A Talk About Life Insurance and Annuity Products

In previous blogs I’ve talked a lot about accessibility when it comes to financial planning. Often folks have to go through the accumulation phase of their financial journey either on their own or with minimal help because they simply don’t have enough money to get an intimate advisor relationship with major advisory firms. Combine that with a well-earned suspicion the financial services industry sparks in Gen X and millennials, and it’s easy to see why people in the accumulation phase rarely get the financial planning they need and deserve.

What is the accumulation phase? We would define the accumulation phase as the period in people’s lives where they are building up their personal finances to achieve their long-term financial goals. Generally speaking, this is when folks are still at least a few years (if not more) away from retirement and they are stashing away as much as possible to reach their financial goals. Whether that’s a couple of 30-ish year olds with a newborn who are saving up for their child’s higher education expenses (and their eventual retirement) or a 45-year-old who is focused on retiring at 60, these folks are in a position where they need to maximize their investments’ growth to get to where they want to be.

The accessibility issue comes in when these people don’t have a large amount of investable assets to bring to the table in their search for a financial planner. The reality is that a lot of companies and advisors won’t give you the time of day if you don’t have at least a few hundred grand to invest with them. I won’t spend too much time on detailing why in this blog, but you should check out our blog on finding a financial planner if you want the 411 on that. The accessibility dynamic is important to this blog because of what it inevitably leads to.

When people in the accumulation phase who aren’t super wealthy go searching for an advisor, sometimes they are simply thrilled when someone is willing to sit down with them. Even more exciting, this “financial planner” details all the things they want in a planning relationship: they will help them save for retirement, manage risk, and map out a financial plan with them.

That’s the shot. The chaser comes next: after doing an “analysis” of their financial situation, the solution presented is cash-value life insurance and/or an annuity. They do a great job of dressing them up: these are essentially risk-free products! Don’t you want to protect your money and your family should something happen to you? What will you do if the market crashes? They show a bunch of (non-guaranteed) projections that make the returns look rosy given the low risk. Next thing you know, people are signing the papers.

I will admit I am not a fan of this process at all. These products are very complex, difficult to understand, and may be useful in certain scenarios. But the bottom line, as I see it, is this: both of these products inhibit growth of wealth, which is the main objective of people in the accumulation phase. Even darker, why is it that people in the accumulation phase without a huge amount of investable assets suddenly encounter such an eager “financial planner”? I believe it’s because both cash value life insurance and annuity products carry extremely high up-front commissions relative to other fee structures. Simply put, an “advisor” who sells someone a $50,000 annuity or cash-value life insurance policy makes a huge up-front commission relative to putting that $50,000 in an investment model at a 1% yearly fee.

In my opinion this is a huge conflict of interest that is often not disclosed by insurance product salespeople. You do not see this as often with big advisory firms as they tend to pay their advisors pretty evenly for what they sell, which is a good thing. The downside is that the big firms don’t make enough money off smaller clients to give them the attention they deserve. This funnel of people searching for financial advice leads to firms selling the high commission products listed above to smaller investors, or those who are just getting started. This is not only potentially putting clients in a product that may not be in their best interest, but they also have little incentive to continue servicing their client after making the sale. This is because the trailing revenue for the “advisor” on these products is usually very small relative to the big up-front pop. Often, you’ll only get another meeting with them so they can try to sell you another one!

You may be asking why I hold disdain for these products. I don’t have a pure disdain for them. They are actually useful in certain scenarios for preservation without immediate liquidity needs. They can provide less stress for very risk-averse investors. There are also some potential tax advantages depending on which product you utilize.

My main issue is that these products are often sold to folks in that accumulation phase who need growth of their investments, and don’t fully understand how they work. The basic principle of long-term investing is this: if your time horizon is long, you should be considering investing for growth. As that time horizon shrinks you generally become more conservative to preserve the growth you achieved over the years. A simple yet complicated concept.

A common feature of these products is that while they help reduce risk, they may also greatly inhibit your growth. They are also highly illiquid (difficult to access the funds without steep penalties), usually for at least 5-10 years (if not longer), which could spell disaster for folks who don’t have much spare money to pull from in case of an emergency. Someone who is young can utilize term life insurance for a tiny fraction of the monthly payment required for cash-value life insurance and use the extra money they would’ve been paying for a cash-value policy to invest in more growth-oriented assets. While they don’t build up a cash value with term insurance, they will be able to help protect themselves while investing more money for potentially more growth sooner. This allows for potential compounding of their investments at a higher rate and gives them a much better shot at growing their funds. Also, people’s investments don’t poof and disappear if they pass away. They are passed on to beneficiaries. Term insurance generally provides a high payout at a far lower cost, and any investment accounts will serve as an inheritance for beneficiaries.

One thing to note is that term insurance does expire after the “term” is up. Cash-value life insurance usually provides a permanent death benefit for the rest of one’s life once premiums are paid. My two cents on this: term insurance frees up cash for diligent investment over a long period of time, which should accumulate to provide a nice-sized inheritance for beneficiaries, while cash-value life insurance generally requires much larger monthly payments that could inhibit investment contributions. If a good chunk of these extra savings are put into a Roth IRA, it will end up being a tax-free inheritance much like a permanent life insurance payout.

Fixed indexed annuities that are tied to a market index’ performance are usually sold as something that allows for no losses but is capped at a certain level of return. For instance, if your annuity caps at 10 percent and tracks the S&P 500 (A barometer of the stock performance of the 500 largest companies in the U.S.), any years when the S&P is up over 10 percent you will miss out on the additional returns. However, any year the S&P is down for the year you won’t lose. Sounds great, right?

I did some armchair math based on S&P 500’s performance for the past 30 years, which is pretty close to long end of what an average investor’s accumulation period may look like. Start investing at 30, retire at 60. The S&P had 8 negative years from 1990-2020. How many years was it up over 10 percent? SEVENTEEN.

The bottom line is that most annuities are a conservative investment—anyone selling them as something that closely tracks market performance with little-to-no risk is not being truthful. Their purpose is to be similar to bonds—lower-risk investments that won’t return an investor as much as equities (stocks) and will deliver income. In contrast it is also possible to derive significant income from your investment portfolio in retirement should you invest diligently over the course of your career.

The conservative portion of your investments as a younger person can serve as a market hedge, an investment for shorter-term goals (like a house down payment), and as an emergency reserve in case you need to access it. Illiquid products negate two of those purposes. And why would you put a large amount of your long-term investment money into something that limits your growth during the period in your investing life where growth is most important?

Ultimately, it is my opinion that growth and flexibility are extremely important for any investor, especially those in the accumulation phase. These products are extremely complex, vary in features, and may be appropriate in certain situations. However, I find that they are generally inappropriate for the vast majority of people in the accumulation phase. You may encounter one of these salespeople who I believe are posing as holistic financial advisors. You should do your research on what they are proposing and speak with other advisor candidates to try to ensure you are working with someone who has your best interests at heart. Or you can talk to us! We are asset-based fee-only financial planners who do not collect any commissions for any particular financial products. Thanks for reading and I’ll see y’all next time.

Disclosures: All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed in this article are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Investing involves risk including loss of principal.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index.

An indexed annuity is for retirement or other long-term financial needs. It is intended for a person who has sufficient cash or other liquid assets for living expenses and other unexpected emergencies, such as medical expenses. Guarantees provided by annuities are subject to the financial strength of the issuing company and not guaranteed by any bank or the FDIC.

Indexed annuities do not directly participate in any stock or equity investment. Clients who purchase indexed annuities are not directly investing in the financial market. Market indices may not include dividends paid on the underlying stocks and therefore may not reflect the total return of the underlying stocks; neither a market index nor any indexed annuity is comparable to a direct investment in the financial markets.

Variable annuities are offered only by prospectus. Carefully consider the investment objectives, risks, charges and expenses of variable annuities before investing. This and other information is contained in each fund’s prospectus, which can be obtained from your investment professional and should be read carefully before investing. Guarantees are based upon the claims paying ability of the issuer.