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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: of 75614  
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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