are annuities worth it or too expensive?

[allanlevy]

If I understand your situation, you would make a single premium and then in 10 years receive 10.50% of your single premium each year for life (5.25% * the doubled annuity value).

By my calculations, if your then receive that 10.5%of your single premiums for 10, 20, 30 or 40 years your IRR is 0.32%, 3.80%, 4.96% or 5.44%, respectively. Obviously the longer you live and receive benefit payments then the better your return is.

First thanks very much for this calculation. Its interesting to me that you do this based upon only the cash flow of the draw amount annual for the duration (correct?). So you assume 0 return of principle at the end of the duraction making the assumption that the actual cash value is zero (or negative) and only the account balance provides the return. OK (or at least that is what I think you are doing.

In contrast, I ran scenarios for 5-8 (ok even 10)% market performance of the equity fund the VA is wrapped around. That does change the ROI different from the method you describe above. The other thing is the effect of tax deferred account, and the probability of increased payout amounts due to the resetting (increasing) of the income base over time as a function of market volatility. How does one model that on the ROI, which presumably has some lift aspect to the return (no? wishful thinking on my part?

Finally, just as a point of comparison on the 20 year duration I came up with an ROI of 3.7% and 4.2% respectively when the underlying equity fund performance is 6% and 8% respectively. Not to distant from your 3.8% figure.

Thx again!

 

[allanlevy]

What features did you like about your VAs compared to a single payment deferred income annuity?

Alas I will admid not comparing the VA to the single payment deferred income annuity. Perhaps I should have.

What I did do is compare it to a bond. Its characteristics are similar to a higher quality corp 30 year bond (paying about 4.5%), but with diversified characteristics un-shared by bonds (eg., protection for the longevity tail risk, and possible upside potential should equity market performance be in excess of 8%), with perhaps comparable safety characteristics.

I also compared it to cash, which I had sitting totally idle, feeling a bit concerned about the market at all time high right now, so not particularly feeling good about entering it in bulk, and interest rates in cash being particularly stupid right now, so not feeling good about leaving it in cash. So moving into VA gave me something to do way better than cash, comparable but different than bonds, maybe an upside potential to equity exposure, comparable safety to higher quality corporate, and the potential for increased upside value should my wife and or I live the long tail.

These threads however and my retrospective numerical analyses does make it clear to me that VAs are an expensive product relative to what they produce. Hmmm, isn't that what the initial flurry of responses to this thread were telling me!!

 

[haha]

It's astonishing what some people expect to get for zero consideration.

 

[sheehs1]

The question in the heading of your thread was "are they worth it or are they too expensive"...
In every possible piece of research you can perform, the expense is usually the first "con". Your withdrawals will be taxed at ordinary income tax rates rather than dividend or cap gain rates and if you have any left at your passing, your heirs will not get the stepped up basis that equities or other vehicles provide.
Those are the some of the reasons that "responsible" financial planners tell you not to invest all of your money in these. Only invest 10% to 20% or a small portion (if any).

 

[sheehs1]

Alas I will admid not comparing the VA to the single payment deferred income annuity. Perhaps I should have.

What I did do is compare it to a bond. Its characteristics are similar to a higher quality corp 30 year bond (paying about 4.5%), but with diversified characteristics un-shared by bonds (eg., protection for the longevity tail risk, and possible upside potential should equity market performance be in excess of 8%), with perhaps comparable safety characteristics.

I also compared it to cash, which I had sitting totally idle, feeling a bit concerned about the market at all time high right now, so not particularly feeling good about entering it in bulk, and interest rates in cash being particularly stupid right now, so not feeling good about leaving it in cash. So moving into VA gave me something to do way better than cash, comparable but different than bonds, maybe an upside potential to equity exposure, comparable safety to higher quality corporate, and the potential for increased upside value should my wife and or I live the long tail.

These threads however and my retrospective numerical analyses does make it clear to me that VAs are an expensive product relative to what they produce. Hmmm, isn't that what the initial flurry of responses to this thread were telling me!!

Comparing cash or bonds to a VA is not an apples to apples comparison. With the former, you still have access to your principal, can sell presumably without penalty or fees, can move your money around based on interest rate environment, etc. After this thread perhaps that has become apparent.
Good luck to you.!

 

[Sun456]

These threads however and my retrospective numerical analyses does make it clear to me that VAs are an expensive product relative to what they produce. Hmmm, isn't that what the initial flurry of responses to this thread were telling me!!

Yes and no. Yes if you are trying to get the same performance of the stock market on the upside. No if you want to get some of the upside but still want to guarantee an income for yourself that has a baseline minimum. I fell into the guaranteed income camp.

To use my real world example of the VA I bought last year. I put $150K in. I picked three funds and got $17,855 appreciation. But lets say I put $150K in and lost $17,855 because the market went down. My account would be worth $132,145. If I were in the market I might be worried about this and wonder if I could make it back.

In the annuity I don't worry because I get $166,950 of accumulated value no matter what. Yes, death benefit is the lower real money value but the income I get in old age isn't affected. In my mind the peace of mind is what your buying with all the fees and for me it is worth it.

 

[ejman]

Yes and no. Yes if you are trying to get the same performance of the stock market on the upside. No if you want to get some of the upside but still want to guarantee an income for yourself that has a baseline minimum. I fell into the guaranteed income camp.

To use my real world example of the VA I bought last year. I put $150K in. I picked three funds and got $17,855 appreciation. But lets say I put $150K in and lost $17,855 because the market went down. My account would be worth $132,145. If I were in the market I might be worried about this and wonder if I could make it back.

In the annuity I don't worry because I get $166,950 of accumulated value no matter what. Yes, death benefit is the lower real money value but the income I get in old age isn't affected. In my mind the peace of mind is what your buying with all the fees and for me it is worth it.

and be done with it?
If all you are worried about is the guaranteed income portion why not buy just an immediate annuity?

 

[Sun456]

and be done with it?
If all you are worried about is the guaranteed income portion why not buy just an immediate annuity?

I did look at those but for me they don't work as well. I bought mine at 45 and plan to allow the annuities to accumulate for 20 yrs before drawing income. Income now would just be another thing to get taxed.

 

[ERD50]

It's astonishing what some people expect to get for zero consideration.

+1

I'm constantly amazed that people seem to think they can offload risk on someone else, w/o paying a high price plus overhead. As if the person on the other side of the transaction is saying 'sure, I'll take the risk, no problem!' We see it with stock options also.

That said, annuities do have the advantage of pooling risk, which (AFAIK) an individual can only obtain by buying into the pool through something like an annuity (or delaying SS, or pension). So I try to keep an open mind, and will consider them if/when that longevity insurance appears to be a reasonable trade-off for me.

-ERD50

 

[brewer12345]

I did look at those but for me they don't work as well. I bought mine at 45 and plan to allow the annuities to accumulate for 20 yrs before drawing income. Income now would just be another thing to get taxed.

You can buy deferred payout immediate annuities (sometimes known as "longevity insurance"). You pick how long you want to wait for them to start paying out.

 

[jclarksnakes]

Two things. This particular VA has an income double for home health care (must lose two activities of daily life) and nursing home confinement. No other one I looked at had the home health care component. I also have 3 equity indexed annuities. I'm pretty sure the caps and participation rates won't allow me to get more than what the minimum guarantee is. I plan to have this money accumulating for 20 yrs. The VA gave me a way to get more out of the market if it should go up, up, up. With the quantitative easing who knows what will happen.

I know of another variable annuity from Security Benefit that has home healthcare and nursing home doublers.
https://www.siaincome.com/sell/sia.aspx
I do not like annuities and especially variable annuities but DW liked the guaranteed income they promise (we shall have to wait and see whether they actually meet that promise) so she bought this one with a portion of her savings. I also do not like LTC insurance products and DW had some concern about that issue so I did not protest (much) when she bought this annuity. IMO taking SS late is a much better form of longevity insurance. With our COLA'd pensions and SS and this and one other smaller VA I would imagine we are insured to live forever. If anyone tells me they are buying a VA and also taking SS at 62 I have to wonder what they are thinking. I am about as equally amazed when someone says they are buying LTC insurance and taking SS early.

 

[sheehs1]

Finally, just as a point of comparison on the 20 year duration I came up with an ROI of 3.7% and 4.2% respectively when the underlying equity fund performance is 6% and 8% respectively. Not to distant from your 3.8% figure.

Thx again!

Was this a before or after tax ROI?

 

[nun]

I like products to be simple and do one thing. VAs combine functions that I think would be best performed with separate financial products. If you want lifetime income buy a SPIA; if you want gain, buy an equity index fund. But if you have access to a stable value fund I'd use that rather than an annuity, you loose the advantages of having a pool of other investors, but you gain a lot of flexibility and have insurance backed principal and gain.

 

[Sun456]

I know of another variable annuity from Security Benefit that has home healthcare and nursing home doublers.
https://www.siaincome.com/sell/sia.aspx

I did look at that one. Initially I qualified to buy it but it took me too long to research how annuities worked. By the time I went to buy they had changed the eligibility of the GLWB rider to the purchaser had to be 55 yrs or older to get the rider. Bummer! It was the story of my life in buying the annuities. By the time I was ready to buy or met the minimum age requirements in all cases the rates and/or terms weren't as good as when I first started studying them. Took me about a year to study them and look at the different offerings.

 

[pb4uski]

First thanks very much for this calculation. Its interesting to me that you do this based upon only the cash flow of the draw amount annual for the duration (correct?). So you assume 0 return of principle at the end of the duraction making the assumption that the actual cash value is zero (or negative) and only the account balance provides the return. OK (or at least that is what I think you are doing.

In contrast, I ran scenarios for 5-8 (ok even 10)% market performance of the equity fund the VA is wrapped around. That does change the ROI different from the method you describe above. The other thing is the effect of tax deferred account, and the probability of increased payout amounts due to the resetting (increasing) of the income base over time as a function of market volatility. How does one model that on the ROI, which presumably has some lift aspect to the return (no? wishful thinking on my part?

Finally, just as a point of comparison on the 20 year duration I came up with an ROI of 3.7% and 4.2% respectively when the underlying equity fund performance is 6% and 8% respectively. Not to distant from your 3.8% figure.

Thx again!

Your post didn't mention any residual value, just the 5.25% for your joint life so I didn't include any residual value. However, even if there were some residual value given the effect of discounting I'm not sure if it would make a huge difference in the IRR.

I didn't include the effect of income taxes because it would complicate the analysis more than the effort I was willing to put into it. Nonetheless, since a portion of the benefits would be taxable and reduce the after-tax cash flows, it would reduce the IRR at any tax rate greater than 0%.

 

[nun]

I did look at that one. Initially I qualified to buy it but it took me too long to research how annuities worked. By the time I went to buy they had changed the eligibility of the GLWB rider to the purchaser had to be 55 yrs or older to get the rider. Bummer! It was the story of my life in buying the annuities. By the time I was ready to buy or met the minimum age requirements in all cases the rates and/or terms weren't as good as when I first started studying them. Took me about a year to study them and look at the different offerings.

If you LTC insurance, buy LTC insurance, I wouldn't roll it into a VA. I try to keep insurance and investment separate.

 

[Sun456]

If you LTC insurance, buy LTC insurance, I wouldn't roll it into a VA. I try to keep insurance and investment separate.

I always try to emphasize in my posts that annuities are not an investment. They are an insurance product. They are alot easier to understand if you look at them that way.

 

[nun]

I always try to emphasize in my posts that annuities are not an investment. They are an insurance product. They are alot easier to understand if you look at them that way.

Unfortunately many people buy variable annuities as an investment. I'd used a deferred or immediate fixed annuity for income insurance and I'd keep LTC insurance separate. Bundling so many functions just makes for added complexity and probably added fees.

 

[allanlevy]

The question in the heading of your thread was "are they worth it or are they too expensive"...
In every possible piece of research you can perform, the expense is usually the first "con". Your withdrawals will be taxed at ordinary income tax rates rather than dividend or cap gain rates and if you have any left at your passing, your heirs will not get the stepped up basis that equities or other vehicles provide.
Those are the some of the reasons that "responsible" financial planners tell you not to invest all of your money in these. Only invest 10% to 20% or a small portion (if any).

Which brings up a point. The word CON and the regulatory environment "governing" this kind of product.

First, after all reflection, much generated from the intelligent comments in this thread, I agree with you to limit the % of the portfolio you put in a VA. There is valid reason to purchase longevity insurance. VAs are NOT an investment; the are insurance. They provide emotional piece of mind (that has no ROI but is a high value and yes it is an expensive to purchase value).

Second, value, is that for the conservative investor, once you "backstop" the longevity risk, you can afford to place the remaining part of your portfolio in high(er) risk/return investments. That is because your "worst case" is covered. (or thereabouts, the exact %ages of portfolio in each is a function of what you want to leave behind in your estate as a min--grand kids will need to attend university at towering costs too!).

Third, an most interesting to me is the CON aspect. Maybe CON is too big a word, but as I have learned about this product, it is 1000% clear to me that the insurance company, and broker were anything but forthcoming about the expense level of this product. Not only is what you write above true about a) tax at ordinary income levels vs cap gains and b) the no step up basis on the estate when passing, but there is a totally hidden, massively expensive cost, and I am astounded that the regulatory industry has not picked up on this (Personally I think they/FINRA/SEC are again asleep at the switch).

Ask: the broker and insurance company the cost. The reply" 2.7%" (1.3% mortality, 1.4% guaranteed life). OK is every other financial product when the answer is a % when referring to cost, it means a % of the money you put in. But NO, not in the VA! Since the insurance company has an income base (virtual) and an account value (real) they can apply the % cost to the former. They choose the former!! (at least that is what NationsWide does).This effectively doubles the cost of the annuity since you end up paying 2x2.7% (ie., 2.7% on twice what you put in).

Got that?...5.4% of your base in fees. This effectively nullifies the equity return of the VA in all but the most optimistic of market scenarios. (So all you are left with is the longevity insurance aspect of the product).

What irks me, is just how opaque this is. a) the sales folks do not tell you about it, b) the sales folks tell you 2.7% when you has for the "all in cost", and they either do not know or intentionally led you to believe that that is 2.7% of what you put in. But NO, the expense is on twice what you put in cause its assessed on the virtual account (called the income base).

This is exceptionally clever trickery and 1000% misleading to the buyer. I actually wonder if a case can be made for fraudulent. They tell you the cost is 2.7% but it turns out to be 2x2.7% because its assessed on a virtual base that is twice what you put in.

You know as I write this I do wonder--are there any lawyers out there (or others) who might respond to the question of whether the ins company is crossing the legal line (after all there is a misrepresentation when they answer and write 2.7%, leaving the buyer to assume its 2.7% of the amount you are giving them, vs a virtual figure of twice that size, effectively doubling the 2.7% to 5.4%!). At a minimum the regulator agencies should be shouting this out and smashing the insurance companies for this (what ever happened to truth in lending).

You literally need to read 1 sentence in the massive VA contract document to spot this. So maybe the insurance company has not crossed the legal line. But I wonder, if a case cannot be made for deceptive marketing.

At a minimum the regulatory agencies should be ashamed at themselves for not protecting the "average" consumer.

Thoughts?

Allan

 

[allanlevy]

its a before tax return:

2.3%; 3.7%; 4.6%; for 25, 30, 35 year duration respectively for the annuity

assuming 0 or negative market return, and only in the most optimistic scenarios would there be a >0 market return on top of that because of the enormous fees dampening any market return

 

[nun]

its a before tax return:

2.3%; 3.7%; 4.6%; for 25, 30, 35 year duration respectively for the annuity

assuming 0 or negative market return, and only in the most optimistic scenarios would there be a >0 market return on top of that because of the enormous fees dampening any market return

When you do the numbers on VAs they are terrible. At least with SPIAs is easy to figure out the effective interest rate you're getting and the fees at a bit less opaque.

Instead of buy a VA why not put the money in a stable value or short term bond fund that will give you 2% or better return and buy a deferred fixed annuity or longevity insurance incase you live longer than the income from the stable value fund.

 

[Meadbh]

It drives me a bit batty that I cannot find intelligent literature on this subject (pro or con) except from the sellers of such products who are obviously biased. If anyone can provide me a reference I would sure appreciate it.

Allan

Welcome to the Individual Finance and Insurance Decisions Centre online...

http://milevsky.info.yorku.ca/files/2010/08/q22.pdf

 

[pb4uski]

......Ask: the broker and insurance company the cost. The reply" 2.7%" (1.3% mortality, 1.4% guaranteed life). OK is every other financial product when the answer is a % when referring to cost, it means a % of the money you put in. But NO, not in the VA! Since the insurance company has an income base (virtual) and an account value (real) they can apply the % cost to the former. They choose the former!! (at least that is what NationsWide does).This effectively doubles the cost of the annuity since you end up paying 2x2.7% (ie., 2.7% on twice what you put in).

Got that?...5.4% of your base in fees. This effectively nullifies the equity return of the VA in all but the most optimistic of market scenarios. (So all you are left with is the longevity insurance aspect of the product). .....

That is why it is so important to look at cash flows - cash flows don't lie.

I suspect in the case of the product you are looking at the 2.7% is applied to the higher of the annuity base amount (whatever they call it) or the account value. This would be fairly typical (rather than what you deposited, just like mutual fund expenses are based on account value rather than what you deposited).

The other expenses that you didn't mention is on top of the 2.7% you are also paying investment management and administration expenses for each subaccount in the VA.

I think you now understand the initial reactions that you got.

 

[Sun456]

Got that?...5.4% of your base in fees. This effectively nullifies the equity return of the VA in all but the most optimistic of market scenarios. (So all you are left with is the longevity insurance aspect of the product).

What irks me, is just how opaque this is. a) the sales folks do not tell you about it, b) the sales folks tell you 2.7% when you has for the "all in cost", and they either do not know or intentionally led you to believe that that is 2.7% of what you put in. But NO, the expense is on twice what you put in cause its assessed on the virtual account (called the income base).

This is exceptionally clever trickery and 1000% misleading to the buyer. I actually wonder if a case can be made for fraudulent. They tell you the cost is 2.7% but it turns out to be 2x2.7% because its assessed on a virtual base that is twice what you put in.

...

You literally need to read 1 sentence in the massive VA contract document to spot this. So maybe the insurance company has not crossed the legal line. But I wonder, if a case cannot be made for deceptive marketing.

At a minimum the regulatory agencies should be ashamed at themselves for not protecting the "average" consumer.

Thoughts?

Allan

Yep! Now your on to them. Some VA do it just as you describe above. That is why the account drains to zero so quick when you start taking payments. But not all of them do it that way. The one I selected does not. The charge is on the actual account value. Its still hard to research the investment funds though. I did find one of my funds had a .8% fee so much better than I though it would.

As an aside I forgot to mention in a previous post that the Security Benefit Annuity mentioned above is not a variable annuity but is an equity indexed annuity.

In terms of your research, Allan you will find some companies that are intentionally misleading and some that are much more straight forward. I found the easiest one to understand was an equity index annuity by Equitrust. I thought they were more straight forward than others in making sure the consumer understood what they were buying. After that both Midland and North American weren't too bad. However, one I bought I thought was disgustingly deceptive. Aviva! They really went out of their way to include language and redefined terms that masked their pros and cons. Some of their language was so obscure and conflicting between the contract and the sales material that I had them send me a clarification on their letterhead in plain English of one point that was particularly important to me. I've got it stashed away in my files so that if it ever becomes a point of contention I can show it to a judge.

I had intended to buy 5 annuities but could only find 4 that I could stomach buying. Aviva was the 4th and I wouldn't have gotten them but they were the only one I bought that allowed me to have a dual annuitant with the nursing home income doubler.

I had at least 6 others I did a full analysis on by putting them into my spreadsheet and a bunch of others that didn't even make it that far. I rejected them based on marketing materials and the models by the sales people.

Buying an annuity can be a challenging task. But when I was done I had a $150K guaranteed income from 4 different insurance companies that I can't outlive. When I was going through the decision process I also took the view I could be a little more risky with the rest of my funds because I have a fall back. One other advantage is that I can turn the income streams on at different times if I need to. I don't envision having to do that because I still have plenty of non annuity funds. In fact the amount I put in the annuities is far less that I've lost in some of the big market crashes so its really hard to even miss the money.

 

[Kimo]

I am going to try and help someone to determine if an annuity is correct for their circumstances. I had to go through all this just like those of you thinking about it. First, I am retired, I don't sell anything or make anything anyone buys. I am not an advisor, I simply worked all my life and invested my savings.

I did not buy the annuities until a few weeks after I retired. They were purchased from my other savings/investments from my taxable accounts.

Start by getting as much information as you can from any annuity product you are considering with the GWLB attached.

Now, compare it to Vanguard, where I have bought 3 at 100,000 each, one in late December, one in January and one in March. For purposes of this post I will use the December 100,000 purchase because everyone can do the math.

For starters, the money is in the Wellington mutual fund so this makes it easy to see how your money has preformed in the past. It is just like looking up any mutual fund company product. Go to your favorite site to research funds and look up Wellington. They have been through every market correction since 1929.

My money is not with an insurance company, it is in my Vanguard account in the Wellington fund, along with all my other funds, stocks, ETF's etc.

I receive 4.5% a year paid monthly for life so starting January 5th I have received a check for 375.00 every month. Right now my 100K is actually worth a little over 109,000. Lets says that by my anniversary date (Date I bought the December VA) my Wellington fund is worth 140,000. I will get 4.5 percent of 140,000. (525 a month) Now, bad news...lets say the market tanks or even worse, every stock and bond Wellington owns goes to zero on my next anniversary date, (of course, very unlikely) my monthly check with still be 4.5% of 140,000. (525)

More details: Yes, I pay a 0.95% fee to the insurance company. Why, if my money is at Vanguard in a fund do I pay an insurance company? Because the insurance company guarantees the payment will last the rest of my life. I pay 237.00 a quarter for the GLWB. (0.95%)

You can pull all your money out of the fund anytime you want with no fee, commission, penalty, etc. Using my example, I can call Monday, close my account and get 140,000 (depending on that days market change) all my money sent to me. There is a seven day waiting period to close your account from your purchase date, mostly because of the paperwork. (Compare that to some products that make you wait 10 years and even then they only give you your original investment, if that)

When you sign up you are given a choice of where you want to put your money. For me it was easy because I already owned Wellington so I put it there. It has about 64% stocks with the rest in Bonds. You can pick a fund with less stocks if you like.

If the insurance company goes broke tomorrow nothing happens to my 140K because no insurance company has it. All I lose is the 375 monthly payment until Vanguard finds someone to replace the old insurance company. (Or I say forget it, send me everything back)

I also pay 0.19% as a death benefit so my wife will get the mutual fund should something happen to me.

All fees are deducted from the mutual fund, my 375 (or higher payment but never lower) stays the same forever. Using my example, if the fund was worth 140K a year later my monthly payment would be 525.00 If the following year my account was worth 80,000 my payment would still be 525.00

Because this was funded with after tax money there is hardly any tax taken out when April 15th rolls around (you never pay from your monthly check unless you ask for it). Most of the 375.00 is really your money, just a small portion is actually taxable. My rental income, other funds etc. offset anything taxable from the monthly payment.

I figured out what I needed for income to pay all bills, I added SS and rental income together, then added the 300,000 in annuities so those three sources of income will pay all my bills. I still have approx. 1 million invested in cd's bond funs, stock funds, etc. so you can see, my Vanguard annuity is part of a much bigger picture.

Also, all dividends and capitol gains (gains are rare for this fund) are reinvested. This will differ in appearance only from your regular funds. You don't see the dividend as a separate line item , it just increases the daily value. The point I am making is you don' t give them up with this product.

Again, all I am attempting to do is help someone out there make a decision regarding their situation. Some of this will be for some of you, some will not....I decided in the big picture it was worth a portion of my money.

EDIT: I was just informed that on May first the GWLB fee went from 0.95% to 1.20%. Also, I should have mentioned that your percentage when you sign up can be larger than mine if you are older than me. For example, age 65 will get 5% with the 1.20 fee for your GLWB.