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Monday, October 01, 2007

How AIG Valic Can Cost You BIG TIME!

Since my wife, Zena, and I returned to the U.S., we have been aggressively saving for our retirement. Here is a table indication our savings among our various retirement savings options. We use Vanguard for our IRAs and our 403b(7) accounts and AIG Valic for our 457b accounts. Previously, we used TIAA-CREF for our 403b accounts, but in August of 2007 we transferred our 403b monies to our Vanguard 403b(7) accounts. While we liked TIAA-CREF, we felt it was better to consolidate our retirement savings at Vanguard to benefit from their excellent products with razor-thin expenses.


Year

Zena 403b

Zena 457b

Zena IRA

Total

2002

$0

$0

$0

$0

2003

$12,000

$0

$3,000

$15,000

2004

$13,000

$0

$3,000

$16,000

2005

$14,000

$0

$4,000

$18,000

2006

$15,000

$3,000

$4,000

$22,000

2007

$15,500

$3,864

$4,000

$23,364

Total

$69,500

$6,864

$18,000

$94,364


Gerry 403b

Gerry 457b

Gerry IRA

Total

$0

$0

$3,000

$3,000

$12,000

$0

$3,000

$15,000

$13,000

$0

$3,000

$16,000

$14,000

$14,000

$4,000

$32,000

$15,000

$15,000

$4,000

$34,000

$15,500

$11,136

$4,000

$30,636

$69,500

$40,136

$21,000

$130,636

Year

Zena Total

Gerry Total

Grand Total

2002

$0

$3,000

$3,000

2003

$15,000

$15,000

$30,000

2004

$16,000

$16,000

$32,000

2005

$18,000

$32,000

$50,000

2006

$22,000

$34,000

$56,000

2007

$23,364

$30,636

$54,000

Total

$94,364

$130,636

$225,000


The aim of this post is to illustrate the effect of expenses on retirement savings plans. The expenses of the various retirement savings options will be compared. I will include the Peach State Reserves plan among the plans compared since it is Georgia’s 457b plan that any district can add, via a board of education vote to approve. A common expense in many retirement plans is an account maintenance fee. Many investors erroneously assume that this is the most important fee associated with their plan. Here is an example of the account maintenance fee of some plans.


Plan

Account maintenance Fee

Vanguard IRA

$10 (waived with assets of over $10,000)

Vanguard 403b(7) account

$15

AIG Valic 457b account

$0

Peach State Reserves 457b account

$50


From the table we see that Vanguard and AIG Valic have lower account maintenance fees than the Peach State Reserve options. However, this is only part of the story. There are also other fees associated with retirement plans. Many 403b/457b plans are insurance products that have two main costs: the mortality and expense fee and the fee for the underlying investment. These insurance investments are usually more costly due to their extra layer of fees (i.e., insurance costs). Plans that only use mutual funds avoid this extra layer of fees. Here are the costs of the plans:

Plan

Mortality & Exp. Fee

Mutual fund fee

Total Investment Fees

Vanguard IRA

0%

.21% (VTTVX)*

.21%

Vanguard 403b(7)

0%

.21% (VTTVX)*

.21%

AIG Valic 457b

1 to 1.25%

.38 and up

1.38% to 2.25%

Peach State Reserves 457b

0%

.06% to .89%

.06% to .89%

* = The majority of our Vanguard 403b(7) and IRA is invested in this fund.

While AIG Valic does not have an account maintenance fee, they have the highest total fees associated with their product. These fees are not insignificant. Let’s assume that all the money that our total retirement savings ($225,000) were invested exclusively in AIG Valic or Vanguard. The total fee is calculated by multiplying $225,000 by the investment fee. The total fee is the sum of the account maintenance fee plus the total investment fee. What would the difference in fees be? What if our money were invested in the same exact fund at Vanguard and AIG Valic? This is possible since AIG Valic does offer many Vanguard funds among is investment choices. For example, we could invest in Vanguard’s LifeStrategy Moderate Growth fund with Vanguard directly or via AIG Valic. Here are the results:

Plan

Account Maintenance Fee

Investment Fee

Total Fees on $225,000

Vanguard LifeStrategy

Moderate Growth in Vanguard 403b(7) account

$30 ($15*2)

.25% * $225,000 = $562.50

$592.50

AIG Valic account invested in Vanguard LifeStrategy

Moderate Growth

$0

1.5%

$3,375

Why we are disappointed:

→→→→→

Difference of :

→→ $2,785.50!


Remember this is the annual cost to invest in the same exact mutual fund. The only difference is that one is held at Vanguard while the other is at AIG Valic. Does AIG Valic provide $2,782.50 of value-added service to our investments a year? NOT EVEN CLOSE!

What if our money were invested in index funds at AIG Valic versus the Peach State Reserve plan? Index funds are “vanilla” funds that simply track market sectors. Let’s assume that Zena and I both had all our retirement money in the PSR plan. That would mean that we had a total account maintenance fee $100 for our accounts ($50*2=$100). That seems like a significant amount of money, but it is nothing when compared to investing with AIG Valic. For example, what would it cost us to invest in an S&P 500 Index fund with AIG Valic and the Peach State Reserve? Here are the results:

Plan

Account Maintenance Fee

Investment Fee

PSR Fees & AIG here and here

Total Fees on $225,000

Peach State Reserves Vanguard Institutional Index fund

$100 ($50 * 2)

.07% * $225,000 = $157.50

$257.50

AIG Valic account invested

Stock Index fund

$0

1.38% * $225,000 = $3,105

$3,105

Why we are disappointed:

→→→→→

Difference of :

→→ $2,847.50!!


If we invest in AIG Valic’s other index funds, it is more of the same. The PSR offers Vanguard’s Mid Cap and Small Cap funds at institutional rates. In other words, the funds are dirt cheat--.07% and .08% respectively. What does AIG Valic charge of similar funds? Voila, 1.40% and 1.46% respectively; those charges are astronomical for index funds. Here are the numbers for the Mid Cap index funds just to emphasize my point:

Plan

Account Maintenance Fee

Investment Fee

Total Fees on $225,000

Peach State Reserves Mid Cap Core Stock Index Fund

$100

.07% * $225,000 = $157.50

$257.50

AIG Valic account invested

Mid Cap Index fund

$0

1.40% * $225,000 = $3,150

$3,150

Why we are disappointed:

→→→→→

Difference of :

→→ $2,892.50!!


Still don’t believe me? Here are the numbers for the Small Cap index funds:

Plan

Account Maintenance Fee

Investment Fee

Total Fees on $225,000

Peach State Reserves Small Cap Core Stock Index Fund

$100

.08% * $225,000 = $180

$280

AIG Valic account invested in

Small Cap Index fund

$0

1.46% * $225,000 = $3,285

$3,285

Why we are disappointed:

→→→→→

Difference of :

→→ $3,005!!


Of the retirement savings plans that we use, AIG Valic’s plan is easily the most disappointing for one main reason—its high costs. The fee differentials cited above are on comparable funds. Why should investors have to pay so much to invest? No one should be subjected to such ridiculous fees especially when a cost-effective plans are available. Without a doubt the Vanguard 403b(7) plan and the Peach State Reserve plan are superior to AIG Valic’s 403b and 457 plans. Fortunately for us, the Vanguard 403b(7) plan is available at my job with the Troup County School System. However, we have to only one 457 plan--AIG Valic’s fee-bloated annuity extravaganza. I am perplexed as to why the PSR plan has never been added; it is obviously in the best interest of every school district in Georgia.

What do we get for all the extra fees associated with AIG Valic’s fee-bloated annuity products? First, we get an investment guarantees. For example, if either Zena or I die while the market value of the investment is below cost, the survivor gets the amount of the initial investment back. We are not impressed with the guarantee; we would much rather take our chances investing in the world’s greatest economy without this expensive guarantee. Second, we also have the option of rolling our money into a stream of annuity payments upon retiring if desired. Of course, we could always purchase an immediate annuity if we wanted that. We do not, nor does anyone else, need AIG Valic to do this. The value of using annuity products is greatly overstated; the benefits” come at a HUGE cost.

10 comments:

greentree said...

I wouldn't gamble on the 'greatest economy in the world' providing for your retirement. The US debt crisis is bound to affect global markets and an annuity could protect at least some of your income from being eroded .

Annuity Options

Gerry Born said...

Greentree,
Thanks for your comment and advice. However, I will continue to "gamble" on the U.S. economy for a large part of my retirement. Like big, secure insurance companies, I will buy stock in the total U.S. economy (in the form of mutual funds) that will provide me a diversified portfolio. I will further diversify my portfolio with the inclusion of various international stocks.

As for stability, I already have an annuity in the form of Georgia TRS retirement plan. While technically not an annuity, it is a safe future stream of income that provides for a cost-of-living adjustment. So for me, it would make little to no sense to buy an annuity--especially a fee-bloated annuity. The security of annuities that you tout do not come without a price. My safe, secure fixed annuity at AIG Valic (my distict's only 457b provider) is in a short-term account getting 3% while CDs and money markets are paying a much higher rate. My 457 money is losing purchasing power to inflation. Overall, most annuities are useless to numerate long-term investors. For the innumerate, annuities are another story.

Ken said...

My wife is just starting her 403(b) in Ill. She has choices between American Funds, Ameriprise (American Express), Equi-Vest, First Investors, Hartford Life, Pacific Life, Pioneer Investments, Vanguard? Whats your thoughts and were can i do research?

Gerry Born said...

I hate to self reference, but take a look at some of my articles at:
http://millionaireeducator.blogspot.com/

Read: Cookie cutter products arent so bad

Whiz bang versus kiss

how to take guess work out of investing

looking for investment guidance

gordon eade and his no nonsense...

I tried to paste the link without any luck so those are the start of the blog titles. If you have Vanguard at work, that is almost certainly your best bet. However, don't be fooled by a Vanguard product offered in a terrible, fee-bloat annuity extravaganza.

I realize that I am hard on annuity products, but their high fees justify my disdain for them. I could not perpetrate such products on the investing public and still sleep well at night.

I hope this helps.

Anonymous said...

One of the main reasons for the extea cost in annuities is because, in the 403b marketplace, THEY COME WITH A FINANCIAL ADVISOR. I do understand that some of these are sold by insurance salesman who don't properly service and help maintain client accounts, but that's not always the case. Your certainly entitled to your opinion, but you shouldn't make blanket statements about companies (I do not work for valic but am in the industry) or products, because some annuity packages are a good value (not to be mistaken for cheap). Not everyone has the time or interest level to learn financial planning on their own, and for those people a reasonably priced VA with good service and top tier funds is certainly a suitable choice.

Gerry Born said...

Thanks for you comment. It is true that annuities come with financial advisors, but that is not necessarily a good thing. Financial advisors are not to be confused with financial planners. Financial advisors work for whatever firm employs them; that is where their loyalties lie. Financial planners are supposed to provide objective advice that benefits the individual investing his money. Sure, the FA provides service, but it is often at a huge cost. I stand by my numbers.

Sure, I make blanket statements, but I feel I am more often right than wrong. Anyway, the financial services industry has lost the benefit of the doubt. After fleecing investors for years in the form of loads, surrender charges and exorbitant fees, they beg more even-handed treatment. My hope is that ever investor will have access to load-free and surrender-charge free funds available at institutional fund rates. 403b investors have been boondoggled long enough.

Stan Smith said...

A financial advisor is prohibited from selling a product that does not suit his/her clients financial need. If the advisor is worth their salt, they don't lead their clients wrong.

Patricia Smith said...

Gerry,
Could you please help me by advising me what to do about my Valic Annuity.I recently retired.I have a year to go before I am 66 yrs. old.I have a 403b and I don't want to lose what little I have in it.It was not explained to me,just that it was the job retirement plan.What is the best way for me to get my money without it being taken up by taxes and whatever?My CPA advised me to let it alone,someone else told me to roll it over into an IRA account.What would you do if in my place?
Thank You
Patricia Smith

Anonymous said...

Financial advisors help people who don't know what they're doing in the financial arena. They also provide products to meet client needs. As to the VALIC hatchet job, the teacher (or other 403b) holder of an older VALIC annuity paying 3% can easily transfer it into a VALIC annuity paying 6 or 6.5%. How come there's never any mention of that?

Gerry Born said...

Look I gave up trying to fix the ills of the 403b / 457 world years ago. I still believe that most plans are wealth extraction devices designed to dupe investors. Also, I stopped looking at all the available options found within variable annuity contracts because there are too many bells and whistles that change constantly. I no more memorize the options in a variable annuity contract than a sailor memorizes the names of call girls in a port.