Annuities...are they a crap shoot?

However you look at it, if the companies could work out some way of providing their products directly to customers without a whole level of middlemen who need to be paid commissions, the returns on investment should increase. That certainly as been possible in the case of equity mutual funds. I wonder if it is coming in the case of mixed equity/insurance products.

After all these posts, I wonder why the OP has not replied before now and cleared up the uncertainty as to exactly what his wife is considering buying and how that commission of $6600 is to be paid. I am inclined to believe he put out the original question as a kind of hypothetical exercise rather than a scenario involving real people.

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Agreed. 40 years was used because the market data was readily available and significantly long. Can you imagine the uproar, if I had used, say, three random years in the middle of the 80's? Taking a quick, uncalculated glance, there really isn't a period of time in recent history that isn't marred with the occassional negative or low postitive return. It is in these years that the guarantee gains ground.

If anything, the uncertainty that your question brings to light is even more of a reason why one may want to employ an insurance product. It eliminates the risk.

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A quick look at many of his other posts suggest it could be a troll.

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Assume the same answer applies if the owner/annuitant never started any kind of withdrawals from the non-qualified annuity. Yes?

Are the beneficiaries limited to a lump-sum taxable payout or can they elect a lifetime payout over their life expectancy (paying taxes only on the amount received each year)?

-HW "Skip" Weldon Columbia, SC

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"kastnna" wrote

So I see, as an example,

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I think that's one potential (but not definite) drawback to many: That the principal or what remains of it is often lost at death. Of course, as I was trying to propose in response to Douglas, I see these vehicles as insurance policies as much as an investment. So no, one does not necessarily get back what one put in. But one might also get back more than one put in. An annuity (variable or otherwise) with reasonable fees is always to some extent about peace of mind.

To me the other major drawbacks are

1. committing for a long period of time before one can exercise (so to speak) the GMIB. Ten years seems usual.

1. expiration of the GMIB at about age 85, or so it seems typical.

I think these are important caveats when mentioning a 6% GMIB. Not to say (1) and (2) above are "bad" things. More that, with all due respect and IMO, it's not quite as great a deal as your post might lead one to believe. (Granted the constraints of posting preclude a complete discussion.) I would in fact be very interested in an investment vehicle that guaranteed a return of max(6%, annual S&P 500 appreciation less 3%). But with the caveats, these annuity GMIB products are not attractive to me. With the ten-year requirement, I am not sure they would be attractive at any age.

These annuities are also sure darn complicated, which to me means the insurance company finds ways to make their money. This is their right, but I cannot feel secure without understanding what the company is getting in exchange for my purchase.

Two cents on this produce from a consumer.

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I don't think I made any indication that an annuity was truly as cut and dry as my "S&P example". If I did it wasn't my intention. Of course, there are numerous caveats. I'll try to give a better primer of an actual annuity below:

Account Growth: When an investor puts money into a variable annuity with a GMIB rider (simply VA, henceforth) two "accounts" are immediately created. One is the actual account value (AV) and the other is the benefit base (BB). The AV experiences the actual returns of the underlying investments. All fees and expenses are deducted from the AV. The BB grows by the guaranteed 6%. At each contract anniversary the BB can be "locked-in" at either the AV or BB, whichever is greater.

Ex: Annuitant invests $100k in the S&P500 fund of a VA. At year's end the investment has returned 15%. The AV is now $112k (15% minus 3% in fees). The BB is the greater of $106 or $112k. The next year, the S&P returns 0%. The AV is now $108,640 (0% minus 3% fees). The BB, however, is the greater of $108,640 or $118,720 ($112k x 6%).

The distinct accounts are very important. The annuitant can call and request the entire AV at any time (minus any applicable surrender costs). The BB is not available for withdrawal. The BB is similar to a defined benefit pension. It's amount off of which the insurer guarantees an income stream. Liquidity is the true drawback of annuities, not returns.

Distributions: Funds can be withdrawn from variable annuities without "annuitizing" the contract. This is actually the far more common scenario. If the above annuitant wanted to withdraw 6% of the BB at year's end, the AV would fall to $101,920 and the BB would stay at $112k.

Annuitizing: If the AV ever reaches $0.00, the contract is annuitized using the annuitant's life expectancy and the BB. Going back to our above example, let's assume the market has a run of bad years and in 5 years the AV has fallen to $0 (REALLY bad years, but it's just an example). The BB has risen to $166,329 ($118,720 grown at 6% annually for 5 years). At that point, the client has the equivalent of a $166,329 immediate annuity. There is no account value to liquidate or withdraw from, only a promised income stream (again, like a pension).

That's the basics. I do believe the 6% guarantee stops compounding annually at age 90 (I think it was 85 and they are currently moving it to 90). Annuities do not receive a stepped up basis at death and the gains are taxed at ordinary rates. Those are definitely negatives. On the other hand, growth is tax-deffered and there's no guarantee as to future tax laws.

One often ignored benefit of the VA is that the guarantee allows investors to take on more risk. A retired investor will commonly have

60-100% of their investments in fixed income. That same retiree investor has less need to carry safe investments if the guaranteed annuity promises a 6% compounding pension. The fixed income/bond/muni/ CD retiree may only get a 5-6% return. On the other hand the VA investor may get 8-9% in equities. After expenses the returns are the same and the VA guarantees have paid for themselves.

Probably my longest post ever. I apologize. I welcome the responses.

P.S. - I would make about $6k in commission in the above example.

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Elle,

For the record, I was unaware of your 12:50pm post when I posted at

1:35. I apologize if it leads to further confusion and/or it appears I ignored your post.

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Yes. It is more commonly the case that withdrawals are never taken or only withdrawn from the contract value without annuitizing.

The heirs can receive a lump sum payout of the originally invested principal minus and distributions or a lifetime payout based on the their life expectancy. Additional (foolish) riders are included to enhance the death benefit, provide an additional lump sum to cover taxes, etc.

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1) The odds of not getting back what you put in are small. It's not like an immediate annuity that removes all account values and liquidity right away. As you suggest, with an immediate annuity, you could invest $100k, die two months later and have only received a couple hundred dollars. Not the case with deferred annuities. They are like most other investment accounts until you actually ANNUITIZE the contract. Many investors NEVER annuitize the contract. If you die without having done so, the death benefit pays your heirs at least what you invested. 2) I think you've misread the 10 year requirement on GMIB exercising. The 6% annual compounding guarantee starts at year one and occurs every year until age 85 (I called MetLife, it will be moved to age 90 in the coming months). If in a given year, the investor exercises the GMIB 6% "step-up", then they must wait 10 years to annuitize the contract (this is what they mean by "exercise the GMIB rider). IOW, if the $100k account value falls to $90k, the investor would wisely lock in the 6% guarantee (resulting in a $106k benefit base). However, they must then wait ten years to call Metlife and request an annuity based on the $106k (or the the account value at that time, ehichever is greater). Keep in mind they have a $90k account value that they can withdraw from as they see fit. So why would anyone in their right mind WANT to annuitize the contract? Annuitizing results in losing all liquidity and is therefore a last resort only once teh account value is gone. Furthermore, the Metlife prospectus clearly states that if the account value ever reaches zero the contract is annuitized based on the benefit base amount even if the "10 year requirement" has not been met. So if the account value is positive, the investor cannot annuitize for 10 years, but they wouldn't want to anyway. If the account value is $0, they get an immediate annuity based on the benefit base amount.

The 10 year requirement is a hollow threat, but to be fair, it is the most common misunderstanding I run into with these annuities.

Given what I stated above, I would appreciate an example of a time when this would be a drawback.

So a guarantee that stops at 85 (or 90) is a drawback to no guarantee at all??? The benefit base doesn't disappear at 85, it just no longer compounds annually at 6%. RMDs and, likely, death will almost assuredly had a bigger impact by the time this even become significant.

That reminds me... RMDs may be considered a drawback.

I completely agree they are complicated and they are not for everyone (or for most, even). However, I don't agree that complexity necessarily means profiteering. The insurance company profits by charging the M&E fees. They also promise to pay later, but they have your money today. Consider a case of putting in $100k and leaving it for ten years: Under the GMIB, they owe you at least $196k, but they've had your money for a decade with which they hopefully made more than 6% with. Furthermore, if you ever do annuitize, they are not giving back all $196k immediately, they'll continue to invest it while the pay you an income stream.

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"kastnna" wrote snip but all comments read

I can't imagine why it would be so misunderstood.

I'd say this is a philosophical question. But for what it is worth, remember I entered this thread plugging low fee annuities (for one) as more of an insurance product, not an investment product. Where insurance buys peace of mind, it can be a good thing yada.

I trust you mean the company made more than the max of either 6% or the S&P 500 less 3%. It was the guarantee of getting the S&P 500 (less 3%) in good years that I found appealing. Maybe that's changing a little?

Thanks for the long explanations. But ya know, if anything, they make me more hesitant to purchase an annuity. So many strings attached. So many more decisions, requiring a fair amount of research to do right, to make in the future.

Just saying as your average college+ and numbers educated consumer/individual investor.

Aside: I do not think you really posted out of order. You responded to Don's post first, not mine, which is fine. I understood what was going on. Oh and by the way thanks also for using proper acronym writing rules. It really helps the reader to first spell out the acronym's words, following them with the acronym in parentheses, as you did with "GMIB." Shows you know something about writing!

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Elle,

Thanks for the valuable input so far.

I think that annuities should be used sparingly and with great discretion. They're definitely not for everyone. I'm also a believer that if an investment makes you uneasy, don't buy it (regardless of the reason). My first goal is peace of mind. Financial savvy comes second.

The lack of aforementioned discretion used by many advisers has fueled the anti-annuity fires. The good news is that many compliance departments are starting to restrict VA sales. I can only speak for the firm for which I work, but our compliance dept. requires numerous forms that justify the use of an annuity (many of which the client never sees). Most of the questions they ask are the same concerns often brought up in this group. I think that's a step in the right direction.

I hope I didn't confuse too many readers. I have much more success using visual aides and hand-written hypotheticals. It's simply too much information to convey through text. Showing the two accounts side- by-side and going through a half dozen examples goes a long way towards clients understanding.

Best wishes to all.

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