Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20
UK Supermarkets Coronavirus Panic Buying, Empty Tesco Shelves, Stock Piling, Hoarding Preppers - 22nd Mar 20
US Coronavirus Infections and Deaths Going Ballistic as Government Start to Ramp Up Testing - 21st Mar 20
Your Investment Portfolio for the Next Decade—Fix It with the “Anti-Stock” - 21st Mar 20
CORONA HOAX: This Is Almost Completely Contrived and Here’s Proof - 21st Mar 20
Gold-Silver Ratio Tops 100; Silver Headed For Sub-$10 - 21st Mar 20
Coronavirus - Don’t Ask, Don’t Test - 21st Mar 20
Napag and Napag Trading Best Petroleum & Crude Oil Company - 21st Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy - Government PANICs! Sterling Crashes! - 20th Mar 20
UK Critical Care Nurse Cries at Empty SuperMarket Shelves, Coronavirus Panic Buying Stockpiling - 20th Mar 20
Coronavirus Is Not an Emergency. It’s a War - 20th Mar 20
Why You Should Invest in the $5 Gold Coin - 20th Mar 20
Four Key Stock Market Questions To This Coronavirus Crisis Everyone is Asking - 20th Mar 20
Gold to Silver Ratio’s Breakout – Like a Hot Knife Through Butter - 20th Mar 20
The Coronavirus Contraction - Only Cooperation Can Defeat Impending Global Crisis - 20th Mar 20
Is This What Peak Market Fear Looks Like? - 20th Mar 20
Alessandro De Dorides - Business Consultant - 20th Mar 20
Why a Second Depression is Possible but Not Likely - 20th Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy Government PANICs! Sterling Collapses! - 19th Mar 20
Coronavirus Market Crisis - Nowhere to Hide! - 19th Mar 20
Coronavirus Most Likely GDP Economic Outcome for Q1 and Q2 2020 - 19th Mar 20
How COVID-19 Leads to 2008-Style Bank Crisis - 19th Mar 20
Coronavirus Impact on Global Economic GDP Numbers - 19th Mar 20
Bticoin Crash Big Channel Review - 19th Mar 20
Gold is Doing Its Job…Silver Will Come Back as a Safe-Haven Asset - 19th Mar 20
The Chartology of Coronavirus Deflationary Event - 18th Mar 20
Fed Slashes Rates to Zero and Introduces QE in Response to COVID-19. Will Gold Rally Now? - 18th Mar 20
Coronavirus - Nothing to Fear but Fear Itself - 18th Mar 20
The Stocks Bear Market Is Upon Us... Or Not - 18th Mar 20
US and UK Coronavirus Containment Incompetence Resulting Catastrophic Trend Trajectories - 17th Mar 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

The Real Scoop on Annuities - Part One

Personal_Finance / Pensions & Retirement Mar 26, 2008 - 06:40 PM GMT

By: Steve_Selengut

Personal_Finance Best Financial Markets Analysis ArticleInsurance companies have always been big time financial institutions, and they could probably have claimed possession of the largest and safest investment portfolios on the planet. At one time, their role vis-à-vis Wall Street was clearly that of a giant customer for the securities the investment banks brought to market and which the securities firms distributed. Their real estate holdings were religious in size and quality. They were direct lenders to corporations, their owner-policyholders, and to other institutions. They were the Trustees who managed the private employee pension plans of the world.


Insurance companies sold life insurance policies and annuity contracts that contained guaranteed benefits that depended on their ability to invest safely and soundly. They sold investment management services that built upon their legendary reputation as an industry built upon guarantees, trust, and the financial integrity of their investment portfolios. They were not known for the production of unusually high rates of return, but they were one of only three entities allowed to utter the sacred g-word, and the only one that marketed products that protected people from the financial vagaries of life and death. It was a simpler world then, one less prone to the conflicts of interest, scandals, and financial disruptions that exist on the modern Wall Street. Today, it's difficult to distinguish one financial institution from another as they compete for the ever-growing pool of investment dollars. Insurance companies, now publicly owned, have become am integral part of an industry that seems uninterested in protecting anything other than their obscenely paid leaders.

The time-honored distinction of the annuity contract was the guaranteed retirement benefit it provided. The "you will never outlive your income" boast could not be uttered by any other financial entity! The annuity contract itself was never intended to be an investment product, although the disciplined savings of the deferred variety was certainly given well-deserved emphasis. This was the original old age and disability retirement program--- a contributory, but trustee directed, investment account that anyone could have for a few bucks a week. Like bank savings accounts and federal government securities, risk of loss was not a factor, and the guarantee was a benefit well worth the lower than market yield. Over a hundred years, the concept became generic: Annuity = Guarantee--- safe, solid, and virtually risk free. Equities were nowhere to be seen; derivatives had yet to come of age; neither seemed necessary. The guarantee was enough--- it still is, but annuities are best suited to the healthy poor.

Annuities were developed for the protection of the indigent--- people without the assets needed to generate enough income to sustain them in retirement. An annuity is a series of identical payments made over a specific period of time. Any departure from a plain vanilla, one-life, annuity reduces the payout because of additional time, cash back, or life contingencies. In its purist form, a fixed amount is paid to the annuitant until his or her death. Any leftover funds belong to the company, and the company continues to pay those who live longer than predicted by the actuarial tables--- a simple concept, actuarially pure, easy to deal with, and with no surprises (until the government decreed that men are required to live as long as women).

Annuitants would never outlive their income, but absolutely nothing would be passed on to their heirs; a dismal prospect for the kids, but a valuable benefit for the retiree. The annuity was a last resort scenario for those who didn't have the financial resources to support themselves. I don't know about you, but this sure sounds like a great way to fund a Social Security program! The companies make enough money on the plain vanilla variety to pay their salespeople between 8% and 12%. Typically, they lock-up the money for eight to twelve years with large penalties and pocket most of the additional income that their actual investment and expense experience produces--- but for those who can't fund their own retirements, this is entirely acceptable. A mandatory, fixed annuity based Social Security really needs to be considered to replace the counter-productive system in effect today--- there would be no need for the commissions.

Enter the modern day Variable Annuity oxymoron, sold by an industry that has lost touch with its noble roots, if not the realities of the stock market. The sales pitch emphasizes the prospect of gains in the market rather than the safety and security of the contract. Hundreds of insurance-annuity companies have rushed in to sell their Mutual Funds to unsuspecting retirees, in the form of a much-more-speculative-than -meets-the-eye retirement program. In it's zeal to claim its share of the investment dollar, the industry has rationalized away the risk of equity investments. Financial Planning computer models are programmed to include variable annuities in their asset allocations, shifting the retirement income risk to the consumer. And it's such an easy sell because what the customer hears is: a guaranteed retirement income plus stock market appreciation.

Unfortunately, the stock market never has been able to generate guaranteed levels of income, and sometimes fails to move higher just because we think it should. Serious problems occur when mutual funds are packaged with annuity contracts and the critical differences between them are either overlooked or undisclosed, perhaps innocently, perhaps not. The founding fathers of the annuity contract would not be pleased with today's glitzy versions. Let's back up a century and consider some basics. Just who needs an annuity anyway?

Keep in mind that the annuity produces the largest possible commissions for the salesperson and the largest potential penalties for the purchaser. The variable variety adds the commissions from the mutual funds to the package, and uncertainty to the income benefit. Here's how to determine if an annuity makes sense economically. Is it clear that there is no such thing as a guaranteed variable annuity? The key suitability numbers are easy to develop and to analyze.

The most important number in the equation is your personal expense estimate. How much income is needed at retirement? Always estimate conservatively (that means to use numbers higher than you really expect). If you need a calculator, you're making it too difficult. Let's pretend that the number you decide upon is $48,000, or $4,000 per month. Next, subtract the amount of any guaranteed income you expect to receive from all sources, including social security, pensions, etc. Do not include the value of your investments or properties you plan to sell in this calculation. Again, be conservative, keeping your estimate a bit lower than what you actually expect, and make sure you know why investment earnings should not be included. Let's say that this number works out to be $27,000.

That's it. Now all you have to do is to determine if the investment portfolio can safely generate the difference of $21,000 per year in income (dividends and interest only, please). For the purposes of this analysis, the current market value of the portfolio is used, so make sure that you include the value of everything that is marketable. At today's interest rates you could get the job done safely with under $300,000 but not with normal equity mutual funds or any form of Index Fund. It is totally irresponsible (actually, its worse than that) to rely on equities to provide retirement income. BUT, if the numbers are just short, and (a) a "windfall" (inheritance) is anticipated within a few years, or (b) the retiree is in poor health, an annuity is the last thing that should be considered! You should be able to invest the money conservatively, generate adequate income and have an estate left over for the heirs! Remember to satisfy the income need before looking at equities. There are no exceptions!

So here we have a last resort product, designed for the poor, that the industry has chrome plated, spit-polished, and supercharged for marketing to people who should know better than to include equities in an income portfolio. Why? Is it because financial pros really think these products are universally suitable? Is it the commissions? Or is RISK just a board game that they played in college?

By Steve Selengut
800-245-0494
http://www.sancoservices.com
http://www.investmentmanagemen tbooks.com
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

Disclaimer : Anything presented here is simply the opinion of Steve Selengut and should not be construed as anything else. One of the fascinating things about investing is that there are so many differing approaches, theories, and strategies. We encourage you to do your homework.

Steve Selengut Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Steve
13 Apr 08, 11:49
Variable Annuities.

VA's are not too good to be true, but they are too good to be free. You should familiarize yourself with the work of Moshe Milevsky, John Huggard, Ben Stein, Nick Murray, Ibbotson & Associates and Harold Evensky for a more accurate and objective "economic" evaluation of the validity of the product as a retirement income producing solution. Not to mention the behavioral aspects of helping individuals remain objective and disciplined about their decisions during times of volatility. Check out Dr. Daniel Kahneman's work in this area. In addition, I dont see how you can possibly conclude that equities should not be used to generate income, or more correctly, sustain purchasing power over one's life expectancy. According to Jeremy Seigel, since 1900 the real return of equitites is 6.5% vs a real return on bonds of 2.1%. Lastly, You dont list the key benefits of variable annuities.


Bert
18 Apr 08, 19:27
Variable Annuity Question

A client of mine liquidates his 401K from his previous job and asks me what he should do with it. First, background on the client. Client is 60 years old, still working with total liquid assets of say $150K. The value of the liquidated 401K is $27,000. He already has a variable annuity that somebody else had put him into with a principal guarantee rider. In 2006, the client invested $57K. The market has tanked since then and that variable annuity has a market value of $53K today. So now what to do with the $27K? I recommended putting the money in a Fixed Annuity earning a guaranteed interest of 4.5% for the first three years of a seven year term, and doing no less than 3% for the remaining four years. An investment consultant mentioned, "I have a product guaranteeing 6%, with the likelihood of being more." The client heard,"guaranteed 6%", and said let's do that, sounds good! Can somebody please tell me, whether a variable or a fixed annuity would have been the correct recommendation.


robert ordonez
17 Nov 08, 14:45
VA annuity

I receive a disability annuity from VA. What could happen to it during a recession?


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules