Do annuities fit into an ER plan? (SWR-related)

[landover]

Probably a good pick.  Just for those keeping score, using this fund option for me and my wife 44 years old, joint with 100% survivor, inflation adjusted (cpi-u), per $500k you'd get a little under 16k a year.  SWR on a similar mix held in a taxable port would be $21,500 @ 95% survivability for 40 years per firecalc.

So you're paying roughly...what is that...about 22% premium for the 'safety', sub off the odds of the insurer (looks like vanguard is using AIG?  Thats what the link to give the online quote started with), sub off or add in the odds that CPI-U will over or understate actual inflation, and sub off the odds that you'll live past the 40 year run I did for firecalc.

Doesnt completely suck.  I'd rather do that than hold a 100% tips port or sit in cash for years waiting for the correction...

How does the taxes affect this 22% difference, it will be more, less, or none? If after the taxes the difference is 10% only, it is much less painful than self portfolio management.

 

[BigMoneyJim]

I just saw an ad and thought of this thread. The ad: "How You Can Make An Easy Six Figure Income Selling Annuities Even If You've Never Sold An Annuity Before In Your Life!" No, you can't have the link.

Annuities have their place, but all the hype I see seems to lead to shark-infested waters. To be fair I guess the hyped mutual funds lead to shark-infested waters, too.

 

[cute fuzzy bunny]

I havent got the slightest idea how an annuity payment is taxed.

With a "regular" porfolio I can, and do, employ a variety of tax strategies. We use my wifes 403b and HSA to suppress "ordinary/earned" income, then use much of whats left to fund both of our Roth IRA's. I can use muni's, ibonds, tips, qualified dividends and other low tax investments. I hold investments until they qualify for long term capital gains. Bottom line is our "ordinary income" is so low, most of the rest of our income is taxed at 0 or at 5%.

Ok, quick google and possibly incorrect analysis says that the annuity is taxable as ordinary income, with the taxable portion determined as the difference between how much you're "getting back" from your original "investment" and the actual payment. If assigned with survivorship, there are all the same taxes as any other inheritance: income and estate as applicable.

I dont know what happens exactly if your annuity "investments" are tax friendly or non taxable, or if you can even employ such critters in your annuity.

At first blush, looks like I can make my own investments a lot more tax friendly. Anyone with actual taxation on annuity experience care to comment on ways to make them tax happy?

 

[Nords]

Umm, but are you mixing up products here?  Variable annuities do indeed commonly include obscene expenses and/or commissions.  Fixed and immediate annuities don't include explicit ones (although the insurer generally pays the agent a commission that gets reflected in the rate paid to the policyholder).  You can buy the annuity version of a no load mutual fund from several companies.  Annuities are like any other investment oroduct: caveat emptor.  But like any mutual fund, they may be suitable for some people.

I'm complaining about the fees in general, let alone the extortion amazingly high fees of variables.  

Although the fees are more reasonable in some annuities, it's still the equivalent of paying for things you could do yourself.  Or paying a load for a mutual fund that mimics a Vanguard index fund.  Or paying mutual fund expenses when you could own the equivalent ETF at a fraction of the cost.  

All of those choices may be appropriate for different people and different times of life, but we all need to understand when we're paying for "peace of mind", "financial management", or merely bare-bones "asset custody".

I've heard this said by a number of people on this board. But the #1 feature of annunities, at least from my perspective, is that there is an income stream that will go on forever.

Until you're dead.  And your heirs don't receive any residuals, either.

Unless, of course, you are the recipient of a government pension ...

Perhaps the ultimate annuity (although arguably it's more in the nature of a tontine and a retainer).  It has pretty low fees too!  It even has a provision, admittedly an expensive one, to provide an income stream after the primary beneficiarie's death.

But maybe I'm being oversensitive when posters bring up the "govt pension" subject in response to my posts.  I was talking about annuity FEES, not the concept of annuities or their appropiateness.

My point is that an annuity involves an additional level of management and insurance that is not free.  Many may choose to self-insure and can do so at a very low risk.  But if annuities are such a screamin' good deal then there wouldn't be annuity salesmen.

No one is condeming the concept just the fees.

Yeah, what he said.

 

[Martha]

A good summary on tax effects of nonqualified (ie, not in a retirement account) annuities is here: http://www.edwardjones.com/cgi/getHTML.cgi?page=/USA/products/investments/annuities_tax.html

From a tax standpoint, it might make sense to do a tax free exchange of retirement account money (but not a ROTH) into an annuity as the annuity payments would be taxed the same as distributions from the retirement account.

Annuities can be a tax nightmare when someone dies with a taxable estate. The value of the annuity is taxed for estate tax purposes and there is no step up in basis--your heirs would pay tax at ordinary income rates on amounts in the annuity exceeding the amount you invest.

 

[cute fuzzy bunny]

From a tax standpoint, it might make sense to do a tax free exchange of retirement account money (but not a ROTH) into an annuity as the annuity payments would be taxed the same as distributions from the retirement account.

I had the same thought as soon as I saw the option to convert our IRA to an annuity. I'm thinking it would be way better to do this as close to wanting to withdraw from the IRA...as opposed to now when we're 20-25 years away from doing that. We'll have a much better idea as to our overall health and life expectancy then than we do now as well...yes?

 

[Martha]

Yes.

 

[cute fuzzy bunny]

I love the air of agreement around this place these last few days...

Do you agree Martha?

 

[Martha]

I love the air of agreement around this place these last few days...

Do you agree Martha?

Screw you, you're baiting me ( ).

 

[cute fuzzy bunny]

Hell Martha, thats two days in a row you screwed me.

 

[Martha]

I was good though, wasn't I.

 

[cute fuzzy bunny]

I'd go for a third.

See ya tomorrow

 

[Gone4Good]

Yrs and I have had this discussion before, but lets just say that not all Aaa-rated insurers are created equal.  Prudence dictates that one should not have too much exposure to any one credit, but I would have few qualms about buying an annuity from the largest, most highly-rated mutual and fraternal insurers, assuming I ever could be convinced that such a product made any sense foe me (it doesn't).

Maybe. But annuities are fundamentally different from 30-year corporate bonds. If you own a bond of an insurer whose credit starts to deteriorate you can sell it and get out with 99% of your skin intact. If you were unfortunate enough to buy an annuity from the same company all you can do is sit and pray it doesn't keep getting worse.

What do you wager the spread to treasuries would be on a 40 year 'Aaa' rated insurance company bond that, once bought, could never be sold?

 

[haha]

Annuities can be a tax nightmare when someone dies with a taxable estate.  The value of the annuity is taxed for estate tax purposes and  there is no step up in basis--your heirs would pay tax at ordinary income rates on amounts in the annuity exceeding the amount you invest.

Martha, this post makes me think that as one gets more invested assets, sometimes expert help really is needed. Especially help from a professional like an attorney or CPA who is acting under a well defined code of ethics.

It might be easy to make big errors.

Ha

 

[ats5g]

Probably a good pick. Just for those keeping score, using this fund option for me and my wife 44 years old, joint with 100% survivor, inflation adjusted (cpi-u), per $500k you'd get a little under 16k a year. SWR on a similar mix held in a taxable port would be $21,500 @ 95% survivability for 40 years per firecalc.

So you're paying roughly...what is that...about 22% premium for the 'safety', sub off the odds of the insurer (looks like vanguard is using AIG? Thats what the link to give the online quote started with), sub off or add in the odds that CPI-U will over or understate actual inflation, and sub off the odds that you'll live past the 40 year run I did for firecalc.

Doesnt completely suck. I'd rather do that than hold a 100% tips port or sit in cash for years waiting for the correction...

(),

I'm a little confused. Are you using a balanced portfolio SWR [with firecalc] to compare to the inflation adjusted annuity? For a 100% TIPS @ 2% real, I get a 40 yr 95% WR of $15,450 per year.

You can still annuitize VWELX variably. I got the following quotes from Vanguard, using similar numbers [500K, 44 yrs old, 100% J&S]:

First, with qualified assets [i.e. IRA]:

Primary Annuitant -- Born: 01/01/1961 Sex: M
Joint Annuitant -- Born: 01/01/1961 Sex: F
Quote Expiration Date: 01/26/2006
Benefit Commencement Date: 03/01/2006
State of Residence: CA
Payments per Year: 12
Total Premium Amount: $500,000.00
Initial Payment Amount for Variable (3.5%AIR ) Joint and 100 % Survivor Annuity: $1,796.31

Qualified Assets: Yes

Then non-qualified:

Primary Annuitant -- Born: 01/01/1961 Sex: M
Joint Annuitant -- Born: 01/01/1961 Sex: F
Quote Expiration Date: 01/26/2006
Benefit Commencement Date: 03/01/2006
State of Residence: CA
Payments per Year: 12
Total Premium Amount: $500,000.00
Initial Payment Amount for Variable (3.5%AIR ) Joint and 100 % Survivor Annuity: $1,762.91

Qualified Assets: No
Percentage of Benefit Excludable: 53.6%

Then upping the AIR to 5% to maximize initial payout, and lower probable increases in payments:

Qualified:

Primary Annuitant -- Born: 01/01/1961 Sex: M
Joint Annuitant -- Born: 01/01/1961 Sex: F
Quote Expiration Date: 01/26/2006
Benefit Commencement Date: 03/01/2006
State of Residence: CA
Payments per Year: 12
Total Premium Amount: $500,000.00
Initial Payment Amount for Variable ( 5%AIR ) Joint and 100 % Survivor Annuity: $2,273.88

Qualified Assets: Yes

Non-qualified:

Primary Annuitant -- Born: 01/01/1961 Sex: M
Joint Annuitant -- Born: 01/01/1961 Sex: F
Quote Expiration Date: 01/26/2006
Benefit Commencement Date: 03/01/2006
State of Residence: CA
Payments per Year: 12
Total Premium Amount: $500,000.00
Initial Payment Amount for Variable ( 5%AIR ) Joint and 100 % Survivor Annuity: $2,231.60

Qualified Assets: No
Percentage of Benefit Excludable: 42.3%

Fairly competitive with a 4% withdrawal, same"inflation protection" as VWELX [or a balanced portfolio], and a much lower chance of outliving money. Of course, one gives up the chance to leave any money to hiers.

Also, IIRC ()'s wife is a nurse and has a 403(b), so I'd definitely check out TIAA-CREF for annuitizing any of 403(b) or IRA money. TIAA is an extremely highly rated insurance company that doesn't have any shareholders with which it must give profits.

- Alec

 

[wstu32]

azanon, i liked your post!

 

[brewer12345]

Maybe.  But annuities are fundamentally different from 30-year corporate bonds.  If you own a bond of an insurer whose credit starts to deteriorate you can sell it and get out with 99% of your skin intact.  If you were unfortunate enough to buy an annuity from the same company all you can do is sit and pray it doesn't keep getting worse.

What do you wager the spread to treasuries would be on a 40 year 'Aaa' rated insurance company bond that, once bought, could never be sold? 

Like I said, we have had this discussion before and I am happy to agree to disagree. I personally think you are ignoring all of the extra protections afforded policyholders, since policyholder status is a far cry from being an unsecured creditor, regardless of the rating.

 

[cute fuzzy bunny]

I'm a little confused. Are you using a balanced portfolio SWR [with firecalc] to compare to the inflation adjusted annuity? For a 100% TIPS @ 2% real, I get a 40 yr 95% WR of $15,450 per year.

I probably used the 5 year treasury for the bond piece a la bernsteins 'stick with short term bonds for your bond piece, there is little risk premium for long term bonds'. I think its due to the frequent periods of deflation or sideways inflation tips dont always give very good results. I wouldnt expect a buttload of deflation going forward, but I could be wrong there.

I've got very little experience or knowledge with these, but I noticed the payout drops quite dramatically if you choose the "inflation protection" option with these, as I did and I think you didnt.

Granted you might be giving a more apples to apples comparison by using the pseudo vwelx variable option and counting on the equity piece to provide the inflation protection, but I'm sort of thinking that the people who would favor an annuity are probably trying to escape the "maybe not sure thing, at least historically" approach with volatility and loss risk.

I keep hearing 'guaranteed income stream for life' as the main mantra.

 

[Jane_Doe]

Two questions-

First, in th's scenario - $500k producing an income stream of just under $16k - if you just stuck the $500 k under your mattress you could pull over $12k out a year for 40 years before running out of money (I know not inflation adjusted, but still ....) To me it just doesn't make sense to hand over that kind of money to let them "pay you interest on your own money" and in the end they keep the prinicipal. Am I missing something?

Second question - slightly off topic - If a financial planner is a fee only planner, don't some take a percentage of your portfolio? Isn't that a worse scam than taking a percentage of your profits?! Or do most fee-only planners just charge an hourly fee? All I know is if I had accumulated a port of say, $2 mm, I sure wouldn't be happy to just had over say 1 - 2 % or more (yearly??) to someone who is simply advising me. Again, am I missing something?

Interesting subject. Sorry, Leonard, not trying to bash you - just trying to figure all this out - you seem like a nice person.

Jane

 

[cute fuzzy bunny]

No Jane, you're right on.

These guys are arbing your money. If they werent keeping more than they're paying out, they wouldnt be doing it. The very best you can do if you dont live longer than you should is to lose enough to make it worth their while to have taken you on as a customer.

You're paying a premium for 'sleeping well at night'.

 

[free4now]

Fee only planners do not take any percentage of your portfolio or profits.  The fee you explicitly pay them for service is their only compensation.

If a planner gets compensated by taking 1% of your portfolio per year and they sell you annuity or other products that have fees or costs of an additional 1% per year, that reduces your SWR in half from 4% to 2%.  So you have to live on half as much money.  

 

[cute fuzzy bunny]

A true statement, but not applicable entirely to the topic. You will pay vanguard a premium in fees and higher annual costs to do an annuity than buying the funds directly. Plus the insurer keeps your remaining principle when you die. Thats a pretty strong fee...

 

[free4now]

My "Fee only" comments were a response to the following:

If a financial planner is a fee only planner, don't some take a percentage of your portfolio?  Isn't that a worse scam than taking a percentage of your profits?!  Or do most fee-only planners just charge an hourly fee? 

And I agree with () that the fees in annuity wrappers are burdensome and unavoidable no matter what kind of planner gets you your annuities.

 

[cute fuzzy bunny]

Ahhhhhh...

Then we agree!

 

[Gearhead Jim]

FWIW, I plugged our current ages (60/58) into the Vanguard inflation-protected annuity calculator, $100K would produce $3,973 per year if i remember correctly, adjusted for inflation.  That looks suspiciously like the 4% SWR we all talk about.

The annuity is illiquid, subject to some (slight) credit risk, and does not cover you when inflation exceeds 10% per year (hard to beat 10% inflation with anything unless you know in advance), and you leave nothing to the kids.

But it also requires no care, is not subject to panic-selling at the wrong time, and avoids the hassles of money management (for that portion of your portfolio).

The vehemence of some of the anti-annuity posts here makes me just as suspicious as the enthusiasm of some annuity salesmen.


When I used the FIRE calculator, putting 10%-20% of our portfolio in the Vanguard annuity increased our 100% SWR just a little over 50-50 stocks-bonds.  Higher percentages in the same annuity resulted in a slight reduction.  Some day I'll figure that out.

In the mean time, I don't have any annuity and don't plan to buy one soon.  But for SOME people it seems reasonable to put SOME of their portfolio in an inflation-indexed annuity from a stable company.