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Annuities: Avoid More Fianancial Razor Blades

Aug 17, 2007
Our nation has just enjoyed one of its most popular annual rituals: the Super Bowl. One can draw many lessons from the drama on the gridiron and all the hoopla surrounding it. But as I watched this year's spectacle, one thing in particular caught my eye. And what I saw can teach a very valuable lesson about investing.

Why do so many Americans watch the Super Bowl every year, anyway? For the commercials, of course! And every year, companies try to wow us with their outrageous ads, or use the national spotlight to launch their newest product.

This year was no exception, as one famous consumer products company introduced a ground-breaking improvement: a razor with five blades. That's right, not a razor with four blades, which is so old-fashioned, but one with five, yes, count them, five blades!

Razor blade companies aren't the only ones trying to sell us on the latest and greatest must-have upgrades. Have you shopped for toothpaste lately? Talk about brand extension!

Why do products that work fine to start with need to be upgraded and improved? There is one reason: sales. If one company comes out with a new improved version, it means that all of its competitors have to also. Otherwise, they might lose sales to the improved version.

These improvements aren't free. Take a quick look at the cost of a five-blade razor and you realize all these bells and whistles carry a hefty price tag, especially when compared to the 'old-fashioned' version.

The same 'brand extension' occurs in the financial industry as well. They're always adding an 'extra blade' to their 'razor' or 'micro-cleansing beads' to their 'toothpaste'. Annuities are a perfect example.

The first annuity in America was offered in 1759. The first variable annuity was offered by TIAA-CREF in 1952 for use in college retirement programs. The purpose of the variable annuity was to allow a teacher to grow their nest egg during their working years and then convert that growth into a steady income stream when they retired. In effect, they were creating their own pension.

You would have a hard time recognizing that product today. A guaranteed minimum death benefit was introduced in 1980. The guarantee minimum income benefit in 1996, enhance earnings benefits in 2000, the guaranteed minimum withdrawal benefit and the guaranteed minimum account balance in 2002.

With each 'improvement' the costs have gone up as well. Whereas variable annuities used to be a low-cost way to create your own pension, now they are bloated, expensive all-things-to-all-people products offering every bell and whistle you can imagine.

The total cost associated with variable annuities can quickly climb to 3% or more with just the basic features--higher if you add all the 'benefits'. The main purpose of a variable annuity is to provide greater returns then a fixed-annuity. All these costs make that much harder to achieve. Moreover, these costs essentially are transferring a large portion of the growth from your nest egg to the insurance company.

Worse, few of these benefits are ever used. The key selling point of a variable annuity is supposed to be a lifetime income stream, but less than 5% of variable contracts are ever annuitized.

If they are a long-term vehicle designed to save for retirement, why are so many being sold to people already retired? Why are 70 and 80-year olds being sold variable annuities?

I say 'being sold' because only 2% of people choose to buy an annuity on their own. The rest are sold by banks, brokers and agents. Could the fact that the commission is so high be a cause?

Call me old-fashioned. I still shave with a two-blade razor. It works well and saves me money. If you want the traditional benefits of a variable annuity, choose the two-blade kind. They are the low-cost, plain vanilla variable annuities sold by companies like Vanguard.

You already know what next year's Super Bowl advertisement will be: a razor with six blades! And you know what your commission-based advisor will be pushing soon: an investment with another costly feature! Don't fall for it! Ignore the hype. Find low-cost solutions to your financial goals and keep control of your money
About the Author
Nationally-syndicated financial columnist and Certified Financial Planner Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He will answer your financial question FREE at http://www.guardingyourwealth.net/
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