In Part 1 of this post, I covered the issue of surrender charges; why they exist, the actual real cost to access your funds and the mutual benefits to you the consumer and the insurance company – in response to the email I received from Eugene J. from Ann Arbor, MI who inquired about annuity surrender charges and high commissions paid to the agent.
[In his email Eugene stated that his wife (age 51) had recently left her employer and she wanted to transfer her TSA (Tax Shelter Annuity also known as a 403b) to a self-directed IRA before she started her new job. Eugene was considering transferring the funds to an FIA (Fixed Indexed Annuity) but had heard from an RIA (Registered Investment Advisor) who told him to stay away from annuities because they have high surrender charges and they pay high commissions to the agents who sell them.]
I also mentioned that the lack of recurring fees is probably the primary reason why Wall Street advocate don’t care much for Fixed Indexed Annuities (FIA) and that Wall Street wants fees and FEES are what drive Wall Street.
So whenever I hear criticism or any bad press regarding Fixed Indexed Annuities, I always consider the source of the criticism, I ponder their motives and recommend you do as well.
I guess I don’t mind telling you that between me and my wife, we own three Fixed Indexed Annuities – two that hold qualified funds (IRAs) and one which holds non-qualified funds. I purchased these products for asset protection and more importantly for the contractual guarantees they offer. I also own my share of Wall Street investments as well as alternative dynamic investment strategies through non-correlated assets – in case you happen to be wondering if I know what I’m talking about.
I will also tell you that I would never make a broad statement to a client that no one should ever buy a Wall Street investment. What I love so much about the financial industry is that there are so many investment options to choose from. Not all are right for everyone, and not all are wrong for everyone, just as some financial sales people are a better fit for certain individuals than others. The investment just has to be a good fit.
Speaking of “good fit” I find that the typical Wall Street advisor is not taught the most important concept that all advisors who give advice about your money should know, and that is the concept of “Asset Protection.” Always keep in mind (especially if you are nearing retirement or already in retirement) that the best financial plan in the world can be rendered meaningless unless it incorporates asset protection – this is why a portion of my assets are in Fixed Indexed Annuities.
Wall Street will tell us that you and I don’t need a FIA for asset protection. They will tell us that they have “investment models” that offer a proper mix of stocks, mutual funds, bond funds and money market funds to mitigate investment risk. But really, why would you or I want to mitigate risk, if there is an asset protection option to completely eliminate it?
And Wall Street can’t seem find any way to guarantee principal protection and a guaranteed income for life from a properly balanced mix of stocks, mutual funds and bonds without using an FIA! All I know is that my Fixed Indexed Annuities didn’t lose a penny in 2001 or in 2008 – this is ASSET PROTECTION at its best.
So here in Part 2 of this blog, we’ll compare the commission based model vs. the fee-based model.
And just so that we’re being real here… as far as I’m concerned, there is no difference in my mind between the words “commission and fees”… it doesn’t matter what you call it, it’s still the same. It is still a commission slash fee-based model… but regardless of Wall Street’s never ending marketing tactics, don’t ever forget, that it’s not what you earn that counts, it’s what you get to keep after fees – as we’ll see in a moment.
Commission Based Model
Let’s start with the commission based model as it applies to Fixed Indexed Annuities and then we’ll address Wall Street’s “commission fee-based” model.
Every annuity on the market today pays a commission which is built-in to the design and the manufacturing of the products. In order for the insurance company to provide the benefits of the annuity and offer commission compensation to the agent who sold you the annuity; it must make long term investments in income producing bonds.
The income from the bonds is then used to purchase options on the S&P 500 stock index, and the return on the options are designed to not only cover the commission paid to the agent, but also make the annuity contract profitable to the annuity owner.
The annuity commission can range from 2 percent to 10 percent and is generally paid to the agent on the front end as a lump sum. According to the market research firm Wink, the average Fixed Indexed Annuity commission for the first quarter of 2014 was 5.80 percent. Let’s just say 6 percent.
And by-the-way, I do want to mention that there are a lot of different types of annuities such as Immediate Annuities (SPIAs), Deferred Income Annuities, Longevity Annuities and Secondary Market Annuities that pay the agent commissions in the 1 to 4 percent range.
After the initial up front commission is paid to the agent, the agent receives no further compensation or any additional fees subtracted from your account. From my viewpoint the biggest consumer advantage of an upfront commission is that they are now out of the annual compounding fee game played by Wall Street.
I never have a problem if my client wants to know how much I’m going to get paid for the simple reason that two years ago I purchased some property and I wanted to know exactly… to the penny, how much commission was going to be paid to both the selling and the listing agent.
So let’s ask the questions, is the average FIA commission of 6 percent, high? The only way to know if the average FIA commission of 6 percent is high is to compare it to the alternative… in this case the fee-only based model used by Wall Street.
Wall Street’s Fee-Only Based Model
AdvisoryHQ is an independent online resource that provides non-biased research, detailed analyses and reviews on the financial services industry. According to AdvisoryHQ, the average annual financial advisor fee (based on Assets Under Management) is:
1.61% for client investment account size of $ 50,000
1.53% for client investment account size of $100,000
1.48% for client investment account size of $150,000
1.24% for client investment account size of $250,000
1.20% for client investment account size of $500,000
1.14% for client investment account size of $1,000,000
This means that the average fee amount for $50,000 is $805 per year (50,000 x 1.61%); for $100,000 its $1,530 per year (100,000 x 1.53%); for $250,000 its $3,100 per year (250,000 x 1.24%); for $500,000 its $6,000 (500,000 x 1.20%); and for $1,000,000 the annual fee is $11,400 per year (1,000,000 x 1.14%).
AdvisorHQ states that these figures were calculated based on a detail review of fee schedules for over 556 financial advisory and asset management firms across the U.S and UK. And that these averages also correlate with Bloomberg News report which shows that clients with more than $100,000 in investment accounts pay less than 1.25% annually in management fees; and investors with $100,000 or less typically pay more than 1.5% in fees per year.
AdvisorHQ also stated that these average fees do not cover expenses for any mutual, index or exchange-traded fund in the managed account. According to Bloomberg News, additional (average) fees for actively managed mutual funds are 0.65% and 0.89 for equity funds.
Also consider the fact that many fee-only advisors will also charge their annual fees on your cash balances or money market funds. This means that you’re paying 1 percent or more on money that is earning less than 0.1 percent annually… not a good thing.
With that said, I’ve illustrated below the following example of an agent receiving a one-time upfront commission of 6 percent on $100,000 (compounding at 3 percent) from the sale of a Fixed Indexed Annuity and no recurring fees vs. a fee-only advisor who sells no-load mutual funds (no upfront commissions) yet receives an annual fee of 1.25% based on the Assets Under Management (AUM) plus another 0.75% (the average expense ratio of no-load mutual funds within their managed portfolio) for a total of 2% per year in fees on your money.
There you have it. Are you SHOCKED, SURPRISED, STUNNED, MYSTIFIED, UPSET, BAMBOOZALED, DISTRAUGHT… as you can see, these ongoing Asset Under Management fees can decimate your earning over time. This is because the Assets Under Management fees hit your entire portfolio and new earnings on an annual base.
The $100,000 account compounded at a conservative 3 percent grows to $134,391.64 in 10 years and in 20 years the account grows to $180,611.12. This means that the 2 percent compounded commission/management fees of $23,929 over ten years and $58,592 in fees over 20 years ate a whopping 70 percent of your return (2% ÷ 3% = .66).
You can see by the numbers that the Fixed Indexed Annuity selling agent makes more money (on your money) upfront and less over time. In contrast, the fee-only Investment Advisor who is managing your money (under the Wall Street commission/fee-based model), gets less of your money in their pocket up front, but substantially more of it over time due to the fact that they are charging you fees each and every year.
It’s really no wonder why John Boogle founder of the Vanguard Group says that “Numbers don’t lie… it’s a mathematical fact… you invest 100% of the capital, you take 100% of the risk, and only get 30% of the return. Boogle goes on to say, “What happens in the fund business is that the magic of compounding returns is overwhelmed by the tyranny of compounding cost.” In short, Wall Street is eating your yearly earnings for lunch!
If you are concerned about fees, start by asking a simple question: Are you getting “value” for the fees you are paying to Wall Street? In other words, what has Wall Street done for you in the past 12 months to deserve the fees you’ve paid them?
This is a fair question to ask regarding value…because the way fee-only advisors charge to manage your portfolio makes absolutely no sense to me, and confusing at best to a client.
From what I’ve experienced the fee based model appears to result in annual charges that are wildly inflated given the small number of man-hours required to “manage” a portfolio of 10 to 15 indexed funds – the more fees they charge (over time) equals lower returns to your portfolio.
What I don’t get is how these fee-only investment advisors who charge you percentage fees claim that charging fees minimized conflict of interest. REALLY! They also claim that the commission based model provides an incentive to generate transactions regardless of whether they are in the best interest of the client. Are you kidding me!
I’m sorry but stating that Fixed Indexed Annuity commissions are high or that the commission based model is not in the client’s best interest is the most cockamamie thing I’ve ever heard, considering the fact that the fee-only advisor income is directly proportional to the amount of your money that he or she manages.
It would be one thing if they only charged you fees if your account was credited with a gain and then only charged a fee on the gain – but that’s not the way it works. They charge you a fee on 100 percent of your account balance including the gain – even when they lose trillions of dollars of their clients’ money, Wall Street still takes their fee and they still issue executive bonuses…
So it really doesn’t surprise me that this fee-only RIA told Eugene to stay away from FIA because “they have high surrender charges” and “they pay high commission to the agents who sell them.” As far as I’m concerned, these are just scare tactics that Wall Street continually throws at the public to keep their fee machine spinning by keeping your money at RISK.
So let me ask you a question: Who is really making the big bucks? Who is really making the “High Commissions” – the annuity agent or the fee-only advisor?
Most people after learning how much they have actually spent on fees feel like they’ve been purposely kept in the dark. And just so you know, Wall Street always deduct their fees and takes your hard earned money only after you’ve received your quarterly statement which shows your credited earnings to your account… this is why most people are completely oblivious to the fact that they are even paying fees.
Let’s be real here, the fact that a fee-only advisor can confiscate an oversized fee from your account is more a testament to his or her sales, marketing and self-promotion skills than any superior investment ability.
As I mentioned, between me and my wife we own three Fixed Indexed Annuities because they provide asset protection, no fees (commissions are paid and out of the compounding formula) and contractual guarantees. If I felt or believed that Wall Street could provide this level of asset protection with better than average returns for our three retirement accounts… I’d have my monies with Wall Street, but that’s not the case.
I don’t know about you, but I do not want to gamble with my retirement savings accounts by letting it all ride in the biggest casino in the world called Wall Street!
Here’s my take on the whole commission vs. fee-only thing: whether it’s a commission or a fee, the key is to find an advisor who can help you set up a game plan that is suited to you, not them. If you are happy with your advisor, have an understanding of what you have and how you’re going to use and enjoy your money and feel as though he or she is working in your best interest, does it really matter how they get paid?
If you feel this information can be of benefit to others please feel free to share this blog via Facebook, Google+, LinkedIn and Twitter
If you have any questions regarding this or any other topic, I would be more than happy to help you in any way I can or lead you in the right direction.
