Annuities & whole Life versus 2-RMDs

To save or not to save? That is the question for your future. Where to invest your savings is another question, and the financial industry has many answers that pay them well. In that regard, the recent deregulation of the DOL’s “Fiduciary Rule” was a mistake, as it negatively impacts participants in 401k plans and I should know as I oversee administration of 5,000 of them. In addition, outside of retirement plans, Brokers/agents and insurance companies are freer to sell annuities as retirement vehicles with impunity. I am sure the insurance agents that follow me will be indignant with what I am about to write, but I have a point to make that doesn’t get said very often. After all, I was an agent once, for four years, and presented the annuity and life insurance projections that the companies produced to make a sale. The Wall Street Journal did an article last month on how the projections on universal life policies haven't worked out, and the policy holders are under water and can’t pay the increasing premiums because of under performance.   

   Buried in the fine print, annuities often pay sales people 6% commissions and contain continuing expense ratios of 2%----rarely paying out more than 4% as income----and half of it is your own money; and the other half is taxed. The companies point to their guarantees and triple A ratings; but the fact is AIG, Metlife and others had to be bailed out in 2009, or they would have gone busted, along with 74 million annuity policies. I believe a better alternative is taking a 4% payout by investing in a Vanguard short-term Treasury bond fund(if you can’t take any risk) and then gradually selling off the difference between the 3% current yield and the 4% that you need. That way, your money will last until age 110 if you retire at 65; and if you die along the way, your heirs will get what’s left in the account; with an annuity they usually get nothing. However, if you must have an annuity, the ones at Vanguard are the best, because they pay no commissions and the expense ratios average 60 basis point. Fidelity also has some good no-load products. With the revocation of the Fiduciary rule, annuity options can now be imbedded in 401k plans; all I can say is caveat emptor. Nevertheless, a worse retirement investment than an annuity is whole life insurance, which combines death protection with an investment account, and usually pays out 100% in commissions the first year of the policy----that is the primary reason it is sold. Usually, there is very little cash value for the first ten years and you will never compound a savings account in an insurance policy that will match buying and holding an index ETF, or a treasury bond fund. Although, insurance company projections make everything look wonderful using aggressive assumptions of return. That said: the first investment every breadwinner should make is to buy life insurance equal to five times their annual income, in order to protect their families until the kids are grown: protection that is accomplished very cheaply with term insurance, the more the better. For example, 200k of coverage costs a 22-yr old about $200 per year for a 30-yr term policy; and $1200 for a similar whole life policy. Now compound the 1,000 difference at 6 or 7% over 30 years in an index fund and you will end up with twice the savings account at the end, not to mention having the coverage while you need it. After the children are grown and on their own, you don’t need the insurance, so why pay for it? Albeit, you can self insure by just saving.

  In any case, that is my financial projection and you should consider all of the alternatives. Another thing to think about is the risk of running out of money after you retire, which is the only positive argument associated with owning an annuity. However, with my strategy you are good until age 100 for sure, and running out is a risk you can afford to take the closer you get to your life expectancy, at which time you can allocate more to the stock market, which you shouldn’t do when you start drawing down your account at age 65. And, consider the timing of the risk…………if you work into your 70s and don’t have to draw on your savings until later, your account will grow bigger. At 80 or so, your risk of outliving your capital is greatly reduced due to the preservation of capital gained by working longer. You could draw 7% and live in style until 100; if you eat your veggies and exercise regularly. Think of the legacy value: you could leave your 70-yr-old children an extra retirement account and two RMDs to live on(theirs and yours). (RMD = required minimum distribution; i.e. see IRS publication 590B for details)