My Experience with Tax-deferred Annuities

My first step into annuities was in early 1987 when an agent. I sold annuities to two business owners to fund their IRAs. I put these in a variable annuities just before Black Monday shrunk the Dow over 20% in a day. I had conflicted emotions, sick over what had just happened, while excited about my forthcoming wedding to my dear wife on 12-05-87.

Fast forward 20 years. By this time I had left sales and “graduated” to no-load annuities. In 2007 a client insisted I managed his Fidelity annuity. He owned a tax service and was enamored with the tax-deferred nature of annuities. I acquiesced just before the subprime mortgage crisis shrunk the stock market over 50% in 17 months. “Déjà vu all over again.”

With deferred annuities you still have to reckon with the same basic investing decisions as with mutual funds. Are you a lender through a fixed annuity or an owner through sub-accounts tied to the stock market within a variable annuity? Most agents promoting annuities will make much ado about tax deferral, but that’s the tail, not the dog. The bookends that frame my experience with annuities rivet my attention on something far more consequential than tax deferral.

Investment strategy should always trump tax strategy. There are sound investment strategies that have solid defense that will fare much better through protracted multi-month market declines such as the tech bubble burst of 2000-2002 or the subprime mortgage crisis of 2007-2008. However they require two primary elements that annuities, even the best no-load varieties such as with Vanguard or Fidelity, do not offer: the ability to trade more frequently and options that are dissimilar to the stock market, such as gold or even inverse ETF’s.

In doing research for a recent article for Sound Mind Investing (March, 2013) I had several extensive talks with the annuity department at Vanguard. One oft repeated expression I heard was, “If you believe in the stock market” (you might want to use a variable annuity). I have reservations that the stock market will always go up given enough time. Remember when we always considered real estate an appreciating asset?

Consider this. The catalyst of the 2007 subprime mortgage crisis stock market debacle was unwise government intervention, a mandate to issue loans to people whom banks had recognized for millennia were bad risks . Such wholesale disregard of economic laws had repercussions. Government cannot defy economic laws any more than command the ocean tide or rising sun.

Their answer to the problem, in the words of Ayn Rand, was more of the same poison that precipitated the initial problem – bad debt, borrowing trillions we cannot repay. More bad seeds will produce another bad crops, though when and how we cannot know.

Scripture says, “A prudent man sees evil and hides himself, the naive proceed and pay the penalty.” Proverbs 27:12. Good investing strategy needs good defense. Annuity’s defense is weak, due to limited options and restricted trading frequency. To be dazzled by the tax-deferred nature of an annuity is misplaced focus- on the tail, not the dog.