My Retirement Blog

A couple weeks ago Chris Hansen and Dateline’s Tricks of the Trade did some undercover work looking at annuities, specifically indexed annuities, and how the salespeople were deceiving people about how expensive those things are if you withdraw too quickly. I didn’t watch the show as carefully as some others but I did get a sense that there was some deception going on there.

Here is an excellent response to the Dateline NBC annuity post and one that I think is worth reading after you watch the expose itself. I’m not a regular reader of the site but I do think that Mr. Paris makes an excellent point about how the salespeople did verbally mention the fees and sliding schedule as well as provide written documentation. The fact that they didn’t push the fees enough is something I think falls on the shoulder of the consumer.

Before you make any purchasing decision, make sure you have all the facts and that you fully understand them. You should never feel pressured to make a decision and you can always seek professional advice to review the documents. If nothing else, get unprofessional amateur advice from someone to see what they think. And lastly, always review things like annuity expenses very carefully because someone is making money out of this deal - it better be you!

Walter Updegrave has a great article out about how the SEC should force annuities to disclose all their fees in plain language, not the billion page prospectus they send and expect you to totally ignore. Anyway, a great part of the article is when he writes about the four types of fees associated with an annuity. By understanding these keywords and the fact they exist, you can have something to key in on when you do scan the prospectus (maybe even search through it online):

Insurance charges, also listed as mortality and expense fee (M&E fee), is the first and they claim it’s for insurance features. In actuality, the fee is for sales commissions and paying the marketing costs.

Investment option specific fees are those fees associated with the investment option you select within the annuity.

Rider specific fees are those that you pay to add features to your annuity, like the promise of a future income stream or that heirs get back as much as you put in.

Surrender fees are paid whenever you withdraw your money.

Keep an eye out!

In his latest “How Not To Ruin Your Life” article, Ben Stein warns that eventually there will be a market correction that is based on fundamentals and not on emotion, like the latest little market dip, and that those close to retirement should consider variable annuities as a hedge against this. The younger and middle aged investor shouldn’t worry, and I agree, because we have the one asset capable of weathering the storm - time. For the near retiree or retiree, a variable annuity puts the risk of a stock market fall on the shoulders of the insurer that sells the annuities and off yours.

A variable annuity is an investment that guarantees a specific withdrawal each and every month for life and the insurer generally invests but it comes at a cost, warns Stein. The benefit of the annuity, besides the financial, lies in the fact that it also gives you peace of mind. Having part of your retirement assets in a variable annuity can guarantee a minimum amount each and every month and can act as a nice starting point for the rest of your assets to add to, plus in a market correction you are still guaranteed that minimum amount despite the performance of your portfolio.

To read more about what Ben Stein’s talking about, check out his latest article titled Anticipating All the Retirement Variables.

When you retire, should you roll over your 401k into an IRA? Yes. Should you roll over your 401k into an IRA Annuity? Ummmm probably not, says Walter Updegrave. An IRA Annuity is basically an annuity held inside an IRA and it’s probably going to be too expensive for what you’re getting out of it. An annuity is generally very expensive but the benefit is that money grows inside of it tax-free, but it’s not a strong selling point of an IRA annuity because money inside IRAs and 401ks is already growing tax-free - you don’t need an expensive fee generating annuity for that.

So, what’s the other draw of IRA annuities? There are living benefits known as GMIB and GMWB. GMIB stands for guaranteed minimum income benefit which is a guarantee of annual income if you hold the annuity for a pre-specified time period, usually 10 years, even if the market tanks. GMWB stands for guaranteed minimum withdrawal benefit that guarantees you’ll be able to withdraw a percentage (4-6% usually) of the original investment regardless of the market performance.

Ultimately the main knock against IRA Annuities is cost, the fees, and all the rules and restrictions regarding what you can do with an IRA. It’s probably a better idea to rollover your 401k into an IRA and stick it in a nice balanced mix of investments, an index fund, or a target retirement fund.

These are Things Six through Ten of the Ten Things Your 401(k) Provider Will Not Tell You courtesy of those brilliant folks over at Smart Money.

6. “…but you still aren’t diversified.”
One interesting tidbit out of the article was the fact that the two most popular holdings in 401(k)s are stable-value funds and company stock - which basically means you’re really conservative and really risky at the same exact time. In fact, they found that one in five 401k participants holds more than 50% of their balance in company stock… Yikes! Stable-value is way too conservative and putting so much into your company stock is a risk too.

7. “If you quit your job, you’ll have to pay to keep your 401(k) here.”
This one was hard to believe because of all the articles out there discussing the benefits of rolling over your 401(k) into a rolleover IRA, a process I just went through. A lot of folks seem to think the paperwork is a hassle but consider the payoff, if you think your options are limited and could cost you money, magnify that by the number of years until retirement and you’re talking serious money. Would you take $200 to go through the process? It’s likely that making the move, if your current options are limited, will result in a difference, in your favor, of at least that much. At the very least, you can roll it into your new job and save yourself the hassle of managing two accounts.

8. “You’d be better off in a Roth 401(k) — too bad your plan doesn’t offer it.”
This is something you can’t really control because the Roth 401(k) is optional, your employer doesn’t have to offer it. However, a Roth 401(k) isn’t necessarily better than a regular 401(k) because the two are two totally different animals. One offers tax deferred investing (regular 401k) and one offers tax free investing (Roth 401k), you should have a good mix of both. Unfortunately, it turns out only 5% of company plans give their participants a choice… which is a travesty.

9. “You want to see some outrageous fees? Try a variable annuity 401(k).”
This only applies to a limited set of folks because a lot of 401k’s don’t offer the opportunity to invest in variable annuities, which is good because its an expensive option. Why? “The insurance company slaps a fee on top of the expense ratio you pay for the mutual funds in the annuity.” Should you be in a variable annuity? Probably not, there are other options out there that are cheaper and possibly better.

10. “Your nest egg could be a whole lot bigger.”
This one is a little bit sensationalistic but it revolves around the fact that people don’t pay attention to their fees and don’t realize how much of a difference a few fractions of a percent in fees makes. “Consider this: Brent Glading of the Glading Group, who used to sell 401(k) plans for Merrill Lynch and Dreyfus but now negotiates better plans for company clients, typically can shave 0.20% to 0.40% off a plan’s expenses. That doesn’t sound like much, but it can translate to $100,000 per employee over 20 to 30 years.” Wow… $100k? That’s huge.

Source: Yahoo Finance

USA Today posted an article today about the four types of annuities and admitted that, while they aren’t the best game in town, they’re the only vehicle, outside of pensions and Social Security, to guarantee a lifetime flow of income in retirement (and you could argue the guarantee-ness of your company’s pension and Social Security). I’ve written about fixed income and variable rate annuities in the past and this post looks to expand on the basics introduced by that post.

To recap, an annuity is a contract with an insurance company that sets up a pension-like income stream for the consumer. In addition to fixed income and variable income annuities, there are two additional versions: fixed deferred and variable deferred. I’ll just discuss the deferred versions since the immediate ones have been covered before.

According to USA Today, Deferred variable annuities are the most complex of the four and should be a last resort for investors (if you’ve maxed out everything else). You can think of them as a mutual fund inside an insurance policy. So your money grows in the stock market as it matures, if you die before you start withdrawing money, then a life insurance provision pays out a guaranteed amount to your heirs that is at least equal your investment. There are significant drawbacks to a deferred variable annuity. The fees cost about 2.3% of assets compared to an average fee of 1.3% with a regular mutual fund. The annuities also tie up your money for a minimum period of time, up to 15 years, and will impose a hefty fee, up to 15%, if you want to take your money out.

Deferred fixed annuities grow at a set interest rate, adjusted every few years, and you can withdraw the money in this annuity in one lump sum or as a stream of income, your choice. Unfortunately, you can’t withdraw your funds until you reach 59.5, or face a 10% penalty.

Also, some withdrawals from both deferred fixed and variable annuities count as a “return of your principal.” That means it’s not taxed (because this money was taxed going in). That is also important if you’re drawing Social Security benefits. Up to 85% of your Social Security payouts may be taxed if you have other income, but annuity principal doesn’t count in this calculation.

The maximum you can contribute to your 401(k) is $15,000 and the maximum you can contribute to a Roth IRA is $4,000 - so where should you put your money afterwards? Well, my personal opinion is that if you’re able to save $19,000 towards retirement and are still eligible to contribute to a Roth IRA ($95k in income) then you should enjoy life a little bit more (just kidding!). Seriously though, and this applies to those who are ineligible to contribute to a Roth, you should contribute it towards a traditional IRA because the recent retirement law changes made it possible for anyone to convert a traditional into a Roth IRA! From a CNN Money article:

Come 2010, you can then convert whatever money you’ve accumulated in your nondeductible IRA to a Roth. And you can continue to contribute to a nondeductible IRA and convert it year after year, in effect skirting the income limitations for doing a Roth.

What if you don’t want to put it into retirement? You don’t have any other options but that same article recommends tax-efficient mutual funds and ETFs because it reduces your tax bill on the sell side. With tax efficient mutual funds, you’re tax liability is lowered because the fund will make moves that reduces your tax liability. With ETFs, the same is also true.

Two things they recommend against? Variable annuities and variable universal life. Variable annuities usually have high fees and variable universal life policies are billed as insurance policies and investment vehicles.

As with variable annuities, high fees are a hitch, but variable universal life also carries a risk that the money you borrowed could become taxable late in life.

Lump sum illusion, a term used by Olivia Mitchell, University of Pennsylvania insurance professor and executive director of the Pension Research Council; is when someone on the cusp of retirement gets when they look at their 401(k) or pension fund and sees all those zeroes. While it’s nice to have a large nest egg, one must remember that the funds in that account are supposed to last you the rest of your days - which could be, hopefully, many decades.

In an article on CNN Money, Walter Updegrave identifies three options:
1) Investing it on your own and withdrawing when you need to.
2) Putting it into an annuity and withdrawing income on a schedule.
3) Both (split your funds into two, investing some and putting the rest into an annuity).

Here is an interesting graphic from the article:

A lifetime income annuity, also called a payout or immediate annuity, is an income annuity that pays you out a dollar amount each month for as long as you live. The lifetime income annuity comes in two flavors - fixed and variable.

With fixed income annuity, you get a set income each month that does not increase or decrease with time. So on your first month if you get $500, then you’ll get $500 in the thirteenth and fortieth months. The benefit is that you get the certainty of income, a set dollar amount, that will not fluctuate at all. The disadvantage is that it isn’t inflation adjusted - $500 in five years may not be worth as much as it is now. It is very important that you shop around for a fixed annuity because how much you earn can vary depending on who you go with.

With a variable income annuity, you invest your money in subaccount portfolios that resemble mutual funds. How much you are paid out each month depends on the performance of these subaccounts, so you lose the predictability but may get protection, potentially, from inflation. There is always the risk that your annuity may lose value and that you’ll get a smaller check. Again, it’s critically important for you to look around for who you pick your variable income annuity with because fees can eat into your earnings very quickly if you aren’t careful.

Annuities are very very complicated creatures in the investment world but break down into three major categories. A fixed annuity is like a CD, paying out a fixed rate that is guaranteed. Variable annuities are like mutual funds that can get you a higher rate of return if you can stomach the higher mutual-fund like risk. Lastly, there are the hybrid annuities which breaks up your investment into fixed and variable so you get a guaranteed but also get a taste of the hot hot stock market. That seems simple enough until you get into the various species of annuities, the little games they play, and how the fees are structured. Some annuities have commissions as high as ten percent!

CNN Money took a look at three annuities you must avoid at all costs: Equity indexed annuities, IRA rollover annuities, and an annuity swap.

Equity Indexed annuities (EIA) are a bad idea because while their returns are based on a market index, such as the S&P 500, your total gains may be capped percentage-wise or dollar-wise and you may not earn the dividends from the holdings (since you’re not actually holding the stock). Take that and the fact that you’ll suffer penalties if you withdraw within a specified time period, typically calculated in many man years!

IRA rollover annuities are even more ridiculous because they aren’t even necessary. Salespeople will pitch these ideas on the hopes of preying on your weakness while they take high fees which can run as high as 3%.

Lastly, an annuity swap is where the salesperson will tell you your existing annuity is outdated, bad, low-returning, but he or she has one that will beat it and he or she will give you a couple extra percent of your investment right on the spot! The downside of this is that you still pay surrender fees on your old annuity and the new annuity may not be much better.

via CNN Money.