OT: Retirement accounts, annuity vs. dynamic income fund

[54ny77]

this. annuities essentially give you your money back and they call it income.

the commissions and residuals are obscene. great for the saleshole, not so great for the investor.

Originally Posted by benb

Anybody who sells annuities is super bullish about them for all age groups and income/asset levels. (See class action lawsuits)

Fee based advisors are pretty often "No f'n way".

Depends on your age, if you're already retired, etc..

It seems very rare for anyone who is still working to ever have a good fee based advisor recommend annuities.

Really it sounds like the main case they can really work is post retirement when you have a certain level of assets and the annuity can shield against taxes a certain way or hedge risk a certain way. Narrow cases.

They are so often sold attached to life insurance to complicate things.

[benb]

Originally Posted by 54ny77

this. annuities essentially give you your money back and they call it income.

the commissions and residuals are obscene. great for the saleshole, not so great for the investor.

The insurance mix-up is what is really disingenous.

I bought a term life insurance plan in my 20s. Then I raised it up to about $800k when I got married. I was < 30 when I got it and in racing shape and scored the absolute lowest risk on the exam, so it's really, really inexpensive. My wife similarly has one like that. Ironically getting the hard sell from a college friend who sells annuity/insurance mix-up and rejecting it was what motivated me to get a term life insurance policy when I had no dependents.

The plan is they run out in our early 60s. Our FA has long said if we are managing our retirement in a sane fashion we should have zero need for life insurance when we are retired.

Life Insurance + annuity combos seem to heavily sell you on the idea that you need that life insurance till the day you die even if you're sitting on millions of dollars of assets in retirement and have no need for a death payout.

In our mid-40s where we are right now with the retirement plan the only real point of the life insurance ironically is that if one of us dies the other one can actually immediately retire if you assume 1 person needs 50% of what the two of us need. If one of us dies and the life insurance payout goes into the investments plus the survivor keeps working that person is almost guaranteed to be in a situation where the retirement accounts don't actually draw down in retirement. If we both die the $1.6M payout would leave enough in the accounts for both of us to have retired and our retirement accounts convert into a very comfortable trust fund for our son.

My only other thought on some of the other talk is it sounds like plenty here manage everything themselves. One big thing our FA does for us is facilitate investing in private markets. That has only been something we qualified for in the last few years, but I don't know how on earth I would navigate that without professional assistance, and the returns on that have been very worth it.

[veloduffer]

Originally Posted by benb

One big thing our FA does for us is facilitate investing in private markets. That has only been something we qualified for in the last few years, but I don't know how on earth I would navigate that without professional assistance, and the returns on that have been very worth it.

I'd be cautious how about how much you want to allocate to private credit. It's the fastest growing market from that was a niche market to almost $2 trillion. These are loans to small to medium sized businesses mainly and many from leveraged buyouts - it is an unregulated market since the lenders are non-banks. Past history on credit bubbles (Latin Am in 1980s, commercial real estate in 1990s, residential mortgages in 2007, oil & gas loans 2016) don't have great endings.

1) Private credit lenders are touting their performance, which is based on a very limited history. Most use traditional bank loan data for their modeling but those assumptions about default and loss given default (LGD) are changing for the worse.
-2) Many of these firms don’t perform their default/loss history like the rating agencies (Moody’s, S&P, Fitch) in that they don’t count loan modifications & extensions (to avoid payment defaults) as defaults; the rating agencies do but are limited to their rated universe. Also, some firms don’t discount their loan recoveries at the Distressed rate (14% and up) and use the loan’s coupon rate; by not using the distressed rate, they are not accounting for the uncertainty of cash flows in a distressed situation and moreover, it doesn’t reflect the price if they tried to sell the loan to an outside buyer, who would use the distressed rate for a distressed loan/security. Furthermore, Moodys’ found that about 50% of all modified loans usually result in another default or bankruptcy - essentially kicking the can down the road which again results in a higher LGD.
3) The historical loan loss data is based on covenant-heavy loans but the market has moved toward almost all covenant-lite loans. Covenants is a key loss mitigant that enables lenders to force borrowers to make changes to avoid a payment default. With the prevalence of covenant-lite loans, borrowers will burn through their resources until the situation becomes very dire and lenders can only watch the deterioration. Therefore, the LGD will be worse than the historical figure of 28% and probably be closer to 50% or more; in recessions, LGDs are usually worse than the long-term historical average.
4) Much of the loan volume is rated B3/B-, only one step away from distress rating. A wave of downgrades could be significant, particularly the collateralized loan obligation (CLO) market in which there are tests for the amount of CCC rated credit in the collateral pool. Managers can replace these loans during the reinvestment period, but a large flux of CLOs issued 2-3 years ago will be ending their reinvestment period and the collateral pools will become static. If the CCC buckets violate the tests, it could trigger the cashflow diversion to the AAA tranches which would cause downgrades and losses in the lower rated tranches of the CLO.
5) Besides the weak ratings, loan volume has primarily come from private equity leveraged buyouts as high interest rates have dampened regular financing. Much of these deals have add-backs to their profit measures (EBITDA) to shore up the leverage ratio tests (debt to EBITDA). S&P completed its fifth analysis on EBITDA add-backs and found that over 80% of the borrower don’t achieve that level of EBITDA in the following year - so the add-backs don’t seem to be one-off expenses.

All of this may not cause the next credit cycle but creates a vulnerability. In the 1990s, it was an oil shock that caused the risk-off wave. With the current political and geo-political situation, a major event could easily trigger the cycle. My one fear is that the US’s strong support of Israel could foment another terrorist attack like 9/11. There is also the possibility of China invading Taiwan or North Korea causing an incident.

Since the loan market is extending leverage throughout the US economy to the small- and medium-firm markets (known as Middle Market lending and Direct Lending), this could cause a deep recession if it collapses heavily since over half of the US employment is through small and medium-sized firms; this is unique in the developed world as most economies are dominated by large firms (e.g. Germany with Siemens, VW, Bosch, etc). Most small firms liquidate rather than reorganize and as you mentioned, private equity firms will make decisions on allocating resources to save firms.

The private market has gotten so competitive that yields are falling and now the non-banks are competing with the commercial banks for the large buyout deals, which in turn results in more yield compression and weaker credit terms.

Good article from Institutional Investor: High Yield was Oxy. Private Credit is Fentanyl.

Note my background was investment risk for major insurers.

[benb]

Originally Posted by veloduffer

I'd be cautious how about how much you want to allocate to private credit.

Goes without saying. <10% total and split 6 different ways. Still not an amount of money I'd want to vaporize.

[veloduffer]

Back to the OP:

You haven't said whether this annuity is trying to solve any cashflow shortfall from your other annuity, ie Social Security.

In general, annuities are expensive investments. A better alternative may be investing directly in bonds and laddering the maturities. A combination of treasuries, corporates and municipal bonds (especially if you live in a high tax state) could provide the same income stream without the fees. Plus they would be more liquid if you needed to sell.

The dynamic opportunity sounds a bit like what is being replicated with buffered ETFs, which would provide liquidity and low fees.

Another consideration is the change in the annuity market. Many traditional insurance firms are reinsuring market-sensitive liabilities (annuities) to reinsurers in Bermuda or to the private equity backed insurers like Athene (owned by Apollo) and Global Atlantic (owned by KKR). The reinsurers now assume the risk and have much more aggressive investment allocations to cover those liabs - more private credit, private asset backed securities, high yield bonds, whole loans. Since these firms are using the same allocations, their risk of collapse is correlated in a hard credit cycle. If they should collapse, the risk would revert back to the original/traditional insurer. Whether the original insurers have the capital to absorb the returning liabilities is still a question that the NAIC has to grapple with.

[54ny77]

it's all fun and games until the level 3 bucket gets full.

Originally Posted by veloduffer

Back to the OP:

You haven't said whether this annuity is trying to solve any cashflow shortfall from your other annuity, ie Social Security.

In general, annuities are expensive investments. A better alternative may be investing directly in bonds and laddering the maturities. A combination of treasuries, corporates and municipal bonds (especially if you live in a high tax state) could provide the same income stream without the fees. Plus they would be more liquid if you needed to sell.

The dynamic opportunity sounds a bit like what is being replicated with buffered ETFs, which would provide liquidity and low fees.

Another consideration is the change in the annuity market. Many traditional insurance firms are reinsuring market-sensitive liabilities (annuities) to reinsurers in Bermuda or to the private equity backed insurers like Athene (owned by Apollo) and Global Atlantic (owned by KKR). The reinsurers now assume the risk and have much more aggressive investment allocations to cover those liabs - more private credit, private asset backed securities, high yield bonds, whole loans. Since these firms are using the same allocations, their risk of collapse is correlated in a hard credit cycle. If they should collapse, the risk would revert back to the original/traditional insurer. Whether the original insurers have the capital to absorb the returning liabilities is still a question that the NAIC has to grapple with.

[verticaldoug]

Originally Posted by benb

Goes without saying. <10% total and split 6 different ways. Still not an amount of money I'd want to vaporize.

It's funny how correlation = 1 very quickly in this space in a stress event.

If you are with a quality manager, you probably don't get vaporized, but you do get gated.

If you look at a listed BSD like BXSL or something, not sure why you'd want a a private fund in the space, when you can get a listed entity with better transparency, better liquidity and probably only slightly worse economics on dividend pass-thrus.

[OtayBW]

I'm planning to retire at age 69-70 this year. One of my 3 vehicles (~1/3 of my bucket) will be a fixed income annuity, fully funded for immediate, guaranteed payout, and with what I think is a pretty favorable interest rate. The second vehicle will be my discretionary stock (and bond?) portfolio for growth (at 1/3, possible less). The 3rd bucket TBD.

That said, I realize (at least some of) the bugaboos about annuities (fees, liquidity issues, no upside potential, complexity), but all things considered, the FIA that I've got planned seems reasonable.

I would appreciate any thoughts about this FIA (or other thoughts in general) that I'm using to fill the income gap as 1/3 of my bucket. This thread has been helpful.
Thanks!

[Ralph]

Just had to chime in. My career was at Merrill Lynch. I retired in 98 mainly because I couldn't take the bad feeling i got from our fees, when I knew same client could go to Schwab, Vanguard, Fidelity, etc....for a fraction of what we charged and if they got a good advisor would get the same results. And I, as an investor myself, would never pay those fees. so, I figured it best I leave.

I never thought of annuities as investments. Always thought of them as insurance. To be used in a situation where you want to ensure a regular payment to someone that is insured by a strong insurance company. Where return of principal is not the goal, or trying to keep up with inflation and buying power is not the goal. I always thought they had limited value in an investment portfolio. And I understand there are many variations of this. I personally would never look to an insurance agent for investment advice. I would look to them for insurance...estate planning, etc. (and BTW I get regular payments from an annuity for an old pension plan before we switched over to 401K's, profit sharing plans, etc. at work). I had no choice in matter. And took provision for last to die. And now 26 years later, what seemed like a decent useful check every month, won't even pay my electric bill now some months.

[reuben]

Originally Posted by Ralph

I never thought of annuities as investments. Always thought of them as insurance. To be used in a situation where you want to ensure a regular payment to someone that is insured by a strong insurance company. Where return of principal is not the goal, or trying to keep up with inflation and buying power is not the goal.

This is similar, but not identical, to my thinking regarding the annuity I bought. It is only one piece of my plan, and the type of annuity was chosen to satisfy a specific part of that plan.

[MikeD]

I bought a 3 year annuity. At the time, the interest rate on it (3.5%) was better than anywhere else. Not so now. I guess it's kinda like a CD for me, and can get periodic payouts from it, which I did and put into a higher paying Treasury money market fund.

[Louis]

Originally Posted by reuben

This is similar, but not identical, to my thinking regarding the annuity I bought. It is only one piece of my plan, and the type of annuity was chosen to satisfy a specific part of that plan.

+1 on this

I think of it this way:

1) What are my expenses going to be in each of the following categories?
a. Generally predictable and essential (e.g. food, energy, healthcare (some), transportation (some), etc.)
b. Unpredictable and essential (e.g. home maintenance, healthcare (some), transportation (some), etc.)
c. Variable and discretionary (e.g. vacation, entertainment, etc.)

2) You then look at your future assets and income and put it in similar categories
a. Cash on hand
b. Predictable income stream, with as little variability as possible
c. Variable income stream, subject to market fluctuations

You then match up the expenses with your assets and income as best as possible:

A) Predictable & essential expenses covered by predictable income stream with little or no variation.
a. This is where having an annuity that matches or exceeds these expenses is very nice.

B) Unpredictable and essential expenses covered by cash
a. Cash replenished ASAP by surpluses in income.

C) Discretionary expenses covered by surplus income of any type

[rounder]

When my sister retired, she rolled her whole 401(k) balance into an annuity. I would not have done that. Instead, we had our investment manager (Fidelity) come up with a mix of investments based on our level of risk acceptance. The annuity portion will generate cash flow for a 20-year period and will be worth $0 at the end of 20 years but will earn income over its life.

[Mr. Pink]

Originally Posted by benb

The insurance mix-up is what is really disingenous.

I bought a term life insurance plan in my 20s. Then I raised it up to about $800k when I got married. I was < 30 when I got it and in racing shape and scored the absolute lowest risk on the exam, so it's really, really inexpensive. My wife similarly has one like that. Ironically getting the hard sell from a college friend who sells annuity/insurance mix-up and rejecting it was what motivated me to get a term life insurance policy when I had no dependents.

The plan is they run out in our early 60s. Our FA has long said if we are managing our retirement in a sane fashion we should have zero need for life insurance when we are retired.

Life Insurance + annuity combos seem to heavily sell you on the idea that you need that life insurance till the day you die even if you're sitting on millions of dollars of assets in retirement and have no need for a death payout.

In our mid-40s where we are right now with the retirement plan the only real point of the life insurance ironically is that if one of us dies the other one can actually immediately retire if you assume 1 person needs 50% of what the two of us need. If one of us dies and the life insurance payout goes into the investments plus the survivor keeps working that person is almost guaranteed to be in a situation where the retirement accounts don't actually draw down in retirement. If we both die the $1.6M payout would leave enough in the accounts for both of us to have retired and our retirement accounts convert into a very comfortable trust fund for our son.

My only other thought on some of the other talk is it sounds like plenty here manage everything themselves. One big thing our FA does for us is facilitate investing in private markets. That has only been something we qualified for in the last few years, but I don't know how on earth I would navigate that without professional assistance, and the returns on that have been very worth it.

Well, not sure who you are referring to about self management, but, if you go index funds, it's pretty much the opposite. You're just following the crowd, the market, or, as some refer to it, the benchmark. Collective wisdom. And it's nearly free. And easy.

[rounder]

If you are still working, that is easy. If you are retiring and have money in a 401(k) plan, then you can reinvest it in an IRA account, otherwise you will have to pay tax on the full distribution in the current year. You can have someone like Fidelity, Merrill Lynch, Schwab, etc. do that for you and manage your account. If you decide to have all of your money invested in S&P 500, you may not have to pay any fee. If you want them to come up with a mix that you think might be better for you then you might have to pay a fee.