BS Annuity Illustrations
This is a topic that should have been covered a long time ago. Annuities are a safe asset so you get the protection in exchange for some yield. But plenty of annuities will illustrate numbers that defy logic and anyone who thinks it looks too good to be true is probably right. Any of the contracts that I like can illustrate extraordinary numbers as well but I make sure to set conservative expectations that can potentially be exceeded. If you expect to see the crazy returns you will most definitely be disappointed.
I picked this topic a few weeks ago based on a conversation I had with a guy who is a few years away from retirement. Since then I’ve seen several others but I had already marked up the annuity illustrations and redacted all personal info so I’m sticking with it. I pick on Allianz all the time and I’ll do it again here, but I also see companies like SILAC, Nationwide, Athene etc. showing some pretty high-flying index returns. It’s nice to look at big numbers but it’s irresponsible for any advisor to set your expectations there.
In this specific annuity illustration my first concern is that the advisor proposed that this guy put all of his money into the contract. To me that should invalidate any other recommendations the advisor makes because he’s so far off, suggesting that for a first time annuity buyer. Some of my clients do have all of their money in annuities but it’s not something that I suggested, rather it’s something they decide to do over time. And that’s what I would suggest for any of you. Start with something sensible and if you like it, you can get another one.
Let’s just use the numbers anyway so we can stick with the exact illustration as it was presented. It had the guy putting $1.6M into the contract, taking withdrawals of $112K annually from years 6-15 and then no other withdrawals were taken over the illustrated 30 year period. The ledger showed a remaining balance of $18,198,031 after 30 years. Wow! That is exciting. But is it realistic? We have to dig into the details to figure out whether that outcome is likely.
Some companies list the internal rate of return so it’s easy to get an idea of total yield but this one didn’t. So I had to make an external amortization schedule to calculate the effective yield. In this illustration the annual effective yield comes to 9.739%. If you don’t know how to do this then ask your advisor. Anyone who makes a living in this business should know how to do it pretty quickly.
I share the documents in the podcast so if you want to see it then go check out the video. There are only four pages with material information that relates to our purposes with it. First we have to look at the indexes used. This one used a Bloomberg index that’s only been around for a few years so right off the bat we know we’re not dealing with actual past performance. I don’t know what type of disclaimers were made but that’s something that absolutely should be disclosed because we have absolutely no idea how it will perform in the future.
The contract offers more index options but the illustration only used Bloomberg. Half the money was allocated to a one year crediting period and the other half was allocated to a FIVE year crediting period. The contract owner would have to wait five years to see if they made any money on that half. I’ve seen some bad outcomes with contracts focused on two and three year crediting periods because longer terms are more risky. Five years is too long in my opinion. I think a small allocation to it is fine but I’d never recommend using it with half the money. That’s just a matter of opinion and anyone who disagrees is not necessarily wrong.
In this case, we can see yields of more than 60% credited in every other five year period and that is clearly the reason for the fantastic numbers. The backtesting obviously produced a time period that would come with some big hits that make for a lovely outcome. If anything changes slightly then the results will be dramatically different. There’s just one more detail to add and I’ll show you how it works.
The final material issue is that Allianz can arbitrarily add an allocation fee to several of the index options, including the ones used in this illustration. Currently the rate is 0% so that adds to the great returns. But the company can take it as high as 2.5% and that would absolutely crush the contract. Most people don’t like the fact that cap and participation rates are adjustable but imagine how much worse it would be if the company could also add a fee. It’s just another lever the company can pull that will affect the outcome.
I’m not here to say this is a terrible contract. To the contrary, it’s just fine, although I’m not interested in recommending it. The purpose is to illustrate how ridiculous the illustration is. If the index doesn’t perform then it won’t work. If rates adjust or a fee is imposed then it’s going to make a big difference. There are far too many things out of the contract owner’s control and I find it hard to believe that anyone would insinuate it might yield close to ten percent.
To see how changes in the interest rate affect the final result, all we have to do is change the effective yield in the amortization schedule. In this case, simply dropping the rate to a flat 9% will subtract nearly $4M from the ending account balance. I’ll do more examples in the podcast and you will see how easily it would be to change the results. With the company controlling so many levers then I’d bet a fair bit of money that actual performance won’t come anywhere close to the illustration.
This is undoubtedly where someone is going to ask what I would recommend instead of this. Well that’s easy and I don’t have to go into too much detail. My top companies for accumulation contracts, in order are Midland National, Mass Mutual Ascend and Athene. All have similar contracts to the Allianz proposal. All have some index options that produce crazy results. With the same inputs, all of them eclipsed the final account value in this illustration by quite a bit. None of them have mandatory allocation charges.
A lot of annuity proposals are complete BS. I see it all the time and it gives me just another opportunity to educate people and tell them what to look for. If you see something that looks too good to be true then put some pressure on the guy who proposed it. He or she needs to disclaim it appropriately and show you all the other possible outcomes. It’s the right way to do this and there aren’t a lot of professionals who are interested in that. If you need me to look at it and help out then give me a call.