Allison sat in my office, singing the praises of an annuity she had recently purchased. She was 64 years old, and she had come in for a free initial consultation after listening to my radio show.
“The investment guy at the bank," she crowed, "told me this annuity would pay me a guaranteed income of 7% when I turn 70.”
I asked her to tell me more.
Allison had invested $300,000 as a rollover from her old 401(k) plan. She was told that at age 70, her annuity would be worth $450,000. Beginning at age 70, she could take $31,500 (7% of $450,000) and lock in that income stream forever.
“And when you die, what will be left to the kids?” I asked.
“The $300,000 plus all my earnings!” she said.
Suddenly my stomach began to sour.
Allison, I was sure, had heard only part of what the salesperson had told her.
I followed up with another question: “Besides the guaranteed $31,500 annual income, will you have access to any other money?”
“Oh yes,” she answered. “I can take up to 10% of the account value at any time without paying a surrender charge. In fact, next year I plan to take $30,000 so I can buy a new car!”
This story was getting worse, not better.
It was time to break the news to Allison.
I asked her to tell me the name of the product and the insurance company that issued it. Sure enough, I knew exactly the one she bought, since I had it available to my clients as well.
That’s when the conversation got a little tense.
I explained that if she withdrew any money from her annuity prior to beginning her guaranteed income payment, there was a strong likelihood she wouldn’t be able to collect $31,500 per year at age 70. Given the terms of the annuity, any such withdrawals now would reduce the guaranteed payment later.
I explained that, with this and most other annuities, if she started the income stream as promised at $31,500, she would not likely have any money to pass on to the children.
She told me I was wrong — and defended the agent who sold her the annuity. She said that she bought a guaranteed death benefit rider so that she could protect her children upon her death.
I encouraged her to read the fine print. As expected, she reread the paragraph that stated that the “guaranteed death benefit” was equal to the initial investment plus earnings, less any withdrawals. When I told her that her death benefit in all likelihood would be worth nothing by age 80, she quickly said, “I need to call my agent back and check on this.”
I have conversations like this a lot, and not just with annuities. When it comes to investments, whether they're annuities, commodity funds, or hot stocks, people often hear only what they want to hear. At various points in his sales pitch, the annuity salesman had probably said things like "guaranteed growth on the value of the contract," "guaranteed income stream," "can't lose your money," and "heirs get everything you put in." What she had done was merge the different parts of the sales pitch together and ignore all the relevant conditions and exceptions.
When people hear about a product, there's an emotional impact. "I want to buy that," they think. They focus only on the benefits of the product; they assume the challenging parts of the product — the risks — won't apply to them.
This story has a happy ending. Before Allison left my office, I asked when she received her annuity in the mail. "Three days ago," she said.
I reminded her of the ten-day "free look" period that’s given to annuity buyers as a one-time “do-over” if they feel that the product they purchased isn’t right for them.
She called me back within two days. "The agent doesn't like me very much," she said. She had returned the annuity under the “free look" period and expected to get a full refund. The annuity salesman had just lost an $18,000 commission.
And I once again saw the wisdom of something I tell my clients every day: Prior to ever making a financial decision, it is absolutely critical you evaluate how this decision integrates into your overall financial life. That's what's important — not falling in love with a product.
Marc S. Freedman, CFP, is president and CEO of Freedman Financial in Peabody, Mass. He has been delivering financial planning advice to mass affluent Baby Boomers for more than two decades. He is the author of Retiring for the GENIUS, and he is host of “Dollars & Sense,” a weekly radio show on North Shore 104.9 in Beverly, Mass.