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September 05, 2008


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I am seriously considering an annuity.

My mother had a pension and although it wasn't much after taxes and health insurance getting that monthly check was a *significant* help in her post-retirement financial life. Since pensions in the private sector are on the whole extinct, the only way I can see having a similar cashflow for life after retirement is with an annuity.

If there is another option I'm all ears.

I'm 26 years old. Back in 2004 when I started I didn't know too much about investing and my advisor opened up a VA within a Roth IRA. After doing my homework I stopped adding to this account when I realized how terrible the VA's alone were, and even worse when combined with a Roth IRA.

My question is, in relation to FMFs, is there a reason why this was a good idea for me for someone my age (nothing special as far as finances go, just a regular guy in mid-20's making regular savings, I pay mortgage on a condo, etc.), or was I being ripped off?

The reason I ask is because I have other investments (a regular IRA transferred from when I quit one job) and a regular mutual fund with higher than ideal expenses.

I'm contemplating pulling the plug and transferring everything to Vanguard, but am trying to weigh the differences between the surrender fees in the VA (they start at 10% Y1 and go down to 0% over 10 years, but drop about a percentage point a year. I'd lose about $300 if I surrender now but I'm thinking I'd end up paying the same in expenses and annual contract charges anyway so I should probably just go ahead and do it.


One aspect of an annuity is, like a 401k or an IRA, you can contribute to it slowly over time. So starting early in life, just as with the other qualified plans, is a good idea.

But I don't see why he put you into a ROTH IRA annuity. A traditional IRA annuity at least you'd be able to deduct the contributions (assuming you qualify for the deduction).

It might be that with a ROTH IRA annuity *all* of the payments back to you are tax free. I'd have to research that more. Would be awesome if it was!!

Does anyone know about this??

Follow up -

I did some research and it appears to be what I thought:

With a ROTH IRA annuity you do not have to start withdrawls (or annuitize) by age 70 1/2 and when you do withdraw or annuitize you don't pay ANY taxes on the amount.

Still need to confirm this with a tax advisor but if confirmed IMO that makes a ROTH IRA annuity pretty sweet! Of course you have to research the specific annuity product well but I don't think it's such as bad idea.

I've always assumed VAs were horrible (just because of how much the brokers make off of them) for the average person, but assumed there must at least be some sort of tax shelter advantage for highest income levels that makes them sensical for someone out there (maybe the lowering of capital gains rates removed any reason for them at all?)

A steady paycheck in retirement sounds nice, which is why I'm definitely considering a lifetime immediate annuity bought with some of my nest egg in retirement. The rates seem really good on those for singles (I'm married, and those numbers don't look quite as good, the bank has to wait for 2 people to die) and no inflation protection (which I think you get around by just not putting too much of your nest egg into buying one of these, which you wouldn't want to do anyway if you have someone/something you'd like to leave an inheritance to). But I have to admit, the only reason I feel confident these must be a decent deal is because brokers don't push them or make much off of them ;)

MasterPo -

I'm not so sure...I think there are more expenses housing the VA inside the Roth IRA that I don't see but am paying over time. It's a long read, but check out some of the comments people made on th is article (scroll down to the bottom, I'm the first comment and then scroll up to read the rest.)

Mark -

You got ripped off. The only reason an advisor would wrap a tax sheltered account in another tax advantaged account was because they make MUCHO commission off of the VA product. You were sold. There is absolutely no advantage to having a VA inside a Roth IRA. The promise of a VA is that you can put in an unlimited amount of post-tax money in and only pay income taxes on the earnings during the withdrawl phase. Its like a 401k, but with post-tax money. The average Joe doesn't normally need to put away that much additional retirement savings that the 401k + IRA window gives. It could probably be argued that the additional expense drag of fees on a VA would outweigh the tax benefits it gives vs investing in a non-tax sheltered savings vehicle.

MasterPo -

You are confusing a Variable Annuity with a (single premium) Immediate Annuity. Assuming you are on the younger side of life, you'd be better served by investing in 401k/Roth IRA type savings vehicles. Once you are at retirement age, you would then want to purchase an immediate annuity, which would pay out a fixed monthly stipend for the rest of your life. There are much fewer hidden costs with the IA vs the VA, and purchasing the IA at retirement accomplishes the same end goal as a VA with better investment options and lower fees in the mean time. VAs are an insurance product that are sold to unsuspecting customers.

Just to add - in my experience with my own investments and my immediate families' investments, banks and insurance companies rarely have the best investment products or the customer's interests at heart with their financial products. Fidelity and Vanguard both seem to do a better job of focusing on the customer's investment goals rather than their own bottom lines.

Yes, many people recommend a fixed annuity to secure a predictable income once you've retired. I worry about inflation becoming an issue as retirements get longer and longer, though, which might be a reason to keep a meaningful chunk of your money in the market.

Sarah is right about the inflation issue of a fixed annuity. And the payout amounts of an immediatel annuity may not be as much as a VA purchased over the years.

BenG you miss the issue of using the Roth to shelter ALL the annuity income from taxes at payout time. Taxes at retirement are NOT so drastically lower than when you're working. That's one of the biggest myths about retirement going - that your income taxes will be sooooo much lower when you retire.

Trust me on that latter point. Been there, done that.


I caught that article and was rather shocked how one sided it was written -- sounds like someone has a chip on their shoulder.

There are certainly instances when an annuity can work for you. For example, younger people who come into large sums of money (i.e. inheritance, lawsuits, etc.) that do not need this new found wealth for a longer period of time. Or, you happen to be lucky enough to max out all of your traditional retirement accounts like your 401k/403b and IRA.

The major benefit is that deferred variable annuities provide tax sheltered status. The MSN article complains about expense ratios, but I'd take 2% fees over yearly capital gains taxes.

Vanguard can set this up for you easily enough with a simple phone call. Their annuity related expenses are higher than their regular fees (for obvious reasons), but it still crushes anything the MSN article mentions.

Like everything, someone took the negative side of an industry (i.e. the sales tactics used by annuity salespeople) and blew it way out of proportion. Use the proven industry leaders like Vanguard and Fidelity, pick up the phone and call them, and you'll be fine.

MasterPo -

You're missing the point that money inside a Roth would be sheltered from taxes REGARDLESS THAT ITS IN A VA! The VA is only providing additional income to a sales agent and VA company when its wrapped in a Roth, you get absolutely no additional benefit from a VA in either a Roth or traditional IRA.

The payouts of an immediate annuity will be whatever the contract is written for at the time of purchase. Its not possible to compare the two, since a immediate annuity is a known entity and a VA is a crapshoot.

Matt -

Vanguard is the exception and not the rule for VAs. They can be as low as 40 basis points above their normal index expense ratios. Your example is one of the few reasons a younger person might have use for a VA.

You state that you'd take a 2% fee over capital gains tax, however if you purchase EFTs with that money you will not realize capital gains taxes until you sell those shares. I'm sure you'd much rather pay 15% long term capital gains vs your normal income tax on VA gains...

A financial advisor I once consulted (who is fee-based, not commission) told me that annuities are sometimes good choices for doctors, as the assets within insurance products are protected from lawsuits. He discouraged me from using one, however (as I have no unusual exposure to lawsuits), due to the high fees, and the treatment of payments as income (versus long-term capital gains).

BenG - I think you missed the point that it isn't the accumlation phase but the payout phase I was talking about.

How can you annuitize a non-annuity Roth IRA? You can't that I know of.

You can make periodic or systematic withdrawls from a Roth IRA but you don't have the life time guarantee of an annuity. So if an annuity is a good move for your plans having it in a Roth seems to me to be the way to go. And if an annuity isn't the right thing for you don't do it.

You annunitize a non-annuity Roth IRA by taking money out of the Roth and buying a SPIA (single payment immediate annuity). *Tada* you now have annuitized the Roth IRA (or a portion thereof), and you didn't have to pay any income taxes (or ridiculous expenses) on the earnings of the Roth.

In a Tax Qualified Annuity, you'll see these benefits:
1) Guarantees
a-high watermark death benefit
b-interest rate guarantee inside fix subaccount investment option
c-other guarantees, sometimes sold as "riders"
2) Ability to Annuitize (receive a payout for as long as you live, often times at contractually guaranteed minimum payouts per thousand)

In a non-TQ account, you'll also see these benefits/differences:
1) Tax-deferred growth
2) Taxed as ordinary income

For people already maxing out their employer-sponsored plans, people who have received a windfall/lump sum, those wanting to 1035 exchange from term life (preserving tax basis of paid premiums), or those wanting a fixed income stream on the payout side, an annuity might be consideration.

Annuities offer "insurance" protection -- they're sold by insurance companies after all -- in exchange for the transfer of certain kinds of risk. In general, most people realize that the costs of annuities exceed the benefits received.

For people who have a family history of extreme longevity -- insurers don't underwrite annuities on an individual basis like they do life insurance policies -- they might actually benefit from purchasing an annuity.

@ BenG,

Thanks for your thoughts. I'm a little fuzzy on your "EFTs" comment. Did you mean ETFs?

If so, I would argue that many ETFs I would hold over the long term have expense ratios roughly equivalent to fees one would use at a Vanguard deferred annuity, which averages 0.57%, or 75% cheaper than most VAs. So we are definitely in agreement Vanguard is tops among it's annuity selling peers.

Secondly, it's been widely shown that tax deferred savings plans like 401k's outperform non-tax deferred plans over the long term. Many of the stocks or ETFs I would buy pay dividends, and over a 30 year horizon, I'm sure the taxes incurred on those dividends offset any difference in income taxes paid at maturation (unless it's DRIP friendly). If you disagree, I'd like to see any research you have. I ask out of curiosity to find the optimal solution.

Yeah, I get the EFT and ETF confused. Too many acronyms in my life!

What makes your typical 401k outperform is the matching funds added by most employers. There was a thread on Bogleheads about this entitled "What to do with high-expense 401k" by verbose. Interesting analysis of high expense funds combined with no match. If you compare the normal VA to taxed investing, it would be real close in terms of final outcome.

BenG - While I agree you can use the funds from a Roth IRA to buy an immediate annuity, the income from the IA will be taxable. So you've just traded a tax-free vehcile for a taxable one. Whereas an annuity with in a Roth IRA will have the life time payments tax-free (as I understand it) forever and the account never runs dry.

MasterPo -

Guess what. You can buy a SPIA with Roth money and still receive that lifetime stream of tax free money. I still stand by my assertion there is no reason to buy a VA within a Roth.

BenG - Can you post the link where it says a standard non-IRA SPIA bought with ROTH IRA money will have tax-free payout status? Thanks.

Assuming this works:

Variable Annuities are a good deal for agents and insurers who sell them. For everyone else, they are almost always a bad choice.

I've got to agree with BenG that if you open a VA, do it with Vanguard or Fidelity, and definitely not a bank or regular insurance company.
But the question was if there is any time when a VA is appropriate. I opened one back when IRA contributions were only $2000 a year and I had no retirement vehicle at work (like 401K or SEP). A VA was a good way to put more money away from current taxes. Once my company started a retirement vehicle, I stopped contributing to the VA. But it still grows nicely, tax deferred.

My mom has 120,000 to invest and our smith barney guy wants to put it into a variable Annuity with retirement income. Mom is 78 and in a rest home paid for by an insurance policy for her life. She requires about 1200.00 extra per month for medicines not covered on her part d etc. What do you think of his suggestion...variable annuities were always a no no in the past. High commisions and high fees please help me someone. We have also set aside 35,000 for the next two years expenses and 25,000 in a mainstay high yield corporate bond fund. so her total money is approx 180,000 and what is the general consensus....thanks patti

Patti --

I'll post your question on the site in a week or two. Stay tuned.

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