Tag Archives: Stock Markets

Why I Dislike Annuities

The following is an excerpt from Tom Ruggie’s book, “Ruggie Rules – for choosing and working with a financial advisor.” If you would like to learn how to obtain this excellent resource, click here.

3DBookWhy I Dislike Annuities – by Tom Ruggie

How you pay someone to give you advice or manage your investments speaks volumes about whether that advice best serves the advisor or you. If product sales are mixed with advice, the potential for conflicts of interest increases, and objectivity may be compromised.

Annuities have lots of bells and whistles that make them sound appealing to many investors, but when you truly evaluate these contracts, you find that most investors do not realize what they are giving up in the form of fees, lack of return, liquidity, or income design to get these benefits.

That’s only the start of why I dislike annuities. Annuities are cost-prohibitive, not easily understood, and oversold, especially to retirees.

  • They are cost-prohibitive because they generally carry larger internal costs, which reduce performance for the investor.
  • Their promises of principal protection and guaranteed income streams sound alluring, but when you look under the hood, many of these products fall short of even modest expectations.
  • Annuities are often misunderstood because they are fairly complex instruments. I’ve read hundreds of annuity brochures, prospectuses, and disclosure documents, none written in plain English. I’ve actually had annuity salespeople who sell significant amounts of annuities not be able to properly explain to me all the details within the annuities they sell to their clients. Scary, right?
  • Many annuities are sold for their “guaranteed income benefits,” which can increase regardless of market direction. That sounds good, right? The illustrations do a good job of showing the ‘growth’ to your future income, but what is often left out are the realities of these products’ capabilities.

A few examples of how annuities become expensive are shown below; it isn’t surprising for us to see annuities where most, if not all, of these apply.

  • Participation/Index Rate: The actual percentage of the underlying index’s return that an annuity holder earns. A participation rate of 50% means that you only get half of the index’s return.
  • Performance Cap: The maximum percentage of the index’s return that you are credited. If the market is up 10% but you have a cap of 3%, then you can’t earn more than the cap, regardless of the excess, which is kept by the insurance company.
  • Market Value Adjustment (MVA): A monetary adjustment to the annuity’s cash value that applies when you withdraw funds in excess of the “free amount.” The MVA is a mechanism whereby the insurance company passes on its interest rate risk to contract holders. When rates rise, the MVA is negative; when rates fall, it is positive. In many contracts this MVA can apply even after surrender, so many people are stuck even after they’ve had their money tied up for years or decades.
  • Then there is the “guaranteed income or living benefit,” the mother of all pie-in-the-sky arrangements. Here, the insurance company promises to increase your contract’s future income capability at a certain rate each year; often the lingo used can give you the impression that you’re ‘earning’ a certain rate, but in reality this is not real money that you could walk away with, but rather a level of funds from which you can draw on an annual basis at a specified distribution rate at a future point. This, too, is sometimes painted to be a rate of return; for example, “This annuity pays 7%.” In today’s low-interest-rate environment this isn’t likely to be the same as if you had a CD that pays 7%. Both are unicorns, by the way. Rather than a rate of return, this is a distribution rate, meaning the rate at which you can receive payments from your account from its income benefit base.
  • In theory, it sounds appealing for your income ability to increase over time and for you to be able to draw a guaranteed amount of funds. However, consider the fact that, when it comes time to distribute funds, the insurance company will first return to you your own money at a particular distribution rate and that, in reality, you’d have to live a very long time to (1) Get back your own money, (2) extract the full value of the “income base,” and (3) recoup the costs you paid for that benefit. The good deal falls apart.

Perhaps the biggest fallacy in annuity sales is that you can have your cake and eat it too, which is to say, your annuity contract can give you market-like returns without market-like risk. Yes, some index contracts can allow you to participate in some of the upside of an index, such as the S&P 500, but how much of that index are you likely to earn?

All that being said, in a few situations annuities could make sense, and there are “fee-based” annuities available, which lower the cost to the purchaser, thereby enhancing the ultimate return the client receives. However, because these don’t offer big paychecks for annuity salespeople, they’re hardly ever the products of choice, even when one would hypothetically make sense for a consumer.

Click here to learn more about “Ruggie Rules.” You can also give us a call at (352) 343-2700 to set up a consultation. We look forward to meeting you and answering any questions you might have.

It’s Not Always A Good Idea To Rollover Company Stock

RWM couple advisorIt’s true, it is not always a good idea to rollover company stock from a 401(k) plan to an IRA. In fact, doing so might mean you pay more in taxes to Uncle Sam than necessary.

If company stock held in an employer-sponsored 401(k) plan has appreciated, the difference between the amount paid for shares (the cost basis) and the current value of those shares is known as net unrealized appreciation (NUA). For instance, if an investor paid $10 a share for 1000 shares ($10,000) for stock that is now worth $15 a share, then the investment is worth $15,000, and the NUA is $5,000.

If the shareholder completes a rollover from a 401(k) plan to an IRA, those shares of company stock will be liquidated, along with the other assets in the account, and moved to an IRA where the assets will have an opportunity to continue growing tax-deferred. When the assets are distributed from the IRA, they may be taxed as ordinary income. If the investor is in the 28 percent tax bracket, the taxes owed would be about $4,200.

There is an alternative that could be a better choice tax-wise. An investor can request company stock be distributed in-kind and sent to a taxable account. The stock is not liquidated. The shares are moved to the new account. The investor may owe ordinary income taxes (and penalties if he or she is not yet age 59½) on the cost basis ($10,000). However, the net unrealized appreciation ($5,000) will not be taxed until the shares are sold. Taxes on the cost basis would be about $2,800.

If the investor takes a distribution right away, and the shares have been held for more than one year, the proceeds may be taxed at the long-term capital gains tax rate, which is currently lower than the ordinary income tax rate. If the investor is in the 15 percent capital gains tax bracket, another $750 would be owed in taxes. In this example, the investor could save about $650 in taxes overall.

Please keep in mind this is a hypothetical example and is not representative of any specific situation. Each investor is unique and your results may vary.  Executing an NUA strategy seems pretty straightforward, but it can be tricky, and not everyone is eligible. If you would like to learn more, please give your tax professional a call.

* This article first appeared in our weekly email newsletter. To subscribe to the Ruggie Wealth Management Weekly Commentary email [email protected] or call us at  352.343.2700