It is rare that I check out a book at the library and then end up wishing I'd bought it so I could keep a copy for future reference. Such is the case with The Truth About Buying Annuities by Steve Weisman, published in 2009. He is an attorney and lecturer at Bentley College in the Department of Law, Tax, and Financial Planning. What he has done with this book is nothing short of a miracle- he has made annuities understandable.
The Truth About Buying Annuities Overview
Most books about annuities and other investing-related insurance products are written by those with something to gain from their sale, so they're generally overly-positive about the merits of these products. Not so with this book. He puts forward nothing but the facts. If you own an annuity, are considering buying an annuity, or would just like to learn more about them, you must read this book.
The book runs 200 8-inch pages, split into 50 “truths” (chapters.) This is one of the strengths of the book. Each chapter can be read in less than 2 minutes and covers a given subject completely. It's like the high-yield books you read in medical school. He begins with the history of annuities, including the “tontine”, which was a combination of a wartime tax, a pension plan, and a lottery. As others who bought the tontine died off, your payments got bigger until the final person left received a huge lump-sum payment. Talking about incentive to murder!
He then moves into descriptions of each of the various types of annuities, differentiating between fixed and variable, immediate and deferred, equity-indexed, and inflation-protected. In each chapter, he points out the pluses and minuses of the product, and gives his recommendations on its use. I was surprised he wasn't more negative about equity-indexed annuities, but if you actually read all the downsides he clearly describes, I suppose you don't need to hear his negative opinion about them! I also found his recommendation against inflation-protected single premium immediate annuities (SPIAs) surprising. He feels the inflation component costs too much, and that you're better off buying a regular old SPIA and investing the difference in an index fund to provide inflation protection. Given how few companies offer inflation-protected SPIAs, and how many offer regular SPIAs, I suspect he may be right.
He discusses payout options for annuities in their many forms, and gives a fantastic illustration of how that affects your payout. For example, here is the monthly payout for a 65 year old Massachussetts man who bought a $100K annuity.
- Lifetime payout with no payment to beneficiaries: $672
- Lifetime payout with installment refund to beneficiaries (get at least what you paid back): $632
- Lifetime payout with 5-year term certain to beneficiaries: $667
- Lifetime payout with 10-year term certain to beneficiaries: $649
- Joint Life (100% to the survivor) $577
- Joint Life (100% to the survivor) with up to 15 years to beneficiaries: $572
Most importantly, he points out the relationship between each of the “bells and whistles” of annuities, and the higher fees. He is quick to point out the tax advantages of annuities, but also the fact that no annuity carries the tax advantages of a 401K or IRA, and so he recommends you max those out first. He also discusses the risks of annuities as compared to the risks of other investments.
Key Takeaways From The Truth About Buying Annuities
Some of my favorite parts of the book are where he points out when an annuity feature isn't nearly as good as the salesmen like to show. For example, the “death benefit” of annuities is not only severely overpriced, but also nearly useless for most people.
One product I hadn't heard of prior to reading the book is longevity insurance. Basically, this is a deferred annuity you buy at age 65, that doesn't start making payments until you're 85 (if you get there.) Because many of those buying this product die between those ages, the payouts can be quit hefty if you actually get there, over four times higher than a typical deferred fixed annuity (where your heirs would get something back if you died between 65 and 85.)
Throughout the book, Mr. Weisman reveals his true Bogleheadish nature to watch for fees and his preference for straight forward investments such as index funds. In the chapter where he compares variable universal life insurance and variable annuities he says this:
Variable universal life insurance policies are like luggage and herpes–once you get them, you have them for the rest of your life….The bottom line is that comparing variable universal life insurance policies and variable annuities is comparing two types of complex investments, where the best choice may well be to choose neither of them.
There is a great chapter on comparing mutual funds and variable annuities in which he concludes “Ultimately, the choice is clear. Mutual funds are a better investment than a variable annuity.” He also reveals why retirement age for IRAs, annuities, and 401Ks is 59 1/2, instead of some round number. (In insurance company actuary years, 59 1/2 is equal to 60.)
He does point out a couple of advantages to using annuities that you might not have thought of. First, you can use one to put money toward your children's retirement without it affecting their financial aid for college. The FAFSA doesn't consider annuities. A Roth IRA is better, but requires the kid to have earned income. Since there's no limit on how much you can put in an annuity, you can “shelter” a lot of money away from the FAFSA. Of course, if you can afford to save for your kid's retirement, you can probably afford to pay cash for their schooling. Second, like a 401K or IRA, an annuity can be protected from your creditors. The amount of protection varies by state, from no protection to complete protection (the book has a list of the protection available in each state.) California, Florida, Indiana, Louisiana, New Mexico, and Texas offer particularly good protections.
Should You Read The Truth About Buying Annuities?
He talks about annuity scams (hint, don't buy a deferred annuity if you're 90 years old), how to get out of an annuity, how to exchange it for another, and where to buy an annuity (from a mutual fund company like Vanguard or Fidelity.) Then he finishes the book with 37 rules, which are basically a summary of the book. You can learn more in 2 minutes about annuities by reading these rules than in spending 2 hours in the office of an annuity salesman. If you want to know the truth about annuities, I suggest you read The Truth About Annuities.
Check out additional book recommendations.
per amazon reviews (likely by insurance agents), the book omits topics on guaranteed income riders, which those reviewers seem to think makes the book outdated. I dont agree with that assessment but just thought id mention it. I clicked through a copy for my shelf. have 1/20th of a beer on me.
Lolololololol!
Ditto what Rex said about the reviews on amazon.
Nonetheless, am interested in the subject matter so thought that I’d add this to my reading list. Wade Pfau and the lifecycle finance people all think that Annuities have a real role in retirement finance, even though they have such a bad reputation. It’s worth learning more about.
I’d certainly trust Weisman over the opinions of the commentators on Amazon (who make money selling annuities).
A guaranteed minimum income benefit is just another “bell and whistle” added onto annuities. Who do you suppose is paying for that? I assure you it isn’t coming out of the insurance company’s profits. If you want a guarantee, you’ll pay for it with a lower return.
Thanks for buying through the site Rex. I know it doesn’t seem like much, but a few pennies here and a few pennies there adds up. I make about $100 a month from Amazon. That’s a tank and a half of gas….
I buy frequently from amazon. I try to remember to go there via a link here.
Here’s my view. Tax deferment is a very powerful tool. So our readers understand, you put money into the annuity after paying tax on your income. The annuity grows tax free. Then you take the money out of the annuity after 59 1/2 and pay tax on that money. The kicker is you don’t know what that tax rate is. I feel the power of this vehicle is if returns on your investment are high, like 8 or 9%. The reason you need such high rates of return is that the fees on the annuities come out to 2 or 3 % a year, or about 25-33% of your earnings. I think a better way to deal with an annuity to make something similar is to dump the money into a 529 under your name, let the money grow tax free, then take it out whenever you want and pay tax plus the 10% penalty. I’ll bet you this is better because you end up paying less with the 10% penalty verses the fee of 2 or 3 % a year. And you have that money growing tax free just like the annuity. And even better, you could use that money for your kids college as a super way of avoiding taxes when purchasing your kids education.
In summary, high fees on annuities/life insurance used as investments are VERY BAD, when rates of return are low in such as the environment we are in now. If you look over the past 12 years, the S and P 500 index has onl made about 2% / year with dividends, so holding it in an annuity would have made you lost money because of the fees. You would have been better using a 529 strategy such as ohio college advantage which uses low cost vanguard funds.
The salesmen never show you the math, you have to figure it out for yourself.
maybe ive gone crazy about this point but joe the annuity grows tax deferred not tax free.
while im in favor of 529s and HSAs, i think just going after tax investing is better at some point.
still your are right the sales folks dont show you the real math. Either they dont know it or they dont want you to see it.
I’m just a doctor, not an insurance salesman, so I just look at things purely at the math. It would be interesting to look at comparing paying the capitol gains of 15% versus the annuity and 529 with the penalties and seeing at what percent per year return what comes out better. Maybe someone could do the math. Also, what happens when the capitol gains rate goes up? But you are right, I used the wrong terminology, the annuity and 529 grow tax DEFERRED!
most of us are physicians. If you thought i was an insurance person, ill try not to take that as an insult.
I think wc has done the math on the annuity in one of his articles. Frankly the only good annuity is a SPIA at an older age.
With the 529 plans, my memory is that its close however assuming the penalties wont change bothers me a little since only people with a decent amount of money would try this trick and thus it isnt worth it to me to game it further. I have a 401k/ps and a defined benefit so taxable is where i want to be after those two, at least with current taxes. If i decide to buy realestate or something along those lines it also helps out that the money is more readily available.
I’ve run the numbers before, and I think a taxable account gets a bad name. Too many docs get “tax-o-phobia” which pushes them into bad investments.
Remember that with a 529, you not only pay the 10% penalty, but you also pay on all the earnings at your regular tax rate, not the lower capital gains and LT dividends rates. The tax-deferral aspect probably isn’t worth the additional tax and penalty costs.
As far as a variable annuity, a case can be made for a very low cost variable annuity if you want to invest in a highly tax-INefficient asset class (REITs, Bonds etc) AND your 401K/IRAs are already full of highly tax-inefficient investments. Personally, I’d probably choose munis over a VA for bonds (at least at current rates), but there is an argument there.
I think you make a good point with stocks. I wonder as the long term capitol gains rate goes up whether the argument for the 529 gets closer.
How about whether holding a us treasury in a bond fund versus using the 529 as a tax deferral vehicle. I wonder where the 529 would become advantaged? Have you done the math on that? Remember, tax free growth can be a powerful instrument especially at high yearly rates of return.
The math isn’t all that tough on these things. Let’s look at the taxable bond fund first (although I suspect the winner in this scenario for a doc would be a high-quality muni fund). Let’s assume a 40% marginal tax rate. Vanguard LT Treasury Fund currently yields 2.16%. After tax, that would grow at 2.16%*0.6= 1.3% per year. After 30 years (obviously assuming no change in interest rates over that time, which is unlikely), $10K would grow to $14,732.
Inside the 529, the fund would grow at 2.16%, so after 30 years you’d have $18,986. You’d pay $1897 as the 10% penalty, and you’d pay 40% of $8986 ($3594) in taxes leaving you a total of $13495.
You’re better off in the taxable account.
Incidentally, if you chose to invest in the Vanguard LT Muni Fund, interest rates stayed the same, and there were no defaults, you’d be looking at $20,311.
another reason to go taxable is that it diversity to the tax situation meaning if income tax rates go up but capital gains stay the similar then it increases the advantage. Many of us who are investing wisely for a long period of time might not go down in tax brackets in retirement.
On a slightly similar note, I used to work with annuities, mostly servicing the currently existing contracts.