Tax advantaged accounts / variable annuities

[aw78]

Hi, new member here. I was wondering if anyone here uses variable annuities as part of their asset allocation?

I invest exclusively at Vanguard and my goal is to maximize after-tax return, which is not a big issue when investing in equities. However, the portion of my portfolio in regular accounts versus tax advantaged accounts (Roth IRA, Rollover IRA) is getting substantiallly larger as time goes by and my career progresses.

I was thinking about parking some of the less tax efficient equity funds in the tax-advantaged accounts such as:

Small Cap Value
Large Cap Value
Total Int'l Value
REIT Index

However, I do maintain a portion of my allocation in bonds. I was thinking about using a variable annuity offered by Vanguard to invest in the Short Term Bond Index or Total Bond Index to maintain my exposure to bonds without paying the high taxes associated with fixed-income instruments. The expenses appear to be one of the lowest in the industry, there doesn't appear to be any hidden fees or contractual issues, and I trust Vanguard.

Does anyone have any experience or comments about this? Thanks for your help!

 

[REWahoo]

aw78, welcome to the forum.

The annuity question is a hotly discussed topic here. I suggest you use the search button at the top of the page and input "annuity" and "annuities" to see what threads come up. Here are a couple of examples:

http://early-retirement.org/forums/index.php?topic=8381.0
http://early-retirement.org/forums/index.php?topic=5590.0

BTW, I think the consensus here is that variable annuites are a very bad deal while immediate annuities may make sense for some people.

 

[grumpy]

aw78,

Earnings in a variable annuity are taxed at your marginal rate when withdrawn. You can defer the tax bite but not avoid it.


Grumpy

 

[brewer12345]

I will describe the sole situation in which you might wish to buy a variable annuity from Vanguard or TIAA-CREF:

- You are currently in a high marginal tax bracket (at least 28% federal plus state)
- You anticipate being in a lower tax bracket when you expect to withdraw funds from the VA in 10+ years
- You have a heavy portfolio weighting in bonds and REITs

Other than that, don't bother.

 

[LOL!]

Would not a tax-exempt muni bond fund be better than a variable annuity bond fund?
You have to be in a relatively high tax bracket to make tax-exempt fund worthwhile.

 

[brewer12345]

Would not a tax-exempt muni bond fund be better than a variable annuity bond fund?
You have to be in a relatively high tax bracket to make tax-exempt fund worthwhile.

Depends. If you will always be in a high bracket, buy the munis. If you expect to be in a much lower bracket in the future, a bond fund in a VA is likely the better choice if you can live with the fees, restrictions, etc.

 

[cute fuzzy bunny]

I will describe the sole situation in which you might wish to buy a variable annuity from Vanguard or TIAA-CREF:

- You are currently in a high marginal tax bracket (at least 28% federal plus state)
- You anticipate being in a lower tax bracket when you expect to withdraw funds from the VA in 10+ years
- You have a heavy portfolio weighting in bonds and REITs

Other than that, don't bother.

What about if its the only option in your wifes 403b?

I'm tinkering with the idea of having her put money into it, then extracting the money later on. Still trying to understand the rules around that though. Its pretax, they have a cheap s&p500 index option, and if i'm reading this sucker right I can take all the money out without penalty after 10 years, after she leaves the job, or when she hits 59.5. And if i'm really reading this right, we can siphon off 15% a year also without penalty. Although it looks like they charge $25 a year and a little over 1% a year for 'fees'...so maybe not such a good idea...but not putting money into it would move us from the 5% capital gains rate to the 15% rate...and bump us into the next tax bracket on income as well...

Anyone that understands variable annuity contracts pretty well that wants to have a look at the text and tell me if i'm getting this right? Can this be rolled over into an IRA or does it have to be disbursed, taxed, and then invested?

http://www.annuitycontent.lnc.com/llsup/PDFLibrary/19462c.pdf

Her option is the "Periodic premium deferred contract"

Under 'charges and other deductions' it says

"Surrender Charge
A surrender charge applies (except as described below) to surrenders and withdrawals of other purchase payments that have been invested for the periods indicated as follows.
A. Periodic premium deferred contract
There will be a surrender charge for the first withdrawal each contract year in excess of 15% of contract value. Any subsequent withdrawals in the same contract year or upon surrender of contract will also incur a surrender charge.
Contract year in which surrender/withdrawal occurs
0 1 2 3 4 5 6 7 8 9 10 11+ Surrender charge as a percentage of the proceeds withdrawn
8% 8% 8% 8% 8% 8% 4% 4% 4% 4% 4% 0%
A surrender charges does not apply to:
• A surrender or withdrawal of contract value after ten full contract years.
• Withdrawals of contract value during a contract year to the extent that the total contract value withdrawn during the current contract
year does not exceed the free amount which is equal to 15% of the contract value.
• A surrender of the contract as a result of the death of the annuitant
• A surrender or withdrawal as a result of the onset of a permanent and total disability of the contractowner as defined in Section
22(e)(3) of the tax code, after the effective date of the contract and before the 65th birthday of the contractowner.
• Contract value used in the calculation of the initial periodic income payment and the initial Account Value under the i4LIFE®
Advantage option or the contract value applied to calculate the benefit amount under any annuity payout option made available by
us.
• Regular income payment made under i4LIFE® Advantage, including any payments to provide the 4LATER or i4LIFE Guaranteed
Income Benefits, or periodic payments made under any annuity payout option made available by us."

 

[brewer12345]

Unless she is getting a match, run away.

 

[cute fuzzy bunny]

She's not.

Really? Why?

We'd save 10% a year on our capital gains and a lower tax rate, and unless I CANT roll this over to an IRA (which would definitely sink it), it looks like it'd come out to our advantage.

Oh yeah, and I wouldnt have to make and pay estimated quarterly taxes either.

 

[aw78]

I will describe the sole situation in which you might wish to buy a variable annuity from Vanguard or TIAA-CREF:

- You are currently in a high marginal tax bracket (at least 28% federal plus state)
- You anticipate being in a lower tax bracket when you expect to withdraw funds from the VA in 10+ years
- You have a heavy portfolio weighting in bonds and REITs

Other than that, don't bother.

I am in the 36-38% marginal tax bracket. As far as future expected tax brackets, who knows? I have about 30-40% in REITS and Bonds, which I would consider pretty significant.

Still, why is it not worth it? Looking at the Total Bond Index Annuity, it looks like the expense ratio is about 0.46% compared to the expense ratio of 0.20% for the regular mutual fund. This doesn't seem unreasonable to me. You have to invest at least $25k to avoid the "contract maintenance fee", which is no problem.

The only downside I see is that I have to wait until age 59.5 until withdrawing the money. Other than that I get tax-deferred returns. I have a sneaking suspicion that my calculations are wrong or I'm missing something here...

Here are the fees and such from the website:

Owner Transaction Expenses
Sales Load Imposed on Purchases None
Surrender Fees None
Exchange Fees None
Annual Contract Maintenance Fee** $25 (Account value<$25k)

Annual Separate Account Expenses
Mortality and Expense Risk Charge 0.20%
Administrative Expense Charge 0.10%
Total Separate Account Expenses 0.30%
Portfolio Operating Expenses (last fiscal year) 0.16%
Grand Total, Separate Account and Portfolio Operating Expenses* 0.46%

Redemption Fee None

 

[cute fuzzy bunny]

Arent those .46% fees ADDED to the separate fund charges?

Thats the case with my wifes available option...looks like they're charging her a little over 1% in the fees you mentioned PLUS an annual expense for each fund invested in.

 

[brewer12345]

She's not.

Really?  Why?

We'd save 10% a year on our capital gains and a lower tax rate, and unless I CANT roll this over to an IRA (which would definitely sink it), it looks like it'd come out to our advantage.

Oh yeah, and I wouldnt have to make and pay estimated quarterly taxes either.

You can probably roll it to an IRA, but you will have to wait out or pay the rather stiff surrender charges, all the while getting nailed every year with excessive fees. This is the kind of crap they offer in a lot of 403b plans and it is a crime, IMO.

 

[brewer12345]

AW, make sure the .46% is all-in, not an add-on to the mutual fund expenses. I am not too keen on the inflexibility ofg these deals, but if you are willing to wait until 59.5, I suppose that's OK. On taxes, the implicit bet you make is that you will not be in a higher tax bracket when the withdrawals start. If tax rates generally go up, or you are in a higher bracket, its not a great deal.

 

[cute fuzzy bunny]

Hmm, ok, well thats what I was asking. Looks like I can get 15% out every year and then after 10 years get it all with no surrender fees at all.

Paying a percent a year seems like a good deal rather than paying 10% extra on our capital gains and qualified dividends.

But other than my weasel-like attempts to use a pretax investment like this as a tax shield and then roll it into an actually decent investment vehicle, I wouldnt touch something like this with a 23' pole, which is a home depot special order item.

hint: never order special items from home depot. In this case, you'd get a 21' pole of the wrong diameter and have to touch it with that. Ick.

 

[brewer12345]

'Sup to you CFB. I look at stuff like that and run the other way. The tax shield is not a particularly large dollar number and in return you pay a lot of fees and put up with a lot of inflexibility.

I would make a spreadsheet and model it out.

 

[cute fuzzy bunny]

I already have, its a pretty straightforward calc. Every dollar put in costs about .75% more per year, compounded for (at this point) six more years, then its rollable into an IRA, or so they told me this morning. The same dollar taken as income is taxed at 25% AND forces a dollar of capital gains or qualified dividends from the 5% rate to the 15% rate.

Unless theres just something I'm completely missing...this is a great way around the IRA contribution limits, especially for people getting taxed at the 15% capital gains/dividends rate and 25+% on income taxes. She can put $15k a year into this sucker, we pay their crappy 1.something percent in fees, we can withdraw 15% a year and roll it into an IRA at vanguard, then when the surrender fee drops to zero, roll the whole thing over to the vanguard IRA.

I dont like the crappy fees and I wouldnt in a million years LEAVE the money in a variable annuity...but this looks like a neat trick for those approaching ER or in ER with a lot of income and qualified dividends that are stuck with a crappy 403b as their only option...no?

 

[brewer12345]

Follow the spreadsheet results. These calculation are so dependant on each person's tax situation that it is the only way to know what to do.

 

[aw78]

aw78, welcome to the forum.

The annuity question is a hotly discussed topic here.  I suggest you use the search button at the top of the page and input "annuity" and "annuities" to see what threads come up.  Here are a couple of examples:

http://early-retirement.org/forums/index.php?topic=8381.0
http://early-retirement.org/forums/index.php?topic=5590.0

BTW, I think the consensus here is that variable annuites are a very bad deal while immediate annuities may make sense for some people.

Thanks, there was some good info in these posts. I found this article that I liked in one of the threads:

http://www.efficientfrontier.com/ef/701/annuity.htm

I actually read William Bernstein's book, which I consider one of the best books on asset allocation that I have seen.

I ultimately decided to put my bond funds and REITs in my tax-deferred accounts and just live with the relative tax-inefficiency (higher turnover) of value funds and small cap funds. At least for now.

 

[FinanceDude]

Some of the living benefit options available today are intriguing..........but the average internal cost of a VA is 2.00-2.60 percent annual............a little pricey for tax-deferral and usually limited investment options........ 8)

 

[brewer12345]

Some of the living benefit options available today are intriguing..........but the average internal cost of a VA is 2.00-2.60 percent annual............a little pricey for tax-deferral and usually limited investment options........ 8)

Actually, most of the products I have seen hung with various guarantees end up at 300+BP annual expense ratio. Not that intriguing...

 

[FinanceDude]

Actually, most of the products I have seen hung with various guarantees end up at 300+BP annual expense ratio.  Not that intriguing... 

I'll agree with that. My retired clients face this dilemna every day. Who doesn't like pensions and SS? It's GUARANTEED streams of income. What about those who DON'T have pensions??

A pension is basically an annuity contract, most are backed by insurance companies or in the worst case scenaio, PBGIC.

We can agree that traditional "risk-free" investments have huge inflation risk in them. I worked at a bank for 3 years...........anyone that thinks CD's are the cat's meow need someone to show them the effects of inflation................