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Scott Burns' Articles -- Recent and Archived

A Tough Decision about a Variable Annuity

Q. We have an annuity with John Hancock. In the nearly seven years we have had it, we have received no dividends from it. It is divided into 47 percent T. Rowe Price Equity Income, 12 percent T. Rowe Price Blue Chip Growth, and two other funds. We contributed $72,888. It is now $72,648.

The annuity has an enhanced death benefit that is now valued at over $98,000. My husband is in the latter stages of Alzheimer's, and I look on this as life insurance. However, I may be looking at it the wrong way. We would pay a penalty if we surrendered it before October 2007.

Looking back, I realize my husband was unable to understand what we were getting into. And I certainly didn't. Can give me some insight into this? ---B. H., by email

A. I think there may be some information missing. While the investment was made at the beginning of a major bear market and the expenses of the product reduced returns, I'm having trouble getting to the low value you are showing.

For instance, had you invested $10,000 in T. Rowe Price Equity Income fund, it would now be nearly $17,000. Even your large investment in T. Rowe Price Blue Chip Growth would be about break-even.

Then, again, the performance of the other funds may have been poor.

I think the solution is to wait until October to avoid any penalties. Then exit the variable annuity. You can do a 1035 exchange and roll it to a low-cost VA like the one Vanguard offers. Or you can leave the VA altogether and invest in managed mutual funds or index funds: Your move should have no tax consequences since your current value is essentially equal to your original investment.

If your husband's health is poor later this year, you should wait, because the death benefit increases the value of the contract by 35 percent.

Your experience is one of the reasons I don't think variable annuities are a good investment product. The high fees favor 100 percent equity investments, which you had, and the death benefit favors speculation, which you had. You were probably aided in your choices by a person who called himself an "advisor" who was really a salesperson for a particular product.

Had you invested the same amount of money in a variety of balanced funds in January 2000, your investment would now be worth at least 24 percent more and possibly 66 percent more. American Funds Income Fund A shares, for instance, would have risen 67 percent---after paying taxes on distributions--- and the salesperson would have received a commission. Had you invested the same amount in Vanguard Balanced Index, your investment would be up 24 percent, after taxes.

Q. In your response to a recent question regarding the value of a pension, you used the example of a lifetime annuity and ended by stating that taking a lifetime income from a portfolio was risky. Could this be mitigated by converting perhaps 25 percent of one's retirement assets into an immediate annuity and investing the balance in a stock/bond index portfolio? I am at the stage where a decision of this type needs to be made. ---T.K., by email

A. Recent research shows exactly that--- your investment portfolio is more likely to survive a long retirement if you convert a portion of your portfolio to a lifetime annuity. The reason for this is simple, if you think about it a bit. What destroys portfolios is high withdrawal rates--- rates that are far above the income-generating capacity of the portfolio. But if you convert a portion of your portfolio to a life annuity, you'll enjoy a big increase in monthly income, reducing the amount of money you'll need to take from the remaining investment portfolio. Of course, the older you are when you annuitize, the higher the income you will receive. That is why some financial planners suggest doing a serial annuitization--- buying one life annuity at, say, age 65, another at 70, and so on. Each will bring a higher income.

Comments

 

ABModerator03 said:

Dear Mr. Burns,

This was an excellent column and you are correct in your analysis. I retired from the financial planning business (after 40 years) and found that most people really do not understand the various charges connected with a V.A. These charges will have a negative effect on the total return of the sub accounts. I always enjoy your articles and they are good advise to people who are not skilled in investing.

Brooks

From Scott Burns:

Thanks for your note. The odd thing is that many people, particularly those who sell Vas, seem to think I have an emotional grudge against variable annuities. In reality, I've run the numbers year after year and gotten the same message--- this is a sold product, by the salesforce, of the salesforce, and for the salesforce.
March 5, 2007 1:53 PM
 

ABModerator03 said:

Scott, I have read your writings for many years and often disagree with you. Your recent article stating that one should only buy term life insurance and that whole life and universal life are bad, infers that one does not need the tax free death benefit of life insurance WHEN they die, not IF they die. I just passed my 40th year of selling life insurance protection to a broad range of clients and wonder if I had sold only term to my 30-40 year old clients where their policy would be today. It would have either expired or became too expensive to continue.

Everyone has different needs, desires, and ability to pay. That is why we offer a variety of products from which the prospect can choose. I asked my prospects, do you want to "own" or "rent"? Sure, it is cheaper to rent rather than buy a home, but you control the property you own and decide what you want to do and how long you want to live there. Then you can take the equity you built up and move on or up.

Many of my clients who bought a permanent policy use them as a "line of credit", where loans are available with a phone call at a reasonable rate of interest. Insurance companies like term insurance, because very few pay off as death claims.

Term insurance is purely a Band-Aid. It may be easier to pay for it presently but in truth, it is the most expensive insurance we offer.

From Scott Burns: Sorry, I just don't agree, even though I own a Universal Life policy. While small business owners and others likely to have estate liquidity issues may need to consider a non-term life policy, the vast majority of the newspaper audience for whom I write have life insurance needs large enough that incorporating a cash value feature would dictate being under-insured because they simply couldn't afford the premiums on cash value building policies.
March 13, 2007 9:07 AM
 

ABModerator03 said:

Mr. Burns, I don't know what type of product this person is in, but I believe your advise to this woman was poor. First off, she would be far better off doing a partial 1035 exchange if possible, as that would, at the very least, keep for her the benefit of the annuity itself which was the guaranteed rising death benefit. I'm curious if you are opposed to all insurance products or merely annuities, as many people own term life insurance as a ten or twenty year product and end up getting absolutely nothing for the money spent. In fact, I understand there are people who buy auto insurance and never receive the benefit gained by getting into a car accident. An annuity is an insurance product whereas, for an expense, the insurance company may protect you against loss as a living or death benefit. For that, yes, there is an expense. From what I can tell, while her variable annuity has not performed well to date, to merely pick one or two mutual funds in hindsight and stating that would have been the better investment seems very easy after the fact. What is peace of mind worth? From Scott Burns: You're right about one thing--- I should have mentioned the option of taking most of the money out, but leaving enough money in the contract to be able to collect the death benefit.

As a practical matter, the death benefit provision of VA contracts is a lousy way to buy life insurance. It's a very expensive way, as well. If you pay an additional 1 percent for the insurance wrapper on a $100,000 investment, the alternative is to use the same money, $1,000 a year to buy term life insurance. That will buy a good deal of life insurance, even at age 60--- it won't be contingent on both a market decline AND death.

If you check "Variable Annuity Watch" on my website you'll find repeated tests, benchmarking the entire universe of VA sub-accounts against the purchase of an inexpensive (and entirely unencumbered) equity index fund. The index fund ranks toward the very top in all instances, and most of the gain is taxed at no more than 15 percent.

If the insurance industry had a shred of honesty, it would label the insurance expense as what it is, the equivalent of the additional charge put on the "B" shares of mutual funds. This allows them to eliminate front end commissions and replace them with back end commissions. Either way, the sales expense comes out of the investor's money and the added drag is highly toxic to long term returns.
March 13, 2007 3:33 PM
 

ABModerator03 said:

After my father died 3 years ago a guy talked my mom into putting all her money into a Anuity with NYLife. Its made about .5 to 1.5% in the last 3 years and the guy has taken $2000 per year in I guess Expenses and commissions.

She is left with 100,000 in her IRA and about 83,000 from Dad's death benefit.

We are in the process of rolling it out to a USAA account and I will put 50% in a Index fund and 50% in a Tax Free Bond Fund.

What do you think? She has retirement income from social security, TX teachers Retirement and Dad's military disability of almost $5000/month. Mom is now 72 and has to start pulling money from the IRA?

Now another slick sales agent from Equi Trust is at mom's trying sell her another Annuity. I was down there last week to do her Taxes and I did all the paperwork to get her IRA and Anuity rolled out of NYLife to a USAA IRA rollover and transfer the remaining anuity to a mutual fund account with USAA. Mom loves the USAA web site and car and home insurance and checking and savings is also with USAA. Please help Bob Day A Concerned Son
April 3, 2007 11:42 AM

About scottb

Scott Burns has covered the changing world of personal finance and investments for nearly 40 years. Today, he ranks as one of the five most widely read personal finance writers in the country. Scott began his career as a newspaper columnist at the Boston Herald in 1977 where he was also the financial editor. Nationally syndicated in 1981 and now distributed by Universal Press, the column appears in newspapers from Boston to Seattle. In 1985 he joined the staff of the Dallas Morning News where his column quickly became one of the most widely read features in the paper. He left the Dallas Morning News in 2006 to become one of the founders of AssetBuilder and its Chief Investment Strategist. Burns is a graduate of Massachusetts Institute of Technology (1962). He has written four books, including "The Coming Generational Storm" (MIT Press, 2004) coauthored with economist Laurence J. Kotlikoff. His fourth book, also coauthored with Kotlikoff, will be published this spring by Simon & Schuster. "Spend Til' the End" uses consumption smoothing to demonstrate the errors of conventional financial planning. His business experience includes working as a staffer for a major consulting company and service as a director and audit chairman of a NASDAQ listed manufacturing company. He and his wife divide their time between Dallas and Santa Fe, New Mexico.
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