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Annuities inside a 401k

On CNBC's web site they say that employers are beginning to offer annuities in their 401k so that participants can choose lifetime income. Here is the article.
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Since they mention high fees, my guess is that they are talking about investing in deferred annuities instead of mutual funds during the participant's working years.
What confuses me is that a 401k participant does not have to invest their contributions in a higher cost annuity to have a guaranteed option for life - at retirement they have always been able to buy an immediate annuity from any insurance company who offers them and initiate lifetime income at that point.
What am I missing here?
Reply to
HW \"Skip\" Weldon
Aside from the immediate annuity you reference, I'm at a loss as to why these products are selling so well. 2%? A cumulative 33% loss over a 20 year period. I love the hyperbole "With many Baby Boomers' retirement accounts decimated in the aftermath of the financial crisis" With deposits since the bottom, our accounts are back above the recent peak of 07Q3. The S&P is down only 13% from peak, and with dividends, nearly even. I'll admit that there's a lot of screaming when the market is down, and there's some value in being able to reduce the risk of loss, but 2% each and every year is too high a price to pay.
Reply to
JoeTaxpayer
So you are thinking that these employees are logical thinking humans who base their decisions on objective information, instead of marketing?
Reply to
PeterL
Remember that the vast majority of 401k participants are some form of clerical help or are working on a factory floor. You are critisizing "these employees" for not doing something that they are completely unequipped by education or experience to do. The people on this forum are NOT your typical 401k paticipant.
--
 .Bill.
Reply to
Bill
A lot of people are still way down. It depends on what specifically you were invested in.
Thumper
Reply to
Thumper
Annuities are by themselves a tax protected vehicle, no? So generally speaking, doesn't putting one's 401(k) allotment into an annuity squander space in one's 401(k)?
I think this has been explored here at MIFP in the past, and there are nuances for some people that might justify having an annuity in a 401(k) or IRA. But they are the exception.
Reply to
Elle
Skip was specifically talking about *immediate* annuities, which are generally not tax protected. See
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Reply to
bo peep
bo - you need to reread Skip's remark. "Since they mention high fees, my guess is that they are talking about investing in deferred annuities..." Which validates Elle's concern.
Truth is, the article Skip cited lacks the level of detail to pass full judgment. A tradition pension looks to the employee like the immediate annuity at retirement, yet the employer takes on the risk of investing until that time. I understand the immediate annuity appeal at the back end, but there's still the years of work and investing along the way that need clarification. As Rick++ pointed out, there are .25% annuity options. If this product were fixed along the way, and low fee, I'd have less issue with the annuity in a tax deferred account, but from the CNN article, this is worse than what we have now, not better.
Reply to
JoeTaxpayer
Does it make any sense to discuss advantages or disadvantages of purchasing annuities at present without at the same time considering interest rates and what they are likely to be in the future? For instance, if someone bought an immediate annuity today with the guarantee of receiving $1000 monthly checks for life, it might seem like a good deal in this period of low interest rates, when the same amount of money would yield much less from the bank. But suppose in another five or ten years inflation takes over and interest rates go way up. At that time the same amount money could yield $1500 or $2000 per month. Is not, therefore, an annuity a gamble, not only on the length of one's life, but also on the future of interest rates? It might seem that today would be the worst possible time to buy an annuity.
Reply to
Don
I get the impression that immediate annuity interest rates move much more slowly than say CD interest rates. Also note that much of the monthly payout on most immediate annuities is initially return of principal rather than interest, unless you live to be *really* old.
You can review rate of return on immediate annuities by month going back to January 2003 at
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Reply to
bo peep
The article does a woefully poor job of explaining how the annuities work, so I won't hold anyone to the fire for the knee-jerk annuity bashing. Now I'm not advocating that everyone (or anyone) go out and buy one of these annuities inside of their 401k, but I do think we should at least understand the concept before we begin bashing it.
The annuities offered inside of those 401k plans offer a guaranteed annual income growth. Basically, any money you put into the annuity is guaranteed to grow by either 5% (net) or by the actual performance of your investments (minus the 2% fee), whichever is greater. So in a year when your investments earn 12%, your annuity may grow by 10% (12% - 2% = 10%). But when the market falls 15%, your account still goes up by 5%.
Once the participant retires, they may then take an income stream based on their annuity balance. Note that the 5% guarantee only pertains to an income stream. It cannot be withdrawn as a lump sum. An annuitant wanting to take a lump sum will only receive an amount equal to how the annuity actually performed. In other words, a lump sum distribution negates the 5% guarantee (which makes paying the 2% annually kinda dumb).
It's falacy to compare these annuities to an immediate annuity because the immediate annuity can't guarantee against losses PRIOR to it being purchased. For example, assume it's 01/01/2000 and you're a 401k participant deciding what to do with his/her investments. You know you intend to retire at the end of 2009 and you've got $100k in your account now. You can either buy one of these evil, dastardly, 401k annuities today or you can keep on investing in the market and buy an immediate annuity upon retirement. If our investor chooses to simply park his money in an S&P500 index fund for those 10 years, he'll retire with an account balance of roughly $91k. He can then go buy a $91k immediate annuity. On the other hand, had he purchased a "401k annuity" with a 5% guarantee, his account would be worth $263k. He could then annutize that amount similar to the immediate annuity. Which would you rather have?
Again, these annuities aren't for everyone. They don't do well with small account balances (an income stream on $10k is about $40 a month, which isn't much). And the annuity is illiquid, so that should be taken into consideration. And as is so often pointed out, the tax deferral is redundant. But the example above speaks for itself. I'll take the redundancy, thanks. It's also worth mentioning that even a (smarter) allocation of 40/60 (equities/bonds) is still going to net over $100k LESS than the annuity over the same time period.
At the end of the day, we each make our own decisions. But for certain individuals, those evil annuities aren't such a bad deal.
Reply to
kastnna
I think readers should know that you chose one of the worst, if not thee worst, ten-year periods for the S&P 500.
Monte Carlo simulation offers a more appropriate comparison in my opinion.
Reply to
Elle
Your statement misses the point. Although the majority of people may not retire into one of the worst financial periods in history, you can never know that beforehand. It's no different than life insurance. Chances are good that most 30 year olds will never make use of the term insurance they own, but you never know when you'll be one of the unlucky few that do. The chance of loss is great enough that individuals aren't willing to play the odds. If they were, the life insurance AND annuity industries would be practically non-existent. There's "cherrypicking" that's done to mislead and there's "cherrypicking" that's done to precisely further a point. Sometimes examining the worst case scenario is exactly appropriate.
By the by... historically, the stock market is down roughly 1 out of every 3 years. So while the last decade may have been particularly brutal, roughly 1/3rd of Americans will likely retire into some sort of down market and would have done so with nearly any time period chosen.
And just for fun, I did sit down last night and take the time to look back over a longer period of time (I expected someone to nit-pick the data). I started with the 70's and looked at every rolling 10 year period up until 2009. In other words, 1970 - 1979... then 1971 - 1980.. then 1972 - 1982, etc.... The annuity came out significantly better in almost every single rolling period. The reason is that investors fail to realize that the stock market rarely performs close to its historical average. If it did, the annuity wouldn't be such an enticing offer. But instead, the market is more commonly up 30% one year and down 20% the next. Due to those wide variations, the "guaranteed 5% years" give the annuity a boost that the general market can't keep up with. Errantly, investors too often apply the logic that "the market averages X% annually, so I'm probably not going to use that 5% guarantee too often. And I'm not paying 2% for something I don't use". The truth is that since 1970, an annuity investor would have employed the 5% guaranteed growth a total 15 years out of the 40 (over 35% of the time).
It's also worth noting that I used the published returns for the S&P 500 and the Barclays' Agg bond index. In reality, those are indexes and cannot be invested in directly. Rather, one would have had to buy VFINX, AGG, or some other proxy. Although the expense ratios and trading costs are (presumably) small, they would have further eroded the market returns making the annuity shine that much brighter.
I encourage you to run one. I like them too! But I don't have the time or expertise to run one given the unique "either/or" earnings structure of the annuity. In order to do a comparison, you would have to run a basic monte carlo of the market and then re-evaluate that exact same "run" using the annuity's "market minus 2% or 5%" scheme. You can't merely compare two separate monte carlo runs. The randomly applied variable would need to be held constant over both runs. Quite a difficult task.
Backtesting isn't perfect by any means (past performance is no guarantee of future results), but it is at least indicitive of potential reality and allows side by side comparisons.
Reply to
kastnna
The crucial issue is how the "cherry-picking" is presented to the reader. If a worst-case scenario is selected in order to make a point, and that fact is clearly stated and explained to the reader or listener, it would be appropriate. But there is hardly doubt that cherry-picking with ulterior motives occurs all the time in advertising and sales, and most people would agree that is not appropriate in rational discussion or educational material. In examples that could easily be misinterpreted, it would usually be informative to present a "best-case scenario" for comparison.
Reply to
Don
I do not think a statement that adds facts to a discussion, on a newsgroup where readers may see all points, can miss a point.
First, I have not confirmed this, so readers beware. Second, I assume you are talking about a hypothetical annuity with a guaranteed 5% return. Third, how many people invest in an annuity for only a ten- year period?
Are you now or have you ever been in the annuity sales business?
To me, implied in the meaning of "average" is that the stock market sometimes does worse and sometimes does better. For the long run, it generally does better than 5%. However, that is certainly not to say all should own stocks.
We disagree on the validity of this statement and much else in your post. It is not worth hashing out here.
Reply to
Elle
I was out a week with no access, getting caught up on my reading. Did you make up the scheme? The numbers actually sound too good to be what's offered. I picture the market as having about a 10% return (ave) with a 14% or so annual standard deviation. I agree that on average there are one in three down years. You are saying that for giving up only 4% (total) in the two good years, I get to clip the down year and actually get a 5% return? The classic up 30% then down 30% swing which leaves mere mortals down 9% returns 1.28*1.05 or 34%? I know you likely shot from the hip, and would bet that the actual numbers don't offer such a pot of gold. As an anti-VAer, I've yet to see the prospectus of one that offered anywhere near such a neat trade off. The cost of clipping those down years is far greater than the 2% figure. If not, show me (link?) the prospectus. I'd get licensed and sell such a product myself. Joe
(BTW - I know it's far worse than the pretty bell. Black Swans and all. Forgive me what's actually a bad analogy)
Reply to
JoeTaxpayer

snipped
There are several very good companies, companies that have been around since the 1860s that offer VAs with living benefit riders that do indeed offer guaranteed growth of the protected income base at 5% and 6%. The protected income base is the number off which they calculate your benefit payments when you start taking money out. And you can take withdrawals WITHOUT making an irrevocable annuitization election so you stay invested in the market. And depending on your age when you start taking withdrawals, these companies will pay out a 4%, 5%, 6% income stream. One company that I am aware of can pay as high as 9% if you're old enough when you start taking making (age 95 I think). Using these VAs with the right riders gives an income stream that you cannot outlive and which can never go down, but which can increase in years where the market returns exceed the withdrawal rates.
As I am licensed and a Registered Rep I CANNOT name names in this forum. But these products are NOT hard to find. If you search on Living Benefit Riders - guaranteed withdrawal benefit - guaranteed income benefit - you should have little difficulty finding them.
Gene E. Utterback, EA, RFC, ABA
Reply to
Gene E. Utterback, EA, RFC, AB

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