Q: I am retired, drawing Social Security and a pension, with a few other investments and tax-deferred accounts. I will soon need to start taking required minimum distributions. I have a 401(k) worth just over $225,000. I am earning about 2 percent annually on this money now. Does it make sense to look at a fixed-index annuity that would increase in value based on the investments I choose? I would be guaranteed that the contract would never be worth less than my original investment. I would also have a variety of choices, such as investment options, living benefit options, death benefit options, as well as potential for annual step-ups and income increases. It appears that fees would be about 3.6 percent a year. I have read many things online, but still cannot decide if this is a good and safe step to take, being retired.
A: There is a strategic reason not to do this, and also a practical reason. The strategic reason is that you already have much of what the insurance product offers — a reliable income. You have Social Security and a pension. The likely withdrawal rate you can have by putting your $225,000 tax-deferred retirement account into an annuity product is about 5 percent, or $11,250 a year.
Now compare that to the total of your Social Security and pension benefits. Since you already have a good deal of guaranteed income, what you need in addition is flexibility and a fund to deal with emergencies. That’s what you have in your current tax-deferred account. There is no reason to give it up.
The practical reason for avoiding this investment is that it is a complicated product built with smoke and mirrors. The only thing you know for certain is that the annual fees appear to be 3.6 percent. That’s nearly twice the current yield on a balanced portfolio. That means the insurance company is taking every bit of the income on your money and a nice slug of principal, every year, in exchange for offering you the sizzle of possible, but unlikely, income gains.
You also need to understand that what you call “income” is likely to be the principal of your investment. So once you start taking withdrawals, the contract will no longer be worth your original investment. In addition, you need to consider the actual purchasing power of your original investment, which will be declining due to inflation. Bottom line: This is not a good choice.
Q: I am a 68-year-old widow, still working part-time at my old job. Recently, my Edward Jones agent quit, so I decided to move my IRA to Fidelity, where my 401(k) is. Everything transferred as is, except for an annuity, which is now in cash. My 401(k) is in Fidelity Freedom 2010. Edward Jones favors American and Lord Abbott funds. Fidelity wants me to decide if I want to change anything.
A: Edward Jones favors American and Lord Abbott funds because it is a traditional retail brokerage firm, selling front-end load funds that provide a commission to the broker. As a practical matter, once the commissions are paid, the annual costs of most American funds are in the same ballpark, or less expensive, than comparable Fidelity funds. And each firm can make proud claims of superior performance for some of its funds, some of the time.
Fidelity Freedom 2010 fund is a conservative allocation fund with less than 50 percent of its assets in equities. It rates only three stars (average) from Morningstar and has an expense ratio of 0.59 percent. American Funds Income Fund of America A shares has the same rating from Morningstar and the same expense ratio, 0.59 percent. The largest and most immediate difference if you make the change is that Fidelity will be collecting the management fees, not American Funds.
A more compelling issue for you is whether you can find a fund that will be superior to either the American Funds fund you hold or the Fidelity fund that is being suggested. Fidelity Puritan (ticker FPURX) has a four-star rating from Morningstar. It also has an expense ratio of 0.59 percent. So there are better suggestions inside the Fidelity camp than what they have suggested.
You could also consider moving to Admiral shares of Vanguard Balanced Index, Vanguard Wellesley or Vanguard Wellington. This would reduce expenses further while retaining the higher performance rating.
There are small differences in asset allocation between these funds so they are similar in risk, but not identical in risk.
Questions about personal finance and investments may be sent by email to scott@scottburns.com.