Until very recently, April 17, 2017 meant something big to many retirement account investors. Those providing them paid advice would have to abide by a federal “fiduciary” standard that put clients’ best interests ahead of commissions and profits.
Now maybe it won’t, thanks to the election of President-elect Donald Trump, whose campaign strategists have said he will repeal the new rule. Another possibility is that the new, Republican-controlled Congress might try to block funding to implement the Labor Department’s rule.
No matter that brokerages and other asset managers have been bracing themselves for the rule, intended to eliminate seller conflicts of interest. Under the new rule, advisers would have to sign a contract that says they are acting in their client’s best interest when they earn a commission on the purchase or sale of investments and insurance products. In short, advisers would no longer be able to maximize profits by putting clients into expensive investments with high fees. Instead, they would have to try to maintain low costs.
The rule would affect about $3 trillion in U.S. retirement assets, according to research firm Morningstar Inc.
Should it be overturned, it may not be an altogether bad thing. The fiduciary rule would generally prod firms to push clients into annual fee-based accounts, costing about 1 percent of assets annually, which could be overkill if, for instance, you just wanted to buy one annuity one time and simply pay a one-time commission.
On the other hand, the rule would curb abuses. Too often, for example, many highly popular fixed indexed annuities (FIAs) are sold to people who do not fully understand the terms of their contracts. In particular, they know they will get a “market-like” return if the market rises, but often don’t realize they will usually get only a relatively small piece of the action. (A FIA is a hybrid of a traditional fixed annuity pegged to an investment index).
“Some buyers know exactly what they are getting in a FIA and have decided it is best for them,” says Andrew Murdoch, president of Somerset Wealth Strategies in Portland, Ore. “Many, however, don’t understand key product basics. In particular, many falsely believe they are getting market-like returns with no risk.
“True, they don’t have risk, but they don’t receive market-like returns, either,” Murdoch added. “They get only a portion of the increase in an index, which today is typically about 25 percent.”
Should the Labor Department rule unravel, it’s particularly important that you take precautions before buying a FIA or a variable annuity, which fall under the aegis of the pending regulation. To that end, here are 10 tips:
- Know why you are buying an annuity. Mostly, it makes sense as a supplement to a traditional investment portfolio. If the stock market tanks during your retirement, you’ll be glad you own an annuity. But there is a tradeoff: annuities are relatively illiquid.
- Make sure the benefits of the annuity fit your particular needs. If you are married, for example, you probably want a joint annuity. If one spouse dies, the other still receives lifetime income. Instead, many couples are sold single annuities, which pay more. The catch: If one spouse dies, the survivor gets only the residual cash value of the contract.
- Shop for annuities with at least three financial planning firms and make sure one of them is an independent adviser. An independent firm usually has a bigger inventory because it isn’t “captive” to an insurance company or a wire house, which sell a limited number of products.
- To determine if an independent adviser fits the bill, ask if he sells securities – specifically, stocks and bonds, mutual funds and variable annuities. If he or she does, they are associated with a broker/dealer or are registered investment advisers. Make sure any advisor you deal with has ample experience.
- Don’t take information for granted. Ask financial advisers good questions and don’t tacitly accept all their answers. Shop for annuities as you would shop for actively managed mutual funds, which have different strategies and tactics.
- Compare several choices in the type of annuity you favor. Among the things differentiating annuities are features, benefits and so-called crediting methods. Know what each means. In the end, most important is the income stream you receive upon taking withdrawals.
- Absorb key details about annuity fees. On a variable annuity, for example, a salesman will probably show you mortality and expense and so-called rider fees covering your expenses for a lifetime income stream and an enhanced death benefit. But he or she may not mention the fees you pay for the management of your sub accounts (mutual funds) within the annuity. Don’t be fooled.
- Be familiar with the surrender fees you would face if you had to liquidate your annuity prematurely. Surrender fees range from 1 to 20 percent. (Some annuities offer zero surrender fees, but they charge higher fees for that.).
- When you zero in on an annuity, check the credit rating of the insurance company selling it. At minimum, go with an investment grade rating. At A.M. Best, the biggest annuity rater, that is B+. The other annuity rating agencies and their minimum investment grade rating is Standard & Poor’s (BBB-), Fitch Ratings (BBB-) and Moody’s Investor Service (Baa).
- Spring for $23 and buy “Annuities for Dummies,” by Kerry Pechter. It’s easy-to-understand, comprehensive and an excellent resource.
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