Why annuities make sense in this market

What recent events have reinforced to me is that you want to diversify your holdings if at all possible, and generally try to stick to what works. Hedge funds were hot as were some local money managers, however in all but a very few cases this market has humbled even the most veteran traders… How the mighty hath fallen. So what does that leave us, where do we turn?

Treasuries at 2%? Do you want to investing in an entity (the government) that is overburdened, overleveraged, printing money at an absurd pace, miss-stepping, and frankly I believe posses significant credit risk ? If I ran my personal financial situation (or yours) like they do I most likely would be put in Jail.

CD’s at the bank? Again 2% to maybe 4% at best if you give them a lot of money and they like you (IE you give them a lot of money.)

Savings or money markets? Same deal at 2% plus these are starting to have credit risk as well, not to mention that you only have a 250K guarantee.

Munis ? Laddered munis can be attractive especially for the high tax bracket investor, but credit risk is seeping in there as well, tax equivalent yields can be OK here, but many of us are a bit light on the income currently thus in a tax bracket that does not indicate the use of Muni’s. I belive interest rates are going to go up, and that they are being held artificially low. Demand destruction in Treasuries from lack of Chinese and international purchasers will eventually take its toll. Muni’s carry both interest rate risk as well as credit risk currently.

So what is the solution for the Aspenite on the go without time to be constantly glued to the depression channel (CNBC)?

For many a good solution to consider may come in the form of Annuities, or for those of us still lucky enough to be in a high income tax bracket, Fixed Defined Benefit plans.

I know, I know, some annuities blew up in the 80’s. Well so did Ford Pintos and you probably own a car now, correct? The contracts that we have today generally offer several types of guarantees, most of which can be combined in one fashion or another, this is in addition to the intrinsically attractive tax deferred nature of annuities.

Three of which are the most common, Living benefit or income guarantee, Death benefit guarantee, or what is called a step up.

With a living benefit the annuitant (you) gets a guaranteed rate of return for some period of years, usually 10. Some of these can guarantee up to 7% simple interest, net of fees. The flip side of this is you are required to give them your money for a period of several years, if you take your money out there will be penalties and fees, also note the IRS will asses a 10% penalty if you remove this money before age 59 ½. So they are not short term or liquid investments and the primary risk is the insurance company going out of business. You can take this money out for your use during retirement or use as a Living Benefit.

The death benefit is structured very similar however the guarantee goes towards a death benefit as opposed to an income benefit. People who choose this option are attempting to maximize death benefit and are less concerned with income.

How a step up works is like a floor under your investment. IE if you put in 1M and your account goes to 1.5 that is your guaranteed withdraw benefit. If it goes down to 900k 1.5 is your guaranteed withdraw benefit.

I will cover Fixed Defined benefit programs in a later submission, but for now what they buy the high tax bracket investor is guaranteed returns with maximum tax deductions, some times as high a 200-300K.

The primary knock against Annuities is their fees which can be up to 3% depending on how many bells and whistles you put on them, however most guarantees are net of fees, so you really only get dinged in years where you make more than the guarantee. Also they can be complex and do have risk as aforementioned, but all in all I believe that they are suitable for many investors who want a decent rate of return with a guarantee on the downside.

Drew Kitchell is an Aspen Local Financial Advisor and can be reached at dkitchell at FPaspen.com or his blog about things Aspen and things financial is at http://www.resorttownblog.com/

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