February 26, 2004 Copyright © 2004, Greenwich Financial Management Inc., a registered investment advisor. Securities offered exclusively through Purshe Kaplan Sterling Investments of Albany, NY, a NASD member firm.

Y OUR W EALTH

Questions and Comments:

Medicare and Long-Term Care; Deferred Annuities

Q. [Concerning the article on Medicare, Medicaid and Long-Term Care], I believe your statements regarding what Medicare will pay are misleading. What you have stated is the maximum Medicare might pay. However, Medicare as I understand it will not pay nursing home costs once a person's condition has stabilized and further improvement is not expected. I have been told that the average stay that Medicare pays is seventeen days. If my information is incorrect, I would hope you let me know.

A. Unfortunately, Medicare is based on a medical intervention model, not long-term care. Therefore, the amounts given assumed that the medical requirements continue to be met. Your point is well-taken, and a revised paragraph, emphasizing that the amounts given are maximums, appears on our Website at www.GreenwichFinancial.com . One source cites an average Medicare-funded stay in a nursing home of only 23 days; see http://www.aging-parents-and-elder-care.com . If you cannot afford the potential cost of long-term care for you or a loved one, it is prudent to obtain private long-term care insurance; as we have discussed, an optimal time to obtain such insurance is while you are still in your fifties.

Q. How can I learn more about deferred annuities? One of my stepfather's financial advisors recommends them.

A. Your stepfather should probably hold on to his wallet. When buying a deferred annuity, an investor makes after-tax contributions in the present in return for a stream of income in the future; there is no taxation of the growth of the principal invested until such income is paid out, while the principal itself is returned tax-free. There are three main conceptual variables pertaining to annuities. First, are the contributions spaced over time or made in one lump sum? Second, do the annuity payments begin immediately (as with a lump sum retirement annuity initiated at 65) are are they deferred? Third, is the stream of future income fixed (defined) or variable, depending on performance of investment assets? Fixed annuities are not very attractive right now, as long-term bond rates are at very low absolute levels—and beware of temporary teaser rates combined with stiff early surrender charges! With variable annuities, the investor normally chooses from a menu of investment “sub-accounts” (often these are special classes of open-end mutual funds), much as you might choose from the investment menu of a 401-K. You can change variable options over time based on your investment view. A Guaranteed Death Benefit life insurance policy is normally packaged along with the variable annuity contract; the “guarantee” is subject to your meeting the payment terms of the contract and to the future claims paying ability of the insurer. There are several serious negatives with annuities. With variable annuities, the bundled insurance contract may not be priced as cheaply as you could obtain separately. Moreover, sales load and management fees are often very high—up to 10% sales load and up to about 3% annual management fee. Finally, tax on all income in the annuity, when paid, is at the ordinary income rate. The maximum marginal federal rate on ordinary income is now 35% compared with the much more favorable maximum rate of 15% on long-term capital gains and 15% on corporate dividends. So you're paying up to 20% more tax at the back end compared with holding long-term capital gain property. Since no tax is owed on a stock that has gone up in price until it is sold and the gain is realized, holding on to capital gains property while it is still appreciating is one excellent way to have growth while deferring tax. An expose in the February 6 th issue of the Wall Street Journal, “Open Secrets—How Variable Annuities can Gnash Investors,” stated that the SEC is looking into possible abuses in the marketing of variable annuities. Make sure you study the offering circular for any annuity product carefully; it will outline upfront fees, management fees and any prepayment penalties.

Notwithstanding these negative factors, there are still cases where annuity investments make sense, if overall fees are reasonable. One use for fixed annuities is a special kind of defined benefit pension plan called “412(i)” that is funded entirely by life insurance or annuities, or both. Another legitimate case for fixed or variable annuities is where a person is presently in a high income tax bracket but expects to receive the annuity when in a much lower tax bracket; in that case, the ordinary income treatment is less onerous. In some instances, a desire to find a conservative tax deferred source of fixed periodic payments until death may suggest a fixed annuity. Finally, a fixed or variable annuity may make sense for an individual who has been denied traditional life insurance due to a pre-existing condition and who wants to build a store of value on a tax-deferred basis.

Next week: Health Insurance

Andy Szabo, CFA , is Managing Director of Greenwich Financial Management Inc. , a Registered Investment Advisor, which advises individuals and companies on investments, insurance and employee benefits. Questions or comments welcome by phone (203-531-2877) or e-mail: Szabo@GreenwichFinancial.com .