Annuity Question

As many financial advisors, financial authors and columnists, and others have repeatedly emphasized for many years in books, lectures, TV shows, etc., invest only in what you can understand. If it is complicated and raises doubts, give it a pass!

You might think of it as sort of like the situation you face when buying a car, where comparing prices can be difficult if all the accessories, options, add-ons, details of financing, value of a trade- in, etc. vary in a complex way from one model to another and you are not quite sure whether or not to believe the salesman who says you are getting a good deal.

By defining what your needs and expectations are.

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Yes, what you describe is referred to as a GMIB - the Guaranteed Minim Income Benefit.

When annuitization is not required it may be referred to as a GMWB - Guaranteed Minimum Withdrawal Benefit.

And sometimes we see that the verbiage varies a bit from company to company - everyone wants to offer something that looks special or unique so their customers feel special.

In my experience, the older contracts offered a GMIB as the only income option. Then they started to offer the GMWB as a way to get people to invest without the need to make an irrevocable election and foregoing any future involvement in the market.

A side observation that I seldom see discussed is that with the GMIB you get to select the annuity period for the income phase. So I could select a payout over 10 - 15 - 20 years, make the irrevocable election and live knowing that the annuity company would pay me the same amount for that period WHILE using the remainder of my money to make money by keeping some portion of it invested in the market.

While the switch to the GMWB is frequently sold as a way to guaranteed an income stream you can't outline AND stay invested in the market, its worth noting that doing so usually means you're limited to a 5% annual withdrawal. This can cut the amount the annuity company has to actually distribute to you if your GMIB option would have allowed you to select a 10-year payout. It isn't all about the client - if there was no benefit to the annuity company they wouldn't offer it.

That is NOT to say that just because someone else benefits that it isn't a good idea or good deal - FOR THE RIGHT PERSON UNDER THE RIGHT CIRCUMSTANCES.

Gene E. Utterback, EA, RFC, ABA

Sometimes it helps to work backwards when trying to decide whether an annuity of any kind is right for you and your situation. Consider this -

1 - you've accumulated $1.25M in financial assets (not the house, car, racehorse or those Nascar Plates) - I don't care whether they are inside or outside of retirement accounts. 2 - you know in retirement you will need no less than $50K annually to make sure you have the basics covered. I'm talking food, shelter, transportation and such. Based on the size of your portfolio this means you have roughly a 4% withdrawal rate - which many consider sustainable. 3 - you know that you've done a good job investing in stocks/bonds/ETFs/mutual funds/whatever - you've actually done well on average. Let's say you've averaged 8% over the last 20 years or so. 4 - you also know that while you averaged 8% there were period when you suffered a 40% loss in the value of your portfolio.

Now you retire - you're fine as long as you can continue to maintain your growth rate and don't exceed your withdrawal rate. BUT what happens when your portfolio takes a 20% correction? You're 1.25M is now worth 1.0M. If you still need $50K then EITHER your withdrawal rate just bumped up to 5% or your income stream drops to $40K a year - remember we're trying to hold to a

4% withdrawal rate for sustainability. If you increase your withdrawal rate to 5% you may wind up invading principal and your money may not last as long. If you drop your withdrawals by $10K a year your lifestyle suffers.

Annuities that don't require annuitization and to which a living benefit can be assigned can offer an alternative.

You put $1M into a VA with 5% living benefit - this VA pays $50K a year for the rest of your life no matter how long you live and is guaranteed to pay out the full $1M to your beneficiary even if you die tomorrow. So if the market goes down you don't take a pay cut. BUT if the market goes up you get to participate because if its up on your anniversary date your contract resets and you now get 5% of the new high-water mark. You still have $250K to invest however you like and to reach into if you need some extra over the $50K payout from the VA.

This provides a sort of safety net - guaranteeing you the income stream you need to make sure you don't outlive your money while still keeping you invested, sometimes more aggressively than you might be comfortable with if you knew that a market decline would mean you'd have less to live on.

VAs do cost more that most other investments, but that is because they offer more. Its like choosing between a Yugo and a Cadillac - they are both cars, they will both get you from point A to point B. One may be better than the other if the circumstances are right.

Generally, I like to see my clients have some portion of their retirement money in VAs with living benefits to make sure that WHEN, not if, the market takes a down turn they won't be left with nothing to live on. VAs are NOT for everyone and I don't usually recommend that anyone put ALL their money into one. I do sincerely believe that any advisor who doesn't at least make his clients aware of VAs and what they can do is doing a disservice to his clients. How would you feel if the day after the market tanks and you've lost 50% of your portfolio that you find out that there was an option available to you that could have protected some portion of the money you need to live on.

As a side note, I saw a case recently where the proverbial little old lady, whose husband bought her nothing but VAs with a slew of benefit riders, died at age 80. She was drawing about $30K a year off them. But the payout to her heirs was well over $2M because of the guarantees.

Like I said, they are not for everyone. And as someone else noted, if you don't understand them you shouldn't get in them. But they are understandable, assuming you're working with someone who understands them themselves.

Gene E. Utterback, EA, RFC, ABA

This stuff is not always easy to figure out; but I have a rule that I don't invest in anything I don't understand.

I agree - just don't want to miss something that the herd is using, and potentially should be part of my financial world....

thanks for the words..... It's not so much a Yogo vs Caddie - it's more like a tractor, wagon, bike, car, truck - but coming to the store riding on your horse. Not quite sure what you may need, since it's all new - the annuity world - compared to your current investment portfolio of stocks, mutual funds.

I've been wrestling more with my current portfolio, as it is heavy into stocks and I need to shift some to the "protection" side such as more fixed income, or whatever.

That is why the entire topic of Annuities floats past my mental desk every so often. But - as this thread shows - it's really hard to consider Annuities compared to the simple analysis of a stock of mutual fund.