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.
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?
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
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.
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.
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.
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
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.
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
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
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
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.
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
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.
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.
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-
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.
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
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.
(BTW - I know it's far worse than the pretty bell. Black Swans and all.
Forgive me what's actually a bad analogy)
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