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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76090  
Subject: Scott Burns on Variable Annuities Date: 3/2/2000 10:01 PM
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Good article from the Dallas Morning News on the subject. While long time "Fools" are familiar with the sad story of high fees and expenses, it may be some food for thought for "newbies."

http://dallasnews.com/business/columnists/42374_burns_02bus.AR.html

intercst
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Author: TTRoberts Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19754 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/2/2000 11:32 PM
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BEWARE of poorly written articles like the one suggested by intercst written by Scott Burn in the Dallas Morning News. I also see this very kind of article in various other newspapers and magazines.

The problem is that brief analysis/comparison in the article is VERY poorly done. For example, Mr Burns says that "the average expense ratio of the fund family is 0.74 percent" (referring to the American Fund Family). Then he goes on to say that "the typical variable annuity has no front-end sales commission but carries a very high expense ratio of about 2.1 percent".

Now what kind of D U M B comparison is it that compares a specific fund family with an "typical" variable annuity. To be FAIR, it would have been better to simply compare a "typical" fund family's average expense to the "typical" variable annuity's expense. But NOoooooo, we have a very slanted presentation of the issue.

There's more. Mr. Burns goes on to say, "Worse, if you decide to change variable annuity providers, you face an early redemption penalty that can be significantly higher than the front-end load American Funds charges."

What he should want to do is compare the surrender charge of an annuity to the tax hit one takes when changing a fund family - not to compare any front end load to a surrender charge. The reason you'd compare it this way is because the reason for getting out of an annuity is very often the same reason for getting out of a fund family (e.g. no selection of funds that perform as expected). He also might have pointed out that if one stays in the annuity, one could change from one investment to another without incurring a taxable event which is not so if one changes from one fund to another with any fund family. So, we have another highly slanted take on what appears to be some kind of comparison.

Mr. Burns then says "Buy the variable annuity and you face 2.1 percent expenses forever. Buy the fund with the sales charge and you recover the front-end charge in four years." Here again we have him using the "typical" variable annuity expense (which by the way has changed and continue to move downward just as American Funds has moved their annual expenses down in recent years). I'm not suggesting that the "typical" variable annuity isn't higher than the "typical" mutual fund (though only about 65 basis points). I'm just appalled that the article is sooooooo slanted and not giving a fair representation.

. . .AND there's MORE!!!

Mr. Burns goes not to provide a so called "example" . . . . "Suppose the American fund and a variable annuity firm both earned pre-expense returns of 10 percent a year and that you invested $10,000 in each. Where would you be at the end of 10 years? Even after taking the upfront commission hit of $533, the remaining $9,467 will grow to $22,950 in the American fund while the variable annuity fund, which starts with the full $10,000, will grow to $21,370. That's a 10-year difference of $1,580."

This is only part of the issues to consider as the lump sum at the end of any period is only part of the story. While it's true that after a given period that mutual fund investment will end up with a lump sum more than in a variable annuity (even using a "typical" average expense for a mutual fund), the annuity can produce a much greater life time income than the mutual fund (even when the mutual fund starts out with more in it). This kind of comparison is a POOR one as it ignores issues concerning just how the investment might be used at the end of a given period.

Mr. Burns then suggests that investing an amount of $2,000 per year over 30 years would have a difference of a little greater than $60,000 and that, "That difference is one of the reasons you don't find a lot of enthusiasm for the average variable annuity in this column." What Mr. Burns fails to recognize is that is issues concerning annuities is not JUST which has the most accumulations. But there are many other issues that people address and producing a life time of income is only one of them.

A MUCH better article that Mr. Burns' is the one done in Money Magazine in the Jan. 2000 issue. That was one of the best one's I've ever seen from a publication produced for the public (though it still had some significant slant against annuities).


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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19757 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/3/2000 12:42 AM
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TTRoberts wrote (in response to the "poorly written article like the one suggested by intercst written by Scott Burn in the Dallas Morning News")

What he should want to do is compare the surrender charge of an annuity to the tax hit one takes when changing a fund family - not to compare any front end load to a surrender charge. The reason you'd compare it this way is because the reason for getting out of an annuity is very often the same reason for getting out of a fund family (e.g. no selection of funds that perform as expected). He also might have pointed out that if one stays in the annuity, one could change from one investment to another without incurring a taxable event which is not so if one changes from one fund to another with any fund family. So, we have another highly slanted take on what appears to be some kind of comparison.

I'm not sure where you see the taxable event on changing fund families. Burns is writing about a 403(b) plan. You can change investments within the 403(b) without paying taxes on the transaction.

Burns comments on annuities are right on! I retired 5 years ago in part because I avoided these schemes. I got friends from college that will be lucky to retire in 15 years, largely because they're in annuities and they're being sucked dry with fees and commissions.

intercst



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Author: jtmitch Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19760 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/3/2000 8:56 AM
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IMHO it is criminal that schools, colleges, hospitals, etc. are so locked into annuities for their 40(B) programs rather than straight mutual fund programs. Any organization which has a "strictly" annuity approach should, at the very least, make TIAA-CREF one of the choices so participants can avoid the high costs associated with annuities run by many other firms.

jtmitch

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Author: KKoleto Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19761 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/3/2000 10:55 AM
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jt...

I'm not so sure they are all locked into annuities only. My wife teaches in a school district and mutual funds are available to the employees. Interestingly, none of them seem to buy the funds. Further, she never seems to be given information on the fund families available to her. Could it be the brokerage that sells the annuities makes out better than if it sells mutuals?

Is is criminal, in a way. I wish I understood why (some) teachers are so passive about their investments.
And please, teachers I'm not intending this as a negative remark. It's just that I believe that it makes no sense to put a tax-deferred product into an already tax-deferred program! You deserve better.

Ken

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Author: TTRoberts Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19765 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/3/2000 12:52 PM
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intercst, you pointed out:

<< I'm not sure where you see the taxable event on changing fund families. Burns is writing about a 403(b) plan. You can change investments within the 403(b) without paying taxes on the transaction. >>

You're CORRECT! Somewhere during the writing of my response I lost that perspective with regard to an annuity within any type of qualified plan. THANK YOU for pointing that out.:-)

I still feel that it's ridiculous for someone like Mr. Burns to exaggerate the difference in expenses and compare the new lowered expense average of a single fund family with the OLD "typical" annuity when variable annuity's expenses are also in the process of being lowered. Mr. Burns doing such a thing is spreading misinformation that really takes away from the good point he is making about having annuities in something like a 403(b).

Let me make it perfectly clear here that it is my position that one should not use an annuity in a 403(b) plan or within any other tax deferred plan. My objection to Mr. Burns article is NOT about this issue - but about his exaggerations.

When you say "I retired 5 years ago in part because I avoided these schemes", I should point out that this kind of thing is NOT a "scheme". While it may be someone's feeling that it's a "scheme" or "criminal" that there is such an emphasis on annuities in 403(b) plans, there were very specific reasons with the idea to actually protect participants in 403(b) plans.

If one will go back in history, rather than just looking at how things are and the environment we have today, one will find that ONLY annuities were allowed in a 403(b) plan. It's only in more recent years that mutual funds are now allowed. There used to be extreme concerns about suitability of investments and wanting to protect people who were in effect managing their own retirement program. One of the reasons that made annuities attractive to the regulators was in fact that very surrender period that we so abhor now. They, the regulators, wanted to discourage people from getting out of long term commitments and encourage them to stay in for the long term. Actively managing their retirement assets was not something that was felt was prudent for the normal 403(b) investor.

In recent years, many more people are now more investment savvy. But, the bureaucracy of schools systems is slow to change. Also, many if not most school systems are still fearful of being held liable for keeping their participants informed regarding investments. School systems and other non-profit organizations tend to look at annuities as a safer risk management and maybe even a less costly approach for THEM in providing a 403(b) plan.

I'm not trying to defend the use of annuities in things like 403(b) plans. I'm only trying to point out some of the history and the environment in which these things are being done - that it's not about there being any kind of "scheme" or "criminal" posture being involved. It's just more complex than most of us understand it to be.





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Author: peppermintpatty Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19782 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/3/2000 10:51 PM
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intercst -

You said: "I'm not sure where you see the taxable event on changing fund families. Burns is writing about a 403(b) plan. You can change investments within the 403(b) without paying taxes on the transaction."

I'd agree with you on that point. However, a good variable annuity, used in a 403b/TSA plan would offer a wider variety of investment choices, managed by a variety of good investment managers (like Janus, Putnam, T.Rowe Price, Fidelity, etc. etc.).

My experience with TSA accounts finds (a) no front end load, and (b) expense ratios as low as 1.25%. With unlimited transfers between investment subaccounts & NO MINIMUMS, I believe some TSA plans can work very well!

Regards, PP



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Author: peppermintpatty Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19783 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/3/2000 11:00 PM
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Ken -

You said: "I believe that it makes no sense to put a tax-deferred product into an already tax-deferred program!"

But there's more to it than that! An annuity package offers more than just the tax deferred status... Consider the fact that there is a "Fixed Interest" account which provides a guaranteed rate of return (granted it's low, but it's appropriate for the more conservative saver...). Good quality TSA's will offer a variety of investment accounts managed by different quality managers (e.g. Janus, Putnam, Scudder, etc.).
And finally, one of the benefits you pay for - the guaranteed "death benefit", which guarantees a minimum lump sum payout to a beneficiary in the event of the owner/annuitant's premature demise! So, in spite of a drastic market drop, the TSA will pay a beneficiary at least what was contributed into the plan (and often will step up the basis every 5 years, to capture gains as well).

So... there's more than meets the eye!

Regards, PP

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19786 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 12:40 AM
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peppermintpatty wrote,

My experience with TSA accounts finds (a) no front
 end load, and (b) expense ratios as low as 1.25%.
 With unlimited transfers between investment 
subaccounts & NO MINIMUMS, I believe some TSA plans
 can work very well!

I don't consider a 1.25% expense ratio low. The
 Vanguard S&P500 index fund has an expense ratio of
 0.17%. The 1.08% difference is HUGE in terms of how
 much it robs from the size of your eventual 
retirement nest egg. See table below:


The Effect of Management Fees on your IRA Balance. 
Assumes $2,000 yr. contribution, 
10% annual return before management fee.

 
IRA Balance after 5 Years 10 Years 20 Years 30 Years 40 Years 
Mgmt. Fee @ 0.02% $13,423 $35,022 $125,696 $360,454 $968,249 
Mgmt. Fee @ 0.25% $13,334 $34,556 $122,204 $344,402 $907,762 
Mgmt. Fee @ 0.50% $13,238 $34,077 $118,528 $327,816 $846,479 
Mgmt. Fee @ 1.00% $13,047 $33,121 $111,529 $297,150 $736,584 
Mgmt. Fee @ 2.00% $12,672 $31,291 $98,846 $244,692 $559,562 
Mgmt. Fee @ 3.00% $12,307 $29,567 $87,730 $202,146 $427,219 

intercst


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Author: nampa45 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19791 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 11:31 AM
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I totally agree. Yes, management fees can and do have a HUGE effect over the long term on investments. They should be CAREFULLY examined before making any kind of investment. Over a lifetime they can amount to hundreds of thousands of dollars.

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Author: TTRoberts Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19800 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 2:05 PM
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peppermintpatty, you wrote:

<< I'd agree with you on that point. However, a good variable annuity, used in a 403b/TSA plan would offer a wider variety of investment choices, managed by a variety of good investment managers (like Janus, Putnam, T.Rowe Price, Fidelity, etc. etc.). >>

Actually, that's a VERY good point. In today's annuity environment, variable annuities provide a wide range of investment selections (as much as 20 to 40 and with varioius fund families)that a single fund family does not do. Sure, one can easily change fund families within something like an IRA or maybe a small employers SEP plan. But in a bureaucratical system like school systems, it's NOT easy to change. So, from the school systems point of view, a well selected variable annuity can be more attractive. Again, as I've suggested before, things tend to be more complicated than what we might normally be thinking.


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Author: KKoleto Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19801 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 2:50 PM
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Peppermint Patty:

You said: "But there's more to it than that!"

Sure, higher expenses, for one.

"Good quality TSA's will offer a variety of investment accounts managed by different quality managers (e.g. Janus, Putnam, Scudder, etc.)."

Agreed, but the funds are available outside of the annuity.

"And finally, one of the benefits you pay for - the guaranteed "death benefit", which guarantees a minimum lump sum payout to a beneficiary in the event of the owner/annuitant's premature demise!"

Of course, it does: it's an INSURANCE product. It's what the last financial planner tried to sell us! And I don't mean to say its a BAD product. My point, which I may not have made stronlgly enough, is that it seems that 403b participants are not that well informed regarding their choices, and are restricted by law from the benefits enjoyed by 401k participants.

Funny you didn't mention that heavy back end load if the partcipant decides to try mutual funds...

Regards,
Ken


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Author: peppermintpatty Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19815 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 11:27 PM
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OK, management fees are worth considering when two or more investments/mutual funds have the same "gross yield", but IMHO the bottom line is what's most important to me! The total expenses are secondary to my NET RATE OF RETURN. Don't you agree?

PP

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Author: peppermintpatty Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19817 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 11:42 PM
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Ken -

Sure, many of the annuity funds are available on the outside... what about minimum funding requirements?
And asset allocation? For the investor with deeper pockets many opportunities are available. But for the beginner/small investor a TSA opens doors.

A TSA's death benefit feature may not be important to everyone... That's fine. If a person can live without it, so be it.

Higher expenses for the TSA? Most likely. But you get what you pay for. If using one mutual fund family for a 403b(7) account suits someone best - go to it!

Heavy back end load? Well, many TSA's have a surrender charge that's a bit higher than Class B shares of a mutual fund, but if a retirement saver will be in it for 10+ years it shouldn't be a major obstacle.

Overall I feel that too few people save enough for retirement at all! If a financial advisor motivates a person to save ANYTHING that's a step in the right direction...

Cheers, PP




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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19818 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/4/2000 11:53 PM
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peppermintpatty wrote,

OK, management fees are worth considering when two or more investments/mutual funds have the same "gross yield", but IMHO the bottom line is what's most important to me! The total expenses are secondary to my NET RATE OF RETURN. Don't you agree?

I think we can agree that everyone seeks, and likes, high net rates of return. The question is "How do you find them?"

Every prospectus I've read includes some variation of "past performance does not guarantee future returns." Then you have the studies showing that this years top performing mutual fund invariably under performs in subsequent years. How do you choose?

The only sure fire method I've found is to minimize what you pay in fees and commissions, and be a LTB&H investor in individual stocks to reduce turnover and the negative effects of the bid/asked spread. My annual investment expenses are less than 0.01% (i.e. less than 1 basis point) and I've enjoyed close to a 40% CAGR over the past ten years.

I retired 6 years ago at age 38. I encourage everyone to pay close attention to how much you're losing to fees and commissions.

intercst



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Author: Dodgeball Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19835 of 76090
Subject: Re: Scott Burns on Variable Annuities Date: 3/5/2000 4:47 PM
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As a schoolteacher, I have indeed found that most of my colleagues are misinformed when it comes to the fees associated with variable annuities.

The important thing for people to remember is that if you contribute to a variable annuity inside of a 403b, you are essentially buying the annuity as opposed to investing.

Dave

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