When I was in my 20s the end of a calendar year was a time to eat 12 plates of food at family dinners. Now it is an occasion for tax and retirement planning. So sad…
I’m poking around looking at ideas that might be better than just sticking money in a taxable S&P 500 index fund.
What I would really like is what state government workers get, i.e., a pension that starts sending me monthly checks when I turn 65 years old and adjusts those checks to account for inflation. So far I haven’t found a product like that. Does it truly not exist? If so, it is interesting that Detroit thought that they could provide this to their workers without going bankrupt. If Goldman Sachs and the rest of the Wall Street geniuses can’t figure out how such a product should be priced, why did states and cities think that they could do what the world’s most sophisticated financial services industry could not?
Insurance companies offer annuities, but they start paying immediately and don’t adjust for inflation. I’m 50 now. By the time I am 65 what seemed like a fat annuity check today might be the price of a Diet Coke. (Note to folks who ask why insurance companies can do this without going bankrupt as Detroit did… life insurance companies save money on their insurance polices when human lifespan is extended so they can use those savings to keep paying annuities that they have promised. When General Motors went bankrupt their oldest pensioned worker was 115 years old and GM had no way to benefit financially from people living longer.)
The “variable annuity” is something that I can’t figure out at all and I want a reader to explain it to me. The basic idea of a variable annuity is that you put money into it today and the investment returns compound tax-free until you decide to start taking money out for retirement income. Vanguard sells them at what they claim (source) are low fees. It turns out, however, that “low” means at least 0.5 percent per year more than the fee on a corresponding index fund. As the S&P dividend yield right now is 1.9 percent (source), that means that one quarter of the yield is raked off to pay Vanguard and its insurance company partner. This sounds suspiciously like paying taxes on qualified dividends plus the new Obamacare rake. If yields were 10 percent and tax rates on dividends were 40 percent this product would make sense to me. But if all of the benefits of tax deferral accrue to the insurance company and/or Vanguard, why go to the trouble and take the risk that the insurance company (think AIG!) will go bankrupt between now and when you need the retirement income?
Are people still buying variable annuities in this low-yield environment? If so, why?
[Oh yes, if you're looking for a little humor from the financial services industry, here's a gem from the Vanguard web site: "Note: The American Taxpayer Relief Act of 2012 (ATRA) raised the top marginal income tax rate to 39.6% and the top capital gains tax rate to 20%." (emphasis added)]