Why The Bank Thinks I’m Stupid – Annuities in an IRA

On Chief Mom Money Mondays, I take you through a financial decision, topic, or story. Today’s story is a tale of terror where a salesperson tried to get me to buy an IRA inside an annuity.

I went down to a local bank branch last year to transfer a small inherited IRA from my grandmother into my name. I was hoping it would be a quick, painless process of filling out some paperwork and getting it transferred so I could later transfer it to a discount investment firm. Unfortunately, what I got was an annuity salesman who took TWO HOURS to get everything done, even though I had come with all the information I needed. It took several calls for him to even figure out what to do. Although I’m pretty sure if I had wanted the annuity it wouldn’t have taken nearly as long. I was literally there until closing.

The IRA had been in a CD, as my grandmother was in her 80’s and didn’t want the money invested in the market. That was fine, all I wanted was for it to get into my name so I could get it transferred and invested at Vanguard (Vanguard fangirl here!). I figured it would take maybe half an hour or 45 minutes, so I left work a bit early and headed down to the bank a few hours before closing.

Once I got there, the person behind the counter suggested I call their IRA department to do the transfer. Um, no. The paperwork I had received from the bank on the transfer clearly said I could either call or go to a local branch to do it in person. I was already in the branch and didn’t want to spend time on the phone, so I politely said that I preferred to do it now. So I was asked to go to a different part of the bank and wait for the next available person.

I sat down and saw my snappily dressed, competent looking banker helping someone else. They were smiling and laughing, obviously having a good time. I was hopeful that everything would go smoothly – after all, the banker looked like he knew what he was doing. Once the person ahead of me was done, I went on in.

The IRA transfer process should have been pretty smooth. After all, I just wanted it to be transferred into a savings account so it could be safe while I waited for the transfer to the investment company. I didn’t care about the month or two of interest (or how much additional I could make in the market) because I didn’t want it at the bank. I didn’t have an account with them, and wasn’t interested in separating out my money into multiple places. All we had to do was (1) take out the Required Minimum Distribution or RMD for this year (calculated based on my grandmothers information since she had passed away before taking the RMD for the year), (2) open a new inherited IRA with a savings account in my name, and (3) transfer the money into that savings account.

Sounds simple, right? Well I wasn’t expecting him to try to sell me on an annuity. He had a printed sheet of paper with different interest rates on different account types, and eagerly pointed out that I could earn more interest with this other option! And there were no fees if I wanted to close it! It was guaranteed! Now on that piece of paper the type of account was called something fancy sounding, and in the list of savings account and CD options it certainly looked better – higher interest rate, after all. Honestly I can’t remember anymore what it was called, but after his description I asked “Is that an annuity?” He defensively said “yes” but it was still a great option! Higher rate! I just looked at him, shocked he would even suggest an annuity wrapped inside of an IRA to a 35-year-old. I assume he would have received some kind of commission if I said OK to the annuity, and I’m pretty sure he would get nothing with a savings account. I had to control myself from just laughing out loud, which I’m pretty sure would have been rude.

Why was this such a bad option? Well, let me show just five ways:

1. Tax Treatment: You shouldn’t put an investment where one of the benefits is tax deferment inside of a tax deferred account. One of the selling points of an annuity is favorable tax treatment. Check out this article from Kiplinger’s on the tax treatment of annuities to learn more. To get good tax treatment, typically an investment returns less than it would if it were not tax favored. So putting a tax favorable investment inside of a tax deferred account is a bad idea.
2. Fees & Commissions: There are fees. Often huge fees. The person I talked to said “no fees!” but I know that’s not true. Annuities have surrender charges – sometimes huge – to keep you from cashing it out when you realize it’s a mistake. Why don’t they want you to cash it out? Well, they need to pay those fat commissions somehow! Annuities often pay a tremendous commission to the salesperson, and that not only motivates them to sell the product when it’s not appropriate, but requires some way to pay all that commission. And who pays it? Not the bank out of the kindness of their heart – YOU. Either through fees or through the difference the bank gets from investing the money vs. what they pay you over time.
3. Insurance: Annuities are a kind of insurance product. For a 35-year-old they’re not a good option. Now if you’re older and concerned about outliving your savings, some kinds of annuities can be a good choice, but you need to research them to find one with a good payout and reasonable fees. The payouts nowadays can be very low because interest rates are low – that’s why it was better than a savings account, but not by much. And the bank needs to make enough to pay out that commission.
4. Risk: A savings account is covered by FDIC insurance up to $250k – so if the bank goes under the government protects your money. An annuity is covered by the insurance company issuing the annuity – so if that insurance company goes under, the FDIC doesn’t step in to pay you. If you decide an annuity is the right option for you, be sure you’re confident of the insurance company. Big companies can go under breathtakingly fast, taking all your money down with it. Check out this link to learn more about what is and isn’t FDIC insured.
5. Deception: I feel it’s deceptive to put a paper in front of people listing interest rates, but not fees, and to position the options as if they’re equivalent when they’re not at all. One is FDIC insured, with no fees, no commission, and no surrender charges. The other is not. Also not calling it an annuity might be a great marketing tactic, but it’s terrible for customers. After all, some may have heard that annuities are a bad idea.  But when you don’t call it an annuity, customers don’t know to ask the kinds of questions they otherwise might. I’m sure it would be somewhere in the fine print, but banks know you don’t actually read that stuff.

So what did I do? After I picked my jaw up off the floor from this bad advice, I told him I just wanted the savings account. Luckily I am not at all uncomfortable with turning down sales pitches. I knew what I wanted to do – just do the RMD, open the account, and transfer the money. So the rest of the two hours was spent with the guy trying to figure out just how to do that. Eventually (after the bank closed!) I walked out with the the RMD and the new account information. Later that day I went to the investment company site and printed the transfer paperwork. I believe it took me 10-15 minutes to fill it out and mail it off. A few weeks later, the transfer went through and the funds were invested instead. Had I not known to ask if this was an annuity, the balance would have been much smaller because of the surrender charges. If I avoided those by keeping the money at the bank, it would have been locked up and I would have lost out on the market appreciation since last year. Great deal for the bank – horrible deal for me.

What can you learn from my experience? Don’t be afraid to ask questions. If something sounds too good to be true, it probably is. So if you get someone at a bank trying to steer you toward something ask – what fees are involved (monthly, annually, load)? Are there surrender charges? What’s your commission on this product? Why do you think this is right for me? Is it FDIC insured? Is this an annuity (especially when someone says the income is “guaranteed!” – it may be an annuity)?

Also, don’t use a bank for your IRA. Banks are almost uniformly terrible places to invest. Usually they’re high fee, low return, and high commission (for the salesperson, not you, unfortunately). Use one of the discount brokerage firms, like Vanguard, Fidelity, or Charles Schwab. Heck if you’re completely risk averse you can use an online savings account company like Capital One 360 or Ally bank. Not only does this allow you more flexibility with your money since you can invest in anything for low costs, but you have the option to get the highest possible interest rate on your account.

Bank products for investing and saving tend to be horrible choices – high fees, extremely low interest rates, and smartly dressed salespeople. The only things I like them for are when you need a free notary or medallion signature guarantee, a safe deposit box, and some checking account options. Their savings accounts are terrible and their investment options are frightening.

Have you ever  been pitched an annuity inside a retirement account? Have you ever had to control yourself from laughing when a salesperson makes a terrible recommendation? Let me know in the comments.