
Subject: Re: Variable Annuities Date: 1/15/2001 4:58 PM
Recommendations: 2
Currently, a little more than half of my retirement is going into CREF variable annuities

I have all of my 403(b) going into TIAA-CREF's "Group Supplemental Retirement Annuity" (TIAA-CREF-speak for 403(b) plans). They seem to be a pretty decent choice: decent "investment accounts", very low M&E fees (0.005%), low investment management expenses (almost as good as Vanguard), and web access for checking one's accounts and reblancing between "investment accounts".

Now they do tend to be somewhat on the conservative side, so if one wants to pick up aggressive, or a heavier weighting in small and mid caps, one has to look elsewhere. (I have taxable investments and Roth IRA elsewhere, where I can get more small, mid, and aggressive exposure.)

Like many 403(b) providers, they offer a range of "investment accounts", some stock based, some bond based, a real estate account, a "traditional annuity" account, and a money market account. (See http://www.tiaa-cref.org and click on "Retirement accounts" near the top of the page for the list of investment options.) For the long term, the stock-based investment options generally produce better long-term returns. TIAA-CREF also has an asset allocation questionaire on their site to help suggest a mix of investment accounts.

Of the 403(b) providers available through my employer, TIAA-CREF is the best one--the other options are either much more expensive insurance companies, or load funds.

I've heard that Annuities are a bad idea for retirement . Do variable annuities share the problems with annuities?

There are several problems with typical annuities:

1. Annuities are insurance company products. (TIAA-CREF is technically an insurance company.) Almost all annuity products carry excessive fees, such as high M&E fees. The M&E is insurance that if you die before annuitising your account (if you ever do), the beneficiaries will get a specified amount. Many insurance companies guarantee that the beneficiaries will get at least the premiums you paid. (Many people view this worthless because it is very likely that after five years of contributions the balance will be higher than the total of the premiums, so the continued M&E is pure profit for the insurance company.) Some insurance companies guarantee premiums or an amount based on the current account balance, ratcheted up once every few years.

My former 403(b) provider had an M&E fee of 1.05%/yr, which guaranteed the beneficiaries would get at least the premiums.

My current 403(b) provider, TIAA-CREF, charges only 0.005% M&E, and they guarantee the beneficiary would get the current account balance (which could be less than the premiums if there is a serious market downturn), but I consider that level of insurance on the account appropriate.

Vanguard also has low insurance expenses on their annuities.

Many annuity contracts put the M&E fees in one place, and the investment advisory fees in another place, making it harder to see the real cost of that particular investment.

Fortunately, by picing TIAA-CREF (and those picking Vanguard) made good choices in this area!

2. Variable annuities outside of a qualified plan convert long-term capital gains into ordinary income. So if investing outside of a 401(k) or 403(b), I would rather pay long-term capital gains taxes of 20% or 18% in a somewhat tax efficient investment than put it in a variable annuity and have the gains taxed at 28% or higher (whatever my ordinary income tax rates will be at that time).

Within a 403(b), this doesn't matter because all gains within a 403(b) or a 401(k) will be taxed at ordinary income tax rates, no matter whether this is in a 403(b)1 as annuities or in a 403(b)7 as mutual funds. (More specifically, all money in a 403(b) will be taxed at ordinary income tax rates when it is taken out. However, by being funded with pre-tax money, the "tax favored" nature of a 403(b) is usually a good deal unless one is paying high expenses, such as prohibitive M&E expenses on top of high investment management expenses.)

3. Almost all traditional annuities in the accumulation phase and all traditional annuities after they have been annuitized earn significantly less than the long-term average market return. This reduced return is in exchange for removing market risk from the customer. (This includes the "Tranditional Annuity account" from TIAA-CREF.)

Unless I need "asset protection" (varies based on state law) or "asset hiding" or wants the insurance protection of premiums offered by some annuities, I would be inclined to put after-tax money in taxable investments, preferably something reasonably tax efficient (tax-managed funds, an S&P500 index fund, or a total market fund), before considering an annuity.
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