Whether now or later, costs of an­nu­ities will be passed to in­vestors

Austin American-Statesman - - BUSINESS - SCOTT BURNS

My wife and I re­cently went to a ‘free din­ner’ to get ed­u­cated on the best way to man­age our money for re­tire­ment.

I’m 66, and my wife is 65. To­gether we get a lit­tle over $50,000 a year in So­cial Se­cu­rity and pen­sions from for­mer em­ploy­ers. Our home is paid for and, liv­ing in Texas, we don’t have a state in­come tax to worry about.

I have a 401(k) with about $150,000 in DuPont stock and about $350,000 in a ‘sta­ble cash fund.’ The sta­ble fund is pay­ing about 4 per­cent. I also have a 403(b) with about $225,000 spread over three Van­guard funds and about $110,000 in a tax­able ac­count with three Franklin Tem­ple­ton funds.

The ad­viser has rec­om­mended mov­ing a sig­nif­i­cant amount of this money into an­nu­ities. She was rec­om­mend­ing $100,000 into a 10year an­nu­ity with a 10 per­cent sign­ing bonus and guar­an­teed in­crease in value of 8 per­cent a year. We would be al­lowed to with­draw up to 10 per­cent per year af­ter the first year with­out penalty. Her com­mis­sion is sup­posed to be paid by the com­pany and not from our pro­ceeds.

Maybe I am just nat­u­rally skep­ti­cal, but I’ve al­ways be­lieved that if it sounds too good to be true, you should run away as fast as you can. My wife is more ac­cept­ing of all these claims, es­pe­cially since she has less tol­er­ance for mar­ket ups and downs.

Do you have any opin­ions on these an­nu­ities? The ad­viser had sev­eral other com­pa­nies that of­fered ei­ther lower in­ter­est rates or smaller bonuses.

She brought them up when she had us in­vest­ing up to $500,000 in an­nu­ities, and I said I wasn’t com­fort­able putting all my eggs in one bas­ket. My wife says we could just do $50,000.

– S.G., Pflugerville

There is no free lunch. No free din­ner ei­ther. While it is true that the sales­per­son’s com­mis­sion is paid by the in­surance com­pany and 100 per­cent of your money is in­vested, I as­sure you that the in­surance com­pany does not look to the tooth fairy for re­cov­ery of its mar­ket­ing and sales ex­penses.

The sales­per­son’s com­mis­sion and re­lated mar­ket­ing costs are a cost of do­ing busi­ness. That cost can come out of two places: from your orig­i­nal in­vest­ment or from the re­turn on your in­vest­ment. Ei­ther way, it’s out of your pocket.

How it comes out will de­pend on how long you own the prod­uct. The in­surance com­pany

Con­tin­ued from pre­vi­ous page guar­an­tees that it will re­cover its mar­ket­ing costs by writ­ing a sur­ren­der charge into the con­tract. These sur­ren­der charges vary, but typ­i­cally range from 6 to 8 per­cent. The per­cent­age typ­i­cally de­clines by 1 per­cent­age point a year.

So if you are charged a typ­i­cal 1.25 per­cent a year for “mor­tal­ity and risk” and the com­pany has a 7 per­cent sur­ren­der charge, the com­pany will re­cover 1.25 per­cent plus 7 per­cent if you sur­ren­der af­ter one year (8.25 per­cent to­tal). Af­ter two years, it will have col­lected 2.5 per­cent in “mor­tal­ity and risk” fees, plus 6 per­cent in sur­ren­der charges, a to­tal of 8.5 per­cent. Af­ter three years, it will be 3.75 per­cent plus 5 per­cent (8.75 per­cent to­tal), etc. If you don’t re­deem early, the com­pany even­tu­ally re­cov­ers the mar­ket­ing costs through the an­nual mor­tal­ity and risk charge.

I am not alone in think­ing that most vari- able an­nu­ities have ex­penses that far ex­ceed the ben­e­fits. This in­cludes those that of­fer a “liv­ing ben­e­fit,” which guar­an­tees an an­nual in­come re­gard­less of what hap­pens to the value of your in­vest­ment.

Rather than con­sider what you are guar­an­teed, you should con­sider what the in­surance com­pany is guar­an­teed — it will col­lect fees equal to about 3 per­cent of your prin­ci­pal each year for as long as you hold the con­tract. You get the right to with­draw at 5 per­cent, re­gard­less of ac­count value. What this amounts to is de-facto life an­nu­iti­za­tion be­cause the odds are that your ac­count will not ap­pre­ci­ate to in­crease your in­come.

You could have more in­come, to­day or af­ter some time pe­riod, if you sim­ply chose to buy a joint and sur­vivor life an­nu­ity. That choice would also in­crease your in­come over the amount you would re­ceive from the prod­uct you have been of­fered.

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