Secrets of the Wirehouse: Variable Annuity Trickery

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Today I received an e-mail from a large variable annuity distributing insurance company that reminded me of a trick these companies use to get more money into their products. The trick has been around for decades and is completely legal, just misleading.

Here is how it works, as explained by the insurance company:

This allows clients to earn 6% on money in our DCA Bucket. (Fees are not assessed on money in the DCA bucket)

Each month we transfer 1/6th of the money into the investments that you select.

The client only sees the fat 6% yield. In their mind if they put $100,000 into this product they will earn 6%. But they will not, not even close. Instead of earning $6,000 on their investment (6% of $100,000) they will only earn $1,779.

The way the trickery works is the interest rate is applied to smaller and smaller balance, the insurance company only pays an annualized 6% rate on the full deposit for one month (the first).

Most people don’t understand annualized rates, they see 6% and think they will earn 6%, but in reality they are set to earn .5% on the balance in the account, a balance that is getting smaller by 1/6th every month.

At the end of 6 months their money has been fully transferred into a variable annuity sub-account where they are likely paying 3% in annual fees. I created a spreadsheet below to demonstrate how it works.

Screen Shot 2015-12-10 at 7.56.31 AM

It’s clear that no one is earning 6% or what a regular person would perceive as 6%. They aren’t even earning 6% on their balance for six months (which would be $3,000). At the end of the 6 months they’ve accumulated about $1,779 in earnings (and this assumes compounding interest), but since the money they transferred to sub-accounts is paying 3% in fees, those earnings are reduced by about $623. The net interest earned is $1,156, a far cry from $6,000.

Now, getting over a thousand dollars in interest on your cash is nice in an age of zero interest rates, but the point is that this “feature” is used in order to get you into an expensive product under false pretenses.

Scott Dauenhauer, CFP, MPAS, AIF

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