The Annuity Puzzle

[MuranoJo]

Thought this was a good article. More and more, I like the idea of a few annuities in the portfolio.

The Annuity Puzzle
http://www.nytimes.com/2011/06/05/business/economy/05view.html

 

[IngridN]

Wow...can't believe how timely. I was just going to post asking if anyone could recommend a good book (current) on annuities in laymen terms. DH and I just got back from a meeting with our financial advisor. We're at the stage of transitioning from saving for to retirement income planning. About every five years or so we attend an in-depth retirement planning class and the instructor did talk about annuities and the many, many that are out there depending on your needs. So, if anyone can recommend some reading, please post.

Tomorrow my boss gets the word that I'm outta there .

Ingrid

 

[Passepartout]

I retired 2 years ago and used a modest percentage of my portfolio to buy immediate annuities that pay about 5% for the rest of my life. Those, along with SS will provide a base income that covers all my necessities. Other funds continue to appreciate for use as needed- or as withdrawals are mandated. Key is the strength of the institution you buy from. I chose Prudential.

My DW, who is still working, bought a similar product, only she chose to let hers continue to earn 7% until she starts withdrawing at age 70 when it will lock in at the highest rate paid since she bought.

These give us great peace of mind that our basic need for income is covered.

Obviously you don't put all your assets into annuities. Their biggest danger is inflation eating away the spending power of the income stream.

I can't help you with reading recommendations as there are waaay too many products and they are changing all the time. A trusted, fee-only, independent financial advisor may be your best source of information.

Jim Ricks

 

[MuranoJo]

We also chose Prudential, and we got a Variable Annuity, which we can't access until I'm 65. But I will seriously consider an immediate annuity on top of that when I take early retirement. Of course, we'll continue a balance of stock and mutual funds investments for growth.

Hey, Ingrid, congratulations! I would love to be in your shoes tomorrow. Best of luck!

 

[pwrshift]

This Canadian book has some good points to know about annuities much of which would apply in the USA.

http://www.amazon.com/Pensionize-Yo...=sr_1_1?s=books&ie=UTF8&qid=1311136086&sr=1-1

The advantage of annuities, and there are many different and confusing ones, is that once you buy them they continue for life like a defined benefit plan but you must diversify. The disadvantage is that the insurance company is betting you won't live as long as you think so they can keep what you didn't get.

Equities in world dominating companies like Heinz, Kraft, McDonalds, JNJ, LLY, AT&T, KMB, Nestle, PG, TC Pipelines, Unilever, Verizon, Sunoco, etc are examples of long time consistent dividend payers of 3% to 6% and at the end of life your kids would get a legacy.

Right now GICs, bonds of any kind, are out of favor but a balanced portfolio of annuities and good equities could make retirement a lot less stressful.

 

[vckempson]

Thought this was a good article. More and more, I like the idea of a few annuities in the portfolio.

The Annuity Puzzle
http://www.nytimes.com/2011/06/05/business/economy/05view.html

This article is a less than cursory smattering of information about annuities. They are tricky enough for buyers but the nuances of riders and taxation issues will trip up many a professional as well. Seeing the responses here, I'll point out that there are two types of annuities, "Immediate" and "deferred". Technically, variable annuities are a type of "deferred annuity" even though they frequently have lifetime withdrawal guarantees that can function just like an immediate annuity.

Between the two, keep in mind that with an immediate annuity, the monthly payments are calculated using current interest rates which are very low. By taking out an immediate annuity, you are locking in todays very low rates. You give up your lump sum for an income stream. The lump sum is gone.

Guaranteed withdrawal benefits from a variable annuity can allow you to accomplish something similar, while maintaining flexibility to respond to economic and interest rate changes. You also retain your principal. The bells and whistles on these, however, change with the wind; way too frequently for a book to have much value. It would almost be out of date by the time it hits the stand. Don't expect to read a book and master this topic; not going to happen.

No more than 1/2 of your portfolio should be in variable annuities, probably no more than 1/3 in reality. Tax issues concerning annuities are way beyond the scope of this board. Most accountants don't have a clue about the nuances of taxation. For example, an immediate annuity is partially tax exempt, a withdrawal benefit from a VA is taxable to the extent you have gain in your policy. Taking money out from either before age 59 1/2 is subject to 10% penalty. There's also no step up in basis for beneficiaries at death. All deferred gains are fully taxable to the beneficiaries at the annuitant's death. And don't dare to have the annuity owned by a trust or other non natural-person entity. That's a tax bomb that blows up right away.

Many people selling these are just that, salesmen. Many have nothing but a rudimentary knowledge of them. Many also do not have well balanced approach as to the appropriate application of annuities. There are new regulatory mandated courses starting next year that must be completed to continue to sell annuities. Hopefully, we'll start to see the chaff being removed from the wheat.

These are my opinions alone, those of a Certified Financial Planner with almost 30 years experience in the industry.

 

[IngridN]

I'm on cloud 9...gave notice this afternoon that I am retiring. Will stick around to either the begining of Sept (my preference) or Oct depending on my boss' need and plans for transition to someone else. I don't know if it's a company policy but in order for the company to pay my insurance and 10% salary match into my 401K for the month ending, I have to work the first day of the following month.

Ingrid

 

[IngridN]

This article is a less than cursory smattering of information about annuities. They are tricky enough for buyers but the nuances of riders and taxation issues will trip up many a professional as well. Seeing the responses here, I'll point out that there are two types of annuities, "Immediate" and "deferred". Technically, variable annuities are a type of "deferred annuity" even though they frequently have lifetime withdrawal guarantees that can function just like an immediate annuity.

Between the two, keep in mind that with an immediate annuity, the monthly payments are calculated using current interest rates which are very low. By taking out an immediate annuity, you are locking in todays very low rates. You give up your lump sum for an income stream. The lump sum is gone.

Guaranteed withdrawal benefits from a variable annuity can allow you to accomplish something similar, while maintaining flexibility to respond to economic and interest rate changes. You also retain your principal. The bells and whistles on these, however, change with the wind; way too frequently for a book to have much value. It would almost be out of date by the time it hits the stand. Don't expect to read a book and master this topic; not going to happen.

No more than 1/2 of your portfolio should be in variable annuities, probably no more than 1/3 in reality. Tax issues concerning annuities are way beyond the scope of this board. Most accountants don't have a clue about the nuances of taxation. For example, an immediate annuity is partially tax exempt, a withdrawal benefit from a VA is taxable to the extent you have gain in your policy. Taking money out from either before age 59 1/2 is subject to 10% penalty. There's also no step up in basis for beneficiaries at death. All deferred gains are fully taxable to the beneficiaries at the annuitant's death. And don't dare to have the annuity owned by a trust or other non natural-person entity. That's a tax bomb that blows up right away.

Many people selling these are just that, salesmen. Many have nothing but a rudimentary knowledge of them. Many also do not have well balanced approach as to the appropriate application of annuities. There are new regulatory mandated courses starting next year that must be completed to continue to sell annuities. Hopefully, we'll start to see the chaff being removed from the wheat.

These are my opinions alone, those of a Certified Financial Planner with almost 30 years experience in the industry.

What is your recommendation as to doing the research? Our financial advisor is a CFP with one of the big investment companies (think Vanguard, Fidelity and the like) and we trust her. The amount we would invest would be about 25% of our portfolio and it with SS once DH and I turn 66, would cover our non-discretionary needs which have been calculated with a nice cushion.

We delved into annuities some and she did provide us with some information on MetLife's Growth and Guaranteed Income product...any thoughts on that particular one or something similar? DH and I both like the 'security' of a nice income stream, however, want to understand all of the pros and cons before we make a decision.

Ingrid

 

[bogey21]

I have lived with a quasi fixed annuity and Social Security since 2000. I say "quasi fixed" since I get a cumulative 2% cost of living payment every January 1st in addition to my monthly annuity payments. What I like about the annuity is not having to worry about the stock market.

My concerns are limited to inflation and the financial stability of the entity on whom I depend for my annuity payments. In this decade of low interest rates my annuity has treated me well but if I had to do it over again I would have put 50% in the annuity and 50% in other investments. But what is done, is done and I'm generally ok with what I have.

George

 

[vckempson]

What is your recommendation as to doing the research? Our financial advisor is a CFP with one of the big investment companies (think Vanguard, Fidelity and the like) and we trust her. The amount we would invest would be about 25% of our portfolio and it with SS once DH and I turn 66, would cover our non-discretionary needs which have been calculated with a nice cushion.

We delved into annuities some and she did provide us with some information on MetLife's Growth and Guaranteed Income product...any thoughts on that particular one or something similar? DH and I both like the 'security' of a nice income stream, however, want to understand all of the pros and cons before we make a decision.

Ingrid

What you laid out is exactly how it should be used. That's how we look to position them as well. As for MetLIfe, they are fine. The bigger issue is what bells and whistles you add to the policy. The expense ratio can rise to intolerable levels. One other new thing that's gaining traction is to have a rider that doubles the guaranteed withdrawal rate as a hedge against Long Term Care expenses. You might want to inquire about that as well.

Good luck. What are your plans for retirment?

 

[IngridN]

Thank you vc. For about the next six months after I retire, I plan to unclutter the house, get into gardening more and learn how to cook more interesting, nutritional meals. Then it's volunteer work, taking some classes, and whatever looks interesting.

DH plans to continue working for a few more years and travels a lot. Because of the pressures of my job, I've not been able to join him on his trips. I've missed out on a lot of the world because of it and that, of course, will change also.

Ingrid

 

[pgnewarkboy]

First, annuities are not guaranteed. Second, how is it possible for an insurance company to pay out 6 and 7 percent on your money when they can't make that much money from their investments - unless they are investing in risky business. Which goes back to the "annuities are not guaranteed".

 

[vckempson]

First, annuities are not guaranteed. Second, how is it possible for an insurance company to pay out 6 and 7 percent on your money when they can't make that much money from their investments - unless they are investing in risky business. Which goes back to the "annuities are not guaranteed".

Why do you think annuities are not guaranteed? Virtually every state has a state guarantee fund... sort of like FDIC.

Payouts on annuties don't work like you think they do. In an Immediate Annuity, you GIVE UP your lump sum for the income stream. So if you die 3 months after you start, they make out like a bandit. They don't need to earn 6% to have a 6% payout. The payout does not equate to earnings.

And with a variable annuity, again, they guarantee the payout, not the earnings. If the payout exceeds your earnings, you eat into the principal of your account.

 

[pgnewarkboy]

Why do you think annuities are not guaranteed? Virtually every state has a state guarantee fund... sort of like FDIC.

Payouts on annuties don't work like you think they do. In an Immediate Annuity, you GIVE UP your lump sum for the income stream. So if you die 3 months after you start, they make out like a bandit. They don't need to earn 6% to have a 6% payout. The payout does not equate to earnings.

And with a variable annuity, again, they guarantee the payout, not the earnings. If the payout exceeds your earnings, you eat into the principal of your account.

I don't know about state guaranteed funds. My state, does not have one. I looked into annuities and the salesman surely would have mentioned it prominently. As a victim of the savings and loan crisis in the eighties I can tell you that having your deposits guaranteed by a state is worthless in my experience. States can't pay their bills much less guarantee your annuities.

You are saying that an annuity can pay out 6% a year when banks are paying 1% because they collect money from those that die before they pay out much money. I can't argue with you because I am unfamiliar with the math and the statistics. I am very skeptical.

There is not point in getting an annuity unless you expect to get paid for a very long time. Of course, in a very long time inflation becomes a big issue. Also, in a very long time there is a greater chance the company providing the annuity will not exist. There is a long list of banks and investment firms that no longer exist, as well as insurance companies. Basically, when you hand over your money to an insurance company you basically have no way out. You can't get it back. That is a great deal of faith to put into one company. With virtually any other kind of investment you have the option of getting your money back. Perhaps with a loss or perhaps with a gain but you can get it and do what you think is the next thing to do.

 

[vckempson]

I don't know about state guaranteed funds. My state, does not have one. I looked into annuities and the salesman surely would have mentioned it prominently. As a victim of the savings and loan crisis in the eighties I can tell you that having your deposits guaranteed by a state is worthless in my experience. States can't pay their bills much less guarantee your annuities.

You are saying that an annuity can pay out 6% a year when banks are paying 1% because they collect money from those that die before they pay out much money. I can't argue with you because I am unfamiliar with the math and the statistics. I am very skeptical.

There is not point in getting an annuity unless you expect to get paid for a very long time. Of course, in a very long time inflation becomes a big issue. Also, in a very long time there is a greater chance the company providing the annuity will not exist. There is a long list of banks and investment firms that no longer exist, as well as insurance companies. Basically, when you hand over your money to an insurance company you basically have no way out. You can't get it back. That is a great deal of faith to put into one company. With virtually any other kind of investment you have the option of getting your money back. Perhaps with a loss or perhaps with a gain but you can get it and do what you think is the next thing to do.

Again your understanding is kind of accurate but not really.

First off, what state are you from? I don't know of any state that doesn't have a guarantee fund. I'll check and tell you the specifics for your state. Agent's are often limited by their knowledge or or their ability (legally) to promote the state guarantee fund. Also, it's a funded account, just like FDIC. Each insurance company pays into it creating a sinking fund for future claims. It's NOT a general obligation of the state.

Second, it's only on Immediate Annuties that you can't get your money back. Deferred Annuties are a different story. You can surrender those and get your money back at anytime, subject to premature withdrawal penalties. The vast majority of annuities sold are deferred annuities, by a factor 1000/1 or more, if I had to guess. Deferred annuities can either be fixed or variable. Fixed annuties pay a an interest rate, just like a CD. The vast majority are at 2 - 4% right now, depending on maturities. With variable annuities you pick the investments, mostly spinoffs of known mutual funds. Being subject to market risk you could do well or not, depending on the choices you make.

I'm not sure where you thought they earned 6% . No one is paying that these days. You might be able to get 6% distributions, but that includes a return of principal to get there.

 

[vckempson]

Here's a link that lists the amounts for each state's guarantee fund. Every state is included plus, Puerto Rico and D.C.

http://www.annuityadvantage.com/stateguarantee.htm

Also here's a quote about the prohibition in promoting the state guarantee fund for NJ, emphasis added in red by me.

Advertising Prohibition Policy
Section 17B:32A-17 “Use of existence of association to promote sales prohibited; summary of act to accompany policy or contract; disclaimer statement; notice of lack of coverage by association” (a) No person, including an insurer, agent or affiliate of an insurer or insurance producer shall make, publish, disseminate, circulate or place before the public or cause directly or indirectly, to be made, published, disseminated, circulated or placed before the public, in any newspaper, magazine or other publication or in the form of a notice, circular, pamphlet, letter or poster, or over any radio station or television station, or in any other way, any advertisement, announcement or statement, written or oral, which uses the existence of the association for the purpose of sales, solicitation, or inducement to purchase any form of insurance covered by this act. This subsection shall not apply to the department or the association or to any other entity which does not sell or solicit insurance.

 

[pgnewarkboy]

Here's a link that lists the amounts for each state's guarantee fund. Every state is included plus, Puerto Rico and D.C.

http://www.annuityadvantage.com/stateguarantee.htm

Also here's a quote about the prohibition in promoting the state guarantee fund for NJ, emphasis added in red by me.

This is not a rhetorical question. It is just a question. Are you saying that these state funds have sufficient money in them to pay 100% of the money deposited in an annuity by an individual? Even if there was a huge default by more than one insurance company? I know the FDIC guarantees only up to a specific amount per account.

 

[vckempson]

This is not a rhetorical question. It is just a question. Are you saying that these state funds have sufficient money in them to pay 100% of the money deposited in an annuity by an individual? Even if there was a huge default by more than one insurance company? I know the FDIC guarantees only up to a specific amount per account.

No, there are limits just like FDIC has limits. Clearly, they don't have an amount of money in the fund that's equal to all annuities from all companies. That would be impossible. The pool accumulates money from ongoing deposits from insurance companies, just like banks make ongoing deposits into FDIC. Money flows in and out (for claims on failed insurance companies). I can't comment on the extent to which these guarantee funds are funded other than to state that I know of no occurence when a state fund ran out of money, thus not having enough to cover claims.

While I have no statistics, my impression is that insurance company failures are exceedingly more rare than bank failures. That's purely from anecdotal evidence and observations over the 29 years I've been in the business.

 

[MuranoJo]

Cullen, thanks for piping in with your knowledge. Much appreciated.

I'm not sure, given your input, if we've made the right decision about the variable, but it felt good at the time. It wasn't like we put a lot of $$ into it, we saw it as a supplemental to other investments. But we felt a few annuities in the portfolio would help stabilize the rest of the portfolio.

 

[pgnewarkboy]

No, there are limits just like FDIC has limits. Clearly, they don't have an amount of money in the fund that's equal to all annuities from all companies. That would be impossible. The pool accumulates money from ongoing deposits from insurance companies, just like banks make ongoing deposits into FDIC. Money flows in and out (for claims on failed insurance companies). I can't comment on the extent to which these guarantee funds are funded other than to state that I know of no occurence when a state fund ran out of money, thus not having enough to cover claims.

While I have no statistics, my impression is that insurance company failures are exceedingly more rare than bank failures. That's purely from anecdotal evidence and observations over the 29 years I've been in the business.

It is a fact that annuities are not a risk free investment. The states simply do not have enough money to back up these funds and the funds will not reimburse all your money even if they did have the money. You say you don't know of many insurance company failures yet AIG was the biggest insurance company failure in the history of failures. It took the U.S. government to bail them out and those insured by their myriad products. The question with all investments is always the same. Am I being sufficiently compensated for the amount of risk I am taking. To answer that question you have to look basically at the return on investment.

Each individual will have to determine for themselves whether their return on investment is sufficient for the risk taken. Each person will see it differently depending on the amount of money they have, their tolerance for risk, and their specific needs. IMO most annuities do not provide a good return once you make the calculation. I also feel that once you go beyond the "basic" annuity, and into variables, they are much too complex to understand. I won't sign a contract committing my money when I don't understand the contract. I know a few things about contracts and examined a variable annuity contract very closely. I came away with more questions than answers. I am sure the contract I reviewed is typical of the industry. The insurance company retains many rights for itself to protect itself. They are couched in very difficult to understand terms. That is not acceptable to me.

 

[vckempson]

r

It is a fact that annuities are not a risk free investment. The states simply do not have enough money to back up these funds and the funds will not reimburse all your money even if they did have the money. You say you don't know of many insurance company failures yet AIG was the biggest insurance company failure in the history of failures. It took the U.S. government to bail them out and those insured by their myriad products. The question with all investments is always the same. Am I being sufficiently compensated for the amount of risk I am taking. To answer that question you have to look basically at the return on investment.

Each individual will have to determine for themselves whether their return on investment is sufficient for the risk taken. Each person will see it differently depending on the amount of money they have, their tolerance for risk, and their specific needs. IMO most annuities do not provide a good return once you make the calculation. I also feel that once you go beyond the "basic" annuity, and into variables, they are much too complex to understand. I won't sign a contract committing my money when I don't understand the contract. I know a few things about contracts and examined a variable annuity contract very closely. I came away with more questions than answers. I am sure the contract I reviewed is typical of the industry. The insurance company retains many rights for itself to protect itself. They are couched in very difficult to understand terms. That is not acceptable to me.

I've not suggested doing anything you are not 100% comfortable with. Nor have I suggested that annuities are desirable. I didn't start this thread and I certainly have NOT promoted annuities. I've only given factual information to dispell misinformation.

Yes, AIG, the parent company did almost fail. The subsidiary that sold annuties, however, was NEVER close to failure. As a matter of fact, it was always healthy and one of the most valuable assets that AIG owned. In the midst of AIG's implosion, they quickly sold off the life and annuity company to gain liquidity. Have there been life/annuity insurance company failures? Yes. I can name 5 or 6 over the last 29 years that I've been doing this. Can you name me even 2 or 3? Probably not. Compare that to bank failures. There were 11 this month so far... THIS MONTH; 157 failures in 2010. There's absolutely no comparison.

I don't exactly know what your definition of "guaranteed" is. FDIC is guaranteed based on the trust fund that's established, then by the full faith and credit of our government. And even then, you're only covered up to a certain limit. That's similar to the state guarantee funds. Do you honestly think there's enough money in the FDIC fund to cover ALL deposits in the US? No! There's only enough to cover anticipated failures, plus some. At it's peak the FDIC had a reserve ratio of about 1.25% in 2008, which dropped to a low of about 0.25% reserve ratio in 2009. That's hardly enough to cover ALL money in the banking system.

There is no such thing as an absolute guarantee. For that, you'll have to put the money under your mattress. Even then, you're subject to future inflation risk, thus eroding your purchasing power. There's just no magic bullet.

Edit: I don't mean to imply there's only been 4 or 5 Life/Annuity Company Failures. That number represents those that were prominent enough to hit our level of awareness. Over the last 25 years, the total failures were less than half the bank failures in 2010 alone.

 

[bogey21]

I also feel that once you go beyond the "basic" annuity, and into variables, they are much too complex to understand.

Agree. I have a "fixed" annuity with an annual 2% cost of living escalator. I see two risks. First is interest rate risk and second is the creditworthyness of the issuer. Handling these were/are my responsibility. I don't even consider that there may be a State Insurance Fund backup.

George

 

[MuranoJo]

I saw this as an assumed risk, and don't count on FDIC. JMO, but I feel it's still a good choice in the portfolio and probably as or more stable than other options.

 

[Talent312]

A note: Each state's "Association" guarantee is privvate, not a government guarantee.

There are annuities that will provide a payout for a minimum # of years (10 or 20), regardless of the death of the annuitant, but the income stream for those is lower than those which end at death.

Annuities should only be purchased with $$ that is not already in an IRA, 401K or other retirement account. These are like self-managed annuities, only you schedule the income stream, and they don't have the higher fees or gamble on longevity.