Executive SummaryThere is way too much dogma surrounding annuity commissions. The commission argument against annuities is most often posed by registered reps, or investment advisor reps who stand to gain by keeping money out of annuities. In the spirit of fairness, I compared the commissions for annuities in general against the fees that would be earned by an advisor charging an AUM fee and came to a simple conclusion: the “annuities are bad because they pay high commission” argument simply needs to be retired.
For the comparison, I assume a 500k portfolio over 30 years to be earning 6% annually, drawing down by 4% initially, then increasing the withdrawal by 3% per year for inflation and discounting future advisory fees by 6% annually. Here’s how an annuity stacks up to a managed account:
If an advisor put $500k in a single premium immediate annuity, commissions to all levels of the hierarchy are likely to be less than 5% of the initial premium, paid one time – for a total of $25,000 to the entire distribution hierarchy. The same $500k in a managed account, using the assumptions above with advisory fees assessed annually at a total fee of 1.25%, would be a present value of over $77k. If the advisor’s fee was .75%, lifetime fees would still be over $51k.
Let’s take another case – a variable or indexed annuity with an income rider. Typical commission across all levels of a hierarchy could be as much as 10% at all levels for a longer surrender product, for a total commission of 50k. If the product has an income rider, it needs to be monitored each year to determine whether to engage the income rider guarantee or to take free withdrawals while continuing to let the rider guarantee roll up. It takes specialized knowledge and time initially research and identify appropriate guarantee structures for a given client and specialized knowledge and time to monitor these guarantees. It requires an annual review process for the same reasons. When an advisor allocates to these products, he expects those funds to stay there for the rest of the client’s years. At 50k for the deferred annuity with income rider, compared to $51k-$77k, the present value of the expected AUM fees, the deferred products with income riders still represent less compensation than an AUM model.
I use annuities with my own clients and I work with other advisors on using annuities in their practices. I do the same with investment portfolios. The appropriate question is how much to each.
If you don’t like the simplified nature of the mainstream dialogue on annuities, read the actuarial journals. You’ll realize that most of the arguments against annuities are oversimplified and are not representative of reality. As an intro, take a look at Moshe Milevsky’s Longevity Risk and Annuities.
The fact is there is no investment portfolio alone can hedge longevity risk. Period. The only way to protect against longevity risk with a portfolio is to have a ridiculously low withdrawal rate (ie 2-3%); to hedge it, you need to pool risk via the use of annuities. As advisors who are truly interested in the best interest of our clients, whether we came up through the insurance industry or we came up through the investment industry, we all need to recognize our own biases and actively combat them with processes designed to help us avoid dogma and make recommendations in the best interest of the client. Despite the fact that annuities carry commissions that need to be disclosed to clients, its not only appropriate, but imperative to use them when the fact pattern requires it.