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Annuity thoughts
Old 11-13-2013, 10:04 PM   #1
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Annuity thoughts

So my wife recently showed me that she has an annuity she bought 23 years ago -before we met- and definitely when neither of us knew anything. She did not know hat she was getting and we are still trying to sort out what have we got. I spoke to the company about it and want the wisdom of members here as well. This is a Flexible Premium Deferred Annuity non qualified-worth about $30000 right now with no Surrender penalty at this point. it earned 3% last year and is on a fixed interest rate. I forgot to ask if that 3% will continue. I was thinking of leaving it be as a part of our rainy day "cash" which is earning a decent interest for cash and at tax deferred. When my wife finally stops working then maybe we could cash it out at the lower tax rate we will be in then. Certainly no matter what we will wait uat least ntil next year when we drop our tax rate with me retiring in 2 weeks!!!
My questions are- does this make sense or am I missing some way the annuity people are continuing to take us for a ride? Also since it is a flexible premium, should I move more cash into it now?
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Old 11-13-2013, 10:50 PM   #2
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Since you're beyond the surrender period most of these older products are basically fixed income investments with an annuitization option. 3% sounds pretty good to me for a credit worthy fixed income investment with no interest rate risk and good liquidity. Better than many CDs available and no early withdrawal penalties. It might also be that you have an older policy and the minimum interest rate is 3%.

I would lean towards keeping it and considering it part of my fixed income allocation, especially of the 3% is the minimum rate.
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Old 11-13-2013, 11:43 PM   #3
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Originally Posted by urn2bfree View Post
So my wife recently showed me that she has an annuity she bought 23 years ago -before we met- and definitely when neither of us knew anything. She did not know what she was getting and we are still trying to sort out what have we got. I spoke to the company about it and want the wisdom of members here as well. This is a Flexible Premium Deferred Annuity non qualified-worth about $30000 right now with no Surrender penalty at this point. it earned 3% last year and is on a fixed interest rate. I forgot to ask if that 3% will continue. I was thinking of leaving it be as a part of our rainy day "cash" which is earning a decent interest for cash and at tax deferred. When my wife finally stops working then maybe we could cash it out at the lower tax rate we will be in then. Certainly no matter what we will wait uat least ntil next year when we drop our tax rate with me retiring in 2 weeks!!!
My questions are- does this make sense or am I missing some way the annuity people are continuing to take us for a ride? Also since it is a flexible premium, should I move more cash into it now?
I would jump at any opportunity to start getting the money out of that annuity. The purchase of an annuity typically results in a wealth transfer of 15 - 20% from the investor to the insurance company and agents who push them. And yes, she was sold this annuity by a salesman who legally worked for himself or his company -- not a fiduciary registered investment adviser working in the best interests of her.

The problem with annuities are numerous. For one they are taxed at the higher ordinary income tax rate and so distributions must be tightly controlled depending on your tax situation.

Heirs pay taxes on gains that they inherit. Heirs pay no taxes on gains from other normal investments like stock and bond ETF's.

3% before taxes is not investing. That's actually doing worse than inflation after you pay ordinary income taxes at the time of distribution. The normal way to invest is with a mix of stock and bond ETF's. The older you get the more you favor bonds obviously.

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I spoke to the company about it
The insurance company will simply spit out facts about their product. Don't expect to get any type of personalized advice from them. Same thing with brokers, insurance agents, and other non-fiduciaries. Whoever is listed on her quarterly statements cannot be trusted either. He earns a 1/4% trailer fee for every year she remains invested. Only a paid fiduciary can really advise you on what to do.
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Old 11-14-2013, 12:17 AM   #4
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Ordinary income taxes are paid on the gains over the original investment. If 10K was invested and current cash in value is 30K, ordinary income tax will be due on 20K. You simply delay taxes on gains until cashed out, though at a higher rate than if it were capital gains. Unless of course you are in the no tax income bracket.
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Old 11-14-2013, 05:23 AM   #5
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Is the 3% interest and $30,000 value "real money" that you could withdrawal or is it the balance that would be applied if you convert to a SPIA? A lot of these types of policies only give you the numbers if you annuitize. You may find that the amount of money you get when cancelling a policy is considerably less.

Have you or her been making payments on this policy or is it just something she bought years ago and just forgot about it?

Is the 3% interest rate a gross return or net after annuity fee?

I am so anit-annuity products that my first reaction is always to get out of it ASAP. It is an insurance product and it's very unusual for anyone to get the better of an insurance company. I suspect that the $30,000 is not a considerable portion of your assets and whether it earns 1% or 3% isn't going to change your retirement finances. If so, consolidating the funds contributes to simplifying your finances and eliminates one more account to keep track of.
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Old 11-14-2013, 05:33 AM   #6
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No fiduciary adviser (who legally works for you and your best interests) will ever recommend an annuity to anyone unless they are a target for lawsuits and they live in a state like Florida that protects annuities from judgments. Even in that case a lawyer must make the final decision. Other than that 99.9% of the time it's broker / advisers and insurance salesmen who dupe people into locking their money in these annuity prisons. The legal "suitability standard" that governs broker /advisers and insurance agents doesn't protect investors much at all.
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Old 11-14-2013, 08:44 AM   #7
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Assuming that 3% in the crediting rate (and may even be the minimum crediting rate which is the case for many older FPDAs) where else today can you get 3% where you have no early withdrawal penalties, no interest rate risk, no market risk, no liquidity risk and negligible credit risk?

5 year CDs are paying ~2% at best. 7 year bond funds are yielding about 3% but have significant interest rate risk. Equities have much more risk and are at all time highs. So for those who are suggesting that the OP bail - what would you invest in that would have a similar risk profile to an FPDA and offer 3% returns?

While I would be the first to agree that one shouldn't buy a new annuity, that is a very different decision from where someone has an old one and is deciding what to do with it. 3% minimum guarantees are no longer available and if that is what your contract have it is a valuable feature in this low interest rate environment.
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Old 11-14-2013, 09:05 AM   #8
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Originally Posted by urn2bfree View Post
... This is a Flexible Premium Deferred Annuity non qualified-worth about $30000 right now with no Surrender penalty at this point. it earned 3% last year and is on a fixed interest rate. I forgot to ask if that 3% will continue. I was thinking of leaving it be as a part of our rainy day "cash" which is earning a decent interest for cash and at tax deferred. When my wife finally stops working then maybe we could cash it out at the lower tax rate we will be in then. Certainly no matter what we will wait uat least ntil next year when we drop our tax rate with me retiring in 2 weeks!!!
My questions are- does this make sense or am I missing some way the annuity people are continuing to take us for a ride? Also since it is a flexible premium, should I move more cash into it now?
I have an old FPRA that I bought 32 years ago. I'm keeping it. Sounds like yours, but mine has a 4.5% rate.

I'll guess that the 3% is the contractual minimum. If so, it should be stated plainly in the contract - look at the first page and then the table of contents.

Mine is "flexible premium", but there is a clause in the contract that says if you haven't paid premiums for 10(?) years you lose the right to pay additional premiums. You could check your contract.

The one tricky thing is that my FPRA automatically annuitizes at 65 unless I tell the company I want to continue to defer. Fortunately, they have good customer service and sent me a letter prior to my birthday (actually, the policy anniversary following my birthday) warning me about this and making it easy to choose another option.

It used to be that the value of tax deferral outweighed the higher regular FIT rates for my situation, so surrendering, paying taxes, and putting the money in equities didn't make tax sense. With the much lower cap gains rates, that probably isn't true any more. But, I like having some "rainy day" fixed money with no surrender charge. This seems like a fine way to fill that need.

(Some people confuse simple fixed annuities with VAs or EIAs. This is a much simpler animal.)
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Old 11-14-2013, 09:18 AM   #9
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I would keep it and leave the money compounding at 3%. Putting more money in would require more analysis.
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Old 11-14-2013, 09:38 AM   #10
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Originally Posted by pb4uski View Post
While I would be the first to agree that one shouldn't buy a new annuity, that is a very different decision from where someone has an old one and is deciding what to do with it. 3% minimum guarantees are no longer available and if that is what your contract have it is a valuable feature in this low interest rate environment.
+1 I am in this situation with a whole life insurance policy. Would I buy it again if I could go back in time? No way. Given that the commissions are already paid does it make sense to keep? In my specific case, yes.

IMHO, these questions require a look forward only. What are the alternatives and are they better? Sunk costs are just that...
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Old 11-14-2013, 10:27 AM   #11
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I have a 5 year CD at at little over 2% which makes me look like an investment champ these days. If the 3% is guaranteed for a while and there are no other red flags, one would be a chump to toss it away.
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Old 11-14-2013, 03:11 PM   #12
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I would jump at any opportunity to start getting the money out of that annuity. The purchase of an annuity typically results in a wealth transfer of 15 - 20% from the investor to the insurance company and agents who push them. And yes, she was sold this annuity by a salesman who legally worked for himself or his company -- not a fiduciary registered investment adviser working in the best interests of her.
The sales agent was paid many years ago. Those were all sunk costs. Right now, 3% is not such a bad deal.

Quote:
The problem with annuities are numerous. For one they are taxed at the higher ordinary income tax rate and so distributions must be tightly controlled depending on your tax situation.
So are CDs, bonds, and all fixed income instruments except for munis. Unlike those fixed income instruments, annuities are tax deferred, which make things a little more fair.

Quote:
Heirs pay taxes on gains that they inherit. Heirs pay no taxes on gains from other normal investments like stock and bond ETF's.
Same as with a 401k or traditional IRA.

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3% before taxes is not investing. That's actually doing worse than inflation after you pay ordinary income taxes at the time of distribution. The normal way to invest is with a mix of stock and bond ETF's. The older you get the more you favor bonds obviously.
Then why are people buying corporate bonds with LESS convexity (the annuitant here gets a lot of optionality with this 3% return) right now? Are they all foolish for lending at 2.5% to IBM for 5 years- and granting IBM a call feature which allows them to buy the bonds back?

Quote:
The insurance company will simply spit out facts about their product. Don't expect to get any type of personalized advice from them. Same thing with brokers, insurance agents, and other non-fiduciaries. Whoever is listed on her quarterly statements cannot be trusted either. He earns a 1/4% trailer fee for every year she remains invested. Only a paid fiduciary can really advise you on what to do.
My advice here is that annuities may not make great investments, but this is an annuity worth keeping. For now. If interest rates hit 6% and this is still paying 3%, ok, cash it out.

The trailer fee is a sunk cost. She could have gotten 3.25% somewhere else.

Here's another way of thinking about this:

You bank with Citi. Citi is a horrible bank. It's 1980, and Citi decides to roll out a 40-year CD. Interest rates are 20%, but Citi, being an unfair bank that offers horrible interest rates, offers it at 10%.

It's now 2013. Someone goes online and asks "Uhh, I have this old CD with Citi paying 10%. What do I do with it?" Everyone offers their knee-jerk reaction "CASH IT OUT! YOU'RE GETTING SCREWED! CITI IS MAKING 10% OFF OF YOU." Only though now interest rates are 1% and when OP goes to Ally to get a new 7-year CD, he/she now gets 1.5% instead of 10% and loses 60% over the next seven years.

So yes. Annuities- if they're not designed to address longevity risk- are often a bad deal. In this case, because the annuity was bought many years ago in a different market, it's a GREAT DEAL. Cashing out would be sub-optimal.
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Old 11-14-2013, 04:21 PM   #13
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I would keep it and leave the money compounding at 3%. Putting more money in would require more analysis.
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Old 11-14-2013, 04:39 PM   #14
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Unlike those fixed income instruments, annuities are tax deferred, which make things a little more fair.
Read Wealth Manager's Article called "Photo Finish". The tax deferred "advantage" is over rated.

Quote:
Same as with a 401k or traditional IRA.
My point is that if you were to pull your money out and put it into normal stock and bond ETF's, those gains would be taxed at a lower rate.

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Then why are people buying corporate bonds with LESS convexity?
Bonds are a hedge against stock market corrections. When stocks go down, you pull a little out of the bond ETF(s). Bonds have more risk than in years past, but stocks and bonds balance each other out and over the long run a conservative mix of stocks and bonds easily beats something like an index annuity.

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You bank with Citi. Citi is a horrible bank.
An annuity has more risk than a bank CD for one thing. Most importantly a bank CD is not investing. That's just hiding money under a mattress.
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Old 11-14-2013, 05:26 PM   #15
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Bonds are a hedge against stock market corrections. When stocks go down, you pull a little out of the bond ETF(s). Bonds have more risk than in years past, but stocks and bonds balance each other out and over the long run a conservative mix of stocks and bonds easily beats something like an index annuity.
So then why can't OP do that with his annuity? When stocks go down, he can cancel the annuity and stick the proceeds in the stock market. Meanwhile, instead of earning 2.5% in corporate bonds you're getting 3%. Not a bad deal IMO.

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An annuity has more risk than a bank CD for one thing. Most importantly a bank CD is not investing. That's just hiding money under a mattress.
1.) It's generally insured by the state- actually by other insurance companies who sell in the state. Most states have an insurance limit above $30K. You have a good point and that is why OP should check his/her state insurance limits.
2.) Compared to 1% interest from the bank, this is a deal.
3.) If OP is still somehow worried, he can probably buy a CDS on his insurer for ~50 basis points and pocket the other 1.5%.
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Old 11-14-2013, 06:23 PM   #16
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So then why can't OP do that with his annuity? When stocks go down, he can cancel the annuity and stick the proceeds in the stock market.
This is based on the assumption that stocks will go down from where they are at now. We've had a bull run alright but from 1990 - 1997 the S&P went 1,767 trading days without a 10% correction.

Quote:
It's generally insured by the state
I'd rather be FDIC insured than insured by a company and that fund that could get depleted in a worst case scenario. That's why an annuity is riskier than a CD. Again both the CD and the index annuity are like hiding from the market. Very conservative. Not investing.
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Old 11-14-2013, 07:29 PM   #17
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So my wife recently showed me that she has an annuity she bought 23 years ago -before we met- and definitely when neither of us knew anything. She did not know hat she was getting and we are still trying to sort out what have we got. I spoke to the company about it and want the wisdom of members here as well. This is a Flexible Premium Deferred Annuity non qualified-worth about $30000 right now with no Surrender penalty at this point. it earned 3% last year and is on a fixed interest rate. I forgot to ask if that 3% will continue. I was thinking of leaving it be as a part of our rainy day "cash" which is earning a decent interest for cash and at tax deferred. When my wife finally stops working then maybe we could cash it out at the lower tax rate we will be in then. Certainly no matter what we will wait uat least ntil next year when we drop our tax rate with me retiring in 2 weeks!!!
My questions are- does this make sense or am I missing some way the annuity people are continuing to take us for a ride? Also since it is a flexible premium, should I move more cash into it now?
I forgot to ask: which insurer is it? Creditworthiness is important.
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Old 11-14-2013, 07:56 PM   #18
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.....Again both the CD and the index annuity are like hiding from the market. Very conservative. Not investing.
Never heard of asset allocation, eh....
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Old 11-14-2013, 08:01 PM   #19
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Never heard of asset allocation, eh....
He/she/it was probably born that way.
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Old 11-14-2013, 08:11 PM   #20
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Am not smart enough to know what to do with a small annuity about 40 years old, paying 4%. It has grown to more than 5 times the original amount. Called the company and was advised that payout was 5 years...
which would make it taxable... Leaving it there. Probably the last item to cash in as we're checking out. Let the kids decide about the taxes.
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