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An IRA and a Variable Annuity

Question: I'm 61 and will work until 65 or 66, unless my employer decides otherwise. My financial advisor is recommending that I put my IRA into a variable annuity for about 4 years, as I can get a guaranteed 5% return if the Market goes down and a better return if it goes up. The fees of the annuity plus the 1.3% fee the advisor is charging now would raise the annual management fee to 2.8%. I ran the numbers and his suggestion makes seems to make sense if the Market does go down for the next 2 years or more and I start taking money out at retirement.

The IRA is about 37% of my current retirement savings, I'm putting 19% of my income into my 401K at work, and pension and social security are expected to replace ~34% of my current income (no adjustments for inflation) if I stay employed until 66. Does a variable annuity make sense for me? Gary, Omaha, NE

Answer: I can't stand this tactic. The fundamental reason I dislike it is that an IRA is a tax sheltered account. A variable annuity is also a tax sheltered account. Therefore, you're wasting valuable tax shelter with this maneuver--and taking on huge fees at the same time.

The Financial Industry Regulatory Authority (FINRA), is the largest non-governmental regulator for all securities firms in the U.S., overseeing more than 5,000 brokerage firms, about 172,000 branch offices and more than 676,000 registered securities representatives. It periodically issues "Investor Alerts" and one was on variable annuities. In its typically cautious language, here's what FINRA has to say about the recommendation to mix together a variable annuity and an IRA:

"Investing in a variable annuity within a tax-deferred account, such as an individual retirement account (IRA) may not be a good idea. Since IRAs are already tax-advantaged, a variable annuity will provide no additional tax savings. It will, however, increase the expense of the IRA, while generating fees and commissions for the broker or salesperson."

You can read the whole investor alert at www.finra.org/InvestorInformation/InvestorAlerts. It's called "Variable Annuities: Beyond the Hard Sell." The bottom line: Don't do it.

03/31/08 by Chris Farrell

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Equity Investment Life Insurance?

Question: Chris---We have recently been advised by a financial consultant to begin to invest in an Indexed Universal Life Insurance Contract, also called an equity investment life insurance policy. After reviewing our financial situation with retirement in mind, the advisor told my husband and me, 55 years and 58 years of age, respectively, that we should stop putting our discretionary income into the qualified plans that we both have at work. He argues that we have enough in our qualified plans to maintain our current lifestyle and that we should begin to look for investments that shelter income from taxes for the future. The vehicle he suggests is an "equity investment life insurance policy". He argues this vehicle is a "Roth look-alike" and will allow us to grow our investments tax free, including the earnings that accrue in the account, and it will be tax free when it is withdrawn. The theory is that because tax rates will continue to grow higher, it would be better for us to be paying the taxes now on the money rather than after we retire, as current tax rates for us likely will be lower than future tax rates. Since our qualified plans defer taxes, he argues we have more tax deferred income than may make sense for us. The type of vehicle he suggests would have a cap on how much it would earn in a given period of time but it will also not go below the start level in any given year..... So, for example, we might buy a policy for $500,000 which would then have a monthly fee associated with it. He argues that we should not be overly alarmed by the monthly fee which includes all fees for transactions, etc. He argues we are paying mutual fund companies plenty of fees and the fees associated with this vehicle won't be higher than the total we're already paying various mutual fund companies.

We are cautious people and will not rush into any major change without thoroughly investigating its pros and cons. I told the guy we'll seek multiple points of view, as he will make his money from selling us on this product. Any guidance you can provide will be appreciated. Greg and Carol, Minneapolis

Answer: I'm not a fan of these plans, although they are a niche product that can work for some people. The fees are high (much higher than equity index funds, bond index funds, Treasury securities and the like). The equity formula is a complicated black box, which runs counter to my "keep it simple" mantra. And you can limit your downside portfolio risk through diversification, inflation-protected securities, and the like.

If it were me, and if I had the assets you have, I would hire a fee-only certified financial planner to look 1) at your overall financial situation and 2) evaluate this policy proposal in light of your assets, liabilities, goals and desires. Yes, a CFP isn't cheap. I could be wrong, but my bet is that she'll come up with a more cost-effective way to build a conservative portfolio.

04/10/08 by Chris Farrell

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Switching Life Insurance Plans?

Question: I am a single, 40 year old woman, no dependents. I got a New England Life Insurance policy about 13 years ago - not for a payout if I die prematurely, but as a way to save money for retirement. I have someone who has been helping me invest my money for these past 13 yrs. but recently sought a second opinion. This second opinion wants to take my money out of my current company and put it with Northwestern Mutual Life. I will lose $286 in a transfer fee, which isn't a big deal if it is a smart move. I will also lose ground as I am now 40 and will be paying a higher 'mortality rate' (using the wrong term but I hope you know what I mean). The man who recommends this move says Northwestern Mutual is such a superior company that the long-run benefit will overcome the short-term loss. What should I do? Thanks - Marti, Chicago, IL

Answer: For most of us, the main reason to own life insurance is to financially protect a loved one from our untimely death. That's usually a child, but it can be a parent or a partner. (Life insurance also plays a critical role in the estate planning of the wealthy.) Although you're accumulating savings, life insurance is not an especially efficient or cost effective retirement plan. It pales next to a 401(k), 403(b), IRA, Roth-IRA and other retirement savings plans--or just building up savings in taxable accounts, a home, and other alternatives. There's no rush, but I would go through your finances and see how life insurance fits into your overall plan, and decide whether it makes sense for you to keep a policy or not. It's dated, but I still find it a useful introduction to the topic is "Smarter Insurance Solutions" (Bloomberg Personal Library) by Janet Bamford.

That said, I'm concerned about this specific proposed shift. Your concerns and questions are legitimate. New England Life is a good, reputable company. It has a AA/stable rating from Standard & Poor's, the rating agency. Northwestern Mutual is an excellent company with an even stronger balance sheet at AAA/stable. Still, New England Life is no fly-by-night operation. It has a blue-chip balance sheet. (If it didn't my advice would be different.) You've owned the policy long enough that you're now really getting the benefits of the savings component. My fear is that this shift is not to your financial benefit but to improve the commission earnings of the "second opinion".

That's my worry. One quick, cheap way to check out whether this move makes financial sense for you is to contact the Consumer Federation of America. It offers a life insurance evaluation service. You can find the details at here. The service helps insurance consumers decide whether to buy a cash value policy or term insurance, decide among two or more cash value policies, and whether an existing cash value policy is worth keeping. The cost for the analysis is $70 for the first illustration.

04/17/08 by Chris Farrell

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HSAs

Question: My employer is switching from a high-deductible health insurance plan to a traditional plan. I have accumulated enough in my HSA to be able to invest it in Wells Fargo mutual funds, which my employer provides along with the insurance. But with the switch I will no longer be able to add to the funds, and Wells Fargo will begin to charge me an account fee every month. What can I do with my HSA money? Andy, Ankeny, IA.

Answer: You're in a good financial situation. With your Health Savings Account (HSA), the contributions were made with pretax dollars. Withdrawals are tax-free as long as the money goes toward qualified medical expenses, which include everything from acupuncture to organ transplants to quit-smoking programs.

Your account remains tax sheltered. The only restriction is that you can't make new contributions. But you can always tap the account to pay for qualified medical bills that aren't covered by insurance. Better yet, if you don't need the money, it will compound in the account over time. You can then make tax-free withdrawals to help defray medical expenses in retirement. After all, Medicare pays for at most half the average retiree's health bill now, and most forecasts say that percentage will shrink.

One other point: As the sums in HSAs grow, more and more people are interested in managing the HSA for long-term growth. Instead of keeping the money parked in a low-risk bank money-market account, as is typical, some of that money is finding its way to equity mutual funds for the long haul. You could keep the money in the mutual fund accounts you have with the Wells Fargo managed HSA or you could roll it into another financial institution, too. (There can be restrictions, so check out the rules with your plan.)

05/13/08 by Chris Farrell

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