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~Variable Annuities~

 

My previous post was about a common investing problem for school employees.  If you missed it, this quote from Warren Buffett sums it up nicely:  "When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients."

 

This post is about the second investing problem that school employees often face:  being in the wrong investment.  

 

Just like fees, being in the wrong investment over time can significantly hinder one's ability to save for retirement.

 

One type of wrong investment is a variable annuity.

 

Many school employees across the country are invested in annuities. Annuities are complicated, restrictive investments, especially variable annuities.  And, generally speaking, they can be unproductive investments, in part, due to high fees.

 

AARP reports that the average variable annuity has an expense ratio of 2.211% (https://www.aarp.org/retirement/retirement-savings/info-2020/learn-about-annuities.html). 

 

For comparison, Fidelity's total stock market index fund has an expense ratio of .02%.  

 

The graph below shows a hypothetical scenario where two employees are both investing $300/paycheck (26 pays per year) over 30 years.  The graph assumes that the variable annuity and the stock market fund grow at a rate of 10% (these are hypothetical scenarios and do not imply future results).  The effect is that the hypothetical employee who invested in the index fund ended up with almost a half million more dollars in retirement:

 

 

The other problem with annuities is that school employees often hold them in their 403b accounts, which is pointless.  If you've ever been in the 2nd floor copy room of the high school, there is actually an old yellow notice stapled to the bulletin board above the copy machine that states just that.  This is because the purpose of a 403b account is to provide tax deferred growth of whatever is in the account.  Since an annuity already has that same tax privilege, there's no good reason to hold an annuity in a 403b account.

 

The Securities and Exchange Commission, which regulates variable annuities, actually states the following on its website: "For most investors, it will be advantageous to make the maximum allowable contributions to IRAs and 401(k) plans before investing in a variable annuity."  (https://www.sec.gov/investor/pubs/sec-guide-to-variable-annuities.pdf)

 

That pretty much sums it up:  don't hold an annuity in your retirement account.

 

If an insurance agent has suggested that you hold an annuity in your 403b account (or in any retirement account), that is a sign that something is wrong.

Obviously this is not the fault of the school employee, as they’ve simply been given improper guidance.

So why do so many school employees across the country hold annuities in their 403b accounts?  

 

One reason is that when insurance companies (i.e. Horace Mann, Lincoln, TIAA-CREF, etc.) sell annuities they earn significant commissions and fees.

 

The odd thing is that the people selling these annuities are technically fiduciaries, which means that they are legally bound to put their client's interests first.  So you might be wondering:  why are fiduciaries selling their client something that isn't right for the client?

 

Even though a fiduciary is legally bound to put the client's interests first, there may be times when the fiduciary has a conflict of interest.  When that occurs, the fiduciary is legally required to disclose that conflict to the client.  For example, an insurance company that is very popular with school employees states the following in their financial disclosures:  

 

"The way we make money creates some conflicts with your interests. You should understand and ask us about these conflicts because they can affect the recommendations and investment advice we provide you."  

 

In other words, the insurance agency is going to sell you something that may not be very good for you, but it is good for them.  So, if you have an annuity, you should ask the agent about these conflicts because they are significant.  And, you may want to consider other options when saving for retirement.