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Don’t Get ‘Sold’

27288731_sA few weeks back, Jerry, a 67-year-old gentleman, walked into my office and asked about “stress testing” his retirement plan. I do a lot of these stress tests and, frankly, I hear the same thing over and over: “I think I feel pretty good about my plan.” When I asked Jerry what his financial goals are, he said he wants to ensure he has enough income to last his lifetime with the remainder of his assets going to his only son, who is struggling financially.
 
Every stress test starts with the discovery of data, which is where I began. As I dove into Jerry’s many financial statements, I felt like I was swimming through a sea of different investment philosophies. You see, as Jerry described to me, he has a “hodgepodge” of investments.
 
Hmm… that was an understatement.
 
Upon the completion of my analysis, I counted 10 annuities. Yes, 10 annuities, making up about 80 percent of his total portfolio. I was impressed by Jerry. He had done a pretty good job accumulating assets. He did, for the most part, everything right. Good guy, great father, worked hard, saved his whole life. In fact, Jerry never made more than $50K per year and he has amassed a $650K portfolio. Pretty darn good. However, as Jerry and I talked about the reasons behind his financial decision-making process, it became very clear what had taken place.
 
When I teach clients how to become financially independent, I explain to them that I never look at a financial product or investment as good or bad. I look at them as either appropriate or inappropriate. You’ve heard me say that before. Unfortunately, in this case, there was no thought, no strategy, with respect to how the annuities were sold to Jerry. He, like so many other seniors I help, attended a dinner seminar and was pitched the product of the month, over and over again. Now, I would suggest that it is impossible for any financial “expert” to know, under such conditions, whether a particular financial product is either appropriate or inappropriate for any dinner seminar guest.
 
Jerry, like so many folks I meet, was what I call “sold.” A person is “sold” when recommendations made are not based on any comprehensive plan. In fact, the recommendations are not, necessarily, in the person’s best interest. Rather, they are made because someone is trying to sell a product to receive a commission.
 
I have talked about this before, the difference between a suitability standard and the higher fiduciary standard. Heck, even the Department of Labor is now looking into it, as discussed in my March 9 column (www.cutter-copy.dev/fiduciary-standard-expansion-law). Once you understand the significant difference between the two standards, Jerry’s plan makes a lot of sense; yeah, for the person who “sold” him! Remember, when someone is held only to a suitability standard, recommendations need only be suitable, and do not necessarily take into account the bigger picture. Unfortunately, the client is only a byproduct of the process.
On the other hand, someone held to a fiduciary standard must put the client’s interest first. This can only be done when taking into account the big picture.
 
So, it is important to understand the right questions to ask up front. The biggest one to start with… what specifically will this financial product do to advance my financial plan? How does it fit into a comprehensive strategy, incorporating the three components of a sound financial system, advanced tax, income, and investment planning?
 
I explained to Jerry that there is a school of thought centered around actively managed portfolios that are geared toward long-term growth, downside risk minimization, and income planning that can be measurable and predictable. This approach designates every investment strategy, or product, as working toward one or a combination of those goals.
 
In Jerry’s case, it is impossible to see the specific goal of each of those 10 annuities. Their benefits could be overlapping or they could be leaving opportunities unmet. There is really no way of knowing without a more defined strategy.
 
There are many other questions to ask as well. What are the all-inclusive costs? What are the tax implications? And, in Jerry’s case, what is the true value from a wealth transfer perspective?
 
Here is what Jerry and I did. I instructed Jerry to contact each of the annuity companies to find out if they had any surrender charges. A surrender charge is a penalty imposed for canceling the entire annuity contract. For example, a surrender schedule of 8 percent, 7 percent, 6 percent, 5 percent, 4 percent, 3 percent, 2 percent indicates a seven-year surrender period with an 8 percent charge in the first year after a purchase payment is made, 7 percent in the second year, 6 percent in the third year, and so on until the eighth year, when a surrender charge is no longer imposed.
 
Jerry discovered that about half of his annuities were still subject to surrender charges. With those that would have been penalized if he canceled them, we designed an income plan with a measurable and predictable income stream, that also ensured that Jerry would receive income for life.
 
We surrendered the annuities that were beyond the penalty period, and we used a portion of those funds to design a portfolio based on the philosophy of downside risk management. The rest of the money was used to purchase a single premium life insurance policy. That life insurance policy will enable Jerry, upon his death, to transfer a predictable amount of wealth to his son in the form of the insurance proceeds.
 
As you navigate the seemingly complicated world of retirement planning, keep Jerry’s story in mind. It’s much easier and more cost effective to design your retirement system before you purchase any financial product or make any investments. It helps to avoid major planning mistakes early on. Folks, learning from your mistakes is good. But, learning from other people’s mistakes is better. And remember, don’t get sold.