Deferred Annuities; Why doesn't everybody do this?

[ThisDinosaur]

I know the general feeling on annuities in this community is against, but I am hoping some more math-inclined folks here could help me figure out why the Vanguard Deferred Variable Annuity isn't awesome.

Here's the deal as I understand it. For an expense ratio of 0.56, you can invest in mutual funds, index funds etc. that grow tax deferred, and take out distributions taxed as income after age 59 and 1/2. You don't even have to annuitize ever if you don't want to, but anything you invest within the annuity is totally protected from creditors and law suits (at least in my state) and grows tax free.

So, if you've already maxed out your 401k and IRA contributions, and you want to expand tax-advantaged space, where is the downside here? Obviously, an early retiree would have to have enough in a taxable account to last until age 59 and 1/2, and your tax efficient investments would mostly go there, taxed as long term capital gains. But I'm going to be sixty some day, and not all of my investments are tax-efficient.

Also, I am going to be in the highest tax bracket this year for the first time (not a bad problem to have, i guess) so there is that consideration as well.

Any thoughts? Why don't more people do this? What am I missing?

[ArkTinkerer]

Maybe the 59.5 age? Most people here are trying to retire earlier than that. I'm planning on doing the ladder from 401K (actually an IRA rollover) into my Roth. The biggest problem I'm facing is how to get cash out of the tax advantaged accounts without losing too much to Uncle Sam.

[George the original one]

My employer pension is essentially a deferred annuity. I don't need another annuity.

[George the original one]

Having all of your retirement monies in an annuity is a bad choice since you can't use the capital in any way, shape, or form. All an annuity does is provide an income.

From the standpoint of securing a minimum income, then having a portion of your retirement capital in an annuity makes sense. The rest of the capital, however, is best deployed elsewhere.

Also, countries providing social security are effectively the same as having an annuity. So, if the SS payments are large enough to meet that minimum income, why would you tie up more capital?

[ThisDinosaur]

But what if you do NOT annuitize, though? Then the funds work more like a 401k or IRA, with the exception that you cannot do a Roth conversion. You can withdraw the funds at income tax rates without using them to purchase an annuity product.

[George the original one]

But what if you do NOT annuitize, though? Then the funds work more like a 401k or IRA, with the exception that you cannot do a Roth conversion. You can withdraw the funds at income tax rates without using them to purchase an annuity product.

Taking the cash payout and purchasing an annuity would be a loss (employer's annuity is more favorable than market rates).

Taking the cash payout and doing my own investing would likely be a wash on income with the detriment of a loss of investment diversity as the pension can (& does) invest in things only the truly wealthy individuals/corporations can invest in. I'm not sure if there are tax benefits I would receive that favor this or are against it.

[Dragline]

Is the 0.56% expense ratio on top of the expense ratios of the underlying investments? Make sure you factor that in.

In my view, these things are so complicated that they are only useful for certain people in certain situations. You may be one of those people, depending on your tax situation and what other vehicles you may have available.

I'm not against annuities per se, but the expenses associated with them are usually what gives them an (often deserved) bad name. Plus the fact that they are heavily marketed, which to me means that they have expenses that pay for the marketing "plus".

But I fully intend to buy an SPIA (Single Premium Immediate Annuity) with some of my stash when I reach my seventies, assuming my health is good. The older you are when you start, the better the payout. Then all you need to do is stay alive to make bank.

[IlliniDave]

Besides what's already said about most people already having some form of annuitized income, all I can tell you is why I don't do it.

A low/medium income person can be a very tax efficient investor. A total market stock index fund will typically have distributions on the order of 2% per year or so. Unless a person's income is very high, that'll get taxed (federal) at ~15% for a tax load of about 0.3% (an ERE-er in the R phase might well pay 0%). Add 0.1% ER for the mutual fund and you're at 0.4% which is < 0.56% (granted I've ignored state taxes). So it's pretty close to a wash so long as the investor practices a buy and hold strategy.

The non-annuity investor has unpenalized access to his money at any time. And does not pay surrender fees to get out of the arrangement (not sure if one would have to pay them through VG, but I'd be surprised if the underlying insurance company would forgo that, even under Vanguard's influence). When he pays taxes he's being taxed on dividends and capital gains which is generally less than taxes on simple income, which I believe the annuity earnings are taxed at if withdrawn early. (I'm not sure how the future annuity payments themselves are taxed, but presumably at least the earnings portions are taxed as simple income)

During the accumulation phase it makes a lot more sense for a very high income person who's getting taxed at 25% on capital gains and dividends, getting phased out of qualified dividends, and paying the ACA investment income surtax, to lock their money into such an arrangement. The tax savings will begin to noticeably surpass the associated fees.

Then once the money is annuitized it's essentially gone except for the monthly check. You can't access it for an emergency or a splurge, and other than potentially a joint annuitant, there is nothing left for your heirs. You also have risk of the underwriting insurance company going insolvent, which is probably greater than the probability the stock market goes to zero.

My strategy is to assess the situation once I stop working and decide if I want to purchase an immediate annuity at that time. Since that is likely to be soon I already know the answer. Between SS and a modest retirement annuity from my employer, I'll have enough monthly income to stay warm and dry and fed with only a token withdrawal rate from my assets, and can probably get by with no withdrawals once SS starts. So I'm not going to annuitize further. But over time if the my situation becomes unexpectedly bad, I could revisit my situation and decide to purchase an immediate annuity down then as sort of a last ditch effort to avoid living on the street. A lot of people view annuities as "longevity insurance" and wait until very late in life to annuitize. Others annuitize just enough to cover their basic living expenses and use any remaining assets for "lifestyle" expenses.

[ThisDinosaur]

@Dragline
The Vanguard representative I spoke to stated that the 0.56% ER was included in the ER of any selected fund, not on top of the expense for the fund. I am also planning on adding a SPIA at some point, as per Wade Pfau's research showing annuities can replace bonds and are superior after retirement. So, I figured if that's what I'll be using a portion of my assets for anyway, I could earmark them already and get the tax and creditor protection benefits now instead of later.

@IlliniDave
The majority of my investments now are tax efficient, i.e. total stock market index. But I am thinking of adding REITs and other tax-inefficient investments to my portfolio. And in my bracket, those are going to get taxed into extinction before I FIRE. If those investments are going to be taxed at income rates anyway, then I figure I should put them into a big tax deferred product and only take distributions when I am in a much lower bracket in retirement. At that point, I can choose to either Annuitize/Not Annuitize Some/All of the gains in the fund.

Maybe a better way to phrase the question is; which is better;
tax deferred followed by taxed as income in retirement vs. taxed now as long term capital gains.

Also, how else do ERE folks with relatively high net worths protect themselves from the threat of lawsuits? Having a lifetime supply of savings and investments and not having to work must paint a huge target on your back.

[Dragline]

Also, how else do ERE folks with relatively high net worths protect themselves from the threat of lawsuits? Having a lifetime supply of savings and investments and not having to work must paint a huge target on your back.

Umbrella insurance -- its quite cheap. There is another thread about this.

[IlliniDave]

@IlliniDave
The majority of my investments now are tax efficient, i.e. total stock market index. But I am thinking of adding REITs and other tax-inefficient investments to my portfolio. And in my bracket, those are going to get taxed into extinction before I FIRE. If those investments are going to be taxed at income rates anyway, then I figure I should put them into a big tax deferred product and only take distributions when I am in a much lower bracket in retirement. At that point, I can choose to either Annuitize/Not Annuitize Some/All of the gains in the fund.

Maybe a better way to phrase the question is; which is better;
tax deferred followed by taxed as income in retirement vs. taxed now as long term capital gains.

Also, how else do ERE folks with relatively high net worths protect themselves from the threat of lawsuits? Having a lifetime supply of savings and investments and not having to work must paint a huge target on your back.

I hold all my REITs , taxable bonds, and other inefficient assets (a couple actively-managed stock mutual funds) in either my 401k or Roth IRA, both of which alleviate the concern for the ongoing tax consequences of those asset classes and allow me to stick to relatively tax efficient equities in my taxable account. If you don't have the ability to use those types of accounts, then perhaps a variable deferred annuity is a good option. Your question was why doesn't everyone use deferred annuities and I'd assumed the majority of accumulators who could purchase an annuity through VG also have some sort of access to at least either a self-directed Roth or traditional IRA or something similar and have the same sort of flexibility I do in terms of what they hold in taxable accounts. That maybe wasn't a great assumption.

The answer to the rephrase of the question is probably still highly dependent on individual situations. If the money going into the deferred vehicle is post tax and the investors income is not too high, then as far as expected return outcome the taxable investment account is probably slightly better, but the devil is in the details. If the ongoing tax rate on the investment returns plus the underlying investment ERs are less than the ER on the annuity then the taxable account should come out ahead with a tax-efficient investment vehicle. You can think of the taxable account as a tax-deferred account with a somewhat higher ER than the fund charges you. Then looking down the road, tax on investment returns is always equal to or lower than the tax on simple income (I believe), so you have to compare the annuity fee to (fund ER + tax load). If the latter is under the former the taxable account should theoretically win as a resource accumulator, again dependent on tax efficient holdings, and me more tax efficient during drawdown. But people's tax situation can change during accumulation, as can tax laws. No guarantees

I think for most people it's a close to a wash between the two (at least via Vanguard). For most who bother to think it though (which you are obviously doing) it more often comes down whether whatever the insurance facet of the annuity provides (usually some sort of guaranteed minimum future income provision) outweighs generally higher flexibility with your assets you get in a regular account. More of a matter of personal preference and overall life situation usually factors in substantially.

Unfortunately many people get into such products without really understanding them and how they compare to the other options; and fall prey to commissioned salesmen who aggressively peddle products with much higher fees. A good one can be a great alternative, but like many things, they aren't necessarily the best choice for everyone.

[grumpy]

This forum Has helped me quite a bit with looking at things differently which has allowed me in my mid forties go from a yea right retirement to I will retire one day position in life. So I will offer my prospective on annuities and how they have helped me personally.

First off annuities are a horrible investment if your buying them to make money your buying them for the wrong reason. Think of annuities as an income insurance policy as insurance its a great product. I bought a 100k 5 year immediate annuity it pays out 1750 a month for 5 years> I could have invested the money better and made a lot more return. However what it has allowed me to do is live off of the 1750 a month and save 84k a year my entire after tax salary.

I enjoy the peace of mind that if something happens to my job the checks continue to roll in and my standard of living is not effected for sometime Unemployment insurance is a dismal joke in my state . I will buy another 5 year annuity before this one runs out at a time and market conditions of my choosing and it will be deferred to start on the date the original one runs out probably timed with a really up year in the stock market . I see no need to be invested in annuities beyond this as again its more of an insurance product that protects your finical health and enables other things than a real investment.

Note there isnt one size that fits all it may not work for your specific situation for me personaly its a god send though i life in an rv full time and own a lot in a resort near my job i pay 400 a year in associan fees and my fixed bills are about 500 a month and i lve like a king on 1750 a month while saving 100 percent of my real salary i work a compressed work week and spend 3 to 4 days at a state park or the beach some where i would rather be this isnt a life style for everyone but i am just trying to help you see how annuities can be valuable if used correctly

[classical_Liberal]

...

[grumpy]

First the (fees) are not out of my 1750 that's what I get the fees are based on a market rate of interest of the day of purchase which is discounted from that rate so I am earning a 1/2 percent less than what market rate was on day of purchase. However with the CD ladder I am purchasing over time and the rate can vary based on FED decisions so one bad political event ect can drive rates down into a bad economy just as easy as up so less variability for me which is part of why I bought this to begin with. In my state as well as most states annuities are actually insured up to 250k not FDIC but government insured (I forget agency its the one that insures insurance companies not banks) which is far more than the 100k I ever have invested. I could do the CD ladder and in fact I had given it a lot thought before I choose annuities but this money is a hedge and less variability is worth the lost potential.

For me the decision gave down to ease and familiarity and elimination of variability again its an income insurance policy not an investment . I don't need the liquidity nor even want liquidity with this money So this point is actually a plus to me. This money makes up less than 15% of my overall wealth however my other investments have much higher variability which I am hedging against .I have enough left over from the annuity to fund my emergency fund as I don't generally need the entire 1750 but I do consider most emergencies apart of my every day living thus this seems like where it should naturally funded from to me

The answer is above the rest is a long winded explanation relevant to me personally why I choose this path. First its the peace of mind I no longer go to work to pay expenses to live. Rather my job is pure investment money which also provides me with 0 cost health insurance. Three times in my lifetime my job has been relocated overseas and I was not as savvy back then and it put me in a world of hurt wiping out my 401k ect just trying to get by. Therefore for me personally this peace of mind is priceless. Again i dont want the liquidity with this money by intent .

This also works great with my wife who has no desire to learn finance stuff but says she trust me to take care of things. She understands a check comes in once a month it doesn't change for the next 5 years and this is what we live on and save from to do things we want to do or need to do like replace a busted air conditioner. There not a lot to explain with this method to someone that doesn't really want to know to begin with

I more focus my attention and research on my investments that have higher yields where I think time and effort is more warranted. There isnt near the anxiety about a down year effecting my day to day living expenses my vacations or any other part of my ordinary life . It allows me 5 years to make the next annuity purchase without really caring about market volatility and trying to time FED interest policy to my advantage or at least an acceptable ROI I have yet to witness the market stay down 5 years straight

Yea i know its a mind game I play with my self in the but its working for me. In the past 7 years i went from heavy debt worried all the time if one downturn in the economy I would loose everything yet again. ERE concepts helped me reevaluate life and we decided to sell the house. With the kids grown we didn't use the house in its entirety anyway the heavy debt load prevented use from going places and doing things we enjoyed.

My compressed work week I work 3 12 hour shifts it made sense to move into an rv we bought out right for 22k We choose to stay most of the time in a rv lot in a resort near work we purchased 12k cash. We later picked a piece of land in the mountains nearby for 1500 that is cool place to go in the summer we run solar and live off the grid when we go up there for a few days. Plus I go visit state parks relatives on a whim on my time off take one all inclusive vacation once a year that we save for in a nice hotel

In my past life I had two shinny new cars and a lot of other stupid things that never really brought me happiness but definitely kept me poor and insure financially. Now I have a payed for older vehicle and 650k in investment accounts plus the annuity thats still active for another 3 years. Not bad for 7 years of change. The way I was doing things before I would still have nothing now as you only really have what you own minus what you owe. Annuities were for me a key component to give me the confidence I needed to embrace this change and helped bring my wife onboard .

To me extreme early retirement is a change of mind set that brings inter peace and less living in constant state of fear enabling us to eventually do the things we want to do full time. I now consider my self semi retired and work mainly for health insurance and the stresses of my high stress job just don't effect me with the same emotional impact any more I have way more control of my life

Back to my original statement i stand by an annuity being a great insurance product for some people that enables peace of mind and confidence but a very lousey investment.

[classical_Liberal]

...

[Riggerjack]

First off annuities are a horrible investment if your buying them to make money your buying them for the wrong reason. Think of annuities as an income insurance policy as insurance its a great product. I bought a 100k 5 year immediate annuity it pays out 1750 a month for 5 years> I could have invested the money better and made a lot more return. However what it has allowed me to do is live off of the 1750 a month and save 84k a year my entire after tax salary.

I enjoy the peace of mind that if something happens to my job the checks continue to roll in and my standard of living is not effected for sometime Unemployment insurance is a dismal joke in my state . I will buy another 5 year annuity before this one runs out at a time and market conditions of my choosing and it will be deferred to start on the date the original one runs out probably timed with a really up year in the stock market . I see no need to be invested in annuities beyond this as again its more of an insurance product that protects your finical health and enables other things than a real investment.

Let me be the first of what I expect to be many requests for a journal.

You may have found eyes glazing over IRL, when you have gone into detail about your decisions, but that won't happen here.

For instance, my first thought in reading your posts, wasn't about annuities, but about whether you have drilled a well and installed septic in your mountain lot. These kinds of questions work best if I can ask in your journal, rather than derail this thread.

Not that it stops me from derailing, mind you.

[Jason]

First off annuities are a horrible investment if your buying them to make money your buying them for the wrong reason. Think of annuities as an income insurance policy as insurance its a great product.

I don't fully understand them, but in my limited understanding, I believe this to be the key. And you think of them as insurance policies because they are insurance policies. They are not investment instruments.

When I bought mine I also bought a term life insurance policy. I did not fully understand that I actually left with two insurance policies. Actually I still don't know what the fuck I left with because I did not learn until later that annuity salesman put their dogs of Cerberus in the kennel before taking an appointment.

[ThisDinosaur]

Every couple of years I start thinking vanguard's deferred annuities are a good idea.

Pro side:
I like the "guaranteed income" promise. Annuities are reinsured by the state. So, if your annuity company folds, up to $100K (depending on the state) of annuity assets will be honored by other annuity companies. They are protected from creditors and tax-deferred. Yield is higher than you can get elsewhere because some of the income is from other customers dying before they collect, but its taxed as though you are just getting some of your own money back.

Con side:
"Guaranteed income" from one insurance company is not terribly different than interest or dividends from a bond or stock. That's where the annuity company is putting your premium dollars, after all. After adding up all the annuity fees, it ends up being greater than or equal to the taxes you would save from tax deferment.

I haven't bought one, but I may consider a SPIA when I get closer to traditional retirement age.

[Riggerjack]

Actually I still don't know what the fuck I left with because I did not learn until later that annuity salesman put their dogs of Cerberus in the kennel before taking an appointment.

And this is why annuities have the reputation they do. The product is fine, with a definite purpose. But they are marketed to risk averse "investors" who don't understand what they are buying, or why. Not a knock on Jason, but on our financial system.

My "back to the land" nieghbors bought one, years ago. It's guaranteed to pay 4% interest until they die. Not adjusted for inflation. The salesman told them he was "forbidden by law" to earn any fees or make any charges on the annuity.

With a sales pitch like that, and with all earnings hidden from the owner, there is good reason for the reputation annuities have. Currently, they serve to pull assets away from risk adverse older accumulators, in a way they don't understand until it is far too late.

On the other hand, if one makes it to middle age, and believes a guy in a suit (often while treating a pool of potential customers to a nice dinner) does anything, while also being forbidden by law from making a profit, maybe a harsh lesson is the only way to learn.

[Jason]

Oh, it's a knock on me. I was not risk averse. I was making an informed decision averse. And I have made it to middle age and made it part of my life's work to liquidate it with a holy vengeance.

And in the can't make this shit up if I tried department, this souless rolex wearing mothereffer was moving at the time I bought the annuity so I referred him to an associate who leased him new office space. Mr. Stuffed Shirt Annuity Douche then proceeds to call me up a few months later to complain about the lease that he fucking willingly signed. I mean can you imagine the size of the non-fiduciary balls on this immoral asshole to call me up to complain after he signed a document that later bit him in his greedy ass? And for only five years mind you, not the better portion of his entire worthless adult fucking life. I can only hope he later pushed one of his fancy maroon colored annuity brochures in front an unsuspecting Jersey Mob boss who after discovering what he signed threw his $1000 suit ass into the weeds after sodomizing him to death with his own pyramid shaped annuity salesman of the year award. Christ this shit still eats at me. Please, tell your children never to underestimate the infinite depths of douche that festers in an annuity salesman's blackened worm ridden heart.1

1 I forgot the name of the annuity salesman on the board. But if you read this, once again, nothing personal.