“The more you read, the more you’ll know. The more you know, the more you can earn.” —Dr. Seuss.
About those Annuities
Investopedia speaks of investments growing recently with market fears, yet “Only about 11%-12% of retirement-age households own annuities, and even fewer rely on them as a primary income source.” The 1929 crash bolstered fixed annuities, and salesmen marketed variable annuities in 1952 with newly popular mutual funds.
Few know annuity millionaires but Mathew Young still publishes “Investing in Annuities: How to Earn High Rates of Return Safely.” Two thirds of annuitants are seniors who like the idea of “annuitization”: trading capital for predictable income streams. At the price of growth, are annuities the best way to assure steady income?
In its accumulation phase, investors contribute money. Penalties for cancellation run as high as 7% to discourage flight and pay high sales commissions, with cancellation unacceptable in the distribution phase. Annuities can pay out for defined time periods or for all of one’s life. If the owner/annuitant dies early, her contract may guarantee survivor life benefits, payment of cash value, refund of payments or even continued payments for “term certain.”
Avoid IRS penalties and possible surrender charges by taking regular payments after age 59.5—but expect ordinary income taxes. This “chaperoned investment plan” avoids probate with contractual distributions but beneficiaries lose the step-up in basis.
Annuity Choices
Who benefits from annuities most: high earners limited by retirement plan income caps may defer or diversify income while trust beneficiaries avoid Medicare paybacks and children’s welfare. But my favorite annuities—nearly pure longevity insurance—are relatively cheap Qualified Longevity Annuity Contracts (QLACs) paid from IRAs that drain retirement assets to reduce RMD requirements. Distributions begin by age 85 allowing investors to maximize stock earnings with low fees as funds accumulate but knowing QLAC payments continue to death.
Fixed Annuities
Matthew Young describes contracts with “…a set minimum interest rate so investors know exactly how much money they will have five, ten, or even 20 years down the road. For retirees on a fixed income, this peace of mind is very reassuring.” (p. 12) Avoiding market dips, annuitants lose out on upswings. Annuities compete with bank CD performance, but CDs are far more liquid. Those who seek the stability of lifetime income, often purchased extra as a rider, must fear not only inflation but withdrawal penalties for surprise expenses like medicine, tree falls or wedding celebrations.
Tax-sheltered Annuities
These include Social Security and payroll deducted teacher’s retirement, but most private employers dropped retirement guarantees that risked insolvency. With employer contributions, teachers should accept annuities and may consider loans to pay back in five years. They also should get 403b mutual funds for growth.
Avoid entangling annuities in IRAs and shelter income in Roth accounts.
Variable Annuities
Securities licensed agents promise greater safety and mutual fund growth with variable annuities that may be indexed for guaranteed payments-but companies usually cap performance for this option. Participation rates limit upside potential by percentage and many annuities follow price indexes to deny investors total returns, which include dividends. Fees lower investment returns so opportunity cost is the biggest price of annuities.
Read fine print! Mark Stoecker warns: “Variable annuity fees can range between 3-4% per year when you dig deep. These relate to the cost of insurance contract charge, internal management fees, turnover fees, expense ratios, riders for lifetime income, just to name a few.” Fisher Investments warns of fees “…of at least 1.4% (according to the SEC) simply to cover the annuity’s cost. Remember, money in a variable annuity is likely to be invested in mutual funds, which also charge fees (averaging 0.94%). Factor in a couple of common riders, like a Minimum Death Benefit (0.51%) and Guaranteed Lifetime Withdrawal Benefit (1.06%), and your fees might reach as high as 3.9%.”
Replacing Unwanted Annuities
Unhappy annuitants can retain contracts, cash out with penalties, sell their contracts at discounts or replace annuities with 1035 exchanges. Mark Stoecker advises clients to consider “the Fee Based Variable Annuity. A fee-based managed portfolio of mutual funds or ETFs inside a low-cost tax deferred wrapper.” Independent CFPs speak truth to power, and this one rarely advises stabilizing income with costly annuities.
Robert Arne, EA, CFP, MS, of Carpe Diem Financial Life Planning, gives holistic financial advice as his client’s fee-only fiduciary. He serves mostly Santa Cruz Mountain dwellers. These articles must not be read as personal financial, mortgage, tax or investment advice; consult appropriate professionals. Learn more at www.carpediem.financial.
