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Clear as Knight

Michael Flack

GOOGLE THE WORD “annuity” and you’ll receive 97 million and one results. Is there anything left to be said?

Yes, I think there is.

About 11 years ago, my 89-year-old mother asked me if she should invest more money in her Knights of Columbus annuity. Unbeknownst to me, she and my father had purchased it many years earlier. It earned a guaranteed 3.5% annual interest rate, which was better than every savings account or certificate of deposit available, plus it was tax-deferred.

As I had previously answered her vital questions—“can I get my hair done every other week?” (she could) and “should I give the front desk lady $20 for Christmas?” (she should)—she expected immediate and salient financial advice from her favorite son.

I told her I wasn’t sure if she should invest more as my knowledge of annuities was limited. I knew that variable annuities were bad, and that immediate fixed annuities had their uses and that their present value could be easily explained by PV = PMT * [1 – [ (1 / 1+r)^n] / r].

I think she was expecting an answer that was a little more concise—and affirmative.

Each time a certificate of deposit matured, she would ask me, “How about putting some money in that K of C annuity?” As a dutiful son—and after the third time she asked—I promised to contact the knight who sold her the annuity those many years ago.

Sir Keith was duly contacted and asked to provide details on my mother’s annuity. He was a very nice man, who promptly mailed my mother her most recent statement, which didn’t exactly answer my question.

When I called Sir Keith back, he claimed that was all he could do. When I asked for a prospectus, he informed me that there was no such thing and that I should look at my mother’s contract. I only mention this to show my commitment to resolving this issue, not to demonstrate how little I really knew about annuities.

“Ah ha, now we’re getting someplace,” I thought. But I immediately realized how this would go. When I asked my mother to produce the contract, she replied with the expected answer, “What contract?”

The Supreme Knight was contacted and my mother received a copy of her contract. Trust me, this was easier—and quicker—said than done.

Unfortunately, the nine-page contract was less than illuminating. It was filled with terms such as “assignment,” “maintenance of solvency” and “the accumulation value as of the maturity date.”

The fact that the contract was in my late father’s name—and that it was now eight years after the contract’s maturity date—made everything that much more confusing. Sir Keith assured me that all of this was not a problem and that, basically, the contract was now in my mother’s name.

I reported all this to my mother—or should I say the “owner,” or maybe “beneficiary,” or possibly the “annuitant”? She was still quite insistent on “investing.” Or should I say making a “premium payment”?

What could I do? Catholic guilt can be a powerful product feature.

My mother died at age 99. During her final years, she never needed to take any “payments,” or should I say make “monthly withdrawals,” because during her later years—besides a cup of coffee and a Bavarian cream doughnut at Dunkin’—her extravagances were few.

After her death, her beneficiaries were paid a handsome death benefit, which appeared to be the answer to a trick question, as it could be either “the sum of the premiums paid, less any withdrawals” or “the accumulation value as of the date of death.”

One of the features that stocks, bonds and certificates of deposit offer is that you know exactly what you’re getting. One share of IBM is just like any other. This isn’t true of annuities. Even the simplest ones are still guided by the specific contract you have with the insurance company—or, in this case, the fraternal benefit society.

I don’t mean to offer an unduly harsh take on annuities, as they can be a useful component of retirement planning. Besides the aforementioned Catholic guilt, I really have no idea why my parents purchased this flexible premium annuity. But I have a feeling my mother wasn’t aware of two of the annuity’s features.

First, as the contract’s beneficiaries were limited to the exact people named, her predeceased daughter’s children were not considered beneficiaries.

Second, most of the accumulation value that was paid to the beneficiaries was now considered taxable income—basically transferring her tax liability to her heirs. Since the exact amount of the payment was somewhat unknown, this complicated the Rothification efforts of at least one of the beneficiaries.

Michael Flack blogs at AfterActionReport.info. He’s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.

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