Annuities are FUCKED UP… aren’t they?

As the resident personal financial advisor for my family (despite that I have no idea what I’m talking about half the time), I’ve jumped into understanding my parent’s financial situation (the good the bad and the ugly) as I will have to help my mother manage her finances for the rest of her her life once my father is gone. He may live longer than her but she is relatively healthy right now and he has terminal cancer, so it’s likely I will be the only person able to really help ensure her quality of life since she understands zilch about money.

My parents are doing ok financially – not great – not as good as they should be doing given how much my father earned throughout his life — but they overspent and now they’re left with about $300k in retirement funds and $400k in real estate, give or take a few hundred thousand since I can’t get a straight answer from my father (who unfortunately doesn’t like to talk about this stuff because his go-to answer about any important financial question longer than a few years out int he future is ‘i’ll be dead then’).

I’ll be writing another post about reverse mortgages – which my father is considering and as I learn more about them I’m trying to tag him out of – but this post is specifically about annuities, because they seem especially fucked up.

My father worked in a financial analysis role throughout his career, so I just assumed he’d be really good at personal finance. Not so. He apparently misunderstood the rules of the annuity sold to him and when I ask him what the contract says now he just gets sore — he can never admit to making a mistake so his temper begins to flair and I stop inquiring. However, it sounds like some salesman got the best of him. I’m not sure exactly when my dad bought the annuity, but it seems like it was around the time he was told he had – at most – two years left to live. He’s since lived nearly 10 and is still kicking. However, when you’re told you have two years left to live, you’re going to make some unwise financial decisions. How can you make a smart financial decision when you’re making a bet on your dying soon – you die, you lose. You live, you lose.

My father put $120k-ish into the annuity which guarantees 4% per year or returns, whichever is higher. This is for a certain number of years at which point (this is the part he didn’t understand when purchasing) he must annuitize the total amount.  Basically, if I’m understanding this right, at the moment if my father were to die before this variable annuity is up, my mother would get all the money put in the annuity (???) – but if he doesn’t die, they have to put it into another annuity (???) which will have a higher rate since he’s older and more likely to die sooner, but then – he doesn’t understand how that works with my mother living long and if it’s based on her lifespan or his or both. In short, my father, who ran sophisticated financial analysis for large corporations, couldn’t understand this product. Yet, probably out of his mind after being told he was going to die, bought it anyway. And some sales person is laughing all way to the bank.

Now, annuities sound to have some place in a retirement portfolio IF you don’t have monthly income. But my parents have sizable social security and a pension, which is about $7000 a month after taxes. At the moment the 4% interest is automatically reinvested in the annuity in the IRA, so they don’t have to pay tax on it as that amount grows. That’s not so bad, as it guarantees a 4% return YoY. However, that 4% going back into the annuity means that the principal is growing but they aren’t seeing any of that money yet. If my dad passes away before the annuity is up, then my mom gets the 4% YoY return plus the principal (we think?) but if he doesn’t, then it must be put into another annuity which, it sounds like, pays out a monthly amount based on a set interest rate (I’m guessing into the IRA?) which can then be taken out monthly and taxed or left in the IRA, except there are required minimum distributions from the IRA which means that money will be taxed monthly… and a certain amount has to come out.

This isn’t a post that intends to explain annuities (clearly I do not understand them enough), only to note that they are so damn complicated and yet again a financial product is sold by sales people who only care about their commission checks and take full advantage of a sick person’s terminal diagnosis to quickly close deals when it may not be the best for the couple or family. I don’t know the sales person who sold my parents the annuity, but so far it sounds like it was a bad idea. What my parents need to do is have a reasonable chunk of their IRA money in stocks and hope the market goes up over the next 40 years, because my mother may very well live 40 more years – and she has high expectations for her retirement living lifestyle which I’m not sure can be met with her current portfolio and fixed income.

Mom’s not going to starve, but my parents just blow through money and I wish they could stop because it’s sad when they had the chance to have no problems whatsoever in retirement and here they are, with only $700k left to their name (much of that before tax), plus a good pension — maybe that’s enough, if she were willing to downsize. But instead of downsizing my parents kept their house in the northwest and purchased a winter condo in a sunny, cheaper part of the world… with renovations the condo cost about $145k, yet they have a home equity out on the main house for $200k on a total of $500k value. My father spends because he doesn’t want to think about the prospect of dying soon or living longer than he thinks he will — and my mother has no control over the money other than what she spends… and she has no real control over that since she loves to spend.

The annuity doesn’t seem like it was a good financially decision for my parents, but it’s too late to get out of it. I hope I’m proven wrong (comments welcome on why I might be) as they’re stuck with it.

 

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2 comments

  1. Max says:

    Damn that sucks. My parents were in a fixed annuity that was growing 3% and it had a seven year declining surrender charge (i.e., after the first year, to get back your deposit there was a 7% charge, second year 6% charge, etc.) A benefit of annuities is that they experience tax free growth. So the fact that they put the annuity in an IRA was terrible! I used to be a licensed investment counselor (dealing with investments mostly) and helped clients surrender annuities to put them in bond portfolios. Most likely, you can surrender the annuity without any charge. I find it hard to believe that they would force you to annuitize the savings annuity. Without seeing the contract it’s hard to say. It may be worth taking it to a fee-based financial planner to get them to better understand it and to best avoid any surrender charges.

    My father passed from pancreatic cancer so I know it’s tough getting through this period. I currently manage my mom’s finances and what alarmed me was that she had almost 400K in cash and only 50K in investments. Fortunately, we’re shifting her slowing into vanguard funds which have given her a nice return, especially this year.

    Anywho, I hope everything works out as best it can.

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