Keep The Financial Sun Shining On Your Clients
On Memorial Day weekend, the eight members of the Smith family in Trenton, New Jersey, embarked on a summer they will never forget. On May 7, they hit the $429.6 million Powerball jackpot and took home $284 million, New Jersey Lottery officials said.
The question for the Smiths is how make this summer truly endless; how to make sure the financial sun always shines.
Which brings me to a spirited dinner conversation I overhead two weeks ago in a restaurant in Yardley, Pa., where I live. The conversation was about whether these big-time winners should invest the winnings in an annuity or in municipal bonds, or “munis.”
Where’s a financial advisor when you need one, I thought to myself. Instead, I put out the query to the financial advisor community.
When it comes to lottery theory, the annuity-muni argument isn’t new at all and is too elementary, said advisor Charles Koch with Prism Financial Group in Spring Hill, Kan.
Here are thoughts from advisors who responded.
“In my experience, annuities alone are too restrictive.And with this level of assets, their guarantees as far as income and guaranteed rates are irrelevant. Annuities may have a place in achieving certain parts of a broader plan but are not a suitable vehicle in which to simply deposit the entire lump sum of winnings. The argument of munis v. annuity is far too elementary when planning for winnings of $430 million. The person taking the muni side of the argument likely knows that annuities are not the best choice. They may have heard that high net worth people invest in munis for tax-free income, but they likely don't have a clear understanding of what it takes to sustain wealth over time,” Koch also writes. “Both arguments are focused disproportionately on income.”
“It absolutely could be a good place, especially if the concern is running out of the money. The upside of an annuity is that you can plan on a set amount of income for life and know you won't run out. You also can save on taxes by deferring taxes on the growth. The downside is that, depending on the product, you generally cannot access the funds if you need more than the scheduled income at some point.”
- Lora J. Hoff, Dallas
“I'd buy a ladder of muni bonds. Annuities have limited insurance, less flexibility and tax issues. Stay simple: National Unlimited GOs, ladder down 8-10 years, A or better. Plus, you can easily carve off a muni or 10 and buy your boat or third vacation home.”
- Leon C. LaBrecque, Troy, Mich.
“To answer the question start by looking and understanding how the state provides the payout, lump sum or a stream of payments. The stream of payments is in essence an annuitization of the amount of winning. My suggestion is to look at the rate of return you money gets over time with the stream of payments and see if you can do better with other investments while considering risk, costs and several other factors."
- Peter J. Creedon, Mount Sinai, N.Y.
“Technically, most lottery proceeds are paid out as annuities -- over 20 years or so in most cases. Paying a huge tax bill to get the lump sum amount (higher tax brackets for the bulk of the winnings when done this way), and then annuitizing it (and paying a fee for the annuity to both the insurance company and the insurance salesperson), is not only redundant, it's kind of dumb. The problem is that most lottery winners want the cash in hand, and so end up with the higher tax bill, and then end up being victimized by more scamsters who are looking for ways to part the winners from their proceeds. Instead of munis, the proper question would be what the best investments would be for a balanced portfolio considering the winners' new tax situations. All munis would make for a very undiversified portfolio, and some municipalities (think Illinois and Puerto Rico) are having problems with their internal finances. New Jersey is also on that same "high risk" list for munis.
An annuity, if chosen properly, can be a good investment against longevity (and against blowing the money on purchases), but again, the payments are annuitized anyway, so why pay twice (plus higher taxes) for the same thing?
Given the New Jersey tax situation -- income and estate -- I'd look into moving to a state like Florida that has neither, as long as there aren't any "hooks" in the lottery payouts that mandate paying New Jersey taxes for the duration of the payments. Do a lump sum payment, and they're stuck with the New Jersey tax bill."
- George R. Gagliardi, Lexington, Mass.
“I would not rule out an annuity if a person wants lifetime guarantees and no liquidity. Personally, I feel the current interest rate environment is too low to get into annuities.”
- Robert Wesley Shannon, Hurst, Texas
“First, certainly not just one annuity. I would recommend anyone looking to purchase annuities over the state commissioned limits to split up their purchase over several companies. This does two things: it diversifies risk (similar to when you buy a fund or index), and it gives the client more flexibility on when to trigger various benefit that are offered by the insurance companies. Lastly, they certainly could buy bonds or annuities, but they should also have a diversified basket of low-cost stocks (or funds) to help hedge against inflation and to generate higher long-term returns than the annuity or bonds will make.”
- Neil Maxwell, Parker, Colo.
“If you don't want to pay all of the income tax upfront and you accept the winnings in annual installments, the winnings are in effect an annuity of and by itself. While annuities are relatively safe the financial benefit of an index universal life contract is far superior. Both accounts grow tax deferred. The indexed universal life contract will consistently have a much higher cap than the annuity. However, the income from an annuity is partially taxed and the indexed universal life provides totally tax free income. The annuity provides a death benefit which is essentially, in most cases, a return of premium. The indexed universal life contract provides a death benefit significantly in excess of the premium deposit and totally income tax free. Annuities and insurance aside, the client would probably be better off with a diversified portfolio in keeping with his/her propensity for risk.
Another important factor would be appropriate financial planning. Many people don't realize that after overt and hidden taxation they have approximately 50 percent of the funds left to spend. I think the financial planning aspect is most important. Any advisor pushing only one or two commissionable products is doing the client a disservice. There should also be a discussion of the use of trusts and asset protection. Depending upon the situation, the beneficiary defective inheritors trust may be a good option as the client would be the trustee and beneficiary but not the grantor."
- Mark P. Silberfarb, Irvine, Calif.
“A fixed single pay annuity can definitely be part of the portfolio to provide for the basic needs for the rest of the winner's life. That way he/she can afford to be more aggressive on the rest of the winnings.
Also it guards against the winner spending all the money prematurely. Putting just a small portion of the $430 million in annuity will go a long way to protect the winner's financial security, and allow them to invest/disperse the rest of the money prudently.
- Hui-chin Chen, Arlington, Va.
“Well, the first thing I would remind the lottery winner is that annuities are basically insurance against outliving your assets. Conceptually, they are priced so that the insurance company makes money (on average) and the purchasers lose money (on average). So, if you have an enormous lottery winning, you’re probably not in need of insurance against outliving your assets. When you consider the internal rate of return of most annuities, it’s not a very high rate of return since most of what you’re getting back is principal. In that light, the annuity isn’t all that great of an investment. Also, you need to consider the age of the investor as well. That doesn’t rule them out entirely, however. For example, maybe it would make some psychological sense to purchase enough annuities to provide a standard of living that makes the winner ‘really comfortable.’ An allowance if you will. Then, the rest can be invested with heirs in mind and can be available to tap for medical and other reasons. There could also be estate-planning considerations that make some types of life insurance attractive as well. So annuities are not a tool I’d rule out altogether but the reasons for using them might be different than the conversation you overheard at the restaurant!”
- Steve M. Burkett, Bothell, Wash.
“Generally, I am not a big fan of annuities due to their higher commissions, fees, surrender charges and underperformance. But in this case, an annuity may actually make some sense. Putting a portion of winnings into an annuity make may prevent a spouse or children from a lump sum, then forced to live on a reduced income. If you fear next of kin may not be able to properly handle this new money, an annuity could be a viable option. Put in annuity for these reasons, not for investment reasons as long-term, in an annuity, you may not come out ahead.”
- Scot S. Hanson, Shoreview, Minn.
"In general, I don't favor annuities for a number of reasons, including poor track records, poor protection against inflation, large fees, and the fact that your money becomes the insurance company's money. OK, not exactly, but you get the point. However, when it comes to lottery winners, I think there is something to be said to lock the money away in an annuity. I have not heard very many success stories of lottery winners being able to meaningfully and permanently change their lifestyle as a result of a lottery win. For most people, it gets spent in a very short amount of time, resulting in more pain than joy. Hence, locking the money in an annuity may help a lottery winner to change their lifestyle meaningfully."
- Chris Chen, Waltham, Mass.
InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected]
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