Does the Customer Have the Right to Know?

The U.S. financial industry does not have a full disclosure law, and reportedly over 80 percent of financial professionals are not fiduciaries. (A fiduciary is a high legal standard that requires the financial advisor provide full disclosure of all material facts with the client, including any conflicts of interest.) There is one category of financial advisors who are required to be fiduciaries at all times. These are called Registered Investment Advisors (RIAs). An RIA is an independent financial advisor registered with the Securities and Exchange Commission (SEC) or state securities regulators.

Most investment brokers and brokerage firms work under a standard that is lower than a fiduciary, called “suitability” or “best-interest.” If the financial industry had a full disclosure law — or required all advisors to be fiduciaries — consumers would be better protected from the unethical sales tactics that are too common in the industry.

Let me provide an example. When readers of my column contact me with questions, I often schedule a phone call with them. A reader recently told me about his experience with a national discount brokerage firm in early 2023. This brokerage firm manages many 401(k) retirement plans for corporations, and, when he retired, rolling over his 401(k) from his employer to an IRA at the brokerage firm was a simple process. His IRA was worth slightly over $1 million. He also recently inherited $1 million after his mother’s death, which he deposited into a taxable account at the brokerage firm. When he met with a “financial consultant” at the firm, he explained that he did not want a lot of risk in his investments.

The financial consultant recommended he buy two five-year fixed annuities for $500,000 each; one for his IRA and one for his taxable account. He was told the annuities are similar to a five-year Certificate of Deposit (CD), and the fixed rate would be 3.7 percent for five years. When he shared this with me, I was stunned. I explained that I have always been a fan of investors keeping control of their money. Buying an annuity requires signing a contract with an insurance company, which involves giving up control to the insurance company. He said he believes he will regain access to the money in five years, but he is not certain.

So, is there a problem here? Maybe not, if the investor is pleased with his decision. However, this conversation led me to do some research. The type of fixed annuity he bought is called a “multi-year guaranteed annuity (MYGA). It is designed to be similar to a CD. So, in retrospect, what questions could he have asked the financial consultant before agreeing to buy the annuities?

1. What other low-risk investments should he consider other than an annuity? Were there better choices available?

In my view, CDs would have been a better choice. When he bought the annuities (paying a fixed rate of 3.7 percent), there were five-year CDs available with yields of 4.5 percent. Brokerage firms can access what are called “brokered” CDs from banks across the US, and they are insured by the FDIC up to $250,000 per depositor, per bank. Brokered CDs typically have much higher yields than those offered by “brick and mortar” banks. The financial consultant could have recommended two $250,000 CDs for his IRA and another two for his brokerage account (from four different banks). (As I submit this article on May 30, there are five-year brokered CDs available at brokerage firms at 4.9 percent. However, many of them are “callable,” and I recommend you look for a CD that is non-callable, meaning it is a fixed, guaranteed rate for the entire five years. There are currently non-callable five-year CDs available at 4.55 percent.)

The fixed annuities with a yield of 3.7 percent (which he purchased for a total of $1 million) will pay him $37,000 per year, which will total $185,000 over 5 years. If he had bought CDs with yields of 4.5 percent, he would have earned $45,000 per year, for a total of $225,000 over five years. The CDs would have paid him an additional $40,000 over 5 years (as compared to the annuities), they would have been FDIC insured, and he would know he will have complete access to the $1,000,000 when they mature in 5 years. Tax ramifications are identical between the annuity and CDs in his IRA. For his taxable account, the earnings on the annuity are likely tax-deferred, but that is a minor benefit when tax rates are expected to go up in 2026 and he would have earned more each year from the CDs.

2. How much did the financial consultant earn in commissions from selling the annuities to him?

It is impossible to know for certain, but online research suggested he probably earned 2.5 percent of the $1 million invested. (Another source suggested the commission rate was likely 4 percent.) If we accept the 2.5 percent estimate, he earned $25,000 for selling the annuities. It is possible the brokerage firm also paid him bonuses for selling annuities. Is this relevant? The financial consultant (and the discount brokerage firm) may argue the investor did not directly pay the $25,000, so it is not relevant. I would argue it is very relevant, because the investor indirectly paid for the commission by accepting a lower yield on the annuities.

The financial consultant did not disclose how he was being paid for selling the annuities, and he did not discuss other low-risk investments that may have been more attractive to the customer. Another benefit of the CDs is that the early withdrawal penalty (if the investor needed to unravel the CD in less than 5 years) is typically less than on an annuity. Between 1–5 years, the withdrawal penalty on the annuity is often 7 percent, whereas a typical early withdrawal penalty on a CD is 6 months of interest. On a CD earning 4.5 percent, this would be 2.25 percent.

This example conveys the impact of the lack of a fiduciary standard and a full-disclosure law. The financial consultant did not break any laws because the brokerage firm is held to a lower standard. There was clearly a conflict of interest present, because the financial consultant knew that CDs were likely a better choice for the investor than the annuities. There may have been other investments (such as treasury notes, bond funds or ETFs) that could have been discussed with the investor for the taxable account. For the traditional IRA a bond (or CD) ladder to support potential Roth conversions over the next few years (that the investor is considering) may have been a good choice, or a bond ladder designed to provide estimated RMDs (Required Minimum Distributions) that will begin in a few years could have been discussed.

Is there a “Buyer Beware” message here? I recommend you ask lots or questions of anyone giving you financial advice. This pertains to financial advisors, financial planners, investment advisors, wealth managers, and many other titles frequently used in the financial, banking, and insurance industry.

Consider asking:

1. Are you a fiduciary? Will you serve me as a fiduciary at all times?
2. Will you disclose all conflicts of interests?
3. Will you discuss all of the fees involved (including commissions or bonuses you may receive from selling a product)?
4. Will you provide me with recommended alternatives so we can discuss the pros and cons of your recommendation?
5. What are your credentials, education, and background?

Even though the financial industry does not go far enough to protect consumers and investors, you can demand a higher standard. The key is to find a financial advisor you can trust. They should be looking out for your best interest, and asking difficult questions is justified.

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Donna Skeels Cygan, CFP®, MBA, is the author of The Joy of Financial Security. She owned a fee-only financial planning firm for over 20 years and is now writing a new book, Sage Choices After 50, that will be published in 2023.