Author Topic: Input please! What to do with parents' annuities?  (Read 766 times)

FINate

  • Handlebar Stache
  • *****
  • Posts: 1799
Input please! What to do with parents' annuities?
« on: February 03, 2020, 02:31:27 PM »
Hoping to tap into the wisdom of the crowd here. Any and all constructive input greatly appreciated.

Scenario: My parents are super conservative financially and disciplined in their spending (keep this in mind). Decades ago they each purchased IRA annuities. This wouldn't be my preference, but they didn't know what else to do at the time, and it is what it is. By a curious sequence of events they have done fairly well, more than anything because they didn't touch them. But I digress, the details of the annuities don't matter much at this point because they are getting ready to move from the accumulation phase to the annuitization phase. Each annuity is worth about $150k. Both parents are about 70 years old, reasonably good health. They own a house outright (worth ~700k?), and expect about $3800/month combined Social Security. No other retirement or investments otherwise. They need to make a decision on this very soon, over the next couple weeks.

Someone at the insurance company is advising that they roll the annuities into another IRA before they annuitize. Of course he's recommending a family of mutual funds with loads and high fees, so that's not gonna happen on my watch. If anything, we will roll it into a Vanguard IRA.

If it were me, I would just do the IRA rollover. But I'm more risk tolerant, and I have a lot more put away in both qualified and non-qualified accounts. If the market dips for an extended period I may have to cut back on luxuries, but I'm not going to end up eating cat food. Of course, I wouldn't let it come to this for my parents, but you get the idea. I think they can probably(?) squeak by on their Social Security income, but it would be tight.

The goal here isn't wealth preservation or passing on an inheritance...I just want them to have a decent and stable retirement. The more I think about, the more a lifetime annuitization makes sense. Combined, these would add about $2200/month of income, in perpetuity, until death. This is more than they need right now, but would give them some buffer as inflation erodes purchasing power. And they their relatively modest nest egg would be protected from market volatility. I've run the annuity valuation numbers under different life expectancies and inflation scenarios and I believe the risks are manageable.

Now, here's where things get interesting. They seem pretty committed to downsizing to a LCOL area. If they do then after selling the house and then buying a cheaper one elsewhere they should have around $400k tax free to invest.

So my current thinking is for them to annuitize for a lifetime payout as a way to guarantee a fixed income stream to supplement to their Social Security. This would (mostly, assuming inflation doesn't go wild) ensure that they don't outlive their investments if either or both happen to live longer than expected. Additionally, would invest the $400k via a non-qualified (taxable) account in something like a balanced portfolio (60% stocks, 40% bonds). This investment could be tapped for unexpected expenses (new roof, car repair, medical, etc.) and should provide some amount of inflation protection over the long term. They should be able to easily live on the fixed income portion for 10-15 years, even with moderate inflation, and there are no RMD on the non-qualified account so they could mostly let it compound unless/until they really need to start drawing on it.

Ok, sorry for the wall of text. I know it's a lot to digest. An apologies if I've left anything out or didn't explain something clearly. Happy to answer questions.

Sanity check: Does this plan seem reasonable? Am I missing or forgetting anything important?

Annuitizing a lifetime payment stream and then investing proceeds from the downsize into a taxable account seems unconventional to me for some reason...is this weird or problematic? E.g. is it better to roll the annuities into a Vanguard IRA and then supplement this with the taxable account?

Other suggestions that I should consider?

Thanks in advance!


TheAnonOne

  • Handlebar Stache
  • *****
  • Posts: 1609
Re: Input please! What to do with parents' annuities?
« Reply #1 on: February 03, 2020, 06:50:27 PM »
If the 300k worth of annuities pays 2200 a month, it will just under 12 years to break even.

That being said, if you took the 300k and invested it in something like 50/50 stock/bond and made 3-4 percent or 100% VTSAX because they are financially fine without this money, you will be WAY ahead taking the payout.

Plus if you take the payout, the money isn't lost at death. (different annuities have different rules on this)

It seems to me that cashing these things out is almost always the right thing to do assuming you can avoid blowing it on a car or something.

FINate

  • Handlebar Stache
  • *****
  • Posts: 1799
Re: Input please! What to do with parents' annuities?
« Reply #2 on: February 03, 2020, 07:45:00 PM »
If the 300k worth of annuities pays 2200 a month, it will just under 12 years to break even.

That being said, if you took the 300k and invested it in something like 50/50 stock/bond and made 3-4 percent or 100% VTSAX because they are financially fine without this money, you will be WAY ahead taking the payout.

Plus if you take the payout, the money isn't lost at death. (different annuities have different rules on this)

It seems to me that cashing these things out is almost always the right thing to do assuming you can avoid blowing it on a car or something.

Thanks for the response. Good points, and totally agree that statistically they can do better investing in the market. This is certainly what I would do, but then again, FIRE means I'm essentially self insured when it comes to market volatility and longevity.

But the bolded above is what gives me pause...I'm not sure they are fine w/o this money, and so their risk aversion in this instance is understandable. If they have guaranteed fixed income to cover essential expenses then they can afford to take on moderately more risk with other assets, while also having a degree of longevity protection. And then they don't have to worry about fluctuating values and withdrawal amounts.

RE payouts at death: One option is a lifetime with 10 year certain. The monthly payment is about $100 less per contract, but this would guarantee a minimum 80% payout, but much higher if they live longer than average.

I know I'm kinda arguing for the annuitization here, doesn't mean I'm sold on it. And I understand the logic and math for cashing out. I'm still undecided.

Thanks again for the input.

ixtap

  • Handlebar Stache
  • *****
  • Posts: 2422
Re: Input please! What to do with parents' annuities?
« Reply #3 on: February 03, 2020, 08:02:49 PM »
What is missing from your wall of text is why you should have any say in what happens to this money.

Even if they have asked for your advise, you don't make any mention of their own preference, just you and the advisor.

Grafter

  • 5 O'Clock Shadow
  • *
  • Posts: 41
Re: Input please! What to do with parents' annuities?
« Reply #4 on: February 03, 2020, 08:22:02 PM »
So, I'm unclear.  Is the 300k in traditional iras?  As if so, an annuity within an idea would be something that I would recommend against, due to the potentially issues with rmds down the road ( when the annual rmd amount is larger than the cash flow from the annuity).  As well as investing in an annuity outside of an ira is more tax advantaged, as only a portion of the cash flow would be taxable vs 100% of the distribution from the ira (unless they have its basis).
« Last Edit: February 03, 2020, 08:24:25 PM by Grafter »

FINate

  • Handlebar Stache
  • *****
  • Posts: 1799
Re: Input please! What to do with parents' annuities?
« Reply #5 on: February 03, 2020, 08:27:03 PM »
What is missing from your wall of text is why you should have any say in what happens to this money.

Even if they have asked for your advise, you don't make any mention of their own preference, just you and the advisor.

They don't understand this stuff very well, so they reached out to me after getting a sense that their advisor didn't have their best interests in mind. My part in this is to honestly and frankly explain their options in a way they can understand. But they've made it clear that they also want my opinion on what they should do. It's a responsibility I take seriously, hence asking for input here from folks who perhaps have gone before me. But yes, in the end it's their choice.
« Last Edit: February 03, 2020, 08:34:41 PM by FINate »

FINate

  • Handlebar Stache
  • *****
  • Posts: 1799
Re: Input please! What to do with parents' annuities?
« Reply #6 on: February 03, 2020, 08:33:20 PM »
So, I'm unclear.  Is the 300k in traditional iras?  As if so, an annuity within an idea would be something that I would recommend against, due to the potentially issues with rmds down the road ( when the annual rmd amount is larger than the cash flow from the annuity).  As well as investing in an annuity outside of an ira is more tax advantaged, as only a portion of the cash flow would be taxable vs 100% of the distribution from the ira (unless they have its basis).

These are annuities held within an IRA. Nothing else is held in these IRAs. At the point of annuitization the annuity is irrevocably converted to a stream of payments, and per IRS rules the value of the annuity is excluded from RMD calculations. Again, I wouldn't have setup the annuity in an IRA, but this was done decades ago. The question now is what to do with it.

theoverlook

  • Bristles
  • ***
  • Posts: 283
Re: Input please! What to do with parents' annuities?
« Reply #7 on: February 04, 2020, 07:31:40 AM »
I'm far from an expert, but had a couple thoughts I figured I'd share in case you found them worthwhile. My opinion is that, depending on their health and how long they'll likely live, the annuity could be a decent deal. The $2200/mo is essentially an 8.8% withdrawal annually. If it's guaranteed until their death and they live over 12 years then they've recovered all of their principal and anything more they receive from the annuity could be considered "return." You couldn't reliably sustain an 8.8% withdrawal rate from a Vanguard fund, even an aggressive one. If they don't end up needing the money to live on, they could put it into taxable investments and in 12 years have a higher net worth than they do now.

Personally I align more with your investment values and strategy, but given what you've said about them I don't think you're off base in giving the annuity serious consideration. It has a cost to it, but from their perspective that cost buys a lot of security.

Do you live locally to them? If you have the kind of relationship where you could sit them down and show them the difference between the annuity and the self directed Vanguard account, I think that could help. Prepare a small presentation and show them the difference in value / return, etc. Don't try to sell them on one or the other, just let them know the projected outcomes, at the end give them your opinion, and then let them decide. If you truly don't need the inheritance let them know not to worry about that, either.

FINate

  • Handlebar Stache
  • *****
  • Posts: 1799
Re: Input please! What to do with parents' annuities?
« Reply #8 on: February 04, 2020, 06:17:56 PM »
I'm far from an expert, but had a couple thoughts I figured I'd share in case you found them worthwhile. My opinion is that, depending on their health and how long they'll likely live, the annuity could be a decent deal. The $2200/mo is essentially an 8.8% withdrawal annually. If it's guaranteed until their death and they live over 12 years then they've recovered all of their principal and anything more they receive from the annuity could be considered "return." You couldn't reliably sustain an 8.8% withdrawal rate from a Vanguard fund, even an aggressive one. If they don't end up needing the money to live on, they could put it into taxable investments and in 12 years have a higher net worth than they do now.

Personally I align more with your investment values and strategy, but given what you've said about them I don't think you're off base in giving the annuity serious consideration. It has a cost to it, but from their perspective that cost buys a lot of security.

Do you live locally to them? If you have the kind of relationship where you could sit them down and show them the difference between the annuity and the self directed Vanguard account, I think that could help. Prepare a small presentation and show them the difference in value / return, etc. Don't try to sell them on one or the other, just let them know the projected outcomes, at the end give them your opinion, and then let them decide. If you truly don't need the inheritance let them know not to worry about that, either.

Thanks for the perspective! Yeah, the payment stream is decent, certainly better than what they can get in the bond market right now. Of course, this is offset in the long term by inflation, but other investments would start kicking in down the road to make up for this.

I do live local to them and we spent all day today reviewing their finances and discussing options. I was able to explain the trade-offs involved: guaranteed income with the annuity w/o inflation protection, vs. higher returns (and implied inflation protection) of an IRA with more risk, tax implications, and so on.

After reviewing their expenses in more detail, they decided to annuitize one of the contracts with the 10 year certain lifetime option. This will supplement Social Security enough to cover essential expenses, with adequate buffer to account for moderate inflation for ~15 years. They have a little more time to decide on the other contract, but having essential expenses covered means they are more open to taking on a bit more risk and rolling this into a traditional IRA. They also have a much better sense now that it is advisable to downsize and invest the difference for the long term.

Thanks everyone for the input!

SunshineGirl

  • Pencil Stache
  • ****
  • Posts: 753
Re: Input please! What to do with parents' annuities?
« Reply #9 on: February 04, 2020, 06:33:06 PM »
Maybe Vanguard’s Managed Payout fund would work for the second contract.

FINate

  • Handlebar Stache
  • *****
  • Posts: 1799
Re: Input please! What to do with parents' annuities?
« Reply #10 on: February 04, 2020, 06:55:03 PM »
Maybe Vanguard’s Managed Payout fund would work for the second contract.

Yes, that is an option. Also looking at Vanguard Balanced Index Fund Admiral Shares (VBIAX).

Thanks!