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Author: magma1 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75616  
Subject: tax deferred variable annuity Date: 12/6/1998 11:51 AM
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I am currently contributing the max to a 403b (mutual funds), a mandatory employer retirement plan (no control on investment, but low annual return), my wifes and my Roth IRAs (currently in non-index growth mutual funds that are underperforming the index funds by about 5%). In addition I have more than 100,000 in a portfolio of individual growth equities and mutual funds (some growth, some bond). I am 5-10 years away from retirement. I have been advised to take some of the bond funds and growth funds in my portfolio and put them in a tax deferred annuity with Fidelity, where my funds are located.

Is this a good idea or would I be better off to (a) put these monies into a combination of an index fund and additional growth stocks or (b)not sell the growth funds becasue I would incur significant long term capital gains now since they have grown appreciably over the years and just continue to invest new monies in growth stocks as I have been doing for the past year?

I appreciate yor guidance.
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7063 of 75616
Subject: Re: tax deferred variable annuity Date: 12/6/1998 3:25 PM
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Greetings, magma1, and welcome. You wrote:

<<I am currently contributing the max to a 403b (mutual funds), a mandatory employer retirement plan (no control on investment, but low annual return), my wifes and my Roth IRAs (currently in non-index growth mutual funds that are underperforming the index funds by about 5%). In addition I have more than 100,000 in a portfolio of individual growth equities and mutual funds (some growth, some bond). I am 5-10 years away from retirement. I have been advised to take some of the bond funds and growth funds in my portfolio and put them in a tax deferred annuity with Fidelity, where my funds are located.

Is this a good idea or would I be better off to (a) put these monies into a combination of an index fund and additional growth stocks or (b)not sell the growth funds becasue I would incur significant long term capital gains now since they have grown appreciably over the years and just continue to invest new monies in growth stocks as I have been doing for the past year?>>


Your question can't be answered other than in general terms without folks knowing one heck of a lot about your personal circumstances. IMHO annuities aren't for everyone. Indeed, unless you have a very low tolerance for risk in the market, desire some assurance of a "guaranteed" income, can let the money sit for 15 to 20 years and/or currently have a very large tax burden that dictates you shelter investment income, then you are far better off putting your money elsewhere. Annuities come loaded with expenses, admin charges and mortality fees that tend to drastically reduce any gains in the investment. They are definitely not the investment of choice within Fooldom. The only person that can decide if an annuity is appropriate in your circumstances is you.

Regards….Pixy


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Author: ataloss Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7070 of 75616
Subject: Re: tax deferred variable annuity Date: 12/6/1998 4:48 PM
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<<I have been advised to take some of the bond funds and growth funds in my portfolio and put them in a tax deferred annuity with Fidelity, where my funds are located. >>

Was this advice from someone who stands to make money from increasing the fees you pay? You should be aware that annuities will underperform similar mutual funds because of higher costs. Also the gains from your annuities will be taxed as ordinary income (39.6% max I think) vs 20% for capital gains. Taking a hit on capital gains taxes seems like a bargain to get out of funds undeperforming that badly.

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Author: magma1 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7075 of 75616
Subject: Re: tax deferred variable annuity Date: 12/6/1998 5:46 PM
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Pixy,
Thanks for the quick reply. I realized that only a genral answer could be given to my original post, but did not want to write too long a message to be read.
I have been invested in mutual funds with Fidelity for a number of years Mainly Magellan, Growth and Income, Ginnie Mae fund, and a muni bond fund. About 8 month ago I inherited some money that was already in a brokerage account and began with the help of the broker to invest the cash in that account in individual equities. That account is now 80% solid growth equities, 20% preferreed stocks (that were inherited). I have gotten turned on to the idea of individual stocks as the way to go, perhaps supplemened by an Index fund. I have been a Fool for the past few months and have really appreciated the information available here.
Over the pastI several months I have converted much of the bond mutual fund holdings (non-IrA/ non 403B) with fidelity so that my mutual funds balance in this account is 80% Magellan, 20% bonds amd the overall balance is about 50% equities and 50% mutual funds. I am pleased with the portfolio I have developed over the past several months which contains about 15 different stocks. Up until this year, my capital gains taxes have been high because of Magellan and the Ginnie Mae. These should be reduced now that I am buying stocks to hold.
So I guess my question now is whether I shuld continue down this path and continue to reduce the fidelithy fund holdings. My biggest concern is the Magellan since I will incur a significant capital gains on sales (the bond funds obviously did not appreciate much. And if I do sell Magellan, where should it go> You seem to indicate that a mutual fund tax deferred annuity is not such a good idea, and I appreciate the reasons given, though I was not aware of the "mortality cost".

Thanks again for taking the time with me.

magma1


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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: 7083 of 75616
Subject: Re: tax deferred variable annuity Date: 12/7/1998 11:02 AM
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C'mon Pixy, what do you mean "drastically reduce any gains in the investment?" If you look at the VARDS report on variable annuities you'll see the range af administrative fees & mortality expense fees. You don't need to let the money sit for 15-20 years, and finally variable annuities aren't limited to low risk investments - many offer a much wider variety of subaccounts that include index funds, large, mid, and small cap funds, and global funds in addition to bond funds and fixed-interest accounts... Some plans have some pretty competitive net rates of return, and also provide for tax-deferred earnings (the primary reason for selecting a VA in the first place). The payout program are not limited to guaranteed periods and/or lifetime, though that is an option! While I admit that VA's aren't best for everyone, they do work very well in some situations (and they're not as onerous as TMF always makes them out to be). Respectfully, PP

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Author: ataloss Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7090 of 75616
Subject: Re: tax deferred variable annuity Date: 12/7/1998 4:05 PM
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<<variable annuities aren't limited to low risk investments - many offer a much wider variety of subaccounts that include index funds, large, mid, and small cap funds, and global funds in addition to bond funds and fixed-interest accounts...>>

WSJ has an article today on the underperformance of annuity based index funds. Well worth reading. Peppermintpatty is in the insurance business, this seems to be the case for most advocates of annuities.

Also, a 20% hit from capital gains taxes will be recovered in 5.1 years if you switch from a fund lagging the market by 5%/year to one matching the market. After that time you are progressively further ahead.

(assumption market return 15%, lagging fund 10%; time to equal performance is less if you assume a market return more like the 10% or so historical norm.)

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7094 of 75616
Subject: Re: tax deferred variable annuity Date: 12/7/1998 6:20 PM
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PP writes:

<<C'mon Pixy, what do you mean "drastically reduce any gains in the investment?" If you look at the VARDS report on variable annuities you'll see the range af administrative fees & mortality expense fees. You don't need to let the money sit for 15-20 years, and finally variable annuities aren't limited to low risk investments - many offer a much wider variety of subaccounts that include index funds, large, mid, and small cap funds, and global funds in addition to bond funds and fixed-interest accounts... Some plans have some pretty competitive net rates of return, and also provide for tax-deferred earnings (the primary reason for selecting a VA in the first place). The payout program are not limited to guaranteed periods and/or lifetime, though that is an option! While I admit that VA's aren't best for everyone, they do work very well in some situations (and they're not as onerous as TMF always makes them out to be).>>

Sorry I gored your ox. :-)

Keep in mind I didn't rule them out. I just said they're not the best investment for most folks. Indeed, IMHO they're appropriate only for a few. "Drastic" is in the eyes of the beholder. The studies I've seen in the past ten years all indicate it takes the average annuity a minimum of 15 years to outperform a taxable stock fund. With the new capital gains rates, my suspicion is that situation will only worsen. That's because of the added fees, which on average are between 60 and 125 basis points more than those in funds.

I don't disagree that "some" plans have very competitive rates. But then I don't disagree that "some" funds beat the S&P 500 and the Vanguard 500, either. The hard part for the investor is finding that "some," and it's a cinch the ordinary agent ain't gonna "sell away" by mentioning them.

Nope. I stand by what I said. They ain't the best deal in town by a long shot. IMHO the ordinary investor should avoid them like the plague.

Regards….Pixy


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Author: magma1 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7103 of 75616
Subject: Re: tax deferred variable annuity Date: 12/8/1998 9:13 AM
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Thanks Pixy, PP and ataloss,

It is only by getting some variety of advice that one can begin to sort out the options better for oneself ( and as Pixy pointed out in his/her first repsonse that is ultimately my resonsibility. My basic concerns here have been two fold: (1) whether the added costs (in this case 0.8% plus the funds operating costs, which are greater than an ordinary index fund, that is a total of 1.08% vs fund cost of around 0.19% for the standard index fund) would be offset by the deferred tax advantage) and (2)whether to take the current capital gains hit to invest in the annuity vs standing pat with the fund or moving it to some other investments.
Asi indicated in my second post, I seem to have started down a "foolish" path and think I will continue to do so. I appreciate ataloss analysis of the capital gains hit, I was about to run a similar thing myself. I also have to determine more accurately whether the fund is currently performing more in line with the S&P, which I thnk it is and monitor it closely, rather than simply liquidate it on the basis of the poorer performance in the previous few years. Finally, if I do determine to liquidate it, I will probably do so over a few years, because I have too much invested over too lont a time to take the hit all in one year.

AGain thanks for the input all.

magma1

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Author: trudyKAS One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7108 of 75616
Subject: Re: tax deferred variable annuity Date: 12/8/1998 7:52 PM
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My opinion is ditto on the annuities. IMHO they are great for someone with megabucks who is afraid they can't make their own retirement decisions. Personally, I would prefer to set up a reverse mortgage with my most spendthrift offspring. (gratefully, I don't have any of those!)

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7126 of 75616
Subject: Re: tax deferred variable annuity Date: 12/9/1998 1:56 PM
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Magma1 sez in part:

<<It is only by getting some variety of advice that one can begin to sort out the options better for oneself ( and as Pixy pointed out in his/her first repsonse that is ultimately my resonsibility. My basic concerns here have been two fold: (1) whether the added costs (in this case 0.8% plus the funds operating costs, which are greater than an ordinary index fund, that is a total of 1.08% vs fund cost of around 0.19% for the standard index fund) would be offset by the deferred tax advantage)…>>

I don't see how it possibly could beat the fund. While you will have a very small current taxation hit in the fund due to dividends, because the index fund doesn't sell its shares very often (only when there's a shift in the stocks composing the index), all of your potential growth will be taxed at a capital gains rate when you finally take it. All growth in the annuity will be taxed at an ordinary rate. I'm not sure what your concern is here; however, it shouldn't be too hard for you to run the numbers as they apply to your situation.

Regards….Pixy


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Author: magma1 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7140 of 75616
Subject: Re: tax deferred variable annuity Date: 12/9/1998 5:54 PM
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To Pixy,
I see your point the idea is that the standard index fund is effectively tax deferred anyway since I do not sell shares of it till I need it. Therefore the annuity is just costing my operating expenses for nothing--plus the annuity withdrawel may be taxed at a higher rate.
Maybe I am finally catching on--a little slow but I will get there eventually. That is why I do not rush into things.

Thanks again,

Magma1

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7149 of 75616
Subject: Re: tax deferred variable annuity Date: 12/10/1998 9:24 AM
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Magma1 sez:

<<I see your point the idea is that the standard index fund is effectively tax deferred anyway since I do not sell shares of it till I need it. Therefore the annuity is just costing my operating expenses for nothing--plus the annuity withdrawel may be taxed at a higher rate.
Maybe I am finally catching on--a little slow but I will get there eventually. That is why I do not rush into things.>>


You got it! And slowness isn't important. Understanding is.

Regards….Pixy



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Author: ataloss Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7170 of 75616
Subject: Re: tax deferred variable annuity Date: 12/10/1998 5:05 PM
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Magma1,

I have recently talked myself into selling a fund I had held for 10 years. It had lagged the s&P 500 by a couple of percent per year. It took me a long time to decide to do this.

I did make a mistake in my previous calculation. I assumed that you lost 20% of the value of your funds immediately to capital gains taxes. This 20% loss, of course, only applies to the gains. If, say, half of your account value (x) is due to capital gains and half is due to contributions, after applying the capital gains tax, you will be starting your new index fund with 90% of x. You will "catch up" more quickly than I had suggested. Of course, life isn't that simple and funds don't have constant annual returns or lag by constant percentages.

If you want to become annoyed at your funds, multiply the annual expense ratio by the number of dollars under management. I did this with my 1996 annual reports.

I have some money invested in Vanguard's Capital Appreciation Portfolio. It hass an expense ratio of .17% (which is less than the index 500) and it strives to minimize capital gains and income distributions. I don't know if it will be better than an index 500 fund but it sure beats annuities for deferral of gains.


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