Mr. Insurance Man, Tear Down This Wall!

Personal Finance
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By Anthony Isola

Learn more about Anthony on NerdWallet’s Ask an Advisor

Mr. Gorbachev, open this gate. Mr. Gorbachev, tear down this wall.”
— President Ronald Reagan, June 12, 1987

I was reminded of this famous quote at a recent educational event my firm gave for our clients. I was explaining why many variable annuities have high surrender charges, or extra fees, if you wish to get out of the contract in the first few years after you purchased it. I explained that the reason for fees as high as 10% is that the insurance company has to recoup the 10% commission it paid to the salesperson who sold you the product. After I explained this, one of my clients commented, “That is like the Berlin Wall.”

What a brilliant analysis. When President Reagan issued his challenge to Soviet leader Mikhail Gorbachev in front of two panes of bulletproof glass to protect him from East German snipers, he changed history. A repressive government that did not look after the best interests of its citizens was on the brink of collapse. The only way it kept its citizens from fleeing its borders was with iron gates, concrete walls, guard dogs and sniper towers. The Communists knew that if their citizens became knowledgeable about life outside their virtual prison, they would depart in droves. The Soviet Union needed a contingency plan. They built the feared wall.

What does this have to do with variable annuities and the individual investor? Plenty. These products are mostly sold with a “hard sell.” They can come with high costs — often 3% to 4% a year — along with a hefty upfront commission paid to the salesperson. The insurance companies, not unlike the old Soviet Union, are able to sell you this product because of your ignorance of its convoluted features. They created the surrender fees just in case you figured things out. Along with piles of complex paperwork, the insurance companies created their own version of the Berlin Wall. It’s like the classic line from The Eagles’ “Hotel California”: “You can check out any time you like, but you can never leave.”

The U.S. Securities and Exchange Commission offers strongly worded guidance on variable annuities, including that you research the financial strength of the company that is offering the product. If you want to learn more about annuities in general, check out this article on NerdWallet.

This product has its place, but only for select investors. If you have maximized all your limits on your 401(k) or 403(b), along with a traditional IRA or Roth, a variable annuity might be a fit for you. But most investors have no need for this additional method of saving money in a tax-deferred account.

While no investment comes with a guarantee, choosing a variable annuity to fund retirement goals decreases your odds of success substantially. A low-cost, tax-efficient, globally diversified portfolio gives you the highest probability of a comfortable retirement. While there may be some dramatic swings along the way, investors who stay the course tend to be rewarded for their long-term vision.

If a salesperson tries to sell you a variable annuity and tries to dissuade you from a low-cost, diversified approach, remember some words from another president. “Freedom has many difficulties and democracy is not perfect, but we never had to put a wall up to keep our people in, to prevent them from leaving us,” John F. Kennedy said in 1963.

Truer words have never been spoken. If there are iron gates to keep you from separating yourself from your investment, your best bet would be to never enter in the first place.