Deferred Annuities in Pension or IRA


By Barry Boscoe, CFP

In a recently filed suit against Prudential, regarding the sale of tax-deferred annuities to a tax-deferred retirement plan in which the state courts moved the suit to a U.S. District Court, it was alleged that Prudential fraudulently, deceitfully, and in a breach of its fiduciary duty, convinced the clients to buy tax-deferred annuities as investments for qualified retirement plans and that these were poor, inappropriate investments because the retirement plans were already tax deferred and they did not need the further tax deferral offered by the annuities.  The plaintiffs claimed that Prudential charged extra fees and costs to buy tax-deferred annuities that were a waste of the investor’s money.

In the lawsuit brought against Prudential, the attorney, comparing the fees charged for the tax-deferred annuity with those charged by a comparable mutual fund, suggested that the excess fees for the tax-deferred annuity are solely charges for tax deferral.  Some would agree it is inappropriate to sell a tax-deferred annuity to a tax exempt or tax-deferred entity.  Some would even say that it is a marketing abuse.  These perceived abuses might be due to the fact that annuities do not have any break points, are heavily commissioned with potential surrender charges and limited investment options as well as higher expenses.

I believe it is wrong, to claim point-blank, that tax-deferred annuities are never appropriate for tax exempt or tax-deferred accounts, just as I would say it is inappropriate to say they are always suitable for such accounts.

In performing the analysis, it is important to look at the specific features of the individual tax-deferred annuity separate and apart from the tax deferral, if the buyer is a tax-deferred or tax exempt account.

The following are examples of why a tax-deferred annuity might be desirable even in a tax-deferred or tax exempt account:

The tax exempt account’s investment policy may be such that using the annuity minimizes withdrawals, which allows the investment manager to remain more fully invested than might be the case in an ordinary mutual fund.  In addition, the tax-deferred construction frees up the manager from having to concern himself with income tax consequences regarding the management of the fund.
Due to the extreme volatility of the equity markets and the fact the tax-deferred accounts are most likely to be used for retirement, and possibly survivorship purposes, the added feature of a significantguaranteed death benefit with an additional enhanced death benefit rider may be quite appealing to clients with a low risk tolerance who are viewing their retirement benefits as a primary means of support for the surviving spouse or other family members.
Some tax-deferred annuities offer a guaranteed minimum investment return of between 4 and 7%.  Such a guarantee is appealing for the conservative investor, especially in light of the volatility of the stock market and its weaknesses.
Some annuities offer an initial 4 to 5% matching contribution, which would allow the owner to switch to a different investment with another matching contribution every so often.
The fees charged by the tax-deferred annuity may not be that significant over those charged for mutual funds, especially when one looks at all of the fees charged over the lifetime of the investment.  It is possible to structure several payment options that might fit better within a particular client’s overall financial and retirement planning goals.
Annuities will often allow for a specific investment allocation plan that will automatically rebalance the allocation as the fund values change. This will relieve the natural tendency of many investors to ignore asset rebalancing after the initial plan has been established.
Annuities will allow a choice between annuitization or liquidation, thereby giving the annuitant the ability to factor his or her own health and family history of longevity into the equation in a manner that may favor the investor over the insurer.
As you can see, there are always two sides to every story.  Some will always believe that the wasted tax-deferral argument outweighs all of the other reasons.  Others will find a tax-deferred annuity can be appropriate within a tax-deferred or tax exempt account.