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gadfly

Back To Basics...a Clarifier & Challenge

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As far as I am concerned, NO one has made any viable argument for purchasing variable annuities within a 403b account. The simple goal of saving money has been overly complicated by the application of commission-based products that are entangled in an arms race style competition of who has the next best bell or whistle and can, with that bell or whistle, obfuscate the consumer.

 

We make money. We want to save it. We want to have as much as possible when we retire. That all there is to it. Forget the loan provision. Forget the annuity provision. If I want a loan, I take out a home equity loan. If I want an annuity, I'll take my money and buy one after I have shopped around for the best one. If I want a relationship, I'll go to my wife or my friends.

 

I issue a challenge to all the fee-based annuity advocates on the list. I want you to ask yourself the following question:

 

Let's assume that the extra fees for the revenue-sharing annuities and the M & E and other expenses add up to 3% (I know that is high, but some are lower and some are higher).

 

Your agent sits down with you, gives you advice, gives you great service and helps you set up you plan and does this annually. The only difference is this:

 

Instead of tacking the expenses on the account, all expenses are tacked on to your HOME MORTAGE PAYMENT. Same difference, but instead of the 3% buried in you variable annuity, your mortgage rate goes up from say 6% to 9% and since this is a new mortgage and you are just getting started, it lasts for 30 years. By the way, if you want to refinance, you can't for 7 years without paying a penalty fee.

 

My question is: are you still interested in the variable annuity even with the loan provision and ability to annuitize?

 

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Gad,

 

Not at 9%, however for 7% if it means you feel comfortable buying the house instead of renting it, I would. Also, most annuities are not costing the clients 3% extra a year. the differance is generally more like 1% to 1.5% in higher costs. True, if you skew the numbers and compare a Vanguard index fund to the most expensive annuities you can come close to 2.5%. However, if you compare the average annuity with the average no load mutual fund, the differnace is 1% to 1.5% in higher fees. With this stated I would still say the vast majority of people do not belong in a variable annuity inside or outside of a 403b plan.

 

Bill Mahoney

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Gad,

 

I believe it was Barnard Baruch who when asked about selling stocks recommended "sell until you can sleep at night." Investing is not a science. The right investment for one person is not necessarily the right investment for another.

 

I agree that in most cases annuities do not belong in qualified plans. However, there are some guarantees built into variable annuities, that might be necessary for some investors to sleep at night. For those investors, the higher costs are outweighed by the benefits derived from the guarantees.

 

One size does not fit all, when it comes to investing.

 

Mark

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And Bernard Baruch would say that if you need/want life insurance buy it outside of the investment product. Don't combine the two and then rationalize that one size does not fit all, when it comes to investing. Buying life insurance is not investing. If you can't sleep at nights maybe you just don't belong in the investment markets. PERIOD.

 

What is the insurance benefit of having an annuity inside of a qualified plan during the vast period of time when the account's market value exceeds the premiums? The return of premium death benefit is no longer in play so you are paying for a death benefit that will never be paid.

 

Moreover, a simple return of premium death benefit should cost no more than 1-10 basis points. Why does the average insurer charge from 75-125 basis points? GREED!! TIAA does not even offer a return of premium death benefit and charges 3 basis points for M & E.

 

Peace and hope,

Joel

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Joel,

 

I do not believe my post mentioned life insurance. I would never suggest that someone buy an annuity for the death benefit. It never has made sense to me. If they want to leave a lump sum to their heirs, term insurance is much cheaper, than the little coverage you get with an annuity.

 

I was referring to what are called "living benefits." They come in many flavors with many strings, however they basically guarantee an investor a return. It is similar to hedging a portfolio with derivative instruments. For some, and some is the operative word, these benefits make sense.

 

Mark

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Actually the main point of the post is to introduce what I call the clarifier:

 

Whatever the extra expenses are, would you be willing to add them to your mortgage instead of the investment product? Same bottom line, but a psychological shift. I believe this would help us decide whether or not the benefits of the products are worth it to us.

 

Thanks

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Gad,

 

Your premise is faulty; in that if you add the extra cost to your mortgage, you do not receive an extra benefit. However, if you buy an annuity with living benefits, you do receive an added benefit over and above a mutual fund investment.

 

Now if you changed he question to:

 

Would you incur the extra expense on your mortgage, in exchange for an agreement in which the mortgage company promises to pay your payments if you become unemployed? Now you have a better analogy.

 

Mark

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Mark,

 

Tomkoz gave us his example of "living benefits". I assume this is what you are advising for those that are averse to investing in the stock market. If john doe is averse to taking market risk I question his/her desire or ability to understand what "living benefits" is and how they work and, therefore, not a candidate for a variable annuity with "living benefits". But as you know there are prospects out there that will buy simply because they cannot admit to the shark that they do not understand the proposal and therefore will not buy the product.

 

Moreover, if the variable annuity had intrinsic value in a pre-tax account the insurance company would not have to think up additional ways to persuade the prospect to sign on the dotted line; i.e., "living benefits". In my view this is the insurance industry's admission that the annuity product has absolutely no place in a pre-tax account.

 

Peace and Hope,

Joel

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Joel,

 

Don't put words in my mouth. I am not advising anyone to buy an annuity with living benefits. I only said that for some people, they may make sense.

 

I was president of a small broker/dealer. I resigned in December. Occasionally, variable annuity wholesalers(salesmen who call on brokerage firms not individuals) came in and present their products. Frankly, since I am not that interested in VA, and I did not sell, I did not really pay a lot of attention to their presentations. However my general feel was that some of the products are not that bad. Some are more complicated than others. Since I did not pay that much attention, I can not recommend one over another, or even describe the product.

 

Also, let's not take the complicated issue too far. If a investor had to figuire the product out by reading the prospectus, many people would have a hard time. However, if a honest salesman understood and fairly presented the product, most people would be able to understand how they work.

 

I would agree that VA without living benefits have no place in a qualified plan. I would disagree that insurance companies developed living benefits to persuade investors to but them inside QP. In fact, they were developed in response to the bear market. For the past three years, investors were gun shy. The insurance companies came up with a product that would appeal to frightened investors.

 

I still maintain for some investors they make sense. Not many, but some.

 

Mark

 

 

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Joel said: "Tomkoz gave us his example of "living benefits". I assume this is what you are advising for those that are averse to investing in the stock market.

 

Mark, did you not say: "I was referring to what are called "living benefits." They come in many flavors with many strings, however they basically guarantee an investor a return. It is similar to hedging a portfolio with derivative instruments. For some, and some is the operative word, these benefits make sense."

 

 

_____________________________________________________

 

How is the above "putting words in your mouth"? In any event I apologize for the perceived slight.

 

Having said that, is not the guarantee that you allude to available only with the annuity? And the annuity's bread and butter fee is the ME fee. So in order for the policy holder to get what he wants (the guaranteed return via "living benefits") he has to pay for something that he does not want (the annuity).

 

Joel

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Having said that, is not the guarantee that you allude to available only with the annuity? And the annuity's bread and butter fee is the ME fee. So in order for the policy holder to get what he wants (the guaranteed return via "living benefits") he has to pay for something that he does not want (the annuity).

 

 

Couldn't Vanguard, TIAA-CREF and T. Rowe Price address this by attaching the "living benefits" (or guaranteed return) to their low-cost mutual funds? That way the consumer could have his/her low-cost funds AND the guaranteed return that an annuity might provide.

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Joel,

 

True in order to get the living benefit, the investor has to incur the M&E charge and the cost of the living benefit. For some, it may be worth the cost. For many, it is not.

 

In my opinion, mutual funds are too prudent to accept the risk of living benefits. In addition, if you had a mutual fund implement a hedging strategy, the hedge is expensive and the management fee would go up to compensate for the managing the hedge.

 

In my opinion, insurance companies are making a big bet that the market will be flat or up over the next ten years. If the US market should experience a long bear market, such as Japan's market did, most of the insurance companies would become insolvent. They are making the bet, because the living benefits have generate a ton of new money.

 

Mark

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As far as I am concerned, NO one has made any viable argument for purchasing variable annuities within a 403b account.

Here is the viable argument. The point is to MAKE MONEY!!!

 

You are missing one important point. I have my money in a variable annuity. It is in a managed account inside that annuity. Over the last 5 years my account EARNED after expenses 7.55%. Your account in a TIAA CREF equity index fund LOST -0.13%. Granted you paid lower fees than me. Lower fees for the privelege to lose money. Vanguard over the same time period lost -1.26%. Most sensible people are more interested in their returns than their expenses. I will be happy to pay fees all day long if at the end of the day my returns out perform the loser fee institutions.

 

Jim

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Jp:

 

Please note there is no correlation between between paying a commission/M & E fee and the return on the investment. The only fee that has a direct bearing on your investment return is the investment manager's fee. So you can see just how much more your return would have been over the last five years if you add on the commission and the M & E fee you paid.

 

Your analysis is faulty inasmuch as you are comparing your actively managed account to a buy-and-hold equity index fund. Surely the investor using TIAA-CREF/Vanguard was free to actively manage his/her account over the last five years.

 

What would your findings be if you used the equity index fund as a buy-and-hold investment inside of your "managed account"? That is the question. Please get back with your findings.

 

Peace,

Joel L. Frank

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Jim,

 

Given that today most seperate accounts are third party funds that are available outside of the annuity, it does not make sense to pay the additional expenses within the VA. For example, using your example, let's say your 7.55% return was derived from investing in seperate account A and B. If you invested in A and B outside of the annuity, your return would have been around 15%. Since ex living benefits(which we will assume are not associated with this VA), there are no substantial benefits derived from investing in the VA versus the underlying mutual funds, the investor should buy mutual funds versus the VA.

 

Mark

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