MONEY 27 - ANNUITIES

THIS IS MY 27^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  In the last blog we talked about insurance.  Let’s talk about investing in an insurance product, annuities.

Annuities have been around for years. These vehicles are managed by insurance companies and sold by bankers and insurance companies.  There are two main types: deferred and immediate.  The names describe the plans, you can defer payments to a certain future date or start payments immediately. 

A deferred payment, sometimes called a regular payment annuity, has a plan set up for periodic payment into the plan until a certain time or age you reach and then you get payments on a defined schedule, usually monthly to supplement social security, a pension plan or other retirement money.

An immediate payment plan, or single payment plan, involves you placing a certain amount of money into the plan. You may start taking out payments immediately, usually based upon a schedule.

Annuities can be either “fixed” (guaranteed) or “variable”. A fixed pay annuity is exactly that.  A fixed plan distributes money from the plan for a fixed period of years or until you die, or perhaps it is set up for payments to continue until your death and the beneficiary death.  This is many times used in a husband and wife relationship; a joint annuity.  If the plan has payments until both you and your beneficiary die, the payments will be less than if just established until your death. As with all insurance products this is worked out with actuarial studies.  A variable policy is associated to the investments made with the money such as bonds and stocks.  These markets fluctuate.

Annuities are set up to your estimated financial wants and needs, normally when a person retires.  These payments are paid to you from your original principal plus the money that has accumulated from being invested.

When there are payments made from the plan to you your original principal paid out from the annuity is tax free, however the amount of money that has grown in your plan from being invested will be taxable income.

The nice things about annuities are: 1) your principal grows tax deferred and 2) you can place any amount of money into an annuity unlike your IRA and other retirement plans where there are limits to the amount you can invest each year.

Just like other investments there are good points and weak points.  Let’s talk about the downside of annuities.

1)    Annuities are insurance products and many times have fairly high commissions paid to sales people, even up to 10%.

2)    There may be policy surrender charges the same as with life insurance if you need to alter the policy and take more money out than scheduled or withdraw all your money.  This could be anywhere from 5% to 20%.

3)    Administration and management fees can be substantial such as 1% to 1.75% of the money annually.

Today, everyone is trying to figure out what best to do with money and investments.  Managed money in annuities goes to the same trough, mainly bonds and stocks so returns have come down over the past 3-4 years. What are we looking at for returns, mainly on bonds where the money managers for insurance companies invest money?  We are down to about 1.6% for a 10 year US bond. An  A-AA mix of bonds reinvested may yield 2.5% now.

Bottom line, with annuities holding mostly bonds in their portfolios and high fees for purchase, management of money and very high penalties for yearly changes and withdrawals, you might be better off with other investments for the majority of your money.  Don’t forget that if and when interest rates go up the market value of bonds goes down. If you, or the money manager, sell bonds before maturity in a rising interest rate environment, you will most likely lose more money than you have made at today’s 1.65% to 2.5% yield rates.

When you look into investments you might run into the term “basis points”.  It may come across as “this” or “that” investment has changed 25 basis points.  What is this?  One hundred basis points equals one percent. Therefore, in the above illustration of 25 basis points, it means the investment has changed 1/4 of one percent.

As you most likely know, inflation (exclusive of food, oil and gas) is expected to remain low and interest rates are also predicted to remain quite low through mid-2013 and longer, so your returns on annuities will be similar.

Another positive point is that US debt is still very desirable in the world markets, and the US dollar should remain strong in relation to other currencies