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Annuities-Variable? Fixed? Immediate
Old 07-28-2003, 09:19 PM   #1
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Annuities-Variable? Fixed? Immediate

I spoke to my friendly Vanguard Variable annuity "specialist" who suggested that the best way to maximize choices when one is considering annuitization is to take a 1035 exchange and buy an immediate annuity. I would love to hear what you folks thinks about how to best use money that is currently be accumulated in a Vanguard annuity. Thanks..........Jackalope
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Re: Annuities-Variable? Fixed? Immediate
Old 07-29-2003, 02:15 PM   #2
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Re: Annuities-Variable? Fixed? Immediate

Annuities are so complicated that most people understand very little about them -- and some unscrupulous "financial professionals" cash in on that fact by selling them annuities that (1) are completely inappropriate for them and/or (2) have very high expenses that are not exactly emphasized by the people selling them.

Annuities are sold by insurance companies, which usually charge substantial fees for administration and certain "guarantees," which vary widely. These expenses are typically in the range of 2% to 3% annually. (The Wall Street Journal provides a weekly summary of various annuities, their performance and annual expense ratios, I believe on Mondays.)

The only two companies that I know charge annual fees less than 1% are TIAA-CREF and Vanguard. (Since Vanguard is not an insurance company, its annuities are actually administered by a company called People's Benefit Life Insurance).

The only feature of annuities that justifies their high expense ratios is the fact that the taxes on their earnings are deferred (similar to a conventional IRA). Thus, if you are in a high tax bracket and are contributing your legal maximum to a 401(k), Roth IRA, etc., you can place more money into tax-deferred status by investing it in an annuity.

While the annuity is growing (and no money is being withdrawn) it is said to be in the "accumulation phase." A "fixed" annuity provides a specified "fixed" rate of return for a specified number of years, whereas a "variable" annuity provides an investment in stock or bond "sub-accounts" (funds) of the owner's choice. The value of the variable annuity then varies according to returns of the underlying securities (minus expenses).

An annuity that is paying out money to its owner (or their beneficiary) is said to be in the "distribution phase." A person may, in fact, purchase an "immediate annuity" for a lump sum of money, which is called that because it immediately begins making periodic payments.

As far as I know, all annuities that are offered with an "accumulation phase" may be converted to "immediate annuities" managed by the same company whenever desired by the owner. I believe that the only time that the "1035 exchange" mentioned by Jackalope applies is when a person switches money from one company's annuity into another's. "1035" is an IRS rule that allows this transfer to be made free of taxes. (I made such a transfer myself into a TIAA-CREF annuity when I realized how much I was paying in annual expenses to another insurance company.)

Having money paid out from an annuity may be done similar to any other retirement account, whereby a certain percentage of the "units" (shares) are liquidated and paid out annually.

A unique and important option, however, is to receive periodic payments of a specified cash value for life -- however long that turns out to be. The major disadvantage to this arrangement is that if you die soon, your heirs don't get what you spent on the annuity. Conversely, if you live long, inflation may drastically reduce the purchasing power of the payments that you receive, since they are not inflation-adjusted.

A lesser disadvantage is that the inherent "return" on the money invested in the annuity (based on average life expectancy) is rather modest -- I figure about 4%.

Right now, my annuity with TIAA-CREF is in the accumulation phase and it is mostly in the inflation-indexed (TIPs) sub-account. When I eventually start withdrawing funds, I think that I'll keep most of the money there rather than take the option of guaranteed fixed payments for life. That will provide both inflation protection and a lump sum for my heirs if I die soon.
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Re: Annuities-Variable? Fixed? Immediate
Old 07-29-2003, 10:28 PM   #3
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Re: Annuities-Variable? Fixed? Immediate

In addition to the helpful information provided by Ted, there is an excellent study of how inflation adjusted annuities can affect withdrawal rates. Older retirees can improve their annual withdrawals by use of inflation adjusted annuities, while younger retirees would mostly just lock in a worse case scenario. Check it out at:

http://rehphome.tripod.com/inflannu.html

Of course, you could do it yourself with TIPS or I Bonds, but you would lose the survivorship benefits of annuities. The annuitants band together and agree that the portfolios of those who die early go to the other annuitants, allowing the survivors a larger annual pay out. Since no one knows who will die early, this is a fair arrangement. Of course, this leaves nothing for heirs since the portfolio goes to the other annuitants, but for those who need a larger annual pay out, this may be their only option.

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Re: Annuities-Variable? Fixed? Immediate
Old 09-26-2003, 11:48 AM   #4
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Re: Annuities-Variable? Fixed? Immediate

I must be missing something. I do not see the advantage of an annuity except that you do not need to invest the money yourself and the return you you get is set just like in a pension. The most important factor is you lose the principle.

What am I missing?
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Re: Annuities-Variable? Fixed? Immediate
Old 09-26-2003, 12:23 PM   #5
 
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Re: Annuities-Variable? Fixed? Immediate

It depends on the type of annuity. If there is an accumulation period before withdrawal, I believe the earnings are tax-deferred. If it is an immediate annuity (payments begin immediately), and you choose to have the payments continue to your spouse after your death, I have seen (internet) where $100,000 could result in a monthly payment of $533. If you buy the annuity in your late 50's, and you and/or your spouse live to your late 80's, the effectice interest rate is about 5%. If you live longer, the effective rate would be higher, die earlier and the rate would be lower. The biggest disadvantage is the loss of control and the fact that you and your spouse could die a week after the $100,000 premium is paid and the insurance company keeps the proceeds. Another issue is that the "guaranteed" payments are only as good as the financial standing of the insurance company. They could go out of business, and I believe you are out of luck. I just attended a seminar on this, but certainly am not an expert. I have been considering such a purchase to make up for the drop in my pension amount (to my spouse) if I die first, but would be interested in comments from others.
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Re: Annuities-Variable? Fixed? Immediate
Old 09-26-2003, 12:34 PM   #6
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Re: Annuities-Variable? Fixed? Immediate

To seeker, I am not an expert either, but as I understand it, immediate annuities can offer older retirees a larger monthly sum of money to live on than they can safely withdraw from a portfolio. For younger retirees, there are few benefits.

For adviceseeker, you might also compare the cost of a life insurance policy to the cost of the annuity. If you are both very young, you could also consider teaching your spouse about financial principles, and letting your spouse withdraw a percentage of your portfolio to supplement the reduced pension. I don't know your situation, so I leave it to you to decide which is best.
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Re: Annuities-Variable? Fixed? Immediate
Old 10-01-2003, 05:36 AM   #7
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Re: Annuities-Variable? Fixed? Immediate

The annuity option is something I am interested in to provide some protection against loss of principal. As I am exploring taking an early retirement package, I am still about 5 years away from retiring and will have to find another job. To this end, I wonder if an equity indexed annuity would be a good vehcile and place to put my pension money to eliminate downside risk, could be converted to an immediate annuity if I don't find another job, and I believe some immediate annuities can provide payments to my children for a 20 year period if both my wife and I were to die. Then I still have 401K to invest for growth/hedge against inflation and of course SS in another 7 years.

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