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Immediate annuities - opinions please


Paul Mihalka

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Paul Mihalka

We are considering to put part of our savings into immediate annuities. Leaving them for inheritance is not a necessity. Starting them at our old age the return is acceptable (they don't expect us to live long), no comparison to CD or bonds. My main question is security. It is done with insurance companies. What happens if that insurance company goes belly-up? It can happen. All opinions welcome.

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Dave McReynolds

If the insurance company goes belly-up, you could lose your investment. So it might not be wise to have all your eggs in one basket.

 

Another consideration would be inflation. While an annuity might provide for your needs now, it might not if the value of the currency inflated to where a dollar would buy only as much as 10 cents would buy before.

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With respect to an Insurer going belly-up, I guess you could loose your investment, there may be insurers aginst such lost, but is it worth it?

 

Here are some more thought i am sure you have wrestled with:

 

- Given reasonable good health and genes, studies say the optimum age to get into annuities, with respect to payback period and thus return of your money, is 72.

 

- right now, with interests at an almost all time low, your monthly check will be relatively small.

 

- unless you have other liquidities (as you said you do) and if you have an unexpected expenditure but too much money is tied up in annuities, you will experience a cash crunch.

 

- with an annuity, your potential heirs, will get nothing. If you don't have any heirs, your leftovers, could otherwise go to your favoured charity at the time of your demise.

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John Ranalletta

Paul, no help here, but had this conversation with a friend in his 70s. For him, it came down to weighing risk, i.e. the risk the insurer would/could last as long as he; rate risk; risk of dying early; survivor benefits, et al.

 

Finally, he decided to take the risk upon himself; consulted the actuarial tables; and adjusted for his family's and his own health history. He chose the year of his probable departure and divided the lump sum he was considering investing in an annuity by the # of years. He just withdraws that amount each year.

 

He figured his guess was as good as the insurance company's; and, if he changed his mind later when interest rates would probably be higher, he'd still have the balance to invest.

 

Every financial newsletter I read predicts higher interest rates in the near future. If my friend thought he'd live another 15 years, he'd use approx 6.5% of the principal yearly. If in another couple of years, interest rates were to increase substantially, say from (current prime) 3.25% to 4.0%, that 3/4 pt increase could mean an increase in the annuity in the annuity to offset the withdrawals.

 

Tom R. here on the board seems to have a good grasp of these issues and I'd suggest you PM him if he's not monitoring the board.

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Paul Mihalka

Interesting opinions. We are not talking real big money. We can use money from a secure but almost not producing CD or from money in a good Fidelity mutual fund. How would security compare between Fidelity and a good insurance company? I remember Merrill Lynch going belly-up. What happened to people who had money in Merrill managed mutual funds?

My wife is 73. Really excellent health. We would do it in just her name. One person pays better than joint. If she goes to heaven before I do (unlikely) I can live without it. Right now payout is 8.5%. Total payback in 12 years. I sure hope she lives longer than that. More opinions?

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If the insurance company goes belly-up, you could lose your investment.
Not necessarily. An A rated insurance company is a very safe bet, unlikely to go belly up and is generally backed up by state gauranty funds in the event that they do fail. It's a state by state situation though so you need to find out what the situation is for the company on whose paper it is written - which is not necessarily the one you think you're dealing with as "name" companies are usually composed of several writing companies.

 

All that being said, an insurance company annuity is generally a bad deal. First they have all the information and are in the business of making sure they make money. The performance of the products sold is less important (perhaps even not important at all). As a rule these are rapaciously profitable - their actuarial models are generally right even if individuals sometimes "win". The reason they are pushed by insurance salespeople is that they are incredibly profitable (which is one reason they don't spend a lot of time pushing term life). A good question for the salesperson is what percentage of people fully annuitize (in other words, who gets what they're projected to get) - you'll find it is remarkably small, well under half in fact....most times the insurance company has actually won twice - on it's initial projections (they're going to make money even if you live as long as projected) and again when you die early or the AIR factor reduces your payout. (AIR is the assumed investment return and is skimmed along with expenses & load before paying the beneficiary.)

 

A better investment if you really want an annuity is one bought from an investment house (Fidelity, etc) as their expenses and load factors are generally lower. Even better would be an investment in Index Funds (almost no one beats the index over any reasonable time period - 5 or 10 years, much less 15 or 20 you'd want for an annuity). In fact most money managers are evaluated against the Index (like the S&P 500) and hope to match it (for which they will be well compensated).

 

Another generally better investment would be setting up a ladder of Treasuries or tax-free municipal bonds. Both have public perception issues about return and risk but those perceptions are generally unfounded although munis are under some strain due to state & local tax/budget issues right now. But, for either of these to fail to perform as sound alternatives to annuities would require seriously bad things to happen to this country that would also take down the insurance companies as well.

 

As always, YMMV and you could always be one who beats the odds because someone does, just that in the long haul that's not an investment strategy, that's just a different form of gambling.

 

BTW, none of the preceding should be construed to be investment or tax advice, nor is it a representation of future performance or a guarantee of future performance and the reader is encouraged to seek out a licensed investment adviser before making any decisions or purchasing any of the named, referenced, or any unreferenced instruments with the intent to derive financial benefit over time. <----legal absolution for 30 yrs in the insurance and financial services business :)

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Paul, I don't fancy myself an expert, but I'm within a few years of retirement eligibility and have tried to run various scenarios. I'm a simple guy (some might say simpleton) and don't have a great command of the world of finance. For someone like me, the appeal of an annuity is that it's easy, easy, easy--I know what to expect over whoever's life we've decided to measure it against--mine, my wife's, or us jointly. However, the truth is that you're hoping to beat the odds, odds that weigh heavily in the favor of those who sell annuities, the insurance companies.

 

While it keeps the mental bookkeeping easy, my personal take on it is that annuities are not presently a good option (in fact, maybe they never are). When I ran through these scenarios a few years ago, the payouts were more than twice what they currently are. Had I been close to retirement eligibility at that time, I'd likely have jumped at the opportunity to place at least a portion of my retirement savings into annuities.

 

However, as I see it right now, the rates of return are low and the risk of one or more of the big guys folding is at least as great, probably greater, than it's been in recent memory. In my simple world that comes out like this: Low rates + higher risk = a bad idea.

 

I think the approach described by JohnRan is a better option. The downside is the possibility that other investments might yield a lower rate of return than annuities purchased now, over the long term (I don't really think that will happen, but I'm just guessing, like everyone else), but you at at least retain control over your principal, permitting you to adjust your withdrawals. If the rate of return on annuities ever comes back to a higher level, you can decide to invest in them at that time.

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I don't think the issue of whether the annuity pays out overall is relevant at all, only guaranteed income and security. With no heirs to be concerned about who is going to care if the beneficiary dies before it pays out? The dead don't need money! If they outlive the actuarial prediction that works out well, better than trying to time your own spending to be broke at some arbitrary expected death date. The only issue would be the death, at a younger age than expected, perhaps accidental, of the payee before the spouse. But Paul has said he wouldn't need the money. Take the biggest return you feel has the necessary security.

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I think that a steady rate of payback is a comforting thing. Nice to know how much money you have to spend each month. However, I also realize that I'm being charged a premium for the company to handle this for me. They're payout is based on them raking a substantial percentage off the top for themselves and giving me the remainder. As mentioned, it's based on acuarial tables, so you're betting you're going to beat the odds and live longer. They don't have to be right every time, just most of the time for it to work out for them.

 

Now, what happens if you cruise along for ten years, happy with the pension check meeting your expenses, and then suddenly have a major expense? Maybe increased medical needs, a nursing home, or just having to modify your home for new conditions. Can you get to your money? Will you have to take out a personal loan? Second mortgage or reverse mortgage? Can you partially cash out of the annuity and continue receiving a lesser monthly amount? I know there are companies that buy structured settlements, but imagine they make a tidy profit for doing it.

 

Lots of questions on my part. For me, this is a bad time to buy an annuity; not a good return on my investment. I'll just continue to freefall in the down economy and hope interest rates go up. Maybe then I'll reconsider annuities.

 

 

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Paul:

 

The question that needs to be asked is "What are you trying to accomplish?" If the answer is a risk free income stream that has guarantees built into it, than an annuity offers that advantage. When you lock it in at 8%, which is wht you said it pays, than that is what you get until the person who owns it or is the annuitant dies. Investing in index's etc. come at a premium risk and a market risk, we saw how that worked out in 2008 and 2009.

 

The strength of the insurance company is extremely important. You can ask to see the ratings. If you need help with that, please let me know. Also, I am not aware of any annuity/insurance companies offering that rate of return, please send me the info and I will look into it for you.

 

Most of my work is in the distribution planning side of life, please don't hesitate to either call me or write, I would be happy to give you guidance.. We dispel most of the mythology that I have seen posted here so far.

Good luck

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John Ranalletta
You can ask to see the ratings.
Are these the same ratings agencies that rated sub prime mortgage securities "AAA" so widows and orphans could invest in them safely; and the same agencies who take money from the debt issuers to make ratings? The same agencies who told congress, "It's only an opinion, so don't hold us to it."
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Paul Mihalka

Pat, thank you very much for your offer of help and consulting. When we get closer to doing something I'll be in touch. For return I just found and checked this table: http://www.immediateannuities.com/

It shows that for 73 years old female $100.000 investment returns a monthly payment of $713, for a yearly return of $8.556, = 8.556%.

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John:

How very dramatic, "Widows and Orphans" invested in sub prime. You should be a writer, you paint great word pictures. I had visions of Tiny Tim standing in bread lines after reading your input. You may want to quit your day job. :thumbsup:

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Paul:

 

One advantage you may enjoy is what is called the exclusion ratio, it means that from your annuity income stream, 85% approx. is excluded from your income tax calculations. It is one of the many benefits of a immediate annuity.

 

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Paul Mihalka

Thank you all for great advice. I'll see what we do when some almost non-producing CD matures.

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Are these the same ratings agencies that rated sub prime mortgage securities "AAA" so widows and orphans could invest in them safely; and the same agencies who take money from the debt issuers to make ratings? The same agencies who told congress, "It's only an opinion, so don't hold us to it."

Ummm...No. Different groups altogether. Painting all regulatory agencies with the same brush is inappropriate - or do you also suspect the AMA, DOE, NEASC, etc etc also in someone's pocket at the expense of widows & orphans?

 

Which raises a question - why doesn't anyone ever go back to the widows & orphans who earned higher than market rates of returns on their investments before the crash (whether mortgages or Savings & Loans, or whatever) and get the extra unearned money back? They were all voluntary participants in the "more money for less risk" scheme and got (at least for some amount of time) inappropriately rewarded vs. true market value of their investment.

 

Probably not a politically correct sentiment though, huh?

 

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John Ranalletta

A.M. Best ratings are most frequently quoted in reference to "safety" when discussing insurors. When these ratings are cavalierly thrown around and sound like "guarantees", the buyer should keep in mind that A.M. Best gave AIG and its products the highest rating "A++" almost right up until it was rescued by Uncle. The ratings may indeed be correct, but there's no guarantee that they are; and if they are cited by a broker who's getting a front end or back load on the annuity purchase, s/he should be clear about the history of these ratings to the purchaser.

 

There is a myriad of purchasers including pension funds, corporate credit unions, et al, whose charters forbade buying anything but AAA-rated securities. They did. The ratings were crap. Employees for the ratings agencies testified before Congress that they would "rate a bag of crap" if a client offered it for rating. Investors who didn't want to take risk were subjected to huge losses and are helpless to sue the agencies because of the "right to free speech", i.e. the rating was just an opinion, not a guarantee, and one with a very spotty, unreliable history.

 

There is so much fraud and deceit in the financial services arena, I'm buying more Mason jars to bury my money. If I had a broker, I'd want him/her to take his commission over the life of the product and take the risk with me.

 

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Paul Mihalka

Just teasing: As AIG was "too big to fail", when it was failing it got bailed out, so I guess that people who had insurance, annuities, etc. with them did not loose. it was safe ;) . So may be the safest is the biggest, because or it will be without problems, or will get bailed out because it is so big.

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John:

In the absence of using a rating agency, public filings etc. what would you recommend someone do that would negate the agent who you feel gets paid front or back as his only motivation, from making a self serving recommendation? While I find people who offer that point of view, by the way, ignorant of how Financial Planners work, it was your position, so I am asking you to explain it in great depth.

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John Ranalletta

Pat, if you're saying a flawed system that proved itself unable to prevent and in fact created our current situation better than no system, I disagree.

 

If the big banks had to sell mortgage-backed securities sans ratings, they could not have done so. Ratings agencies are proven whores. They take money from the company that wants the rating. They do not work for the individual investor. That's a fact. I'm simply writing that fact is not clearly understood my many investors and it should be.

 

I believe they are worthless and work to create markets for products that otherwise would only trade amongst investors with high risk appetites.

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John:

 

I didn't take any position, I asked you to explain your position. I am trying to understand that in the absence of "Proven Whores" {the rating agencies}{your words} where does an investor turn for information? I also now need to understand how you made a leap that fixed annuities, which in our investment world are among the lowest risk products offered, occuping the same risk space as that of CD's and Bonds, are now, because of rating agencies "trade amongst investors with high risk appetites." {Your logic}

I am not sure I understand your unbiased thought process here, John.

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Paul Mihalka

Just comment: CD at FDIC banks are fairly safe, that's why they pay almost nothing nowadays and that's why we are looking for something else.

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Paul, what John has been saying is that it's YOUR responsibility to research and understand the risk you're willing to take and not to rely on ratings agencies which screwed the pooch in the recent past. Moving from the realative safety of low return FDIC backed CD's to perceived safe investments such as annuities is an escalation of risk. I think he's spot on.

 

We don't live in the same environment we used to. The rules have changed and we all need to understand things as they are, not as they used to be.

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More drama, "Escalation of Risk", where is this coming from? What facts are you using to project an inflamitory statement such as "Escalation of Risk".

Let's see, if someone is getting a guaranteed rate of return, the company has a rating,{which is nothing more than a measurement of financial strength on a given moment}{all banks and investment companies have ratings} it has passed the due dilligence of the state insurance departments, there is public research on the financial strength of the company, the persons cash is protected from bankruptcy and law suit, the person knows what they want and why they want it, where is "Escalation of Risk".

 

Over what is it "Escalated"? Is it over a .075% CD, where inflation and taxes erode the purchasing power and create a negative real rate of return in the minus 2.5% arena, is that positive rate of return and guaranteed income stream on the annuity, "Escalated Risk?"

 

Or is it "Escalated Risk" compared to a hedge fund that generates a poitive rate of return one year and than with no guarantees loses 45%, so your cash flow is devistated, is that what you mean be "Escalated Risk?"

 

Would you compare "Esculated Risk" to a Government bond, backed by the full faith of the debt free government and yielding .025%, would that make the annuity an "Escalated Risk??"

 

Or is it "Esculated Risk" compared to putting your money in a mattress?

 

As you may be able to discern, I am a little confused by "Escalated Risk?

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Paul Mihalka

"the persons cash is protected from bankruptcy and law suit"

Pat, could you expand on that? Thanks...

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Pat, you're coming across as being miffed that some people don't trust the products that you're selling. Why don't you try a more tutorial approach and just tell us what the spectrum of risk is for different investments.

 

I'm sure that if I sold motorcycles, I'd be defensive if anyone started talking about the dangers of riding. But it might be time to correct flawed facts and emphasis the benefits instead.

 

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Quinn:

Thanks for that insight. I am not miffed, only trying to correct nonsense. On occasion we use these products, we are a planning firm, different from a product firm, but on occasion they fit with what the client is trying to accomplish.

So, to expand, annuities are tax deferred products that offer a guaranteed income stream as an option for the distribution side of retirement. If you are taking a lifetime income stream, you have transfered the risk of performance to the insurance company. That is why it is important to know who you are in bed with, and a person can only research it so far. A Black Swan event or a low rated company may be at risk if you are asking for a 30 year income stream. You can't know that going in, but it does not make it impossible. You seek the highest and strongest financial strength you can at the time. There are a few more moving parts to an annuity and many more choices on both product design and distribution choices. If you want more info, send me your E-Mail and I will be happy to give it to you.

 

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Paul:

 

Because an Annuity is considered an Insurance product, most states and the Feds have exempted the cash value from law suit and bankruptcy. That is not to suggest that the Feds can't lean it, as they can override everything, but in most cases, it would be free from consumer type events.

Cash Value Life insurance enjoys the same privilage, which makes it a very valuable asset for small business owners. I am not opening that can of worms here!!! But in the asset protection world of wealth, that is a powerful product.

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