More on annuities: It all boils down to this — don’t buy them

To pick up right where we left off last week: Here’s another reason I don’t like fixed-rate, fixedindex and variable annuities — their low returns and high costs.

These are directly related: The higher the costs to you, the lower your returns.

To begin with the simplest of the three types, fixed-rate annuities are the exception in that they do not charge high fees. In fact, generally, they don’t charge you any fees at all. Instead, they offer very low returns.

I recently pulled some quotes from my preferred insurance company. For amounts less than $100,000, I could earn 2.6 percent guaranteed on a fixed-rate annuity for the next five years, and I could earn 3 percent if I invested more than $100,000. I checked rates with another provider online and received quotes in the similar range — 2.8 percent and 2.95 percent. That rate changes over five years. Mine had a minimum reset rate of 1.3 percent after the fiveyear term.

What should we think about these rates?

You should always expect that the annual return on a fixed-rate annuity, adjusted for inflation and taxes, will be approximately zero. That’s not a typo. That’s just a rule of fixed-rate annuity products and risk-free products in general.

Now, figuring the returns of fixed-index and variables annuities is trickier because they are somewhat market-driven and depend on what you pick as underlying investments and risks. But we can understand what the costs are — and therefore their expected underperformance versus comparable assets you could buy from a brokerage company.

With a variable annuity, you have the chance to purchase mutual funds similar to funds at a brokerage account. Costs will weigh down your returns, however.

The management fees of mutual funds offered inside a typical variable annuity are typically very high. In the 2018 Brighthouse Financial Life (formerly MetLife) variable-annuity contract I reviewed, the costs of mutual funds ranged from a low of 1.56 percent to a high of 2.71 percent. Hello? 1987 just called, and it wants its mutual fund fees back.

I really didn’t enjoy the 1.66 percent fees quoted on the Blackrock Ultra Short Bond Portfolio. That fund has a 10-year return of 0.39 percent, meaning you could have locked in huge losses after fees for the past decade on a product supposedly meant to preserve capital. These egregious fund management costs are the rule, not the exception, when it comes to most variable annuity fund offerings I’ve reviewed.

The Teacher Retirement System, or TRS, just capped mutual fund fees inside variable annuities at 1.75 percent following a “reform” to go into effect in October. These fees are, in a word, bad. Even after that “reform.”

Why are the fees so high? I have a theory, and it goes like this:

Insurance companies can impose huge fees on variable and fixed-index annuities because they have selected their customers very carefully. Only people who don’t know what they are doing would select these providers and these products. So, in essence, they can charge whatever they like.

They employ psychology that works similarly to the way the “Nigerian Prince” scam artist who supposedly wants to wire you $10 million will purposefully misspell words in the solicitation email. The scammer knows that any target who replies has no powers of discernment; it is a purposeful selection process by which the scammer chooses the right kind of victim.

Similarly, whenever a public school employee sets up a “finance and retirement discussion” meeting with a commissioned insurance salesperson, the salesperson can have high confidence that person has absolutely no idea what they are doing financially. The result: high fees, with impunity!

Of course, there are more fees after that.

Arguably, the main service an insurance company provides with variable and fixed-index annuities is a lifetime guarantee of payments because they employ actuarial math that helps them make educated guesses about how long you’ll live. That seems like a service. And the insurance company seems to be taking a risk on you.

Ah, but they aren’t, not really. These complex annuities also charge a fee on your account called the “mortality and expense risk charge” — offloading that risk that you might live too long to you.

Finally, here’s my least favorite of all the low-return/high-cost features of fixed-index annuities. This gets a bit technical, but bear with me because this is really how the sausage is made.

The insurance company calculates the “growth” in your fixedindex account value based on the change in value of a stock market index over a year. But it does not take into account dividends or the reinvestment of dividends that you would get were you invested in the market directly through a brokerage account.

Over long periods of time working toward retirement — I’m talking about decades — the growth of your investment may be in large part due to dividends. Because of the way the company calculates returns, however, you probably don’t get the return on dividends from a fixed-index annuity.

As I do not sell annuities, all I can say is: Don’t buy these.