I got a glimpse of one such dangerous trap when I was, once again, invited into an "insurance agents only" webinar this month that was promoted with the line: "Learn how you can turn Roth IRA conversions into annuity gold!"
Experts in finance will tell you that one of the dumbest things you can do is buy an annuity with your retirement money because annuities are almost always loaded with high fees that will rob you of hundreds of thousands of dollars in wealth. I'll get to the specifics later, but someone with $100,000 to invest for 20 years is likely to end up $250,000 poorer by choosing an annuity over a simple index fund in their IRA. But selling annuities on retirement money is a great deal for an insurance agent because he or she earns a commission that often amounts to 5% to 7% of your assets. Where do you have most of your assets? Most likely in your retirement account.
In a conference call on January 7th, a California insurance salesman named Doug Warren, who has dubbed himself "Mr. Roth IRA," told his audience of insurance agents (and me) that offering informational seminars on Roth conversions was a gold mine.
"The reason to get involved in this [Roth conversion] market is because it's a tremendous prospecting opportunity," said Warren.
By discussing Roth conversions, which are all over the news, Warren says you can lead people into your office, break down their resistance to a sales pitch by providing unbiased information about the costs and benefits of a Roth conversion and then go in for the kill with your product pitch.
"I don't care whether the client converts or he doesn't," he said in the webinar. "The important thing is that you pivot to your product sale."
To understand how he's going to do this so smoothly that even a smart investor might be tempted to buy into his pitch, a little background is necessary.
At the beginning of the year, U.S. taxpayers got a new option: They could take money sitting in traditional Individual Retirement Accounts and "convert" this money into Roth IRAs. In the past, income tests blocked most well-heeled investors from trading in their traditional IRA for a Roth.
If you convert in 2010, Uncle Sam will even allow you to spread the tax hit over two years. (You have to pay income taxes on money coming out of the traditional IRA to convert it into a Roth. Normally you'd have to do that in the year you convert. But a special tax law allows you to delay declaring the conversion income and split it into the 2011 and 2012 tax years.) That's got a number of financial advisors saying that this is a once-in-a-lifetime opportunity that investors should seriously consider. (Or not...Check here for a detailed analysis of how to figure out whether you'd be better off converting or leaving your IRA alone; I did a piece on the same topic here; or you can listen to MoneyWatch's Eric Schurenberg explaining the key issues below.)}
What's pernicious about Warren's pitch is this: He can give you unbiased advice about Roths because he doesn't care whether or not you convert. What he cares about is that you come in to him with a complete snapshot of your financial life. He'll use his unbiased information on Roths to get your guard down. And, then, while you're still in his office talking about conversions, he's going to try to talk you into using your retirement money to buy high-cost insurance products.
How does he do it? First he hosts a "free informational seminar" at a public place, such as a public library. Nothing is sold at that seminar, and he accurately explains that because of the up-front tax hit generated by a conversion and the uncertainty about future tax rates, there's no one-size fits-all answer about whether or not it's a good deal.
"How you end the seminar is going to determine how many appointments you get," Warren said. "I offer a free-one hour consultation."
He tells attendees of his free seminar: "You bring in your tax return and your account statements. We spend an hour. I am going to understand what role the income in your IRA is going to play in your future, and then I am going to share strategies that have worked for my other clients."
Most of the people who come in will choose not to convert their IRA, Warren said. But the agents listening to the webinar were advised not to care.
"What becomes critically important is that you have strategies that when these people come into your office, you are going to be pivoting into a product that you sell."
If these guys were selling low-cost mutual funds, I wouldn't bother with this warning. But Warren is selling annuities and universal life insurance.
Universal life insurance is a complex product that requires lots of explanation. I'll do just the short version here. The only way this product could prove valuable to a retirement investor is if the agent managed to "overfund" that policy without running afoul of tax rules (which is tough) and if that product managed to generate investment returns of at least 8%, which is highly unlikely. In today's market, these policies are paying about 3%.
That analysis, by the way, isn't mine. It comes from David Bergmann, Los Angeles financial planner, who has earned impressive professional credentials in financial planning, tax and insurance.
As for the annuities:
"The cost of the guarantees [that all annuities provide] dig into the net investment return," said Bergmann. If you add up all the fees loaded onto the annuity (all of which buy you some little bell or whistle, such as the ability to tap your account for long-term care expenses), the cost of this product could amount to 2.5% to 4% of your account value every year, he projected. That's subtracted from your annual return, which reduces your wealth over time.
Just how much could that cost you? That depends on the amount you invest, the actual fees associated with the specific product you buy, your average annual return and where else you would invest your money. You can use a tool on the Securities and Exchange Commission's web site to estimate the cost with your own numbers. (After you've plugged in the dollar amount of your investment and your anticipated return, skip to the question about "total annual operating expenses. With annuities, you don't have to worry about "loads.")
But, for example's sake, let's take a look at what you'd have after 20 years with an annuity that costs 3% per year versus a Vanguard index fund that charges 0.20% per year. We'll asssume that your original investment was $100,000 and you earn an average of 10% per year (roughly the market's historic average over the past 85 years).
You'd accumulate $365,837 with the annuity. Not half bad, you say? You'd accumulate $646,345 with the Vanguard index fund, or some $280,508 more.
The insurance salesman will tell you that the annuity fees are buying you valuable services. But before you buy into that notion, you need to ask yourself whether those bells and whistles are worth a quarter of a million dollars. They're normally not even worth a fraction of that amount--except to the salesman, who will retire quite happily on all the commission money he pulled out of your retirement account by selling you this junk.