Help a Reader: Mom's Financial Plan

Here's an email I recently received from a reader:

I am asking a question on behalf of my mother.  She is 75 years old, retired and lives alone in a rented apartment, having sold the family home within the past year.   She faced the classic "house rich, cash poor" situation, went into some debt and felt forced to cash in her retirement account to contend with merciless repairs and maintenance on the house, until finally having to sell the place.  So:  she has NO separate retirement savings, no pension, no longterm care insurance.   She collects social security and her sole asset is now the proceeds from the sale of the house, which, after estimated taxes, amounts to approximately $650K.  Decent amount, but how to best make that work for her and last for her remaining (20+) years?

She hired a fee-only CPA/financial planner to handle her complex tax situation this year, to analyze her expenses, and to devise a sound investment plan for this nest egg from the property-sale. 

Here's the plan, in brief:

To match her expected annual expenses  (accounting for super-high housing costs in the area where she lives, inflation, etc.) of an estimated $46K with an annual income of roughly $49K to come from:

Sources of Income:

(1)  Proposed annuity - $1500/month ($18K annual withdrawal).

(2)  Proposed stocks/bonds allocation- $1600/month ($19K annually, assuming 5% withdrawal, 5%returns, 3%interest).

(3)  Social security - $1000/month ($12K annually).

Of the $650K, the suggested breakdown for proposed investment product allocation is:

(1) $290K - Fixed Index Annuity Contract, with guaranteed income rider.  Specifically, Guggenheim Partners' Security Benefit "Total Value Annuity" is recommended by the advisor, with allocation among several interest crediting options within the contract.

(2) $360K - Invested and allocated among several Vanguard stock and bond index funds, with emphasis on income.

This plan seems reasonable and appropriately conservative at first glance.  The $360K will be relatively liquid, in case of any unforeseen health (or other) crisis.  I don't fully comprehend all the ins and outs of annuities, but I'm starting to get the picture of how an annuity and its guaranteed income might work for her as a financial base.  I'm not sure how to evaluate this particular choice (Security Benefit TVA) against competitive products.   I trust her advisor but want to do some due diligence to both understand and endorse this plan for my mother's financial future.

I wonder if you have any feedback about this proposal, this specific annuity/company, or questions that you suggest we consider before she signs on the dotted line soon?

What's your advice for her?

Comments

[freebird]

My mother is in a similar situation except she has a pension so she didn't buy an annuity. Her overall numbers are about the same though. You can get an idea of what an SPIA should pay if you check various annuity quotes websites. I'd guess that the ~6% range is about right for her age bracket. It seems to me that a half and half split between fixed income and something that will probably grow is appropriate. My mother has tracked her expenses and they run about 36K per year on a slightly higher taxable income, so she's letting her stock/bond portfolio value rise. She's more focused on leaving assets to her grandkids than spending on herself.

[Kurt]

I'd fire the financial planner, put it all in the Vanguard GNMA fund (expense ratio 0.21%), use the monthly interest payments to supplement Social Security, and don't worry about the decline in principal value if/when interest rates ever rise again. This is exactly what I did for my own mother ~15 years ago; she's happy.

In my opinion advice to put half of a 75-year old's savings into stocks should be criminalized. Also, I'd ask the planner for a detailed accounting of the upfront and annual fees your mother will be paying under his/her plan. I predict you'll be astounded by the result.

[Jonathan Goldstein]

I'd be very skeptical of a fee only CFP who is recommending an annuity for over 1/2 the money.

The Wall Street Journal recently did a series of article on how many CFPs who advertise themselves as fee-only are, in fact, not.

If an annuity makes sense, look to Vanguard.

I understand the need to annuitize some of her cash into a guaranteed payment stream, but I'd be very skeptical without more information.

[JayCeezy]

This CPA/financial planner may be fee-only, but the annuity product he recommends has a sales-load, annual fees, and duplicated underlying expenses. The Guggenheim option is invested 50% in bonds, which you could do yourself at no cost. If you do decide to go with an annuity, Vanguard has low-cost choices with no sales fees.

That $290K could be invested safely in a CD ladder at 2%, and more than $18K/yr could be pulled out for more than 20 years. Your mom would control the funds, have flexibility, and no potential surrender charges. Just a thought. Your mom sounds like a great lady, and I say that because she has raised a good son.

[Old Limey]

I manage investments for my wife and I as well as our three children. In the last week I happened to have $1.25M of CDs with 5% coupons maturing that we had held for 5 years and needed to reinvest the money.

I chose to put it all into a no-load mutual fund called OSTIX (Oberweis Strategic Income Fund). The fund has been around for 12 years and has by far the best record of all funds in its category. The fund invests in high yield corporate bonds and pays a quarterly dividend. Its annual rate of return over the last 5 years was 9.98% and its total return 60.77%. Fidelity charges a $49.95 fee to purchase shares and no fee to sell them. The fund has a 2% short term redemption fee of 2% for shares held less than 30 days. What I like the most about this fund is that it has very low volatilty. In fact its largest drawdown over the last 5 years was only -3.69% so it's a fund provides total liquidity and access to your money and that won't cause you any sleepless nights. Any shares that you receive as dividends can be sold immediately without any charge. This seems to be a great solution for your mother who will need to make at least 4 withdrawals/year.

[Old Limey]

Something else that just occured to me is that you have to be very careful if you try to compare mutual fund performance using the freebee charts that are widely available on the Internet. In most cases these charts are not "Dividend Adjusted" and it's essential to have dividend adjusted charts for income funds. For example the most recent dividends for OSTIX were 20.6c on 12/17, 12.4c on 3/15, 16.0c on 6/17, and 10.8c on 9/16. With the current share price of $11.85/share it's absolutely essential to take account of the extra shares that are received when the dividends are paid, otherwise when the dividend is paid and the share price drops by that amount you will get a totally phony and useless picture of the fund's performance. That's the single most important reason why I have subscribed to a proprietary database of mutual funds for the last 20+ years.

[Sarah]

"The Security Benefit Total Value Annuity, a flexible premium deferred fixed index annuity..."

That right there tells you all you need to know. If you can't understand what it is, you do not need to be putting your elderly mother's retirement into it. Also I have never seen a variable annuity that isn't a ripoff. There *might* be some benefit to a fixed annuity (with inflation adjustment, since your mom could easily be around 20 years or more), but not a variable.

I'm a little skeptical of this CFP. I would expect a commissioned salesperson to recommend an expensive option like a variable annuity, not a fee-only planner.

[jim]

Can she move somewhere less expensive?? No reason a single person needs to be spending nearly $4000 a month. If she really absolutely wants to stay in her city then I understand if thats not on the table but it should be considered.

In this situation I think a fixed annuity can be a good idea. It operates no different than a pension or social security in this situation to provide a guaranteed income stream for life.

For the stock/bond investments they should be very conservative and light on the stocks. For simplicity sake you could get the Vanguard Managed Payout Fund which manages a fixed 4% payout and invests in a mix of Vanguard index funds.

Shop around for the annuity. Ask your advisor how much commission they'd get off that annuity.
The $1500/month benefit costing $290k doesn't seem like a great deal. You can get a guaranteed life annuity that pays $1500 /month for around $210k. For a 75 year old woman payouts should be in the 7-8% range. However it depends on the details of the annuity. If it has a guaranteed payout and a inflation increase built in then paying $290k isn't bad. But I'd definitely shop around. You can get annuities via Vanguard and they're certain to be a good price and you can shop at www.immediateannuities.com to get an idea of pricing in general. You can get free quotes without giving your address or anything. Note that the annuities may not have a cost of living feature which she may want and adding that generally increases the up front cost 20-30%.

[Jake]

This is when the low interest rate environment really kills people who need fixed income. Current 5 year rates on a CD are averaging around 1.34%. Even then, you lose access to the money for 5 years!

It requires that your Mom take on a little bit more risk.

@Kurt mentioned the Vanguard GNMA fund which has a current yield of 2.43%. Your Mom shouldn't worry about principal risk as much - that is, if interest rates rise, the principal value of the fund you invest in will drop.

One of the benefits of investing in a higher-yielding conservative income fund is that you would have access to the principal in case of a long term care event. You may have to sell at a loss but at least you have access.

The only issue is that the annuity portion of the proposal you outlined is basically putting in 290k and getting out 18k per year which is around 6.2%. There are very few funds that don't carry a substantial amount of risk that have this type of yield. Otherwise, she would have to dip into the principal to supplement that portion.

If an annuity is an option, Vanguard offers one that has a lifetime withdrawal benefit. Check the site.

Be careful with indexed annuities. Here is one article to peruse: http://www.kiplinger.com/article/insurance/T003-C000-S002-an-annuity-you-really-should-avoid.html

Annuities are a bit hard to understand if you don't have past experience with him. If you can, find 3 on your own and get a spec policy from them and an illustration. Go with top rated companies. Have the CFP review the particulars if you don't understand the fine print.

If it were my mom, I would probably opt for the safety of an annuity for half of the amount and then the other half would go into a mix of 20% stocks / 80% fixed income. Worst case, she could tap the half invested in the market if something came up.

[Bill]

My advice is simple get a new advisor. The annuity they are recommending is garbage. It is not a simple annuity, it's an index linked monstrosity that I couldn't understand completely after reading about it for the last hour. My quick internet search turned up the promotional material they sent to advisors hawking it, it indicates commissions of up to 7%. It should be obviously that that is a bad thing. As a registered investment advisor myself I can tell you that complexity in financial instruments is never created for the retail customer's benefit. Its purpose is to obfuscate the true cost of what you are investing in.

If she does want an annuity as many have mentioned about look for something very simple. If the goal is to support her for the remainder of her life a single life income annuity with nothing for the beneficiaries is as straightforward as them make them. One mistake made above is to compare the annuity payout to interest rates available on fixed income investments. This is a simple mathematical error, annuity rates are going to be higher than market interest rates simply because has no principal payment at the end, the investment pays you annually and when it's gone it's gone. When you buy a bond you get par back someday. Think of annuity as buying a bond where you not only receive coupons but you also sell a small part of your investment continually so by the time the annuity term is up there is no principal left.