I’m again’em! And my financial structure had a couple within it. My objection centers on two notions. I think most investments would have better returns (there’s a reason insurance companies can afford deluxe buildings), and they are generally very inflexible instruments.

I’ll argue against an illustration in Patrick Astre’s book, This is Not Your Parents’ Retirement: A Revolutionary Guide for a Revolutionary Generation (yes, a 2005 copyright, but while the marketplace has grown and changed in detail, fundamental questions about classes of products like annuities, remain). A couple (or an individual- whatever) in early middle age plans on leaving the workforce at something like 55 years of age. In some occupations, such as military service, police, fireman, this would be a realistic goal, certainly a possibility. But from full-scale salary, there will be quite a reduction when this occurs. At 62 to 66, Social Security benefits will be added to pension, so the goal is to “kick up” income in the gap. Astre’s suggestion is to pay into an annuity that will then, at the set time (say, 55, that’s what we’re working toward), start paying out on a monthly basis so that the proceeds are exhausted as Social Security begins to pay.

The alternative would be to pick a solid mutual fund, do the numbers based on a 5% growth rate, and handle it yourself.

Weighing on the side of the annuity, if you fund it from a lump-sum payment, it’s a known quantity, almost risk-free, almost guaranteed (nothing’s guaranteed except death and taxes, and we’re working on death). If you pay it by monthly payments, you regard it as a primary payment, and are likely to keep up the payments in almost every circumstance.

Weighing against the annuity, if you fund it with a lump-sum payment, the moment you are committed to it, your lump-sum becomes perhaps close to three quarters of the size the lump was. The sum the annuity company says they are working with may still be the size of your deposit, but the cash value you can withdraw has suffered a severe case of the shrinkage. Typically, the cash value goes back up as you hold the annuity toward its term, but if you absolutely need the money in the interim, the penalty can really hurt. Further, when the payout starts, you are being paid from dividends and interest and your own principal, but the payments might well be taxed as regular income (this should be checked with a tax expert, not the annuity salesman and not me; I’m not a tax expert).

Suppose you try to achieve the same thing with a mutual fund. The pros include flexibility, access to your money at almost any time, and the opportunity, if you choose the fund wisely, to do better than the annuity would in final payout. Against that is the need for greater discipline (keep your hands off the money, you don’t need it to pay for the swimming pool) and the fact that mutual funds do go up and down in value, which means you should be keeping your eyes on your investments (always a good idea anyway). Why did I say to calculate 5% growth above, when many people say the market will generally grow 10%? Well, we’ve just seen several years when the market didn’t grow 10%. On this point it’s instructive to look at some mutual fund performance charts. Most charts would be like Fidelity Investment’s (simply click on any of the funds listed to see what I mean).

Look at the 10-year or life-of-fund columns, Look at the 5year column, and you can see which ones were hit hardest by the 2000 crash. These returns also do not consider any taxes you may or may not have to pay (it’s probable you’ll have to pay at least a 15% tax on your fund’s earnings).

So, which would you opt for- put your money in annuity jail for low risk inflexible usage, or put your money in somewhat more risky mutual funds, for probably higher rewards?

At the beginning of this article I said I was against annuities as a general principle, although I had some of my own. One was a small tax sheltered annuity from my work, paying a modest return but better than a bank CD or some such. At retirement, I moved it into a higher income investment.

My second annuity is a variable annuity. I had a mutual fund IRA that was becoming mediocre in its performance, I felt, and I was approached by an acquaintance from church who gave me a presentation on the benefits of his variable annuity. My mistakes were several—first, I was comforted by his presentation that the investments that formed the annuity were, if not great, at least OK (I should be equating OK with mediocre); second, when I received my copy of the annuity document, I should have immediately read and understood it; and third, at the time I didn’t realize the taxation aspect. My income tax on income from the annuity will be at a rate perhaps 10 to 15 percent higher than it would have been had I retained the mutual fund IRA.

Now, none of the issues mentioned above are disasters. I won’t throw eggs at the salesman’s porch. I probably won’t need the money any time before it can be paid out without penalty. What bugs me most is the feeling I could have done a lot better.

For another view on annuities, look at this article from the Motley Fool web site.

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