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Dissecting the offer

I may be going out on a limb, but after receiving numerous negative comments about my decision to purchase a deferred variable annuity from Ohio National Insurance Co. a decade ago, I am laying out the specifics of the company’s recent buyout offer and invite readers to offer their opinion on whether I should accept it before the Feb. 11 deadline.

Think of it as a case study of a client in the retirement red zone, that period starting about five years before retirement when potential market downturns can wreak havoc on future withdrawal strategies by reducing the size of a nest egg before distributions begin.

During last year’s InvestmentNews Retirement Income Summit, David Blanchett, Morningstar’s head of retirement research, cautioned financial advisers that they should assume low investment returns for the near future, with the strong possibility of some negative returns. Mr. Blanchett warned that declining markets could put those closest to retirement in a “pretty dangerous place.”

For example, a planned annual withdrawal of $40,000, representing 4% of a $1 million nest egg, would need to be reduced to $30,000 a year if the account balance dropped by 25% just before retirement. If the withdrawal amount was not reduced to accommodate a smaller starting balance, that $40,000 would represent a higher initial withdrawal rate of 5.3%, potentially threatening the sustainability of the portfolio.

Here are the facts of my case study. I am 64 and have no pension. My retired husband, 66, does. Our only other source of guaranteed monthly income will be future Social Security benefits. The annuity represents about 25% of our retirement nest egg, with the remainder invested in a balanced portfolio of stocks, bonds and cash. We both have long-term care insurance.

I opened my Ohio National ONcore flex annuity in 2009 and added about $145,000 in IRA rollover funds over the next two years. I was attracted to the annuity contract’s generous guaranteed minimum withdrawal benefits with a wide array of underlying investment choices and no surrender fees. I was clearly more interested in the income guarantee aspect than the tax-deferral aspect of the annuity since this was already qualified money.

The contract includes two balances: my actual account balance based on market performance, which has fluctuated over the past decade, and a guaranteed benefit that continues to grow by at least 6% per year or the highest anniversary value, whichever is higher. The contract’s annual mortality and expense fee is 1.5% of the cash value. The guaranteed minimum income benefit with annual reset rider costs an additional 1.5%

Fast forward to October, when I received a buyout offer from Ohio National. My current account balance is about $324,000. The guaranteed amount is more than $508,000 — a spread of about $184,000. Ohio National offered to pay me about $92,000, half of that $184,000 enhanced value, to cancel my contract. Added to my actual account balance, it means I could walk away with about $416,000.

Sure, it sounds like a nice deal, but what would I do with the money?

My main goal is to use this portion of my investments to create secure income. Using a prudent 4% withdrawal rule, that $416,000 would create about $16,640 of annual income. Or I could purchase a straight life immediate annuity and generate about $26,000 a year of income.

In contrast, once I start tapping my variable annuity, the contract allows me to withdraw 6% a year of the guaranteed amount. That’s more than $30,000 a year based on today’s guaranteed value, which will continue to grow — minus any withdrawals — until my 85th birthday. Even if my account nearly runs out of money, I can still annuitize the contract by age 85 and receive income of almost $50,000 a year guaranteed for at least 10 years or life, whichever is longer.

The buyout offer document lists a range of factors I should consider when deciding whether to accept or reject this offer. I can check all the boxes under the decline list:

• I don’t need immediate income from the buyout.

• The annuity with its guaranteed minimum income benefit rider still suits my goals and is an appropriate product to address some of my retirement income needs.

• There is a potential death benefit for my heirs.

• I like the potential upside of the underlying investments.

Yes, these guarantees come at a steep price. But if you think I should take the money and run, please suggest an alternative investment that would create similar predictable or guaranteed income at a lower cost with virtually no chance of outliving my money. I look forward to hearing your ideas.