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Bonds Take A Bath
- William Jordan, Financial Advisor

There is no investment which creates more confusion than annuities.  There are annuities which are reasonable options for retirees and those nearing retirement, yet there are annuities to avoid at all costs.

In the broadest terms, annuities fall into three categories.

  1. Variable annuities
  2. Fixed annuities
  3. Immediate annuities

This month, I would like to address Variable Annuities, and a recent popular rider called an Income Benefit rider.  It may be found under different names, but the basic description is a guarantee of a minimum amount of income for life. 

This sounds good and the marketing materials make it seem like an obvious decision.  However I have never seen an Income Benefit rider on a variable annuity which actually makes sense or truly benefits the client.

Variable Annuities

A variable annuity is similar to a mutual fund which is tax deferred.  There are no taxes on gains until you take money out.  It may be good for someone in a high tax bracket who hopes to be in a lower tax bracket when they take income out.  Keep in mind if taxes go up in the future this benefit becomes much less valuable.

The downside of variable annuities is they are extremely expensive investment accounts.  You pay 1% - 2% for the annuity portion, and another 1% - 2% for the investment portion. 

Thus an average variable annuity has annual costs around 3% and in many cases it’s as high as 4%.  These costs lower your returns so a similar mutual fund will always outperform a similar variable annuity.  For most people over 50, a variable annuity is not a good investment account.  The costs are just too high.

Income Benefit Riders

Recently, many variable annuities have added an Income Benefit rider which sounds great at first.  You may hear something like “Guarantees you make 7% a year until you start taking income, and then you will receive 5% a year for the rest of your life”.  Lets look at an actual contract offered to one of my clients, and discover if this is really a benefit.

Someone came into our office recently having been offered one of these annuities and wanted my opinion.  Here was the exact offer.  An 8% guaranteed growth rate until they retired (12 years away) and then a guaranteed income of 4% for the rest of their lives.  At first glance who wouldn’t want that?

Here’s the first catch.  You can never take your principal, only 4% income for life.  Even so it still sounds good.  Now let’s look at the actual numbers.

This couple was considering investing $300,000.  If they made 8% for 12 years the value would have grown to $755,451.  Next the client would begin receiving 4% a year, or $30,218 for life. 

Think about what this means.  Twenty two years from now the client would have received back only $302,180, or $2,180 more than they invested.  This means for the next twenty two years, the investment potentially earns nothing!

We ran the numbers out to thirty years, and the client still has received only $543,925, which is the same as a CD earning 2% for thirty years.  Would you buy a 30 year CD paying 2%?  Neither would I.

Run the Numbers

Here’s the bottom line.  If you are seriously considering a variable annuity because of it’s income benefit, you MUST run the real numbers first.  Feel free to contact our office for a free Income Benefit Analysis of any annuity product you are considering before making a decision.  We can quickly run the numbers for you and tell you if it is a good or bad idea.

William Jordan is a nationally recognized wealth manager and well known speaker on financial and investment topics.  To ask a question or request an investment review meeting, contact his office at (949) 916-8000 or online at http://wjica.com. William Jordan Associates is a Registered Investment Advisor with the state of California.  Past performance does not guarantee future results.


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