On creating an annuity

This is probably not the right board for this, but I can’t think of a better one so here goes. Feel free to point me in a better direction.

I have an elder SIL with no substantial assets, save a small house and >$50k savings. She has designated her nephew (who is also our nephew) as her sole beneficiary in case of death. He is the only child of anyone on that side of the family.

Unfortunately, about a year ago he had a breakdown, and has since become paranoid delusional, quitting his job, living with his parents after moving out of the big city. He refuses help, won’t take meds, and now has a dysfunctional personality. He is “human being” capable but not “business” capable, and has lost jobs as he sinks into the miasma. (“My brain is being controlled by the CIA from California.”)

It seems to me that an annuitized payout would be a better way for the SIL to go, I think if he got the house & cash in one fell swoop it would last less than a year (new car! Drinks for all my friends!) And yet the estate isn’t large enough to go through the expense of a trust or similar.

So is there is cheaper way to structure something like this, and hopefully bullet-proof it so he can’t also just take it to J.D. Wentworth because “he wants his money now”?

[I figure people on this board may have some working knowledge of this sort of thing as we investigate our own estate planning. At least I hope. Looking for help, here.]

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She would need a trust that specifies those conditions, and a trustee that is not your nephew.

Or you (or someone) could have him declared incompetent to handle his own affairs. In fact, someone should do that regardless of setting up a trust. At some point the parents will die, and he’ll be on his own.

Getting him committed may be good, too. Maybe if they can clear the psychosis with meds, he’ll be clear enough to realize he needs the meds. Why would you expect someone who thinks the CIA is controlling his brain to submit to meds? That’s an unreasonable expectation.

In summary:

  1. Both SIL and the parents need to setup trusts, with a trustee that is not him.

  2. He probably needs to be committed until they can get his condition under control. Eventually every benefactor will perish, and he’ll be on his own. If he’s as bad as it sounds, someone (likely the police) will have to commit him anyway.

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Is all this in Tennessee? Isn’t that just the normal Tennessee mentality?

But seriously, folks, this sounds like a perfectly normal annuity would be best for him. I know, I know, annuities are a rip off. I can refer you to the American Legacy variable annuity through American (mutual) funds. We were duped into paying $40K for one many years ago. Last time I looked, it was up to $126,000-odd, and we have been getting ~$559 a month income. For this case, this seems like a no-brainer. Needs to be set up so that he can’t touch the principal, but get some income.

There needs to be some way to prevent him from just liquidating the annuity.

CNC

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There needs to be some way to prevent him from just liquidating the annuity.

JG Wentworth and other predatory companies are adept at helping people liquidate their annuities. I don’t know of any way to stop them.

So I think a trust would be better. The drawback is cost. I think a trust is taxed at a higher rate, plus, a professional trustee would charge a percentage. If anyone has info on those costs, I’d appreciate it. (If not, I’ll find out soon enough after my dad passes.)

I don’t have an answer for OP. One thought I have is that if the amount is too small to make a trust worth the trouble/expense, then it hardly matters. Nephew blows it all in short order, or it’s divvied up into such small amounts over time that it won’t be much help anyway.

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J.D. Wentworth

Absent a trust (and the administration of such is often more expensive than any annuity), or someone else being the owner (cough you cough), there is little to keep him from selling the income stream for a lump sum - assuming his state of residence doesn’t prohibit such.

As others mentioned, getting him declared incompetent to handle his own finances would be helpful. Once that is accomplished, then his legal guardian/conservator could purchase the annuity and the insurance company would then only take a change in payout instructions from the guardian or their legally appointed successor.

That being stated, the problem I see with the above situation is that she would have to at least write a testamentary trust now in such a way that it empowers her executor to have the discretion to purchase an annuity with the proceeds from her estate. She would also have to ensure that all of her assets are transferred into that trust upon death and liquidation. Not an easy nor a cheap thing to do for someone with very few assets.

Might just be easier for her to give it to you and you set it up for him.

As a footnote, when people talk about annuities being expensive, they are ALWAYS conflating variable and indexed annuities and (which often have various fees and expenses) with fixed and/or immediate annuities, which do not.

Makes as much sense as saying all mutual funds are expensive while completely ignoring the universe of passive index mutual funds

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I’m just curious, if someone has an annuity (or was given it) and say it pays $1,000 a month, can that person simply borrow against the trust and essentially get around the purpose of the trust in a situation like this (i.e., prevent the immediate disbursement/spending of all of the money)?

I would assume so but don’t know.

…borrow against the trust…

My dad’s and my trusts specify that trust assets (which are not, btw, annuities) can not be used as collateral for loans.

…trust assets … can not be used as collateral

Not sure how strictly this is enforced. When I was prepping my dad’s house for sale, I paid contractors using a line of credit attached to his brokerage account, which is in his trust, then paid it all back once the house sold.

Hawkwin writes,

As a footnote, when people talk about annuities being expensive, they are ALWAYS conflating variable and indexed annuities and (which often have various fees and expenses) with fixed and/or immediate annuities, which do not.

It depends on what kind of immediate annuity you’re talking about. I agree that a 10-year fixed annuity is basically a 10-year CD without FDIC insurance – as long as you’re getting enough extra yield to compensate you for the risk, it may be a reasonable purchase. Anything with a “life contingency” (i.e., single-premium immediate life annuity) has more opportunity for the insurer to add costs. They’re just buried in the contract and not disclosed by prospectus as is the case with variable annuities.

The latest research reveals that you lose about 8% of the purchase price of an immediate life annuity to the insurer’s various fees, expenses and costs.

Discount Rates, Mortality Projections, and Money’s Worth Calculations for US Individual Annuities
https://www.nber.org/papers/w28557

Our central estimates, using discount rates drawn from the corporate BBB yield curve and future mortality rates that combine a Society of Actuaries individual annuitant mortality table with projections of future mortality improvements from the Social Security Administration, suggest money’s worth values for annuities offered to 65-year-old men and women of about 92 cents per premium dollar. Recent Department of Labor rulemaking requires defined contribution plan sponsors to provide participants with estimates of the annuity income stream that their plan balance could purchase. These estimates, like EPDVs, are also sensitive to both prospective rate of return and mortality rate assumptions.

intercst

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I think that you are trying to do the impossible.

He and/or JG Wentworth is going to find a way around any restrictions.

Probably the only way to do this is for her to direct the money to a trustworthy 3rd party (that is, you) with the understanding that this person would distribute a certain monthly sum to the nephew, as a “gift”.

Probably more heartache for you than it is worth.

Best advice I heard in an investing seminar: “Everybody has problems. Don’t make their problem become your problem.”

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Look into a special needs trust. DH and I both have one. There is nothing in it until one of us passes, then the assets of the deceased spouse go into the trust for use by the surviving spouse. I assume there is some kind of “special needs” in your circumstance, and an estate lawyer would probably need to set it up…and the cost may be prohibitive.

Isewquilts2

My mentally handicapped brother has a special needs trust that will be funded after Dad passes, from:

  • Bro’s share of Dad’s assets, which will be divided equally among all siblings, and
  • Survivor benefit from Dad’s Navy pension. Typically pensioners name spouses to receive survivor benefits, but Mom & Dad agreed to name Bro, realizing he’ll never be truly independent.

So if the former is zero, Bro will still receive something.

He’s receiving SSI and is in subsidized housing now. Has a social worker, but hasn’t officially been deemed incompetent, so doesn’t have a guardian, which makes things complicated because he’s sometimes foolish and uncooperative.

IIRC, it was about $2k to set up. With Sis as Trustee, shouldn’t be any more expensive to administer than any of our other trusts.

I paid contractors using a line of credit attached to his brokerage account, which is in his trust, then paid it all back once the house sold.

The brokerage account had the means to secure assets.

Trying to secure a loan using trust assets as collateral - when one does not control the trust, is likely to fail.

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Our central estimates, using discount rates drawn from the corporate BBB yield curve

Wait what? Did you read the entire paragraph you selectively quoted?

Why would someone compare the lowest quality non-junk bond yield to a virtually FDIC insured income stream?

That makes as much sense as comparing the yield on a CD (5 yrs will get you about 0.36% per Bankrate.com) to the current BBB yield (3.97% per https://ycharts.com/indicators/us_corporate_bbb_effective_yi…) and then saying that you only get 92 cents per dollar for your CD. That is an apple to grapefruit comparison.

Even worse, this paper is about the BBB yield curve in 2020 Quick guess, no cheating, do you know what the BBB yield curve was up to in 2020?

Over 5%.

Even the authors at your link qualify their comparison (two sentences before your quote):

The spread between the interest rates on Treasury and corporate bonds was high by historical standards as a share of the riskless Treasury yield during much of 2020, making the choice of discount rate more consequential than in the past.

Basically, they picked one of the worst times to use the BBB yield - and they acknowledge such. The discount one picks is arbitrary and unless you are investing all your money in BBB bonds, then it is a rather facetious comparison. No one is getting 4%, much less 5%, from a very safe investment these days.

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Hawkwin complains,

Our central estimates, using discount rates drawn from the corporate BBB yield curve

Wait what? Did you read the entire paragraph you selectively quoted?

Why would someone compare the lowest quality non-junk bond yield to a virtually FDIC insured income stream?

They’re not comparing an FDIC-insured CD to a junk bond. They’re saying that they used the BBB yield curve as the discount rate in the “present value of a life annuity” calculation. If they used 1% instead of 4% or 5%, the annuity would look even worse.

That’s why waiting until age 70 to start Social Security effectively allows you to buy an inflation adjusted life annuity for about half the price that a commercial insurer would charge for the same monthly benefit.

intercst

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I would also favor a trust over an annuity, hoping that the trustee would be a trusted family member who would not require an annual trustee’s fee. If that’s the case a trust doesn’t have to be very expensive to set up, any more than a will is.

And if the trust is invested in income-producing stocks, or even just index funds, it might very well produce a better return than an annuity, especially considering inflation. And qualified dividends, even if run through a trust, would be tax-free to the beneficiary as long as he’s in a lower bracket. By contrast, income from an annuity is subject to tax at ordinary income rates.

Bill

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It seems to me that an annuitized payout would be a better way for the SIL to go, I think if he got the house & cash in one fell swoop it would last less than a year (new car! Drinks for all my friends!) And yet the estate isn’t large enough to go through the expense of a trust or similar.

So is there is cheaper way to structure something like this, and hopefully bullet-proof it so he can’t also just take it to J.D. Wentworth because “he wants his money now”?

If this were me I would:

  1. Talk to a lawyer who deals with estates, trusts, etc., to see what the options are and what he recommends, and
  2. Make the best possible choice, but understand that there’s no way to truly “bullet-proof” the arrangement because people can find a way around safeguards that are put there even for their own good.

In our will, we made it so money would be parceled out to our kids at certain age points. A high school or college age kid can make some poor financial choices and lose out, but we figured the gradual distribution would give them a second chance. But, IIRC, the last amount was paid out at age 35. Sure, 36 year olds can do something dumb or naïve and lose it all, but there’s just so much you can do to help from beyond the grave. In your case, it sounds like nephew is in a situation where an influx on money might not even be a positive. A friend has a niece who is finally off drugs, but a large bequest might be more than she could resist. I wouldn’t suggest that the friend not make her an inheritor, so I sure wouldn’t suggest that to you (who I don’t even know), but it bears considering.

If SIL can spare some of the money now, and she could give him a slice of the pie while she’s alive, it would:

  1. Act as a test to see how he handles a chunk of cash, and
  2. Allow her the pleasure of seeing him enjoy it (if he does so responsibly).

Bottom line: It really would be worth paying lawyer to arrange things vs. “rolling your own.”

That’s why waiting until age 70 to start Social Security effectively allows you to buy an inflation adjusted life annuity for about half the price that a commercial insurer would charge for the same monthly benefit.

You don’t even have to take intercst’s word for it–compare your own numbers from SSA.gov for taking at FRA, age 62 and/or age 70 to the annuity quote from a salesman or an online annuity site. Delaying social security has beaten a commercial annuity in every comparison I made.

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You should actually read from the article you linked:

https://www.nber.org/system/files/working_papers/w28557/w285…

The option-adjusted spread between high-grade corporate bond yields and Treasury yields was 207 basis points in June 2020, compared to 139 in January 2020 and 185 in July 2020. This suggests that the differences between the money’s worth findings using Treasury and corporate yields may be somewhat larger for June 2020 than in an average month over the last decade…

Discounting future annuity payouts using the Treasury yield curve is likely to overstate the EPDV of an annuity, because annuity payments are likely to be riskier than the yield on Treasury bonds. Similarly, the BBB yields probably overstate risk and apply too high a risk premium.

The average annual payout on an SPIA for a 65-year old man was $5,748 in June 2020, compared to $6,456 in June 2015, $7,344 in June 2010, and $7,740 in June 2005. The yield on a 10-year Treasury bond, which averaged 0.73% in June 2020, was 2.36% in June 2015, 3.20% in June 2010, and 4.00% in June 2005.

The unusual financial market developments during the second quarter of 2020, primarily associated with the pandemic-induced disruption in financial markets and the Federal Reserve’s response, raise concerns about the representativeness of findings based on June 2020.


In other words, June 2020 was one of the worst possible times to both consider an annuity and to analyze such in this century - and the authors acknowledge such in the last sentence I quoted.

Like trying to analyze the stock market by only looking at March 2020.

But wait, it gets better:

When we apply discount factors based on the Treasury yield curve, we find to construct discount factors, money’s worth values are greater than unity – suggesting that that the present value of expected future payouts is greater than the premium cost.

For those that struggle with innumeracy, greater is better.

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When we apply discount factors based on the Treasury yield curve, we find to construct discount factors, money’s worth values are greater than unity – suggesting that that the present value of expected future payouts is greater than the premium cost.

Fantastic! Perhaps you can point me to the commercial insurer who’s going to give me a quote that beats delaying Social Security to age 70? That’s where “the rubber meets the road.”

intercst

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