I think both of us tried to really dig in and find some real good academic research on returns of these products. It’s really hard to find them. And I’m not really sure why the products when you dive into the research that has been done on them and you start to look at who is sponsoring this research. It’s the insurance companies. So a lot of times it talks about how great these products are, but you always have to look at the, you know, the robustness of the research that’s getting done.
But this is just a total anecdote, but I have a long time period that I was able to look at for a client that came to us with one of these products. We were able to pull a statement from them. They bought this product, very similar to what we’re talking about. It was an S &P 500 linked product, so it was going to link to whatever the S &P did. I have the numbers here. They bought the product in 2007, or at least that was when I first saw the statement with the value on it. I think they had actually bought it even earlier than that.
And as of 1231, 2004, so we were basically looking at about 18 years of data of them holding this product. During that stretch, the S &P, which is what it’s linked to, earned 10.4 % average return. And if you remember, they bought this in the very beginning of, before the Great Recession, and probably in the very beginning when they bought it, we’re like, that was such a great idea that we did this because
I’m sure they had a floor and the market went down 55 % from peak to trough and they basically said, man, I am so glad that I did that because we missed out on some of the losses. again, obviously then the market recovered 10.4 % average annual return. Their investment in the product was 3.5%. So it shows you the
Marcus Schafer (31:08) Yep.
Patrick Collins (31:29)
Difference, even though this is, and I’m sure it was sold to them, as this is tracking to the S &P and you get some participation in the upside. You have a floor on it. It probably sounded great to the client in the very beginning, but they lost out on about 7 % per year. I don’t even want to calculate how much lost wealth that was, but it is a tremendous amount. And so that’s the thing that we all have to realize when we’re looking at these products is all is not what it seems.
It doesn’t mean that you’re gonna get returns similar to the index that you’re tracking.
Marcus Schafer (32:03)
Yeah, wow. A 7 % return gap from expectation to realization. 3 % returns over that time period, inflation over the whole time period. I know it’s been higher recently. Let’s call it 2%. That’s not a great outcome to get 1 % more than inflation to protect your…
your purchasing power, your ability to do the things you want in life. And what’s crazy about that is these are kind of like one time, hey, I’m going to sell you this thing and maybe I’ll sell you something down the road. But 20 years later, where’s the accountability? Where’s the ability to go back? We talk a lot about, is it a good decision in the moment versus the outcome? But how can you go back? You can’t really. Wow.
Patrick Collins (32:57)
Yeah. And to be fair, obviously, are there market environments where these products could outperform? The answer to that is yes. If you expect the market to go down or the market does go down and it’s worth less than when you purchase, you know, most likely the floor will help you there and you might get a 0 % return in that example. And that could be, could be better than what you would get if you put it into an S&P index fund. One of the issues though, is these products, and we haven’t really talked about this much,
But the way that they’re sold is if I put a hundred dollars into it, one of these annuity products, when I look at my statement on the first day that I get it, it says a hundred dollars, but there was a massive commission. You know, do you mention it? could be five, six, seven dollars of my hundred that went to the agent. So how do they do that? Where it’s, they have say my investments worth a hundred. They’ve already given let’s say six or $7 to the agent. It really should be worth 94, $93.
But on paper it says it’s 100. Well, yes, but if I went to go try to sell that product a year later, they would say, oh, sorry, there’s a surrender fee associated with this. And if you want to sell it now, you’re going to pay a 7 % fee to get out of it. Because they’ve front loaded the commission to the agent, they have to make sure that they can recoup that. So that surrender fee stays in place.
Marcus Schafer (34:06) Yeah.
Patrick Collins (34:22)
typically for, it depends on the product, three, five, seven, I’ve seen in excess of 10 years. And so as a buyer of this product, as someone who’s investing in it, that’s another part of this is you earned a three and a half percent return in my last example. For the first X number of years, you basically had almost no liquidity on this product. You couldn’t take it out if you wanted to. So low return, barely keeps up with inflation, poor liquidity.
What’s not to love? It’s one of these things where I think people really need to be mindful of what they’re getting into. One of the things that I hear most often is people buy these, they come to us later and they go, I bought this thing three years ago. Man, it’s been terrible. It hasn’t been performed like I thought and I can’t get out of it. What do I do? And so that’s just, and there’s not a whole lot you can do unless you want to pay the surrender fee.
Marcus Schafer (35:14)
Yeah, and I mean, stories like that, and then I juxtapose to what’s the reason why we’re even talking about annuities, the benefits of a SPIA potentially. The fact that they’ve been around for 2,000 years, anytime something has been around for 2,000 years, it’s probably gotten better. There’s a reason for it. There’s demand for it. People are willing to supply it.
And then you just see this massive disconnect between the hope of it and the realization of it. So we’ve kind of talked about a few things. We’ve talked about upfront commissions. Those can range. Upfront commissions are going to be offset by the surrender fees. The ongoing expenses. So you kind of have multiple layers of fees, right? If you’re in a variable annuity, you kind of have to pay for the annuity wrapper, if you will.
then you’re going to have to pay for how you choose to invest that annuity within it. So there are some things that you could think about. Hey, are these index products? Are they active products? Those fees are going to vary widely. And then in addition to kind of front end variable annuity administrative charges and then the expense ratios of the underlying investments, now you’re going to have this extra section of kind of like a la carte.
you add these different riders and benefits. And with each of those comes with a fee. And that’s where you can also really start to see these fees jump up, where you’re looking at in the Wall Street Journal example, it’s 2 % a year, roughly, was the fees they were quoting once you add everything up. For individuals, the more riders and guarantees you add, the higher those expenses go, where it might be 3.5 % kind of at the top end.
Variable Annuities Are the Most Missold – what “guaranteed” riders actually mean when you unpack the contract
So let’s maybe talk about what are some of those different add-ons that sound great, but they come at a cost.
Patrick Collins (37:08)
Yeah, the variable annuity product is the one I’ve seen miss sold the most, I guess I would say. So it starts with the sales pitch and this kind of explains the riders that you’re talking about. So typically the sales pitch is you’re going to invest your money into this annuity and you’re going to select a number. It’s kind of like your 401k. There’s a menu of choices. You can invest in stocks and bonds and you’re going to get the greater of how those investments perform.
or some level of return and it’s maybe 5%. You get the greater of the two. That sounds amazing. I can get market returns or 5%, whichever is greater. First off, hopefully everybody that is listening to this podcast would understand that doesn’t really work in principle. So let’s unpack that a little bit because that 5 % relates to something different. first off, let’s talk about how you invest your money.
you put it in these investment products, so it looks like mutual funds. They’re not quite mutual funds, but they look like them. And you will get whatever those, your investment results will be whatever those do. Now, to your point, I’ve seen those fees be anywhere from two to 4 % typically. take whatever you think the expected return of your asset allocation is, six, seven, 8%, and deduct, let’s just call it 3 % off that.
Right there, so all of sudden you’re going to have a big drag on your overall performance. But you say, OK, but I’m also getting this guarantee over here of 5%. Let’s use the example you put $100,000 into one of these products. So what’s happening is you’re going to see two values on your statement. You’re going to see one value that shows you what your actual results are with your investments you’ve selected minus your fees, which tend to be hefty.
And then you have the other side, is going to be your, what a lot of times you’ll see something called like a guaranteed minimum withdrawal benefit or a guaranteed income benefit, but it’s going to be this guaranteed return and you’re going to see your a hundred thousand go to 105,000, then 110 and some change and so forth. And it’s going to keep going up. Now that would be great if you could turn around to the insurance company and say,
Well, my investments didn’t perform as well. paid a lot of fees over here. I’m just going to take my 5 % and go home. They don’t let you do that. What they basically say is, if you want that amount of money, you now have to turn that into an annuity. So that kind of comes back to the original annuity product. The problem with that is they don’t give you the typical annuity rates you would get if you would just go to insurance company and say, I’ve got $100,000. Tell me how much I’m going to get in income. You mentioned how competitive that market is.
You don’t get that. You get a set interest rate that they would tell you. So it might be, you can take out 5 % of this value. When you start to do the math, what you realize is that at best you’re getting your money back during your life expectancy. So for example, if I’m, if finally at age 75, I’ve looked at this product, I’m like, you know, I really would like to turn it into income. The one side that is kind of the pure investment results hasn’t done well.
I’m now at a point where I think I’m just going to take my income off this. What you’ll find is it might be they’ll offer you 5 % on that. 5 % of the value you can take off each year. So you think about that, you have a 10 year life expectancy left, 5%. That means I get about 50 % of the value out of this product by the time I pass away. Now there’s been some upside because there’s been some guarantees during the first stretch, but
when you start to do the math and we’ve done the math for clients, you end up being right back where I mentioned before, which is around 3%. That’s what I’ve tended to see for most clients. Now it can get better. If you’re going to live to a hundred, it gets a little bit better. If you’re going to die a little bit sooner, it gets a little worse, but essentially you’re getting back to bond like returns. And that’s totally different than how it was sold on the front end. And so anyways, that’s, if you are thinking about a variable product or you have one,
Marcus Schafer (41:10) Yep.
Patrick Collins (41:15) I would encourage people talk to an independent advisor, talk to somebody that can do the math for you to kind of do that, you know, go through the exercise of saying, hey, on this side, you get investment results minus let’s say 3%. You know, again, might be better, might be worse, but that’s a huge drag on your returns. And over on this side, you’re almost guaranteed, if you take the guaranteed 5%, you’re not getting five. It’s gonna be something much worse than that. So anyways, I think that’s the…
The message there on the variable annuity side is there are things that sound great, all of these guarantees, and when you unpack them, the results are not nearly what they’re sold.
Marcus Schafer (41:53)
Yeah, and it’s so tough. mean, you think financial theory, right? You have your investment units, what they call them, or accumulation units. hey, if those go down, you would kind of expect your annuity units, what they call the stream of payments, you kind of expect them to go down. And then when you say, hey, this went down, but this went up, how can that be true? Risk and return are related. Hey, we had a bunch of risk. at the same time you got return, no, you
You lost value. So it’s really tough to unpack these. And as you mentioned, these documents, what they show you is a two-page fact sheet. And when I’m looking at them, there’s like 10 different brochures for the same product, and they all kind of tell you about the same thing. And then you go look at a slightly different way it’s the same picture, was one thing I noticed, but they’re claiming different things. The words are just subtly different. So there’s all these marketing, but the real power is in this 500-page.
prospectus where you can really unpack this stuff and that there’s a cost to that.
Patrick Collins (42:53)
So I thought maybe before we wrap up, was one thing I wanted to mention, which is when does it make sense? And when should you think about buying an annuity? So again, there’s some research out there on this and I think it’s worth noting. And what I would say is that there is a particular client I found that, type, know, client circumstance that I found that really it could make sense. And that’s when…
When Annuities Make Sense – only in their purest form (SPIAs), and under guidance of a 100% fee-only, 100% fiduciary advisor
your assets are at such a level where it’s borderline whether your assets are going to be enough to cover your retirement expenses. So that could mean that when I do, you know, if I work with my planner, I’ll work with my advisor, the probability of results starts to go down. If a bad market environment happens, I could really struggle with meeting my retirement goals. That’s where annuity can make sense. Now what you’re giving up with the annuity is ending wealth. You will not have any ending wealth.
When you have an investment portfolio, you hopefully are not only, you know, having enough income for yourself, but you also are going to have a legacy for next generation or just very, you know, just kind of optionality as you get older to change your spending habits a bit. With an annuity, obviously, you buy that, it is what it is. You’re kind of, that’s your set amount for life. But for someone who it’s basically the insurance company guaranteeing you’re not going to run out. kind of guarantees you can spend down exactly to zero in a lot of ways.
Marcus Schafer (44:13) Yep.
Patrick Collins (44:14)
You can’t
do that with an investment portfolio. Nobody knows when they’re going to pass away. That’s the longevity issue that annuities solve. So what I would say is, is that where are annuities? And when I say annuities, I’m talking about immediate annuities that give you a set income. Those are the ones that we actually tend to like and have purpose. Those can make sense when you are kind of borderline, whether your assets are going to be enough to be able to cover your expenses. So I would say that is something.
for a lot of people to consider. There’s other research out there that suggests that immediate annuities can help improve overall probability of success in a portfolio as well in small doses. What I would say is, know, Greenspring clients for the most part tend to be higher net worth. They have built up a lot of assets. And so if you are, you know, someone who is not as worried about having enough, then annuities tend to be
suboptimal from the standpoint of ending wealth. And so, you know, some of our clients say, okay, I’m willing to, I know I’m going to be okay in every market environment. So the annuity doesn’t really intrigue me as much because it’s just going to mean that this portion of my assets are worth zero at the end of my life. So that’s, like I said, I, I’ve found annuities to be really compelling for people that are borderline. I think as, as wealth increases,
they become a little less interesting or advantageous. But I do think that’s something for people to consider as you’re getting close. If you haven’t saved enough and you’re okay with the idea of not leaving a legacy to the next generation, annuities can just give a tremendous amount of peace of mind and solve for that longevity issue.
Marcus Schafer (45:53)
Yeah, and you know, that everybody kind of has an annuity. It’s their social security benefits as well. So a lot of times, you know, the analysis that you’re doing is you’re saying, hey, let me think about how I can optimize my social security benefit. That’s kind of my floor. Do I need payment streams above that? And then the question is, what’s the most efficient way for me to get those payment streams above that? Those SPIAs would be one
way to get it. A lot of times people are looking at, well, have dividends coming out of my portfolio. If I’m willing to take this portion of my money, know, loss of control is a big thing and put it in this account and have it be annuitized, then I might be willing just to sell down that premium myself over time, right? But it is complicated. All this stuff we talked about is complicated. So you probably want a second set of eyes. And when I’m
thinking about these choices, this is whether it’s us or somebody else, independent fee only 100 % fiduciary advisor can help you make these choices. And nowadays the market has gotten better. So there’s ways where we’re not going to take a cut on any annuity. We don’t want any part of that. We don’t want any conflict in the advice that we’re providing. We want to remain as focused on putting your interests first. So
But there’s ways where, hey, there’s a marketplace for this. That’s going to be competitive. So there’s ways that you can still get advice as opposed to being sold a product and telling the difference between an advisor and a product salesperson. It’s, tough and it’s tricky. I think beyond on the first one we did, why, Greenspring about 12 % of the “advisors” out there fiduciary fee only according to
to our research, so 1 in 10 can help you make a really, really good choice.
Patrick Collins (47:48)
The point, maybe I wanna end with actually two points. One is going back to who else could be a candidate for annuity, kind of falls in the same camp. And this might sound a little bit harsh, but people that are self-aware enough to know that they have a spending issue. I know that if I just have a pot of money that I’ve saved up and I need to make this last for my whole retirement.
But gosh, I have a tendency to go out and buy the shiny new car. And I have a tendency to want to upgrade my house or do, and I don’t know if I have the discipline to stick with a budget. One of the things that’s been nice about working is that I’ve had a paycheck that comes in. I have to live off that paycheck. Now I’m in a situation of retirement where I have this huge pot of money and I got to figure out how to make it work. Again, it’s maybe suboptimal, but for somebody
who has that concern and annuity kind of solves that to a degree. makes you become more like having a job. So that’s something to consider. But going back to your last point on finding an advisor that can help you evaluate these things, I think that’s extremely important. I’ve been in the business a long time, 25 years. I have never, and this is kind of an interesting stat. I know a lot of fee only advisors like Greenspring. I’ve never come across one that has made recommendations
Tax Implications and Wealth Transfer – ordinary income taxes, no step-up in basis, and painful outcomes for heirs
to their clients to buy a deferred annuity. Now I’ve seen immediate annuities and I think those have places and I think they can be really helpful for clients. But for someone that comes in and says, I want you to take some of your money and put it into this deferred annuity, I’m sure they’re out there. I just haven’t seen them yet. And I feel like I’ve known a lot of them over the years. So that says something. So it says that if you don’t get paid to sell a product, this isn’t a product you typically would recommend.
Probably because it’s not the right thing for your client most of the time. But if you do get paid to do it, you see a lot of it. There’s a tremendous amount of annuity sales out there. So I think that’s telling. The last couple of things I just wanted to mention, because we haven’t touched on it, and this might get a little bit nerdy here, but it’s taxation. And annuities I talked about in the beginning, they’re deferred, so you pay tax later. But to your point, if you have two options to accumulate wealth,
Marcus Schafer (49:59) Yep.
Patrick Collins (50:03) One is an annuity, a deferred annuity, and the other is, just say, an index fund. The annuity, when you take that money out eventually, you’re going to pay ordinary income taxes on that. And that’s going to be at your highest marginal rate. If you invest in, an index fund, when you take the money out, you’re going to pay capital gains taxes on that.
could be half as much depending on your tax bracket. So I think that’s important is that your after-tax wealth with annuities probably going to be less or can be less than with an alternative. And then the last part is they’re tremendously bad wealth transfer vehicles. If you’re buying this thinking, I’m gonna use this. I don’t even know if I’m gonna annuitize it because I’m just gonna pass it on to my kids. Again, I’ll use that example. It’s even worse in this example. So in the annuity example, the growth
gets taxed to the next generation. So they’re going to pay income tax on any of the gains that happened. But if you had bought an index fund or some other product that’s direct, you’re going to get a step up in basis, meaning that your heirs are going to not pay capital gains if they were to liquidate that after you pass away. So at death, it’s even worse. You have a zero tax situation on one hand, and you have a fairly taxable situation with the annuity on the other hand. So again,
you want to make sure you’re evaluating these things, not just by investments and not just looking at longevity, there’s so many different things, but taxes are another one too. And it’s going to be used for estate transfer. So long-winded, you know, I think the, what I’ll end with and I’ll turn it over to you to kind of finish this off is there are places for annuities. We talked about that, but you have to be really, really skeptical. You have to be really,
Understand what you’re buying if you’re going to get into any of these deferred products. Understand the incentives that your advisor has or your broker has to sell it to you and make sure you know exactly what you’re getting into.
Marcus Schafer (51:59)
Yeah, wow. Thanks for that. And you didn’t even get into the real complicated stuff around inclusion ratios and what percentage is taxed. gets I would just maybe end with the fact that what is an annuity? It’s an insurance product. And that’s different than the way it’s marketed as an investment vehicle. And they’re kind of trying to blend the two a little bit.
But if you want to think about what a pure annuity is, it’s an insurance product and there are places for insurance products. But everything we’ve learned about investing has been, we’ve solved so much, we’ve innovated so much, cut the fees down, increased the diversification. And in a lot of these annuities, we’re not seeing that come to fruition. There’s a lot of add-on fees.
that they sound great, guarantees are one of the most expensive things in finance. So anytime you see the word guarantee, you’re thinking, man, what percentage am I pulling off in an absolute terms? then percent, you the example you gave 10 % return, 70 % of that you never saw. That’s crazy. should be the inverse. should be 10 % returns. You got everything except 0.1 % at
max with some of the innovation we’ve seen. So with that, Pat, let’s end it because I can’t get too deep into taxes. Thank you for the walkthrough. was fun, a little disheartening though, some of these stats and some of these stories.
Patrick Collins (53:36)
Great to be with you. Thanks.
The Best of What We Researched
1A Couple Won the Powerball. Investing It Turned Into Tragedy (WSJ, 2024)
2The History Of Annuities in the United States (Poterba, 1997)
32024 Retail Annuity Sales Power to a Record $432.4 Billion (LIMRA, 2025)
4New Evidence on the Money’s Worth of Individual Annuities (Mitchell, 2001)
5The Value of Annuities (Wettstein, 2021)