The other day I was having a conversation with a young couple and the topic of conversation turned to financial planning and debt load. The explained that they felt like they were swimming in debt and could see no light at the end of the tunnel. After asking a few questions, I was shocked at the story they told me.
The Facts
The couple, both age 36 have a $125,000 line of credit secured to their home. About three years ago, their investment advisor told them that they could use the money from the line of credit to invest and deduct the interest from their income tax (which is generally true).
Having little knowledge of investing and being somewhat risk adverse, their investment advisor suggested they purchase a Guaranteed Minimum Withdrawal Benefit (GMWB) from Manulife, called IncomePlus.
What Are Guaranteed Minimum Withdrawal Benefits
A GMWB is a product designed for those who are in retirement and need guaranteed income or those nearing retirement. It is an insurance product that works kind of like a mutual fund with a guaranteed withdrawal rate. Essentially, the insurance company guarantees you access to an income stream of 1/20th of your original investment. If the investment goes up, they will adjust your income stream up every three years: If the investment goes down, they guarantee your original income stream.
There is also a 5% bonus added back to the GMWB for those years you don’t draw income. However, this bonus is not paid if you close out your GMWB.
To find out more about GMWB’s and how they work, I recommend you read Manulife IncomePlus: The high cost of peace of mind.
A GMWB has a place, but for younger clients saving for retirement or for other reasons, is not appropriate.
The Problem
This couple was told by their investment advisor that they would make a guaranteed 5% on their investment every year and if the market went up they would make even more. There was no downside risk.
The advisor downplayed the $1,500 per year annual fee and failed to tell them that the 5% guarantee would not be available if they needed to cash out the GMWB. He also did not tell them about the 5% sales charge that would be levied for early cash out of the GMWB nor the up front $6,000 commission that was paid to the advisor for selling the GMWB.
The Math
According to the illustration provided by their investment advisor, the value of their investment in IncomePlus would be worth $333,000 at age 65. This ignores the cost of borrowing and the client would still have a $125,000 loan and would have been making interest payments over the whole 29 years.
If on the other hand, had this couple contributed $8,000 a year ($6,500 of interest expense and $1,500 of GMWB direct fees) to their RRSP earning 5%, they would have accumulated about $500,000. On top of that, they would have also received a tax return for their RRSP contribution.
My Counsel
I told this couple they should get out of IncomePlus and pay off their investment loan. After all is said and done they would be left with about $10,000. This $10,000 should be contributed to their RRSPs and they should make annual contributions of $8,000 per year.
In addition, I suggested they begin a complaint with the Ombudsman for Banking Services and ask that they be reimbursed for the excessive fees which I estimate at just under $10,000.
I also suggested they find another investment advisor and gave them the names of some reputable people in the area.
Afterthought
The advisor who sold the GMWB to this couple was money hungry and took advantage of a lack of investment product knowledge. Has this couple sought another opinion before signing the GMWB contract, the may have found better advice and saved themselves thousands of dollars in fees.
If you have been sold a product you don’t understand and you can’t get your advisor to explain it or resolve your complaint you can complain to the Ombudsman of Financial Services and Investments. They can help resolve issues and complaints about investments that have been sold to you.
Do you have any comments on this article? Please feel free to leave a comment below.
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{ 5 comments… read them below or add one }
I agree with you that it makes no sense whatsoever for a young person to buy a GMWB product, especially with borrowed money. There are far simpler alternatives: paying down mortgage debt or building up RRSPs. It may not be criminal that an advisor suggested this but it should be.
Thanks for the mention!
@ Canadian Capitalist
I posed this scenario to Preet (wheredoesallmymoneygo.com) and he mention these tactics were under the scrutiny of branch managers.
My issue is really one of oversight at the investment dealer level. Most firms compensate their advisors by commission and their branch managers (who are responsible for ensuing compliance and suitability guidelines are held to) by branch profit. Most firms then provide an atmosphere where this kind of activity flourish.
I find very few investment dealers who seek to provide their services in a way that is customer focussed.
Note: Another colleague I spoke with also mentioned that the GMWB vendors (manulife and Sunlife) do not recommend these types of plans either but don’t do anything to stop them.
@ Tax Guy and Canadian Capitalist
Both of your arguments are flawed, because there are 2 facts that you do not take into consideration:
1- The investment loan will be taxed as capital gains, whereas your investment into the RSP will be taxed as income. Yes you do receive a tax refund from the government on the amount you put in, but you get taxed on the entire growth of your investment, you will also receive a tax refund on the investment loan (if invested for the purpose to generate income etc…) but at the end of the day your growth will be taxed as capital gains. Many assume that when you retire (for most people the question now is if they retire) your MTR drops which may not be the case.
2- you are also assuming a 5% return on their RSP, but i am sorry to advise you that had your clients invested in 2007 they would have been worse off. The 5% guarantee on a GMWB is guaranteed plus you also receive any upside in the market. For any client who is risk averse this is a better option. The market was down 50% in 2008, $1500 is a small fee to pay in return of a 5% guarantee… you do the math $125,000 – 50% = $62,500… i would much rather pay the $1,500.
Finally as financial advisors, we always promote to our clients to invest early, and invest as much as possible to help meet their financial goals, how many of your clients would like to make 5% on $8000 vs 5% on $125,000, take into consideration the power of compounding and time and you do have a winning formula.
I would only say that this advisor did a poor job explaining the GMWB to his clients, he only focussed on the 5% guarantee without talking about the disadvantages of the product, this is unfortunate because the GMWB is a great product.
@ Shamar:
My rebuttal:
GMWB’s are distribution (person living in retirement) product and were not designed for accumulation. This is a young couple who are clearly in the accumulation phase of life.
Manulife themselves state that the sequence of returns does not matter during accumulation but DO very much matter in the distribution phase. If the sequence of returns does not matter why would anyone in the accumulation phase ever use a GMWB? They are paying excessive fees for a guarantees they don’t need.
Instead of using a GMWB, they could have borrowed to invest in a plain vanilla equity mutual fund and would probably have been better off.
I agree the advisor did not do a good job of explaining the product, but the ultimate question is why would anyone in their 30′s ever need to own a GMWB? I just don’t see it.
Point of clarity – Interest on investment loans is a deduction from all income and the loan itself has no other tax consequences.
All i’m going to say is , read the fine print,and if you change you mind it will cost you to get out of this plan…