If An Idea Seems Too Good to Be True, Run


A few years ago, I changed careers and rolled my money from my 401(k) plan to an annuity to continue tax-deferred growth on my investment.

A few weeks ago, the financial planner I worked with on the rollover invited me to a seminar, and what I heard seemed too good to be true.

I've signed all the paperwork, but now I'm having second thoughts and would like your opinion.

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Here's the deal: I can take a 10 percent penalty-free withdrawal out of my annuity, and use this money to pay a premium on a universal life insurance policy. The policy provides me with a million-dollar death benefit, and I get tax-deferred growth on my investments and tax-free withdrawals in retirement.

I'm in my early 40s, with kids, so the insurance is needed. With this new plan, I can drop my term policy, have coverage and a great retirement plan. I have enclosed the illustrations for your review.


The illustrations look great. Too bad they are riddled with inconsistencies and inaccurate assumptions.

I also note that your financial planner has no professional designation after his name, which leads me to believe that he doesn't have any. Judging by the products he is recommending, the fixed annuity for your rollover and now universal life, he is probably limited to selling insurance.

When making major financial decisions, you should look for someone who can assist you with a variety of investment options and someone who has at least made the effort to obtain one or more recognized credentials in his profession. Credentials won't assure you that the adviser is ethical or knowledgeable, but at least you know he has made an attempt to gain some knowledge in the financial-planning profession beyond just getting a license to sell products.

Research the requirements for a designation. You may find that the requirements to obtain some designations are very minimal, making the designation virtually worthless.

You should have had first thoughts about this proposal, but at least you had second thoughts before your right-of-refusal period ends. Going back a few years to your planner's first recommendation, why was an annuity recommended for your 401(k) money? One of the main benefits of an annuity is the tax-deferred growth on investments.

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Because 401(k) money already grows tax-deferred and could have been rolled over to an IRA containing almost any type of investment and grow tax-free, the tax-deferral aspect of an annuity is not of any benefit.

There may be other reasons to invest in an annuity within an IRA, but the high costs and surrender charges associated with most annuities need to be considered before selecting this type of investment over other less costly alternatives, such as mutual funds. Even funds that have a sales charge will usually be less costly than an annuity.

The annuity might have been recommended because that is what the planner is licensed to sell, or because annuities pay a higher commission than most financial products -- with the exception of the life insurance he is now recommending!

The first step when presented with an illustration comparing what you are currently doing to an alternative is to review the illustration and make sure you are comparing apples to apples. The illustrations should be run using the same assumptions.

The following red flags are in the illustrations presented to you:

  1. The rate of return assumed in the illustration for your current annuity is 6 percent, while the rate of return used in the universal life illustration is 8.5 percent. Of course the universal life illustration looks great: 2.5 percentage points over a 29-year period make a big difference in the future balance of an account!
  2. The 10 percent penalty-free withdrawal is merely what you can withdraw each year without a surrender charge. This has nothing to do with the IRS early withdrawal penalty from an IRA. The illustration assumes you take $15,000 each year for the next 10 years until age 51. This does not meet any of the IRS waivers for the 10 percent early withdrawal penalty for funds taken from an IRA before age 59 1/2. The illustration should reduce the amount left to invest by 10 percent to reflect this penalty.
  3. The illustration also doesn't reflect the reduced amount you will have to invest in the universal-life policy because of income taxes. In addition to the 10 percent penalty, all funds withdrawn will be subject to state and federal income taxes.

I'm willing to bet that an illustration using payments to the universal life policy in the amounts left from your annuity withdrawals after taxes and penalties and a lower interest rate won't look nearly as enticing.

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