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Deferred Annuity ??? should I go for it

edited June 2011 in Fund Discussions
Howdy folks,

I hope all is hale and healthy on this forum.

I am 41 years old and I might be moving out of my job pretty soon.

We are planning to move back to India in another 10 years from now. We are looking for some gauranteed returns when we ready 59 years. Due to my time constraints in job, I am thinking of putting say 100K (from IRA) into Deferred Annuities. Spoke to Northwestern mutual. They gave me a ball park number. If I invest in deferred annuity with them with amount 100K, from my age of 59 years, they would start paying monthly 600$ untill I die.

I am kind of attracted because, I don't need to invest that 100K. They take care of it and I get gauranteed monthly payments.

What do you folks think about this investment. Please share your opinion.

Thanks
nath

Comments

  • There are (at least) three issues here:
    1) Generating a guaranteed stream of income at retirement
    2) What to do now with your $100K
    3) Mixing IRAs and annuities

    I'll take those in reverse order.

    Generally, it is not a good idea to put annuities into IRAs. The reason is that annuities have additional costs above what the comparable non-annuity investment would cost - this is for the annuity insurance (and sales commissions, and ...). See the cautionary note that the SEC has about mixing variable annuities at http://www.sec.gov/investor/pubs/varannty.htm

    That brings us to what to do with the $100K IRA. Fixed annuities (like a savings account, where the insurance company pays you a a fixed rate of interest that it may change periodically) make a little more sense in an IRA, if you can get a better rate than you would at a bank. In each case, the money is guaranteed, though when you go to a bank, the money and interest are guaranteed by the federal government, while if you go to an insurance company, the money's guaranteed by the insurance company (here, Northwestern Mutual). So a fixed deferred annuity can make sense if (a) you want a bank-type rate of return, maybe a little more, and (b) you're comfortable with the insurance company's guarantee. Since you're investing for 18 years, you should be able to do better, but as with most investments, the more return you get, the more risk you take. Personally, with 18 years to go, I'd invest in something that was likely to do better than a fixed annuity, but that's me.

    Finally, the guaranteed income - you can always buy an annuity, even when you're 59.5 and you want the income stream to begin. If it begins paying out immediately when you buy it, it is called, well, an immediate annuity. They're very easy to buy, and IMHO make more sense. In the meantime, you'll get a higher return by investing elsewhere. When you turn 59, you can take the IRA and "annuitize" it (get the constant stream of income) by buying the immediate annuity with the bigger pile of money you'll have accumulated. (Or you can use just some of that money, and put the rest somewhere else.)
  • what if I don't have stomach for these market gyrations. And I don't want to invest that 100K for next 18 years myself. In that case does "Deferred Annuity" makes more sense?
  • FWIW, remember that once you give your money to the insurance company, it is gone for what ever period of time the surrender period lasts. Usually fixed annuities have a much shorter surrender period than variable annuities. And also remember that once you begin to annuitize a contract, the principal is, in effect, owned by the insurance company. In return for the guarantee of a specific income benefit, you are giving up access to the principal once you start annuitizing.

    As for the next 18 years, no one knows what will happen. However, I think I would rather use staggered-maturity CDs than put my money in an annuity now. If you believe, as many of us do, that interest rates will be considerably higher 15 years from now, the last thing I would want to do is lock in what could be a very sub-par rate on a fixed annuity. You could, of course, use a fixed-annuity with a 5-year maturity, then roll it to a new contract every 5 years. But Northwestern will get a commission every time you do that.

    For my money, I would consider a diversified mix of asset allocation funds (PRPFX, WASYX, OAKBX, TIBIX, VWINX, etc.) as a way to establish a flexible mix that ought to do ok for you over the next 15+ years. No guarantee, of course. You could even include some alternative strategies like good long-short, absolute return, or even gold in the mix to lower volatility.

    The truth is that no person knows what will happen over the next 15 years, let alone the next 12 months. I recently attended a forum on alternative strategies, and the predictions were all over the place. U.S. markets up, U.S. markets, down; emerging markets up, emerging markets down; precious minerals and energy up, precious minerals and energy down; etc.

    Whatever you do, stay away from anything that resembles an equity-indexed annuity. Even the folks who sell them cannot explain the fine details, and regulators are placing more and more restrictions on how they are sold, for good reason.
  • You can achieve similar results and generate significantly better income. For instance, you can invest your 100k in zero-coupon treasuries. The 11/15/2029 bond is priced at just under 46. Invest your 100k in this and you'll have about $222k in 2029. All you'd need is about a 3.25% return on that $222k to simulate the annuity payout of $600/month. That shouldn't be hard to generate seeing that the long bond is paying out something like 4.2% right now, and it's about as low as it's been in a long time. The primary risk is that rates will be lower than 3.25% in 19 years. On the other hand, your family will still get the 222k bond if you were to pass away at 60, vs the bank which could come out quite well if you passed away at 60 only one year into the payout period. If you really don't want to take the risk and like the security of an annuity, consider waiting for interest rates to goose up, the annuity payout offered by banks is correlated to the interest rates. Keep in mind that $600/month may not be worth very much in 20 years, especially if we have a stretch of elevated inflation.
  • edited June 2011
    I think for 15 years time horizon a blend of conservative balanced funds is a better choice:

    GLRBX: 15 year return is 7.89% annualized. The fund has only 2 negative years in the last 10 years. 2001 with -0.81% and 2008 with -5.52%.
    VWINX: 15 year return is 8.14% annualized. It only has one negative year in the past decade. 2008 with -9.84%.
    PRPFX: 15 year return is 9.00% annualized. Again, it only has one negative year in the past decade: 2008 with -8.36%

    I would not give up liquidity of my money for a petty annuity especially at this low interest environment. When you need guaranteed income stream in 15 years, you can buy an immediate annuity then.
  • mns,

    Can individual investors buy zero coupon treasuries?

    nath
  • mns,
    One more question:

    So can I take IRA amount/401k amount and invest in zero coupon treasuries?
    thanks
    nath
  • Folks,

    I contacted schwab (my 401k account is with them). We are not allowed to invest in zero coupond treasuries through my account (called as PCRA account).

    So, I was wondering may be I will invest in mutal funds (bond funds) that invest in zero coupon treasuries?

    I came across these funds on schwab site that would invest in zero coupons.

    BTFTX, BTTTX, BTTRX...

    any suggestions?
  • bnath 001: You just had some of the smartest people on the board (1) advise against buying an annuity at this time and (2) recommend some great funds likely to do much better over 18 years than an annuity. I'd go with that advice, making sure to diversify into two or three different fund companies for an extra modicum of safety.

    Zero bond funds (sometimes called "target maturity") are probably the most volatile type of bond fund you can own. They can make a fund like OAKBX feel like a walk in the park. Buying one is a bet on the direction of interest rates. If rates rise for any length of time, you can loose your britches.

    I'd say guarantees are worth paying for - for some things. Maybe for a TV or dishwasher. But when investing for the long term they are a dubious proposition. The others have already explained that better than I can.




  • If you're talking about what you can buy in your employer's 401k (Schwab PCRA), then you cannot buy the Northwestern Mutual annuity. If you're talking about an IRA through a brokerage (Schwab or anyone else), then you'll be able to buy Treasuries (zeros, TIPS, or anything else you'd like) with no problem.

    As others have pointed out, there are better long term conservative investments than a deferred fixed annuity, from laddered bonds or CDs, to balanced or asset allocation funds.
  • bnath, sounds like the PCRA is somewhat limited in what you can invest. If you have a standard IRA, you should be able to invest in zero coupon bonds. Can you roll over your PCRA account into an IRA? If you're going to use the zero coupon strategy, don't implement it funds that implement in zero coupons. Zeros are great for two particular situations: betting that interest rates will drop and when you need a specific amount of money at a specific point in the future, but beyond that they are crazy volatile. Mutual funds will trade in and out of investments for investment and liquidity reasons which could drastically change your expected return from a zero bond fund.

    That said, I think you will be better served with one of many conservative strategies suggested by others. I offer my zero coupon strategy as an alternative to annuities, but the strategy is expensive in terms of lack of liquidity and inflation protection.
  • Not all zero coupon bond funds trade in and out of investments. See American Century Zero Coupon 2025 BTTRX. Not saying the idea of zeros is a good or bad investment, just that it is possible to target a maturity date with mutual funds.
  • If you want the interest rate offered by a deferred fixed annuity, but don't want to be locked into the policy (addressing BobC's comment), you could take a look at Mutual of America. No surrender charges, no matter how short a time you hold the policy. Reasonable, though not great, credit ratings. And comparing it with the "best" five year fixed deferred annuities (those whose rates are fixed for five years before fluctuating) from the Barron's article JohnN linked to, you see that MofA's rating is at least as good, and rate on a $100K policy very competitive. (The MofA rate floats from day 1, but with everyone saying interest rates have nowhere to go but up, this is not necessarily a bad thing.)

    Unlike most insurance companies, they post their rates, and they state up front that there are no tax advantages to an annuity if it's for an IRA.

    Again, not recommending an annuity - just pointing out options that address particular concerns.
  • Thanks a lot for all who responded to me. Great advise.

    I am not a believer of buy and hold strategy. So buying a balanced fund like OAKBX and sitting on it for 15 years or so, is not something I can do.

    I was invested in oakbx (oakmark balance fund) for about 4 or 5 years (back in 2007 or 2008). Got out of it with no profits. Didn't find appealing for me to be invested for years and not making any profits in it.

    It is very confusing to pick a strategy now. Whether to invest in zero coupon bond funds like BTTRX or sit in cash. I am adding quite to my 401k account (40K per year including employer match + pension cash everything). So, may be if I continue to add every year and just sit in cash as long as I can and at 59 years of age, I can buy an immediate annuity with what ever balance I have in 401k/IRA account??

    I didn't hear Rono's comments.

    thanks
    nath

  • Yes, an individual can buy zero coupon treasuries. Keep in mind that you must pay taxes on the 'phantom' income each year. They are called STRIPS (Separate Trading of Registered Interest and Principal of Securities) and must be purchased from a broker.
  • I would not buy an annuity inside of an IRA. In fact, I wouldn't buy one at all.
  • bnath 001: As msf pointed out, zero coupon bonds, including the AC funds you cited, do allow you to lock in a guaranteed payout amount if held til maturity. I should have mentioned that. However, they still confront you with some serious issues.

    (1) Over the intervening years their price/value will bounce around like crazy. The farther out the maturity date the more they bounce. Anything beyond five years is quiet volatile, having owned them in the past. But, if you can take your eyes off them and not worry over those 18 years, the promised payout should be there. Heaven help if an emergency comes along or your circumstances change and you need to pull money out while they are depressed.

    (2) From msn, it appears 100K invested in zeros today would be worth a bit over 200K in 18 years. With a fund, your return would be somewhat less than actually holding Treasury zeros due to fees. This sounds like alot but really isn't. Think how prices have risen since 1993. While houses and some technology costs held steady or dropped, most of the things we depend on like cars, food, fuel, medical care, satellite tv, have risen sharply over that time, despite what the government number crunchers would have us believe. Imagine what prices will look life if have some "serious" inflation over the next 18 years.

    Your skittishness regarding risk investments is one reason I advised against zeros. Its presently hard to get much perspective on how they can gyrate, since interest rates have gone in only one direction, down, for many years. But IMHO neither zero coupon Treasuries or an annuity would be the best way to invest for retirement at your relatively young age. Think you should give some serious heed to the many suggestions above by some of the regulars. Perhaps reading more on investing would help raise your risk tolerance a bit. Lota good reads on David's featured list. I still enjoy looking at the light-hearted book by Andrew Tobias and recently downloaded it from Amazon for a few bucks. A quick afternoon read!

  • bnath:

    Lots of good responses already.

    First off, I want to say we all "feel your pain". Yes it is hard to choose a strategy now, and I would bet most of us are sympathetic to the desire to pick something safe and just let it be. The problem is, with such a strong likelihood of increased inflation sometime in the next 20 years, confidently picking one approach now that will preserve your capital and even grow it a little for the next two decades is impossible.

    If you really do not want to be making investment decisions over the next 20 years, consider investing the time it takes to select an advisor you would be comfortable with. I think that could be a better bet than spending the time with an annuity salesperson.

    If you still want to consider an annuity product, your due diligence should include:

    - Are inflation-protection features available? What do they cost?

    - Are there any circumstances in which you can get some or all of your 100k back? What are they?

    - In the event the insurance company fails, how much coverage will you have for the annuity from your (current) state's insurance guaranty organization? You can find your state association's web site at: http://www.nolhga.com/policyholderinfo/main.cfm I think exploring what happens when the insurer's guaranty fails is important to think through, now that we have seen AIG go close to the brink.

    - Have you taken away from the office, read and understood an example of the contract that you would sign? These contracts tend to be rather complex.

    Best of luck with your decisions.

    gfb
  • edited June 2011
    If you had not sold your OAKBX and held on over the past 5 years you would have earned 6.78% annualized. You did not lose money on CDs or Bank accounts but you probably did not do this well either. If you cannot stand volatility and lose sleep, you will have to switch to CDs and annuities even if they are very likely to perform worse over time. I've offered you a blend of 3 mutual funds that are even more conservative. I still think you should do a bit more research yourself.

    You have to understand that if there is no risk, there is hardly any return. You have to make your own trade-offs given the time horizon... I do not suggest you risk all your money but you need to take appropriate risks for appropriate time horizons. Guarantees in this business cost a lot and offer little in exchange.

    I personally do not think you will be happy with Zero Coupon bond funds either. These bond funds do not trade bonds but when rates change they will get a hit on the valuation of the bonds they hold as they still have to mark to market every day. When losses begin, other investors (if not you yourself) are likely to jump the ship and fund will have to sell bonds to pay for redemptions at these lower market prices. So, you are more likely to lose money on these bond funds. I strongly advise to stay away.

    You can buy and hold the zero coupon bonds themselves and you will be guaranteed to get principal and interest payments but you can feel regret when interest rates rise and new bonds are offering higher payments than yours. You will be stuck with lower paying bond for the duration of the bond or take losses on principal to sell it to someone else on secondary market so you can buy higher paying new bonds. Can you hold a low paying bond for 30 years? Insurance companies buy these bonds so they can match their liabilities exactly. But these are not appropriate for individual investors.

    With your risk tolerance, you will be a CD or fixed annuity investor. Yes, you will overpay for some guarantees but you will probably not lose sleep and panic at a couple of percentage loss in a single year over a decade.

    Good luck.

  • The AC funds cited do not protect the principal. See my message to bnath on how you can lose money in a defined maturity bond fund. These funds are not bond substitute. The issue is that they have to mark to market every day so NAV will go down as interest rates go up.
  • American Century Zero 2025 holds 30 bonds, over half maturing in 2025, the remainder maturing in 2024 and 2026. Virtually a pure 2025 mix. If held to maturity (2025), mark to market doesn't matter, just as it doesn't matter if the value of the individual bond you hold goes up or down.

    The usual problem with this argument is that investors may flee a fund, forcing it to sell holdings at inopportune times. But this is a homogeneous portfolio - there is no inopportune time. If the owner of, say, 1% of the fund, sells, then the fund sells 1% of the portfolio and gives that owner the proceeds. The remaining 99% of owners hold a homogeneous 99% of the portfolio, still. Even if that selling had a market impact, so what? The remaining 99% of bonds in the portfolio will revert to par value at maturity (and they all mature about the same time), regardless of the transitory market impact.

    The prospectus says this quite succinctly: "If shares of the fund are held until the fund is liquidated and all distributions are reinvested, the fund’s performance should be similar to an investment in a zero-coupon U.S. Treasury security with the same term to maturity as the fund. " (Of course, after the Janus ruling, we all know that American Century is free to lie, since only the board of the fund actually makes "statements" in the prospectus. But that's another thread.)
  • Investor,

    Good comments and suggestions....when you are already holding positions in a fund, how do you know that if you wait for another 5 years or 6 years, you would get 7% or 8% returns. No one knows that.

    Folks on this forum highly regards OAKBX fund..and I don't understand why.

    Thanks
  • Thanks everyone...you folks are very kind and generous people in sharing information and making sure guys like me don't make mistakes.

    I got (as usual) great advise again on my "Deferred Annuity" question. Let me think though this one more time and see what suits my needs. Though I am 41 years, due to my family and work situation, I am almost like 50 year old man. So my circumstances, I thought Annuities make more sense for me....but I guess not ..considering all the expenses and risks involved in them.

    Thanks again.
    Nath
  • edited June 2011
    You don't know for sure. The returns are uneven. But over some time period diversification you get returns similar to those. It only averages to that over time. You cannot assume such returns in short periods. Even 3-5 years is risky. But if you have long term goals you can invest in these long term instruments.

    Take a look at those 15 year returns. Those 15 years include 2 recessions one of which has been the worst since great depression, several crisis in between. It has been a really bad period. Those returns are despite these bad times.

    Now, you say you need certainty. Financial world does offer certainty with CDs and fixed annuities. But they will not offer those high rates. They will instead take your money and invest in a number of instruments where they can make much more money and give your own low but certain return. In other words, the bank and insurance company will be compensated for taking the additional risk.

    All I can say, match your goals and investment horizons appropriately. Short term instruments for short term goals and long term instruments for long term. As time passes, long term becomes intermediate and short you make the appropriate transition gradually. If you insist on using short term guaranteed instruments for long term goals you will have to save substantially more. Hopefully you have a great paying and secure job.

    But it looks like no amount of historical evidence is likely to convince you. Only you can do so. To do so you need to have to look at the historical evidence and familiarize with the history of stock and bond markets. Investing requires a bit of faith in capitalism and markets. If you cannot develop a little bit of faith, you cannot invest for the long term. In that case, the only instruments you will be satisfied will be CDs and fixed annuities. Even so, you still have to have faith on banking system, the insurance company or the government to make you whole.
  • msf,

    I have to admit that given the bond holdings are uniform if you can hold the fund to maturity you may likely to get returns close to holding the bond yourself. So, I was not correct there. But if you are going to do that holding the bond itself is a better option so you do not get erosion of expense ratio.

    One other downside, while holding the target maturity bond fund, you will probably be more aware of bond price fluctuations as NAV will be marked to market.
  • Nath: You talk about "50 year old man" like you feel old or something. Just wait until you're actually there... Keep well, and try to feel your (youthful) age. - gfb
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