Daily Speculations
The Web Site of Victor Niederhoffer & Laurel Kenner
Dedicated to the scientific method, free markets, deflating ballyhoo,
creating value, and laughter;
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Daily Speculations The Web Site of Victor Niederhoffer & Laurel Kenner
Dedicated to the scientific method, free markets, deflating ballyhoo,
creating value, and laughter; |
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Q&A With Friends of Victor Niederhoffer: Annuities
04/13/2004
| Q.
A woman I know whose husband
is confined to a nursing home with Alzheimer's has a
large amount of money in a muni bond fund at Dreyfus.
Out of the blue, she gets a call on Thursday from a
broker strongly recommending putting the money into an
annuity which pays 2.85% with a first-year additional
bonus of 1%. His reasoning for switching to an annuity
is that interest rates are going up and her principal
will disappear. He asked no questions about her
financial health or anything about other assets she
might have. Of course the rate is totally enticing and
the paper work arrived the next day by overnight mail. My feeling is that the guy is looking for a sale. Paying commissions is fine if the advice is halfway decent, but isn't an annuity for a 74-year-old with huge cancellation fees a little absurd?? I just think with so many investment vehicles to choose from, an annuity has to be the worst possible idea. I want to tell her to invest in anything but an annuity. I'm not writing for investment ideas (although they would be quite welcome), but rather to get a feel for whether my position on the subject of annuities in this case is wrong. |
| A.
Art
Cooper: His reasoning for switching to an
annuity is that interest rates are going up and her
principal will disappear. His "reasoning" may be that interest rates are going up and her principal will be thus impaired, but his "reason" is to get a commission. If the rationale behind such a switch is an upcoming increase in interest rates, the obvious answer is to decrease duration, or even move to a muni bond money market fund. Buying an annuity for someone in her position seems on its face wildly inappropriate. Mr. Cooper manages and trades a corporate pension fund. |
| A.
Dick
Sears: I'm not up to date on annuity rates, but I
would have thought a 74 year old woman could expect a total return (interest plus gradual diminution of principal) on the order of 8% to 10%. If her munis are long-term bonds and she's worried about interest rates going up, she could sell now and park the money temporarily in CDs or such, but it doesn't make sense to buy an annuity when you think interest rates are going up. An annuity is just one more form of long-term fixed income investment. If you wait until interest rates have already gone up, you get that much better a return on the annuity when you do buy. Many individual life annuities (especially those that prompt salesmen to make cold calls) carry huge commissions, which means you're throwing away a significant portion of your principal when you buy. It also means an incentive to the salesman that may overwhelm his concern (if any) for the customer's best interests. Bottom line, 2.85% doesn't make any sense to me, but it's hard to know what's going on without seeing the actual annuity product. For instance, maybe it's inflation adjusted and has large death benefits, but even so it seems way too low. With 0% interest (and no commissions) , you'd expect a return for a 74 year old woman to be at least 4% and probably closer to 5%. If you assume she won't live past age 99, that's 25 years, so you can pay out at least 4% a year. Maybe 2.85% is the underlying interest rate on which the annuity return is being calculated, in which case the total return to her should be on the order of 7% or 8%. If so, it's more palatable. An annuity can be a good solution for someone in her position, because it means she doesn't have to worry about outliving her income, though she would have to worry about inflation. Another worry is the underwriter's solvency, though most states now provide insurance up to a point. But the way to buy an annuity is not in response to a salesman's call. There are annuity brokers who charge minimal commissions and track the current offerings of all the major writers, so that the individual gets the best rate available. |
| Mr. Sears is a retired managing partner of a leading actuarial firm. He runs a Web site, www.gtindex.com, that offers a weekly market commentary and tracks technology guru George Gilder's stock picks. |
| A.
Tom Ryan:
Of course it depends on many issues. Are they
living off the interest, or are they dipping into their
principle routinely. There are also tax implications and
not knowing more about the annuity product I can't say much more. We had a similar situation with my mother's (85 years old) account this January as we wanted to shorten her duration in her bonds. She replied that what the hell did she care she wasn't dipping into principal anyway but we convinced her to shorten up a bit and move from Vanguard Muni Bond Int Term, which was about 7 years, to Vanguard short term which is about 3 years, and took some of the capital gains (another tax issue) and stuck it in her money market account to make up for the lost interest and so that she could continue to pay herself the same income each month for the next 18 months or so, figuring that after the bonds correct a bit we can move back the other way and lengthen her duration again. So I guess it all depends on the person and their situation. She also is better off on income now that her stock dividends are not taxable so that helps too. BTW John Kerry is going to get blasted by the retirees if he gets elected and tries to repeal that dividend tax change. That one very popular with the folks at my mom's place. |
| A.
J.A.B.: My answer is generally that a
laddered muni portfolio is a pretty good, low maintenance idea--especially in a rising interest rate environment--for a high net worth person who doesn't want to be active in managing their portfolio. |
| A. Kurt Specht: One other additional point, on the use of overnight delivery vs. U.S. Mail. This is often a red flag. No chance of prosecution via mail fraud if U.S. Mail is not used. I would read all the fine print on this one and find out how much the broker makes on the deal too. |
| A.
G.Z.:
The phone call would open the door to wire fraud, but that is a minor point compared to all the others. |
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