Riversource innovation

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skbroker's picture
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So I have been researching for a variable annuity for those Clients who are looking for income 3 to 5 years from now and came up with riversource innovation where the income base increases to 20 percent of original premiumt after 3 years which at that time the clients can withdraw 6 percent income for life. Looks pretty good to me but anyone see any negatives with this contract. Rider costs about 1.1 for single and 1.5 for joint life

3rdyrp2's picture
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I think you may be misunderstanding the rider.  It's called SecureSource Flex.  It basically means that after 3 years (and be at least 65 yrs old) you can withdraw 6% of the annuity for life.  Immediately you can withdraw 7% for 14.2 years.  If the contract drops 20%+ of the original contract value then the withdraw rate drops to 5% for life, until it gets back to within 80% of the original value.  As the value of the contract increases then on the contract anniversary there is a step-up in the basis where the new value is locked in and the income is now guaranteed based off the new value. 
 
As of right now its the only variable annuity that I can sell.  Starting in a couple months we'll have a few more added to our arsenal.

skbroker's picture
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No. I think we are talking about a different annuity product through riversource. There is a 20 increase in income base after 3years

3rdyrp2's picture
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What's the name of it? 

Milyunair's picture
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3rd, trying to be positive here. If the client (and the advisor) understand the terms you described (seriously, I worked late tonight closing a big add-on to a wrap account by drawing pictures), can't the issuer just raise the internal fees if the market underperforms? Doesn't that kind of undermine the guarantee? How do you sell this this idea?

3rdyrp2's picture
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This happened last year.  What Riversource did was this:  Jan 10, 2009 - Put out announcement that the last day to make new sales under the current terms/fees is Jan 25th.  The company guaranteed that the fees on existing contracts wouldn't increase, but there were no more allowable add-on purchases after Jan 25th.  After Jan 25th all new sales would be under the new fees, which were about .15% or .2% higher than what the pre-Jan 25th contract fees were.

Milyunair's picture
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So, Riversource guaranteed that fees on existing contracts wouldn''t increase? I thought any variable annuity contract with any insurance company could be subject to a review of fees if the insurance company experience adverse conditions.

 
Just trying to understand.  At one point, RVS had a contract that would pay out 6% for life at age 65, (withdrawals decrease the principal) and the survivors got anything that was left  on the subaccounts, after performance and fees- but the internal fees could change.

3rdyrp2's picture
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Sorry about the wording.  There is a "maximum fee" in the prospectus that hypothetically if worse came to worse they could increase the fee.  I meant it more as a "We are not going to increase the fees on the existing contracts, but we are going to increase the fees for new contracts."  Shouldn't have said 'guarantee'.

Milyunair's picture
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Yeah. I just don' get those contracts. I mean, they provide guarantees, but the internal fees can go up if the insurance company has an adverse experience with the investment portfolio. It's hard to understand the benefit of risk transfer through a contract. That's why I don't use them.

In old contracts, what does the company have to do to justify raising the admin fees? I just don't understand, everyone talks about the bells and whistles, but from my point of view, basically you are buying the promise of an annuitized contract, a pension. You could annuitize the money at any time, so the real value of the contract is the potential for tax deferred growth, which could be nice IF the market does well. Just trying to understand here.

3rdyrp2's picture
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The only annuities I've been selling the past few years have had a guaranteed withdrawl benefit living rider on them.  Take for example:
 
Client buys $250,000 annuity in 2003, with auto step-up each year if contract value is higher.  Guaranteed 6% withdrawl for life starting at age 65.  Annuity is worth $350,000 on anniversary date in 2007.  That amount is locked in, so the client's guaranteed income will never go below $21,000/yr (6% of $350,000).  At the end of 2008 the annuity is worth $280,000 (No withdrawls up to this point, account lost 20% in market performance).  Without the step-up, they'd now be withdrawing $16,800 to get the 6%.  In a regular brokerage account they'd be withdrawing less than that because 6% wouldn't be a safe withdrawal rate throughout retirement.  Say the $280,000 was in a fee-based IRA in a bunch of funds.  The safe withdrawal rate would be 4%, and they'd have to take out only $11,200.  With the living benefit rider of the annuity they bought, they got themselves an extra $10,000 of income due to the step-up in their annuity.  Of course this example worked perfectly because of the 2008 collapse, but this really happened.  This situation probably rang true for a lot of folks out there.
 
Over time the markets will go up and accounts will continue to rise, but a ton of people will begin to start making withdrawls in one of those years where things don't go exactly right and they'd be glad they locked in their income power.  For many people they wouldn't mind paying 1% or so for this kind of insurance. 

Milyunair's picture
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Please bear with me, I'm not trying to be difficult, and I appreciate your investment of time and energy.
 
So, if I understand, the client begins the 6% annuity withdrawal at age 65, with the option to pass on whatever principal is left to the survivors, at death.
 
I imagine the 6% payout stops if the client takes any principal? So you wouldn't put all of the portfolio into the annuity, which means you could have invested the annuity money in stocks and bonds, and taken the "6%' from a side fund of cash or short term bonds in down years, and left the stocks and bonds alone?
 
So yeah, under perfect conditions, the annuity lock in created value.
 
But looking over ten years, say, in a flat stock market, no real advantage. The real benefit is an annuitization type feature, " you leave the money alone, and you get 6% for as long as you live, and if there's anything left, you can pass it on to your heirs?"
 
Without the annuity, until age 65, I go 60% stock and 40% bonds, at age 65, I go 30% stock and the rest fixed, with a 4% withdrawal rate. (And take 2% from a "side" fund of cash. With a 4% withdrawal rate on that mix, I can probably get an inflation adjustment each year from the withdrawal.
 
"Annuitizing", taking a 6% withdrawal rate from the variable annuity, the first few years I come out ahead, but there is no COLA. When I think of annuities and insurance, I think of insurance against the risk of living too long, and transferring that risk to folks with a shorter life span, and sharing the profits with an insurance company.
 
I don't see how you locked in income power. What am I missing here?
 
Is there a "feel good" feature. So, client locks in 350k at age 65 at 6%, and the market and subaccounts go down - does the statement still show 350k, or does it show the value of the subaccounts?
 
Because, basically all you are doing is saying, you can continually recognize program A, which is, we annuitized 350k at 6%, with the potential for increases going forward if the market does well.
 
But, we're going to subtract 6% per year from the subaccount value, minus expenses.
 
I only kind of get it. Logic says, it will be harder to make money going forward, and downward volatility will win. In down years, if the market goes down 25%, you have to go back up 35% the next year to get back to even. (Plus withdrawal amount.)
 
It seems you end up with the major feature being the annuitization, along with the M&E expense and the proprietary fund fees.
 
Is there any objective research to prove the viability of these contracts - I'm sure there's value in peace of mind, but it feels like smoke and mirrors, especially with regard to having your money locked up.
 
Very few folks will choose to annuitize money, not saying that's smart, just reporting the fact.
 
Believe me, I have studied the RVS product, but I just can't hack it.

anonymous's picture
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skbroker wrote:So I have been researching for a variable annuity for those Clients who are looking for income 3 to 5 years from now and came up with riversource innovation where the income base increases to 20 percent of original premiumt after 3 years which at that time the clients can withdraw 6 percent income for life. Looks pretty good to me but anyone see any negatives with this contract. Rider costs about 1.1 for single and 1.5 for joint life

 
First of all, this post makes no sense.  If it increases to 20% of the original investment, then a $100,000 investment becomes $20,000.   Anyway, I don't know exactly how this works, but I can address the negatives of this type of contract in general.
 
1)The high fees are a major drag on accumulation. 
2)The fees are much higher than they appear.  When one starts withdrawing money, it is very possible that all that the person will get is the guarantee.
 
These are like cross training shoes.  They are mediocre for a bunch of purposes, but good for nothing.
 
Examples:
1)High Fees: On a $250,000 investment, an extra fee of 1% will typically cost the client $100,000 in lost accumulation.  $250,000 growing at 7% will equal $689,000.  $250,000 growing at 8% will equal $793,000.  1.5% in extra fees will bring it down to $643,000.
 
2)Fees are higher than they appear:  Client invests $100,000.  Market crashes.  Client has contract value of $50,000 and a rider value of $120,000.  How much does the rider cost?  $1,320.  What is this as a percentage of the contract value? 2.64%  What are the M&E and admin expenses? 1.5%?  Fund expenses?  1.0%?  All of a sudden, the client has an investment that has an expense ratio of above 5%!
 
Assume that the market does well and the contract value comes back to the level of the rider value.  (Keep in mind that without that rider, the contract would now be well above the rider value.)  What happens at withdrawal? 
 
The client has $120,000 and is able to take 6% ($7200).  Let's assume that they take this money and the market stays flat that year.   What happens?  Rider fee =$1,320.  All other expenses =$3000.  Total fees = $4320.  $4320 +$7200 withdrawl =$11,520 being removed from the investment.  The contract value now equals $108,480.   Forget the calculations for a minute.
 
You are trying to take 6% out of an investment that has fees in the 3% neighborhood (and much higher when the contract value goes down).  The very likely outcome of this is that the contract value will go to zero which means that all that the person receives is the guarantee.
 
It's smoke and mirrors.   There are better products for accumulation.  There are better products for income.

3rdyrp2's picture
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anonymous wrote:[
2)Fees are higher than they appear:  Client invests $100,000.  Market crashes.  Client has contract value of $50,000 and a rider value of $120,000.  How much does the rider cost?  $1,320.  What is this as a percentage of the contract value? 2.64%  What are the M&E and admin expenses? 1.5%?  Fund expenses?  1.0%?  All of a sudden, the client has an investment that has an expense ratio of above 5%!
 
The percentage of the rider cost would always stay the same.  If its 1%, then if the value drops to $50,000 then the rider cost would be $500.
 
Another thing:  If a client knows that they have their income locked in and the amount they can take out can never decrease, wouldn't that hypothetically mean that their risk tolerance on this investment can be bumped up 1 or 2 notches?  A 65 year old that is otherwise Conservative can invest in this closer to Moderately Conservative, right?  There's a little extra leeway as far as investing goes, and over a 10-15 year period would you think thats good for at least 1-2% per year?  As long as the market doesn't suck over that period?  I'm not trying to sound like a wholesaler but thats not a bad example right there.

anonymous's picture
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3rdyrp2,
Do yourself a huge favor.  Read the prospectus and then post again. 

LockEDJ's picture
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Quote: ...  What are the M&E and admin expenses? 1.5%?  Fund expenses?  1.0%?  All of a sudden, the client has an investment that has an expense ratio of above 5%!
On the whole, I agree with most of the post. But ... there are a couple of overstatements here. Generally speaking the fees associated with insurance funds tend to be lower from what I've seen than is normally available in ... let's say A shares. On the whole, the performance suffers not one wit.

And I haven't placed an annuity with higher fees than 1.35 for M&E. I'm quibbling, I know. I do place variable annuities, with the express statement that they are expensive tools and only a part of one's portfolio should be placed in them. In point of fact, I used one recently (1035 exchange, out of surrender) in a NQ account to give the client exposure to international funds he couldn't get through his 401k.

anonymous's picture
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Riversource is actually higher.  It is 1.55 M&E + .15% Admin fees.  Additionally, the typical fund expenses are higher than 1%.  They charge a management fee + 12b1 fee + other expenses.
 
If I made an overstatement, I'd like to hear about it, but I don't think that I did.

3rdyrp2's picture
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anonymous wrote:
3rdyrp2,
Do yourself a huge favor.  Read the prospectus and then post again. 
 
That I did.  You are correct. 
 
Nonetheless, I think there are a lot of people out there that would pay for this type of insurance to protect a part of their income.  This fee is nothing different than charging someone 1.5% in a wrap account.  Only difference is the insurance company keeps the fee instead of the advisor.

anonymous's picture
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Do you understand the impact of the fees?  Assuming 1% fund expenses, the fees are 3.8% at the very cheapest.  In a down market, the fees are much higher than that. 
If the underlying investments get 10% for 15 years, a $100,000 investment would equal $417,000.  With the fees, it would equal $246,000 at the most.
 
What happens with withdrawing money?  If one tries to take 6% out of an account that has fees of higher than 3.8% (and very possibly higher than 5%) do they have any reason not to expect their contract value to go to zero?
 
It's different from a 1.5% wrap account because the total fees are much higher and a wrap account doesn't increase their fees as the account value decreases.
 
It's the decoupling of the fees from the contract value that really screws the client.
 

Milyunair's picture
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Good points, Anonymous. And thanks for the discussion, P2.

 
In the end, I can't see where these annuities are in most clients' best interest. In fact, P2, I hope you are doing your due diligence.
 
Annuitizing a certain amount of money makes sense. But using an annuity as an accumulation vehicle probably doesn't, for the reasons mentioned. If I am in a high tax bracket, maybe, but then, I'm probably wanting more a more "sophisticated" portfolio.
 
I think the problem with all of this is it confuses folks about the true value or trustworthiness of financial advice. Using smoke and mirrors to make folks feel good can backfire.
 
I suspect the insurance company is also banking on a number of folks needing to invade principal during the withdrawal phase, thus voiding the guarantees? Look at long term care insurace, product manufacturers assumed these policies would have a high lapse rate (like term and perm) - and in fact folks have held on to them, and now the premiums on old policies, which were designed to be level, are being jacked up.
 
How can you feel good about placing money in something that has the potential to blow up for the client? Compared with, say, at retirement, placing 1/3 of the money in stocks, and the rest in cash and bonds.
 
I'm sorry our industry still struggles with honesty issues.

Milyunair's picture
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Ice, you're right. I was thinking in this case, use the VA as an accumulation vehicle, and then annuitize the (untaxed) growth and principle, based on the owner's life expectancy. Annuities are lousy estate planning vehicles.

 
To maximize the value of untaxed growth, you have to take on more risk (even if it's high yield bonds) - that doesn't really go along with the whole idea of feeling good about guarantees, experiencing less volatility, and so on.
  
One of this biggest "features" of the product is the guaranteed withdrawal rate, while technnically not an annuitized contract, acts like one. They are in effect preselling the withdrawal feature, and the only thing you can put up against the high expenses (that you couldn't get outside an annuity or life insurance contract), in non qualified money, is tax deferred growth.

Milyunair's picture
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From what I can see, and please tell me if I am wrong, you're selling peace of mind with the guaranteed withdrawal rate. You're saying, we're going to protect the downside, and give you exposure to the upside, if things do well. We're reducing your risk.
But the client is taking on new types of risk, this is what is not being talked about.
 
One risk is the opportunity cost of not doing somethings else. Another is illiquidity risk. Another risk is that the internal contract fees will be jacked up if the internal rate of return blows up for the life insurance company.
 
What about inflation risk? If you start taking 6% off the base amount, at 4% inflation, after 18 years you are getting half the money in today's dollars. Age 65 plus 18 years, that's age 83. The purpose of annuitized income is to generate (meaningful) income that you can't outlive.
 
What the client is really getting is an annuitized like payout, with the opportunity to break that revenue stream and invade whatever amount of (reduced) principal is left at some point in time. Obviously the insurance company isn't taking any risk. Let the buyer beware.
 
If we call ourselves financial planners, we have to crunch the numbers - if we are just product salespeople, maybe we should be more heavily regulated to protect consumers.  
 
Other than a perfect scenario of ideal market returns and point in time "annuitization" of guaranteed withdrawals, can you give me an example of appropriate application of this product solution?

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Milyunair wrote:How can you feel good about placing money in something that has the potential to blow up for the client? Compared with, say, at retirement, placing 1/3 of the money in stocks, and the rest in cash and bonds.
 
I'm sorry our industry still struggles with honesty issues.
 
In 2008 your 1/3 in stocks would have blown up, and whatever part you put in bonds would have most likely dropped by 20% or so.  Unlike your GWB annuity rider which would have protected 100% of your income!

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Milyunair wrote:Ice, you're right. I was thinking in this case, use the VA as an accumulation vehicle, and then annuitize the (untaxed) growth and principle, based on the owner's life expectancy. Annuities are lousy estate planning vehicles.
 
You purchase a $250,000 annuity with no riders.  2008 happens and your value drops to $175,000.  Jan 1, 2009 you die.  Your heirs get $250,000.  How is that lousy?

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Milyunair wrote:Other than a perfect scenario of ideal market returns and point in time "annuitization" of guaranteed withdrawals, can you give me an example of appropriate application of this product solution?
 
Client is 60 years old.
Has $100,000 in retirement expenses.
Has $75,000 in pension income.
Has $500,000 in IRA money.
Has $100,000 in NQ private REIT's, generating 6.5% annually.
Has $150,000 in cash eqivalents.
 
In this scenario, the client has 6 years worth of excess expenses in cash reserve.  Where would the negative be in taking $200,000 of the IRA and placing it into an annuity with a GWB rider at 6% for life?  There's now an extra $12,000/yr of guaranteed income.  The client just cut half of their pension/expense shortfall for the rest of their lives.  Their cash reserves now make up 12 years worth of their income shortfall, and they can now take $75,000 of their cash reserve and put it in bonds/short term vehicles that would now work harder for them than it would still sitting in cash equivalents.  Say it earns an extra 2% per year, now thats an extra $1,500 more than it would earn in a 12 month CD earning 2%.  They can take their private REIT income and either reinvest that, or regenerate their cash reserves.  By the time the client hits age 70.5, their RMD's will come directly from their annual annuity disbersement, and their IRA can just sit alone without it being bothered.  This is just one scenario where this strategy would work perfectly.

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3rdyrp2 wrote:Milyunair wrote:Ice, you're right. I was thinking in this case, use the VA as an accumulation vehicle, and then annuitize the (untaxed) growth and principle, based on the owner's life expectancy. Annuities are lousy estate planning vehicles.
 
You purchase a $250,000 annuity with no riders.  2008 happens and your value drops to $175,000.  Jan 1, 2009 you die.  Your heirs get $250,000.  How is that lousy?

 
Right. But that's a very short time frame, with a very strong estate planning goal. Unlikely scenario in the real world.
 
As long as you point out that the heirs don't have to sell a "down" portfolio of stocks and bonds into a down market, I guess you could make a case for your insurance benefits. I just don't see how you are elevating the investment education of folks by focusing on  insurance and short time frame scenarios.
 
After all, when you talk about guaranteed withdrawal benefits for life, I think you're starting from expected longevity. Why would someone with poor health ever buy such a product, unless they expected to die soon and the heirs would be needing the money right away?
 
If the annuity purchaser happens to die soon, sure it's nice to have the guaranteed principal, this is a nice short term benefit. But in a straight investment account of stocks and bonds, the investment risk could be considered before hand, and one shouldn't be taking excessive risk in consideration of the (multigenerational) planning goals.
 
You have to be honest about the opportunity cost of the alternatives. I meant annuities are a lousy estate planning device, meaning the taxability of long term accumulation values, not the benefit of cashing out immediately into a down market. I think you know I'm talking about the potential for a stepped up basis on stocks, versus taxation on ordinary income.
 
I hope you know what I'm talking about.

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3rdyrp2 wrote:Milyunair wrote:Other than a perfect scenario of ideal market returns and point in time "annuitization" of guaranteed withdrawals, can you give me an example of appropriate application of this product solution?
 
Client is 60 years old.
Has $100,000 in retirement expenses.
Has $75,000 in pension income.
Has $500,000 in IRA money.
Has $100,000 in NQ private REIT's, generating 6.5% annually.
Has $150,000 in cash eqivalents.
 
In this scenario, the client has 6 years worth of excess expenses in cash reserve.  Where would the negative be in taking $200,000 of the IRA and placing it into an annuity with a GWB rider at 6% for life?  There's now an extra $12,000/yr of guaranteed income.  The client just cut half of their pension/expense shortfall for the rest of their lives.  Their cash reserves now make up 12 years worth of their income shortfall, and they can now take $75,000 of their cash reserve and put it in bonds/short term vehicles that would now work harder for them than it would still sitting in cash equivalents.  Say it earns an extra 2% per year, now thats an extra $1,500 more than it would earn in a 12 month CD earning 2%.  They can take their private REIT income and either reinvest that, or regenerate their cash reserves.  By the time the client hits age 70.5, their RMD's will come directly from their annual annuity disbersement, and their IRA can just sit alone without it being bothered.  This is just one scenario where this strategy would work perfectly.

 
You designed an interesting scenario. Okay, you and I both know that these annuities are overused and overrationalized by advisors.
 
In this case: 
 
Client already has $75,000 of pension income. That represents well over a million dollars that is already annuitized. You've got more money tied up in illiquid REITS.
 
Now you want to tie up more money in the annuity. I don't like it from a liquidity standpoint.
 
A clean portfolio (4% SPO from the IRA, plus the REIT), handles the income need, and gives better upside potential for the long run. Your annuity doesn't handle inflation, which is likely to kick up after relative dormancy for the past decade.  The risk of owning the annuity offsets a more aggressive investment profile for the non annuity money.
 
Knowing what I do about the internal expenses on contracts, assuming longevity and a desire to spend as much as I want and still be flexible if my life changes, you're losing me.
 
Even after a couple of beers, I think it's a hard sell. I wouldn't take it, would you?
 
If you can find somebody to take it, you got yourself a nice sale. How does it feel. I don't think you'll impress many experienced planners who are reviewing your work.
 
Best case, somebody might step up and justify your strategy. Don't count on it. Sorry, just my opinion here.
 
What I'm beginning to sense here is that the RVS contract is a fancy way to sell annuitization. Most folks wouldn't choose that option, in some cases it helps enforce self discipline regarding conservation of principal, but in the case of copious resources, as you describe here, I wouldn't overdo the annutization, I would strive to educate the client about investing, and be paid to hold their hand, and feel the risk/reward favors that strategy in this case.
 
Don't forget, the product guys at home office are more focused on their short term goals, best case scenario, you get to work across generations of wealth stewards within the family.
 
I don't think you've proved anything here, and I think all things considered, yours is the more "aggressive" strategy, from client's point of view. I'm just saying, I've been around long enough to see how this stuff plays out.
 
If you sell permanent insurance and the client dies young, you're a genious, but the insurance company is the big winner when (most) permanent policies get dropped when folks can't afford them due to longevity. If you get to control the time frame assumptions, you can justifty almost anything, unfortunately, I think good financial planning is about finding a reasonable "middle way", and I don't like this product for most people in most situations, in fact, I'm open minded, but I still don't see the light.
 
The name of the thread is Riversource innovation. Maybe there is still hope for educating this dumb old planner, teaching an old dog new tricks, I keep thinking there's a way to  save the baby boomers from their own lack of saving and overspending, but I don't think there are any new shortcuts.
 
Step back and consider the big picture: income goal $100,000. 75% already comes from a pension. If you could pull four percent off a pool of money at age 60, you need 2.5 million.
 
If this client is worth 2.5 million, is living a long life based on that amount of wealth accumulation, and has already taken a pension of 75k, representing maybe 1.5 million of the accumulated  wealth, it's not your job to figure out how to get paid on parking a crummy 250k into an annuity contract, so you can get paid. Rather, focus on managing the liquid wealth that remains, in terms of the relatively flexible long term goals of the family, and everyone will do just fine.
 
 

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Ok, I'm not gonna get in an argument with someone who's already set in their ways.  If you're fine with your way thats great.  I'm fine with mine.  I'm not gonna bash you.  You talk about "illiquid REIT's", and why would I tie up more money when I already stated in the example that the client has 12 years worth of income shortfall in cash equivalents.  I'm not trying to prove anything.  Can you honestly tell me what scenario is going to play out for all of your clients prior to you recommending strategies?  You talk about how "the client dies young, you're a genius", but can you tell me at what age your clients are going to die?  All I know is that the example I gave works perfectly, and if I can guarantee to my clients that their income is covered until age 100 I really don't think they are going to cry about a fee.  BTW, the 4% of $500,000 does cover the income, but in your previous post when you said 1/3 stocks, 2/3 cash and bonds, the client would have far less than $500,000 at the end of 2008 and the 4% may yield about $13,000-$15,000 as opposed to the $20,000 that a half mil portfolio would.
Like I said, none of us know how long our clients will live or what will get in their way as time goes on, but we can control putting them in the best chance to succeed and there is no cookie cutter way of doing it.  Both of our ways work. 

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BTW, the 4% of $500,000 does cover the income, but in your previous post when you said 1/3 stocks, 2/3 cash and bonds, the client would have far less than $500,000 at the end of 2008 and the 4% may yield about $13,000-$15,000 as opposed to the $20,000 that a half mil portfolio would.
 
Hang with me here, please. I'm sure there is more than one way, but I think we're talking about good financial planning, and  client's best interest. Me looking at your work, and you looking at mine, and holding each other a little accountable.
 
You said: $100, 000 income goal. $75,000 is already in a pension, which is annuitized money, right?
 
We need $25,000 (minus $6500 off the REIT)  income, from $650,000 available "cash".
We need $18,500 from $650,000.
 
18.5/650 equals a 2.85 portfolio withdrawal rate.
 
That withdrawl rate is well below the yield rate on my portfolios last year.
 
I hope you know that if I put $500,000 into stocks and bonds, and the portfolio value declines, the "yield" doesn't necessarily go down. It may well go up.  Neither does planned portfolio withdrawal rate go down in a bad year.
 
Are you a CFP, and have you studied portfolio construction and withdrawal rates?
 
At age 60, having annuitized enough money to get a pension of $75,000, at the standard payout rate, the client already annuitized, what, 1.5 million?
 
Do you know that one rule of thumb says, consider not annuitizing over 25% of your money.
 
I'm just trying to understand your thinking here.
 
I understand the annuity you are proposing is not annuitized. Do you see where it might look like your are using smoke and mirrors sell unnecessary guarantees?
 
If your client here ever worked through the details, I think you might end up looking bad. I'm just saying, I think this kind of work can end up making us all look bad. Why would you do it?
 
I hope for your sake as a financial planner that the $75,000 pension includes a cost of living increase. ( Odds are it doesn't).
 
Putting a large portion of the available cash into a vehicle that chews up the principal with high expenses, and which further damages liquidity, looks like sloppy work at best, assuming a level load on the annuity product.
 
I believe your solution is higher risk for the client, stands a greater chance of "blowing up". One solution is better than the other.
 
Maybe I'm wrong, but I believe you should have to run the numbers (using the internal costs of the annuity and so on) before you tie up more money in a contract, and show the client the opportunity cost of your strategy. That would professional.
 
First, do no harm.
 
And if you could explain it the client, then perhaps I would understand your strategy and would see the light, finally.
 
I think part of the problem with the annuity is, you have to take more risk to cover the internal fees. And in this example, the client only needs to take 2.85% off the portfolio.
 
Your 6% guaranteed withdrawal rate is attractive in the early years, but it does not cover inflation in later years. You say, the rest of the money will cover that - maybe. That's a risk.
 
Admit it, for planning purposes, you have to assume you only got 6% off the annuity money. In fact, you have to wait five years to start taking the annuity pension, right?
 
So the rest of the cash, which you draw off of for the first five years, needs to be more conservative.
 
Yet, the "rest of the cash" is the money that is supposed to be handling inflation in later years.
 
The annuity is your aggressive money. Yet, it's pretty likely that money will be chewed up by internal fees, and the client will be stuck with taking the 6% with no inflation adjustment.
 
At best, this is a roll of the dice. I don't see how you are giving me any piece of mind.
 
You designed this scenario, please don't give up on the analytical work now. Good case study, thanks for your investment of time and energy.
 
I don't like it.
 

Milyunair's picture
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All I know is that the example I gave works perfectly, and if I can guarantee to my clients that their income is covered until age 100
 
Just more thinking out loud here.
 
You put $200,000 into an annuity at age 60, and start taking 6% at age 65. Maybe the market goes up or down.
 
$12,000 a year with no COLA. You say you are guaranteeing income to age 100. In 35 years, at 4% inflation, you would need to generate $47,000 per year to equal $12,000 at age 65. What kind of guarantee is that?
 
We have to wait for 5 years (from age 60 to 65) on your $200,000.
 
We have to generate $18,500 from the other $450,000. That's a portfolio withdrawal rate of 4.1 %, still not too scary.
 
Since the annuity doesn't act like an annuitized vehicle for five years, why not just make the $200, 000 investment outside the annuity? Aren't you basically just preselling your financial planning idea. Because, if you want to be able to "annuitize" at least $200,000 in five years, you better not be too aggressive, so that diminishes the implied value of tax deferred growth.
 
Besides, the client is already retired, spending NQ money, I would assume, or blending it with IRA distributions, which are already tax qualified.
 
I think you would want to do some tax planning projects and internal cost/portfolio allocation projection to justify the annuity. What about maxing the lower tax brackets in the early years, and how does this relate to the nq/q money, and the investment profile, considering you basically have two separate income portfolios for five years, now.
 
Since the annuity money needs to be moderate, and the non annuity money needs to be moderate (for the first five years) the whole portfolio may "underperform". That's risky.
 
And by "moderate", I mean, you have to consider the risk of owning (what kind of) bonds in the current environment, where interest rates are probably starting to go up, as well as stocks and cash.
 
Essentially, you have sliced the porfolio into two separate (income producing) vehicles for five years, meaning, you need to have at least a couple hundred thou in the annuity in five years, your time frame for the annuity is five years.
 
And, your drawing the 18.5 off the balance of the money for five years starting now, at a 4.1% withdrawal rate, which is on the edge of longer term sustainability - you get to change that profile in five years, but right now it's an income portfolio.
 
Be careful.
 
 

Milyunair's picture
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Ok, I'm not gonna get in an argument with someone who's already set in their ways.  If you're fine with your way thats great.  I'm fine with mine.  I'm not gonna bash you.  You talk about "illiquid REIT's", and why would I tie up more money when I already stated in the example that the client has 12 years worth of income shortfall in cash equivalents.  I'm not trying to prove anything. 
 
I'm not trying to prove anything, either. If you're in your third year, and I'm in my second decade, maybe you can teach me something. This really is about trying to teach an old dog new tricks.
 
Wouldn't you agree, we have to try to do what's best for the client? We don't owe the insurance company anything.
 
If insurance companies are creating new products that can solve problems, I want to know about it.
 
I understand annuitization. It brings a lot of discipline to a situation. I don't think it brings a lot of upside potential for the client, or inflation protection or liquidity ,and I don't think you can just say, "this feels good, now you can sleep at night". Otherwise, you're just a product salesman.
 
Your guarantee that the owner can start taking 6% withdrawals (like it was annuitized) in the early years, but pass on the remainder at premature death, is attractive.
 
So this must be the heart of the product.
 
I guess I understand how the potential to take withdrawals but pass on principal to heirs is a benefit, but you and I both know that annuity is going to chew up the cash value over time.
 
 You're probably better off annuitizing money and buying term insurance in the early years. If the client is uninsurable, and maybe under different circumstances that what you described, maybe this is an appropriate tool, but I doubt it.
 
In the case of insurability, this suggests a lack of longevity, so you could just tone down the investment allocation on the cash and take 6% withdrawal.
 
I don't know, guaranteed insurability on someone who is uninsurable, where you collect their money in a contract, and pay it back to them slowly, sucking off whatever expenses you need to maintain the integrity of the insurance company based on the mortality experience of the group, sounds like a Ponzzi scheme.
 
As far as them paying for insurance to take more risk during their brief lifetime, if the market tanks, they get to die knowing their heirs got less. Not exactly consistent with a concrete estate planning goal.  
 
Take a couple of steps back, you're basically selling the idea that you can take more risk with better potential reward - and then not talking about all of the other financial planning risks.
 
Those other risks are pretty analytical and geeky, but you can't ignore them. If you want to keep it simple, first seek to do no harm.
 
You and I both know that a lot of clients end up hating annuities, maybe for good or wrong reasons.
 
If someone ends up hating their money, or part of their money, and you can't explain it to them, that's a different kind of harm.
 
I hate the way this industry sometimes pretends like it's doing no harm.

anonymous's picture
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3rdyrp2 wrote:Milyunair wrote:How can you feel good about placing money in something that has the potential to blow up for the client? Compared with, say, at retirement, placing 1/3 of the money in stocks, and the rest in cash and bonds.
 
I'm sorry our industry still struggles with honesty issues.
 
In 2008 your 1/3 in stocks would have blown up, and whatever part you put in bonds would have most likely dropped by 20% or so.  Unlike your GWB annuity rider which would have protected 100% of your income!

 
If the investment drops 40%, how much do the expenses increase?  Once this is understood, it becomes easy to see why the product doesn't work well for income.  

Milyunair's picture
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I haven't studied the new contracts, I assume the worst. How much DO the expenses increase? I assume the insurer will increase the expenses whatever they need to, but do the state regulators set limits, by law to limit gouging consumers? Is all of that set by contract when the annuity is approved by a state?

Milyunair's picture
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I confess ignorance. Is the higher column set by contract, like the guaranteed interest in a permanent life insurance policy (except, they switch to a higher expenses, instead of lower fixed interest which are preset by contract)?How does that compare to long term care insurance contracts, are the premium increases negotiated with the state insurance regulators?

anonymous's picture
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Joined: 2005-09-29

There is both a contract value and a rider value.   Let's make things as simple as possible.  Let's assume that the rider costs 1% of the rider value.  The rider is guaranteed to increase 5% Simple every year.   The client invests $100,000.  The rider costs $1,000.  This is 1% of the contract value.   Let's assume that the client removes $5000 from the contract and the investments (net of all fees) goes down 45%.
 
The rider value will still be worth $100,000 since it went up $5,000, but $5,000 was removed from the contract.   The contract, however, will only be worth $50,000 since the investments dropped 45% and $5,000 was removed.  The rider will still cost $1,000.  This is 2% of the contract value. 
 
This decoupling of the rider fee from the contract value makes these incredibly expensive if the market goes down. 
 
Ex. For ease of calculation, let's assume that the rider costs 1% of the GMWB value.   GMWBs work in all different manners.   They typically have a benefit base.  It is from this benefit base that the rider cost is calculated.  For instance, the benefit base may be guaranteed to increase 5% every year or equal the contract value, whichever is higher. 
So, at purchase, the contract value will equal $100,000 and the GMW value will equal $100,000.  The rider will cost $1,000 which is 1% of the contract value.  Let's fast forward several years.  The market has been good and both the GMW value and contract value are

Milyunair's picture
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You're cut off here, I think I get it. I wonder if p2 could complete the logic here, with his understanding of the product.

Mike Damone's picture
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Milyunair, the best way to explain a VA with a GMIB or GMWB is:  You're invested in the market.  However, there is an insurance component that will promise you a guaranteed minimum payout for life at sometime in the future if you so choose to use it. It's almost like a future spia.
 
If the markets goes up, you will probably never use the insurance component even though you paid for it.   If the market is doomed you will be thankful that you have a contract with a GMIB or GMWB.

Milyunair's picture
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Thanks, Mike.  That helps with the big picture selling concept. What I'm not so sure about, I'll need to work out from the prospectus.

army13A's picture
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Joined: 2009-03-22

So people on here are saying that using a portion of a client's retirement assets to create a guaranteed pension is a bad idea? If a clients main and only concern is to make up an income shortfall of $50K a year in retirement, how is utilizing a VA a bad idea? 

deekay's picture
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Because if you want to create a 'personal pension', your client is better off using a SPIA when the goal is maximum guaranteed income.

army13A's picture
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deekay wrote:Because if you want to create a 'personal pension', your client is better off using a SPIA when the goal is maximum guaranteed income.How about when the client is a couple of years away from retirement and wants a guaranteed increase of about 5-6% in the income base?

anonymous's picture
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Army13A, these products just do what they are supposed to do very well.  The fees get in the way.  Let me give you an example.  Jim is 65.  He has $200,000.  He's guaranteed to be able to take out $10,000/year for the rest of his life.  
 
We know that the cost of the contract "all-in" is going to be over 3% (1.1% rider cost + 1.7% M&E + 1% fund expenses) 3.8% is just crazy.  Let's assume that this can be done for 3%.  What happens when the underlying investments earn 5%.  The client has a gain of $10,000 -expenses of $6,000-withdrawal of $10,000.  The contract value is now $194,000 and the expense % the next year will go up.  If the underlying investments go up 5% each and every year, the contract value will be $0 in less than 20 years.
 
Here's a much better way to take $10,000 a year.  This is just one example, but there are many:
 
Put all of the money into fixed products.  Take out $10,000/year.   Assuming 3-4% growth, in 12 years, there should still be about $140,000.  Annuitize the remainder of the money at that time.  Even at today's low rates, that should generate an income of about $15,000/year for the rest of his life.
 
Another option is to split it into 2 $100,000 piles.  The first pile invested very conservatively in fixed products will last about 12 years.   With the other pile put it into a VA with a 10 year 0% GMAB.  After 10 years invest it conservatively.  If the market tanks, they'll still be over $100,000 and enough to take a guaranteed income of $10,000 a year.  If the market does well, there will be a lot more.

skbroker's picture
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There too many variable to say the one option is better than the other. Rate of return on the market, tax deferral, annual step in income base. Also innovation will guarantee 20 percent increase in income base or higher contract value

army13A's picture
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anonymous wrote: 
We know that the cost of the contract "all-in" is going to be over 3% (1.1% rider cost + 1.7% M&E + 1% fund expenses) 3.8% is just crazy.  When I compare a VA to a mutual fund/wrap pfolio, I say it's about 2% more expensive because you're going to have fund expenses in either option.  Let's assume that this can be done for 3%.  What happens when the underlying investments earn 5%.  The client has a gain of $10,000 -expenses of $6,000-withdrawal of $10,000.  The contract value is now $194,000 and the expense % the next year will go up.  If the underlying investments go up 5% each and every year, the contract value will be $0 in less than 20 years. Isn't the selling point of a VA that regardless of your account value, you're guaranteed x amount per year? If the clients only concern is income, why should they care about the account value?
 

army13A's picture
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skbroker wrote:There too many variable to say the one option is better than the other. Rate of return on the market, tax deferral, annual step in income base. Also innovation will guarantee 20 percent increase in income base or higher contract value And Prudential's HD6 policy will guarantee that if no withdrawal is taken after 10 years, your withdrawal base will be at least 200% of the original contract value, which is about 7.2% compounded over 10 years. 

anonymous's picture
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army13A wrote: anonymous wrote: 
We know that the cost of the contract "all-in" is going to be over 3% (1.1% rider cost + 1.7% M&E + 1% fund expenses) 3.8% is just crazy.  When I compare a VA to a mutual fund/wrap pfolio, I say it's about 2% more expensive because you're going to have fund expenses in either option.  Let's assume that this can be done for 3%.  What happens when the underlying investments earn 5%.  The client has a gain of $10,000 -expenses of $6,000-withdrawal of $10,000.  The contract value is now $194,000 and the expense % the next year will go up.  If the underlying investments go up 5% each and every year, the contract value will be $0 in less than 20 years. Isn't the selling point of a VA that regardless of your account value, you're guaranteed x amount per year? If the clients only concern is income, why should they care about the account value?
 
 
Army13, you seem to be missing some very key points.  You can't say that it's 2% more expensive.  That is only true when the contract value equals the rider value.  The problem is that most of the time, the rider value will equal more than the contract value.  Whenever this is the case, the cost of the contract becomes more expensive.  If a contract starts at $100,000 and several years later the rider value is $150,000 and the contract value is still $100,000, the cost of the rider has increased from 1.1% to 1.65%.
 
If the client's only concern is income, I just showed you how the client could have $10,000 for 12 years and then $15,000 for the rest of their life.  Isn't this better than $10,000 every year?
 
 

anonymous's picture
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army13A wrote: skbroker wrote:There too many variable to say the one option is better than the other. Rate of return on the market, tax deferral, annual step in income base. Also innovation will guarantee 20 percent increase in income base or higher contract value And Prudential's HD6 policy will guarantee that if no withdrawal is taken after 10 years, your withdrawal base will be at least 200% of the original contract value, which is about 7.2% compounded over 10 years. 
 
Smoke and Mirrors.  Instead, put the money into a VA with a GMAB.  In 10 years, the contract value will be more.   This is because the contract will probably cost on average 1-2% less per year.  This makes a huge difference.  The worst case scenario is that there will be no growth at all.  If it is annuitized at that point it should give the same amount of income.  At anything other than a worst case scenario, the GMAB combined with annuitization will give significantly more income. 

ChrisVarick's picture
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Make sure to use a variable annuity WITHOUT investment restrictions. Last time I checked, Prudential does have investment restrictions (75/25 fixed income portfolio I believe). Why would anyone need an insurance wrapper for a bond portfolio? Keep it simple, use a VA with cheap expenses and NO investment restrictions for a conservative client.

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