Had a chat with an acquaintance a few weeks ago regarding a 1035 exchange (tax free) of 3 annuities purchased in 1982 and 1992 into Fidelity's annuity product. The annuities were purchased by the parents at: 2 x $10,000 and 1 at $35,000 cash, at the time. All 3 are straight forward annual interest rate paying with the
average minimum (via contracts) of 4.83%.
Obviously, through the about 30 year time frame, these annuities have a grown to a decent amount of value and way past the "surrender charges period".
NOTE: the overriding consideration for this exchange is to consolidate their investments to one house, being Fidelity.
A few rough overviews of Fidelity's annuity product, for those not familiar (links below):
--- Cost = the expense ratio of the invested fund + .25%
--- Investment choices = 55 funds
--- The VIP funds are not exact duplicates of holdings related to the retail product, but close enough
http://fundresearch.fidelity.com/annuities/category-performance-annual-total-returns-quarterly/FPRAI?refann=005https://www.fidelity.com/annuities/FPRA-variable-annuity/overviewSo...... 3 existing annuities averaging 4.83% yield annually, set by contract minimums; 2 x 4.5% and 1 x 5.5%,
WITHOUT annual fees as expressed in the original contracts (knowing the insurance company was banking on making enough money from the cash paid for the annuities to be able to pay these rates and still make a profit).
Regarding the move to Fidelity, the following would have to be overcome as a break even scenario:
--- the 4.83% current return + .25% (Fidelity annual annuity fee) + average underlying fund E.R. of .83% =
5.91% annualized returnAn investment consideration I expressed is to build a moderate allocation. An example from fund choices available would be a 50% to Contra or Growth and a 50% to Investment Grade bonds mix. The total effective E.R. would be about .83%, which includes the .25% annual fee. My favorite push would also include the healthcare fund within the equity mix to 25% to Contra or Growth and 25% in the healthcare fund; with the remainder 50% into the IG bond fund.
With the above, one might hope to surpass the "break even scenario" above by 1%. At the least, barring a market melt lasting for several years; one would likely at least maintain an equal return versus the "original" annuities.
Summary for this person/spouse: They have sufficient income streams in retirement, being: SS, traditional and Roth IRA's, defined benefit pensions from previous employers. Also, their debt ratio is near 0%; with the only affect on this area is ongoing normal expenses for auto/home insurance, food, real estate taxes, utilities.....the normal stuff, eh? They have Medicare and supplemental insurance. Their net worth is at the low 7 figure range. So, this annuity switch is not critical to their maintaining adequate cash flow to keep them from falling off of the edge of the "don't have enough money" abyss. Consolidation of accounts is the main driver here.
As
@VintageFreak details, am I missing something critical here with my
ANALysis?
Lastly, as an interesting side note. Having a brief opportunity to review the original contracts and a few statements from the 1990's; I found that the annual yields paid on the annuities was around 7% for several years. 'Course, during the 80's and into the early 90's interest rates were high by today's standards and one could obtain a high yield from a standard money market account. I recall MM yields to be near 18% for a short period of time when the Fed. banged hard on rates to "kill" the inflation rate at the time.
Thank you in advance.
Catch
Comments
- not all VIP funds are clones, e.g. VIP Contra is team managed - 10 managers, none of them being Danoff.
- I think TIAA is better than Fidelity (slightly higher cost, dropping to 10 basis points after 10 years) with much better/cheaper underlying fund options, and I find Vanguard better also, albeit with more limited (but obviously less expensive) underlying fund options.
Well, I be hav'in lots of sticks in the fire today; including during the write.
Now doing the lunch break..........and maybe should have a nap, too.
Okay, the combined annuities yield 4.83% annually. This would be the first return hurdle to jump.
Fidelity's annuity fee is .25%/year and is return hurdle two.
The Fidelity fund choices I noted have a fee average of .58%, more or less; and would be the third return hurdle to over come.
The add math on these 3 is 5.91%.
This is the return that would have to be matched annually, using Fidelity, to at least keep "even" with the existing annuities return.
Anything above 5.66% return would be the bonus area.
Thank you, Tony; and let me know if I've gone off the track with my view of this.
Regards,
Catch
It also says that unless you can beat 5.5% net return, it doesn't pay to exchange the larger contract. You expressed a desire to beat this return with a moderate portfolio. FWIW, many "experts" project lower returns over the next decade, both in stocks and bonds, so this may actually be a high goal to meet. Remember too that you're comparing a 5.5% certain with a speculative return. In addition, should interest rates soar (not likely, but ...) the present annuity could return more.
All that said, since your focus is on annuity costs, IMHO you should use the Vanguard annuity as your reference. There, many of the funds have a lower combined annuity+fund ER expense of 0.45%; such funds include Vanguard's total stock market index and total bond index.
Be careful that you don't double count. If you were looking at a mutual fund outside of an annuity and wanted to beat 5.5%, you'd just look at the net return of the fund. Say you're looking at an index fund with a 0.10% ER. Saying that you need to beat 5.6% (5.5% + 0.1%) means that the underlying portfolio (i.e. the index) would have to beat 5.6%. That's not the way people usually look at funds. If it works for you, that's fine. Just be sure that you're not setting the bar too high by comparing the net fund returns with 5.5% plus expenses.
The Vanguard annuity returns posted by Vanguard incorporate the 0.45% or so combined fees, so you're seeing the net returns and you can compare them directly with your target 5.5%. Likewise, the Fidelity annuity returns are net. (Fidelity has multiple annuities with the same VIP funds, so you need to be careful that you're looking at the returns for the fund within the chosen annuity.)
FWIW, here are the Vanguard VA funds' net returns:
https://personal.vanguard.com/us/funds/annuities/variable/bytype?View=PP
The prospectus for the Fidelity annuity you're looking at (Personal Retirement Annuity) says that the share class used for the underlying funds is "Investor Share Class". VIP Contra's Investor share class ER is 0.71%. VIP IG Bond's Investor share class ER is 0.45%.
http://fundresearch.fidelity.com/prospectus/annuities?product=FPRAI
The unweighted average is 0.58%. Add to that the annuity's 0.25% and you get 0.83%. You seem to have added in the 0.25% a second time.
Also, multiplying 2 x 4.5%, adding 1 x 5.5%, and dividing the result of 14.5% by 3 to get 4.83% ignores the difference between $10,000 and $35,000.
It's the same reason why, in a prospectus, they add the individual expenses to get the total ER of the fund, rather than multiply them all together.
Thank you for your inputs.
I did adjust what I had as a 5.91% return to a 5.66% as I had not averaged ER's properly.
And yes, I know these are assumptions regarding forward returns versus back looking at the life of, 10 yr, 5 yr, 1 yr and YTD data.
The "couple" realize that 4.5% and 5.5% by today's standard are pretty decent returns without investment decision risk taking; aside from the insurance company going up in smoke.
I'm sure the insurance company may not mind not having to "fund" these anymore; as they scramble to obtain returns in the current investment climate to support these older annuities with the contracted interest rate floors.
Take care,
Catch
You asked: "Not everyone should or should want to be 100% in stocks/ Other than the annuities what financial assets do they own?"
>>> It wasn't expressed that they are 100% invested in stocks. As to the "other" you ask about; this list is considered financial assets relative to their current and future cash flows/income/access to money:
---Social Security (Cost of Living Adjusted going forward, although not much since the market melt)
---Pensions (no C.O.L.A. provisions; so these assets have declining purchasing power going forward)
---IRA's, both traditional and Roth
---debt free; own primary residence, 2 vehicles and all other personal items
An overview of their financial assets have the following considerations, as to "investment sector"; although others may not agree with the pseudo classifications:
Social Security, pensions and the aforementioned annuities are considered "bonds" for purposes of their overall portfolio.
The IRA's currently contain about a 50/50 mix of equity and bonds.
Hopefully, this information answers your question.
Regards,
Catch
I cannot comment on your "friends" situation, but I do invest in the FPRA, and the underlying funds can fill voids in a portfolio than cannot be filled elsewhere (IRA, 401(k), etc.). I currently invest in the Templeton Global Bond VIP fund, and I am overall satisfied!
http://quote.morningstar.com/fund/chart.aspx?t=FVUSA000TW
If you have the annuity because you've maxed out other tax-sheltered options, and you've got over $100K in the annuity, you might consider Jefferson National's Monument Annuity. It charges a flat $240/year, which is less than 0.25% for a $100K+ portfolio. It also carries the same share class of Templeton Global Bond VIP fund.
Note: Jefferson National was just acquired by Nationwide, but still seems to operate somewhat independently. Consequently its credit ratings have been upgraded (they were quite poor), though still below Nationwide's. I'd still be hesitant about annuitizing or otherwise relying on the creditworthiness of Jeff Nat. But it should be safe for segregated accounts like VA funds.