Annuities can be nice, but don't fit everyone

Each situation should get an objective evaluation before purchase is made

Dollars & Sense

July 21, 2002|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE SUN

Recently my tax adviser said annuities are one of the best investments for a person near retirement. I am 57 and fully vested in a government retirement pension plan that will give me a generous monthly check in retirement. I also invest in a government thrift savings account and contribute the maximum to Roth IRAs each year. I still have some extra cash to invest after all this. I have no children and plenty of insurance. My friends suggest I simply spend more. What advice do you have for me?

Does your tax adviser sell annuities, by any chance?

Annuities can be a decent fit for some people, but they have some significant disadvantages as well. You'll definitely want an objective evaluation of your financial situation before you invest in one.

It's probably time anyway for you to chat with a qualified financial planner to see whether your pension and current investments are enough to assure you a comfortable retirement.

If on review you find that your pension and current savings will provide more than enough for you to live on in retirement - and that's possible, given how generous some government pensions can be - then you might want to take your friends' advice and start spending a little more of your hard-earned cash now. You also could consider paying down your mortgage, building your emergency fund or buying long-term-care insurance with the extra cash.

If you do decide to invest more and you're already contributing the maximum in all available retirement accounts, you carefully should weigh the advantages and disadvantages before investing in an annuity.

There are several types, and it's not clear which kind your tax adviser was suggesting. The most common is a variable deferred annuity. Like other annuities, variable annuities don't give you an upfront tax break, but your earnings grow tax deferred. The downside is that those earnings are taxed as income when you withdraw the money. If you invest directly in stocks or mutual funds instead, your earnings could qualify for lower capital gains tax rates, especially if you're a steady buy-and-holder.

If you mess with your investments a lot, however, variable annuities might be a good fit. Frequent traders can incur big tax bills when their funds aren't held in a tax-deferred account, so if you're one of those who constantly fine-tune accounts, you might find more tax protection in an annuity.

Variable annuities have some disadvantages in estate planning, although this might not matter as much to you, because you don't have kids who are likely to inherit this money. The investments inside annuities don't get the favorable tax treatment, known as a step-up in basis, on your death that comparable mutual fund or stock investments would receive.

Variable annuities also typically have higher costs than comparable mutual funds, and you would need to hold this investment for anywhere from seven to 20 years for the tax benefit to outweigh the extra costs. Typically when variable annuities are recommended, they're aimed at younger working folks, not those near retirement who might need the money soon.

Your tax adviser might have been talking about a different kind of an annuity - one that's designed not for building retirement savings but for paying a guaranteed stream of income during retirement, a stream that typically ends at your death. These are known as immediate annuities and can make sense for people who don't have a substantial guaranteed income during retirement. You do, however, through your pension, so an immediate annuity might not be the best fit either.

I am 63 and my husband is 67. When we retire, we will have about $300,000 in my 401(k) account. In addition, we have about $110,000 in various mutual funds. Our Social Security income will be about $2,200 a month. Should we take some of the money from our mutual funds to pay off our $85,000 mortgage balance or continue making mortgage payments to retain the tax deductions?

It's a lovely thing to be mortgage-free by the time you retire. Many people decide to accelerate their mortgage payments as they near their 60s so that they can reduce their monthly expenses in retirement and have the security of a paid-for home.

Whether you should tap about 20 percent of your retirement funds to do so is another story.

How much money you have in retirement matters less than how much you spend. If your post-retirement expenses, without the mortgage, are entirely covered by Social Security, then you may want to pay off that mortgage. In the long run, your mutual fund investments might earn more, but you might prefer the security of not having to worry about monthly mortgage payments.

If your expenses are substantially higher, however, you might want to leave your investments alone. You could spend 20 or more years in retirement, and your money might not go as far as you think.

The issue of tax benefits is secondary at best. If you're in the 27 percent federal bracket, for example, you're getting only 27 cents of tax benefit for every dollar you spend on mortgage interest. It doesn't make much sense to spend a buck to get a quarter or so back from the government, does it?

Liz Pulliam Weston is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.

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