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Author: MTBer One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76397  
Subject: Old Question/jesserivera67 Date: 11/27/2003 10:14 AM
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Happy Thanksgiving, Fools!

Reposting my quesiton as no one answered before -(hoping it was just overlooked, and not offensive!). I am looking for easy to understand information on annuities vs. regular mutual funds as my employer is interested in listening to any information I have on including other options other than an annuity in our 403B.

Jesserivera67, I see the link you posted to the recent querry as to rolling over to an annuity, but the link was unfound and I can't find it. Could you post again?

Thanks!

MTBer
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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38005 of 76397
Subject: Re: Old Question/jesserivera67 Date: 11/27/2003 12:25 PM
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While you can invest in stocks or bonds through mutual funds or annuities, annuities typically have far higher fees than mutual funds.

The chief draw of annuities is thier tax deferred growth, but you get an anyway in a 403b!

Do you have the name and/or expense information of the annuities your company offers? Then we can do a comparison.

See also:

Annuities: Who Needs Them?
http://www.fool.com/news/commentary/2003/commentary030813rb.htm

Annuities: What's to Like?:
http://www.fool.com/retirement/annuities/annuities.htm?source=LN

Annuities: Buyer Beware:
http://www.fool.com/retirement/retireeport/2000/retireeport000821.htm

Nick



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Author: jesserivera67 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38009 of 76397
Subject: Re: Old Question/jesserivera67 Date: 11/29/2003 2:18 AM
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I've included my old post below. I changed my answer to #1 for you Nick...;-)

I noticed Nick provided you with some great links...here's another link for you...

http://www.fundadvice.com/FEhtml/InvestingBasics/0103b.html

If you provide some more details on your 403b plan we could perhaps help further...

The annuity in your 403b plan doesn't offer any advantages that I can see but I may be missing some details...I would expect that what it does offer you is a larger fee structure...

old post below...

"1. Leave it where it is."

I wouldn't...I like to add to my investments. Won't kill you to leave it there as it will grow.

"4. Roll it to an annuitity"

DON'T, DON'T, DON'T, DON'T, DON'T...This is abominable choice. I'll explain later.

"2. Roll it to a Roth IRA"

Always a good choice but as indicated you need to roll it to a T-IRA first. See pub. 590 for more details. It's written fairly well.

http://www.irs.gov/pub/irs-pdf/p590.pdf

"3. Roll it to the new company"

Depends on the quality of the funds in the 401k. Many 401k's are not very good passing up free money from your employer if they offer it (and they should) is a big mistake.

Not sure of your situation but you might want to ask yourself a few questions...

1) How am I saving today? Am I on target for retirement?
2) Am I contributing the max to my new company's 401k?
3) Do I also contribute max to a T-IRA
4) Am I making more than $160,000 a year? If so, a Roth is not an option.

If you are not contributing the max to your 401k or T-IRA then find a way to do that first depending on your ultimate goal.

Annuities are just not very good choices at all (See http://www.fool.com/retirement/annuities/annuities.htm).

There are way to many alternatives to really make an annuity a good deal. Look at annuities vs. just regular mutual funds. The selling point of tax deferral comes at a significant cost in fees and the death benefit is rarely worth it. 401k's and T-IRA's gains are taxed at your income level when you retire. Annuities follow the same pattern. If you're income tax rate is say 31%...well...whack 31% off of your gains. You can invest in a low cost no load index fund which is very tax efficient and as long as you hold on to it for over a year (some times vary I think) will be taxed at 20%...correction...15% long term capital gain!!!

Some aren't bad like TIAA-CREF but if you're not contributing the max to your 401k or T-IRA/ROTH then an annuity rarely makes any sense.

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Author: MTBer One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38027 of 76397
Subject: Re: Old Question/jesserivera67 Date: 12/2/2003 5:56 AM
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Jess/Nick,

Thanks so much for the information/reading materials. I am going through it now and suspect that I will have some questions regarding what I have read.

I appreciate your help!

-MTBer

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Author: MTBer One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38080 of 76397
Subject: Re: Old Question/jesserivera67 Date: 12/7/2003 12:19 AM
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Hey, Fools!

I think that I have a better handle on some of this now. I believe that I better understand the mortality and expense charges, the management fees, and the surrender charges. Mortality expenses and fees are 1.0%, and my "subaccount" (500 index fund) runs .32%, which is the "management fee", correct? So, my fees and expenses are 1.32%, plus the $25.00 I pay a year. Make sense?

So, of course that is not too exciting.

What I am trying to understand is this. They talk about how when you begin withdrawals (from the variable annuity), that the money is "taxed as ordinary income tax", which means it is taxed based on my tax bracket. If my 403B was NOT an annuity, it would STILL BE TAXED in the same way, correct? Is it only the "gains" that are taxed?

So, outside of the fees described above, there is no other downside to the variable annuity vs. a regular 403B (yes, as stated, I am trying to gather up a list as to "why we should get the heck out of the annuity only option", for my employer).

In the reading material suggested, when looking at the downside of annuities vs. other investment income, they spoke about a "capital gains tax break". They say this is 15%. They are referring to "after tax" accounts, correct? I don't understand what "capital gains tax break", means per say, but perhaps it means that when income from other sources, such as, lets say, money in a 500 index account in Vanguard, is removed, I would get taxed at 15%? Is this on all the money in there, or just what I made? Or does this relate to something completely different (this I would really like to understand b/c the money I have in said account is my "house fund", so I would like to know the consequences of this).

Anyway, back to retirement, specifically. If I am understanding this whole thing correctly, perhaps my retirement investment strategy (if I am stuck with this annuity at work), should look something like this:

1) Invest up to employer matching in 403B (annuity)
2) Max out Roth yearly
3) Put rest of money in after tax account in Vanguard (or whoever)

Thanks in advance for your wisdom!

-MTBer


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Author: jesserivera67 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38087 of 76397
Subject: Re: Old Question/jesserivera67 Date: 12/7/2003 2:17 PM
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"Mortality expenses and fees are 1.0%, and my "subaccount" (500 index fund) runs .32%, which is the "management fee", correct? So, my fees and expenses are 1.32%, plus the $25.00 I pay a year. Make sense?"

You're well on your way!!! Basically there are four components of fees with an annuity. I've taken this directly from the SEC website, http://www.sec.gov/investor/pubs/varannty.htm.

Mortality expense risk fees (your case: 1.0%)

Surrender charges (which only apply if you try to withdraw money from your annuity within the surrender period, typically 7-10 years. It'll start at around 7% and then drop by 1% each year until it's gone.)

Administrative fees (your case: $25)

Underlying Fund Expenses (your case: .32%)

"If my 403B was NOT an annuity, it would STILL BE TAXED in the same way, correct?"

You are correct. Actually this seems to be a qualified plan which means you're depositing pre-tax dollars so the lump sum will be taxed at your income tax rate at the time of withdrawal.

"Is it only the "gains" that are taxed?"

No, since you have a qualified plan the total will be taxed at your income at the time of withdrawal(If this was a non-qualified plan, using after-tax dollars, this would be correct.)

"So, outside of the fees described above, there is no other downside to the variable annuity vs. a regular 403B"

You've pretty much got it. It might be beneficial to looks at the benefits of an annuity for your discussion with your employer. (I'll just speak to variable deferred which is what your annuity looks like.)

Death Benefit:
This is the insurance component of an annuity. Basically let's say over 10 years you deposit $10,000 into this annuity. Close to the end of your term the market performs horribly and your investments are only worth $5,000. Now say it's really not your year and you become deathly ill (heaven forbid mind you) and pass on. Whoever you list as your beneficiary will get at least the $10,000 you put into it. Hey, pretty good deal eh? How can you lose?

You lose with the fees as you described. This "benefit" is not worth the price you pay. In fact, one study determined the price of the death benefit for a $25,000 annuity should be in the range of $8.75 a year! That would be .03%! (See paper at http://www.yorku.ca/milevsky/Papers/JRI2001A.pdf).

Why not just get a good term life insurance policy that would cost a lot less?

Tax deferral:
The annuity offers you guaranteed tax deferral until you withdraw your funds when you retire...you can get a 403b plan which already offers tax deferral without having an annuity which means that the 1.0% fees would be gone....32% is quite a bit better than 1.32%

This seems odd to me. The Vanguard 500 charges .18% in fees. Within an annuity, typically this expense goes down a bit (reason being that they charge you a boat load of other fees) but yours went up. Just seems odd but if that's what the contract says your stuck with it for now.

No limiton deposits:
In non-qualified plans there is typically no limit on the amount you can deposit. Since yours is qualifed the limit would most likely be $12,000 so this doesn't really pose a benefit.

"They are referring to "after tax" accounts, correct?"

yes for the most part but you can have capital gain in your 403b plan. The difference is in how it's taxed.

I don't understand what "capital gains tax break", means per say, but perhaps it means that when income from other sources, such as, lets say, money in a 500 index account in Vanguard, is removed, I would get taxed at 15%?

I'll try to explain...hopefully I don't confuse the issue...You start out with some money to invest. This would be your capital. When you invest your money, your money will do one of two things...grow or shrink. The amount your money grows is known as the "capital gain" (capital loss if it shrinks). Uncle Sam says, "I want a piece of that action!" and slaps you with taxes.

The taxes will apply when you remove your funds. So if you invest $10,000 and it grows to $11,000 you will owe capital gain taxes on $1000.

Now will it be short term capital gain or long term capital gain? The difference is for short term (held for less than a year) you will pay ordinary income tax on the $1000. Depending on your income this could be 35% or $350! For long term (more than a year typically) the tax rate jumps down to 15% or $150!!! I think this is the tax break you are referring to and yes it is for after tax investments (e.g. go to scottrade, open an account and start depositing after-tax dollars into a mutual fund.)

"(this I would really like to understand b/c the money I have in said account is my "house fund", so I would like to know the consequences of this)."

You got me...not sure what a "house fund" is. Are you referring to your e-fund???

"
1) Invest up to employer matching in 403B (annuity)
2) Max out Roth yearly
3) Put rest of money in after tax account in Vanguard (or whoever)"

I'm assuming with "whoever" you mean no load, low cost mutual fund providers. This looks like a good strategy to me.

This is an unfortunate situation but all is not lost. At least you got some free money from your employer match and as long as you keep the money in there for the long run you should still come out ahead. I'm guessing your employer was woo'd by whoever sold him the annuity (Annuities are typically sold...not purchased.) with some of the benefits listed above, thinking he was perhaps doing it for his employees best interest. The bummer is he could have done better.

Best of luck to you.

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Author: MTBer One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38093 of 76397
Subject: Re: Old Question/jesserivera67 Date: 12/7/2003 10:00 PM
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I appreciate you answering my questions so thoroughly and in simple terms. I now feel like I have enough information to present to my CEO why a change would be useful.

I do have a few thoughts/questions.

If, for example, we went to a 403B (without the annuity component), what kind of fees would we have? For example, my 500 Index in Vanguard has that .18% fund expense, as you mentioned. If a business had their 403B through Vanguard, should I expect that the above expense in the same fund would stay the same, or would it increase? Additionally, would there also be a administrative fee? Any other fees that a typical 403B would have?

When I said "house fund", I was referring to savings to purchase my first home, which I hope to purchase within the next year. Sorry, I didn't explain that! I have been putting the majority of any additional "house savings" (monthly deposits,) into an ING savings account, as I understand that this would make more sense. However, I have been putting a small deposit, monthly, into my 500 Index toward this savings goal. After reading about how these additional deposits would qualify as "short term capital gain" (taxed as ordinary income), if I withdrew it within a year, it makes sense that I immediately stop these deposits. Right?

In the meantime, besides market risk, is there any other downside, financially, to leaving the rest of the "house fund" in this account until I am ready to purchase my home? Actually, I guess that the more the money grows, it means that much more money would be taxed at 15%. I would have to make over 17% on the investment in order to beat the 2% I would get at ING (after losing 15% on the withdrawal from Vanguard). Am I looking at this correctly?

Again, I appreciate the help. Sorry so many questions!

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Author: jesserivera67 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38101 of 76397
Subject: Re: Old Question/jesserivera67 Date: 12/8/2003 11:42 AM
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"If, for example, we went to a 403B (without the annuity component), what kind of fees would we have?

Depends on who your get your 403b from. Since we've been talking about Vanguard here's a link to there business retirement plans. Just click ont he 403b section.

http://flagship4.vanguard.com/web/corpcontent/scatRetBusSubcat.html

"If a business had their 403B through Vanguard, should I expect that the above expense in the same fund would stay the same, or would it increase?"

Depends on the plan. Typically the answer is yes the fee would be the same. You'll need to read through it though.

"Additionally, would there also be a administrative fee?"

Yes...again depends on the fund. I believe Vanguard charges $15 annually per fund.

"Any other fees that a typical 403B would have?"

see above.

"However, I have been putting a small deposit, monthly, into my 500 Index toward this savings goal. After reading about how these additional deposits would qualify as "short term capital gain" (taxed as ordinary income), if I withdrew it within a year, it makes sense that I immediately stop these deposits. Right?"

Depends on how long you've held them, longer than a year? If you're planning to use the money within a year then they shouldn't be in any equity investments. Too volatile and if "things" happen you could stand to lose a large amount of your investment. I get this moved to a more liquid account. ING is fine and probably gives better interest than most all brick and mortar companies (e.g. BofA, Wells, etc.). You could also place in money market mutual fund, 1 year CD, etc. Lots of options but keep that money in a very safe place if you're going to use it in a year! Equity investmests should not be made unless you have 5 years or more to invest in them. I prefer 10 or more to be a little more safe.

"...is there any other downside, financially, to leaving the rest of the "house fund" in this account until I am ready to purchase my home? Actually, I guess that the more the money grows, it means that much more money would be taxed at 15%."

See above. Again, if you're using this money within a year I would HIGHLY recommend you move it to a safe place such as the examples I gave above. I see you have a lot of questions regarding taxes so I'll leave you with some links to do some additional research (and more than likely ask even more questions!!! :-) )

Taxes are unavoidable, it's just a matter of when. Yeah, much more would be taxed but your anticipating your gains to be much higher as well. Don't let taxes scare you. They're just a fact of life that all of us need to deal with.

"I would have to make over 17% on the investment in order to beat the 2% I would get at ING (after losing 15% on the withdrawal from Vanguard). Am I looking at this correctly?"

Not exactly. Let's go back to the $10,000 investment that grew to $11,000 and say you held onto it for over a year so you will pay the long term gain on the $1000 (growth of 10%) so that would be 15%(long term capital gain tax). You take 15% of the $1000 or $150 for taxes. You still make $850 on your investment of $10,000.

If you sold the investment within a year (short term) you'd be taxed at your ordinary income rate, let's say 28% so you'd pay about $280 instead. You'd still make $720 on your investment. That's basically the advantage of long vs. short term taxes. Make sense?

No need to apologize for the questions that's what the fool site is for!!! I will say when you post don't necessarily put a name in your post. I have no problems helping but there are a ton of folks on this site that are ALOT smarter than I am (TTRoberts, yobria, BuildMWell, pauleckler, PosFCF, to name a few) that can offer additional insights that I may have left out.

Since you've opened a can of worms even more info on the 403b's. I decided to do some research in the area that will perhaps help your conversation with your CEO.

403b's came into existence around the 1930's. At that time they were all required to invest in annuities (Ah HA! I knew there was something fishy here.) In 1974, mutual funds were made available for 403b investments but the insurance companies have such a strangle hold on them that as of 2001, over 80% of 403b's were invested in annuities.

I have a hypothesis for this. The 403b market caters to nonprofit organizations. Budgets for these organizations are typically very tight and HR departments are very thinly staffed. Many of these organizations just want to set something up quick and dirty so they fall prey to insurance salesmen and VOILA...another annuity in a 403b plan.

You'll also notice how 90% of all articles are written for 401k's. I have a thought on this as well...the 401k market caters to "profit" organizations which more than likely have larger incomes...the mutual fund industry unfortunately cater to them because of larger investments, leaving the 403b's out in the cold unfortunately.

It seems that you will need to get some additional support if you're to convince your CEO so talk to as many people as you can so you can all discuss with him. I would explain to him that all of his employees deserve a good retirement and the 403b plan represents an opportunity for all of them to have just that; however, money is being siphoned away due to fees associated with the annuity whose death benefit is just not worth it.

I wish you the best of luck on this as it is no easy task but you're on a journey that I hope and pray ends well for you.

Here are some additional links for you...

Capital Gain
http://www.fool.com/school/taxes/2000/taxes000107.htm
http://www.fairmark.com/capgain/index.htm

403b IRS info
http://www.irs.gov/pub/irs-pdf/p571.pdf

Books (I took a lot of the information I gave you from these)
Retirement Bible (great explanations of all types of retirement vehicles)
http://www.amazon.com/exec/obidos/tg/detail/-/0764552457/qid=1070901557/sr=1-1/ref=sr_1_1/104-9019455-1783130?v=glance&s=books
Investing Bible (Solid general info)
http://www.amazon.com/exec/obidos/tg/detail/-/0764553801/qid=1070901557/sr=1-2/ref=sr_1_2/104-9019455-1783130?v=glance&s=books

Jesse


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Author: MTBer One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38155 of 76397
Subject: Re: Old Question/jesserivera67 Date: 12/10/2003 10:00 PM
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Thanks for all your help and all the information (again!)

Yes, I am looking to buy the house in about a year, so I am thinking that it would be best to take the money out now. I was just hedging my bets since seeing the numbers go up (finally!)is so pleasing. Since I am hoping to purchase a house in a year, that was why I focused on how I should not add any additional funds (the whole ordinary tax thing). I still don't really understand it all (how it works in terms of taking all of it out and how the money that has been in there for a longer than a year gets taxed, versus the less than one year amount), but I'm certain that Vanguard can explain it to me.

I have been trying to find companies that cater to the nonprofit crowd, but haven't had much luck yet. Vanguard, for example, requires an initial investment of $5,000 for each participant, which I am certain is not an option for many of my fellow employees. So, we will see.

Thanks again for putting me on the right road. Even when I was searching this website, I must have been looking in the wrong places because I didn't find several of the articles you mentioned. The many links that you have sent me have been quite helpful. I have no doubt that with the information that you have given me, that my CEO will surely be interested in looking at something different.


Take care.


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