Annuities Unmasked

Annuities ® UNMASKED

The pros, the cons, and the critical questions you need to ask before you go swimming into retirement.

By Jeff Junior ©2024. All rights reserved.

®

ANNUITIES UNMASKED

This e-book covers:

• Factors to consider within the income puzzle that is retirement.

• What annuities are used for, their history, and reasons why you might want to consider one.

• Major types of annuities and their general pro’s and con’s.

• Balancing the benefits and the risks of annuities.

• The bottom line: How to decide if an annuity is right for you.

Important Notice:

These materials are for informational and educational purposes and are not designed, nor intended, to apply to any person’s individual circumstances. It does not take into account the specific financial objectives, tax conditions, or particular needs of any specific person. You should work with your financial professional to discuss your specific situation. The tax treatment of FIAs is subject to change. You should consult with your legal and/or tax advisor before making any taxrelated decisions.

Annuity guarantees are based on the claims paying ability of the issuing insurance company. Any examples provided are hypothetical. Annuities are issued with prospectus and sales brochures and should be reviewed carefully before funding as features and benefits vary. D.B.A. in most states as Trajan® Wealth Insurance Solutions. Legal services are offered through Trajan® Estate, L.L.C. in Arizona and Utah, and independent law firms in other States.

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Introduction by Jeff Junior, CEO

I became a financial advisor for a series of reasons! And they all came together to show me there was a real need in the world that I was particularly equipped to fulfill. It started with my parents; My dad, who was a business owner and former mayor, and my mom, a registered Flight for Life nurse. They held a high standard for service and social responsibility, and I wanted them to be proud.

Perhaps that’s part of the reason that I enlisted in the Marine Corps immediately after I graduated high school. Besides the fact that I needed a surefire path to help me grow up! I was stationed in Okinawa at age 18 and later served in the Marine Expeditionary Unit during Operation Desert Storm.

Throughout my military service and college career, I learned many different ways I could serve my community and country, but another “reason” would soon come into play. My father passing away suddenly when I was 20 years old. This event helped me to clearly see, for the first time, where I could do the most good. It was a difficult experience that taught me many things, but mostly the importance of insurance, and the power of compounding interest. That’s when everything became clear to me.

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BECOMING A FINANCIAL PROFESSIONAL

The experience with my father’s untimely passing taught me many things, especially about money and finances. I learned it’s not just about work, savings, or what you can buy. It’s actually about safety, protection, and fulfilling your dreams and those of the people you love.

Unfortunately, taking care of your money is one of the most challenging, complex, and bewildering things most people face. And that’s why I decided to enter the financial profession. Helping my clients navigate the multifaceted world of financial planning so they can create safe, comfortable lives for themselves and their families—this is what I’ve dedicated myself to.

Today, I’ve spent over two decades in the financial services profession. Helping individuals and couples who are in, or nearing, retirement to better prepare for the challenges associated with the ever-changing financial landscape. My commitment is to help clients successfully align assets with objectives to leverage and manage portfolios that will weather market fluctuations.

FI DU CI AR Y

\DEFINITION\: A Fiduciary is a financial advisor bound to a standard of care, who acts on behalf of another person, or persons, to manage assets. Essentially, a Fiduciary is a person or organization that owes to another the duties of good faith and trust. It also involves being bound ethically to act in the other’s best interests in regard to fees, strategy, and conflicts of interest.

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THE FINANCIAL CHALLENGE

It’s easy to look at the days of pensions wistfully. It was so simple then, right? There were no 401(k)s, IRAs, overnight stock market meltdowns. People would just work for one company their entire careers. And when those careers ended, checks would magically begin to show up in their mailboxes every month!

Okay, so it wasn’t quite that simple, and certainly not for everyone. However, things have become a lot more complicated as pensions have become mostly relics. Instead, it is now your responsibility to amass enough assets to last for the rest of your life. Once you’ve acquired those assets, you are also responsible for figuring out how best to manage them.

This is where so many people get stuck. They work, they save, and they want to create a blueprint for that financial foundation, and so they start looking around. They go to the Internet to search for advice, or maybe they visit the bookstore, or even ask their friends. And they quickly discover that there really are no clear answers. Everyone has a different opinion about how to plan your financial future, and many of these opinions conflict.

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In fact, there is no one answer out there. Because YOU are the answer! Your goals are the only ones that matter when planning your financial future. And any plan you make, with or without a financial professional, has to start with your needs, your goals, and your circumstances. Creating a blueprint that will achieve your financial goals isn’t simple. It requires coordination of several different strategies and tools, all ready to be implemented at the right time.

It’s important to choose a trusted financial professional to help create and execute your plan, but you’ll also need a personal understanding of certain key strategies available to you. Remember, while we absolutely can create a financial plan that achieves your goals - nothing is simple in this world. And, while we’re on the subject, if anyone ever tries to tell you that all you need is “this stock” or “that policy” and you’ll be set for life - run the other direction!

The necessary truth that you must understand is this: Every financial tool and strategy available to you has both risks and rewards. In order to put any tool to use, you need to know how just how it can help you! And also how it could potentially hurt you if not used properly.

Annuities are no different! They are often misunderstood financial planning tools which can actually provide an excellent way to save for retirement. Providing protection

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for your family, and mitigating some of the risks of living a long life of leisure after you stop working. Taxes, longevity, healthcare costs, etc., the list goes on and on - and we’ll get to that. Annuities also have some very specific rules and factors that must be considered, with some annuity types having even more than others. Some of these variables can become termites in your ideal financial “house!” I won’t allow this to happen! The goal of this book is to prepare you with knowledge to help protect your finances and future.

NO MORE LOOSE ENDS

Today, I’m CEO of Trajan Wealth. However, my military training and experience from decades ago are still with me. Young soldiers will often lament all the constant, rigorous inspections of their lockers, beds, living quarters and especially their uniforms. However, they quickly learn that the small things often have the biggest impact. That’s why when we work with you to create a financial plan and oversee your portfolio, you can be sure that there will be no loose threads to unravel the plan we’ve built together. You can count on my military precision and my commitment!

Now, how about we get to work on your future?

-Jeff B. Junior

CHAPTER 1

THE RETIREMENT INCOME PUZZLE

When Trajan Wealth advisors meet with new or potential clients - the conversation often begins with one question: How much money do I need to retire?

It’s a seemingly simple question, but actually one that illustrates the complicated task that many retirees face. See, just like there is no 1 tool that can help you build a sound retirement plan, there is also no “magic number” that will let you know you have enough to retire. There are many factors that can affect how long your money will last, and therefore how much you need. Keep in mind, your ideal retirement income amount is determined by your personal goals for retirement.

Do you plan on downsizing, moving to a small cabin on a mountain lake and spending the next 30 years fishing? Do you have your heart set on traveling the world, buying a second home in a foreign country, or helping pay for your grandkids’ college tuition? Different goals, clearly, will require different incomes.

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One way to begin determining a target income to base your retirement planning around is to consider what you’re currently spending. Many people believe you need 70-80% of your pre-retirement income to retire. Although, again, there is no magic number!

With a solid idea of how much you earn each month, and how much you spend, we can determine a goal amount. For example, if we know you require $5,000 per month, and we factor in the amount of savings you have to work with, we can determine if you have enough assets available to generate your goal income. This involves using various retirement income tools such as annuities, mutual funds, Exchange Traded Funds (ETFs), and more.

However, it does get a bit more complicated. Today’s retirement planning comes with a number of inherent risks that we have to consider. The only good retirement plan is one that protects and provides for you for the rest of your life. And in order to do that, your plan must mitigate all of these risks.

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COMMON RETIREMENT RISKS

LONGEVITY

The good news is that you will most likely enjoy your retirement for a much longer time than the generations before you. Your grandparents might have planned for 15 or 20 years of retirement, but now we are all living in healthier times. You need to plan for around 30 years or more of retirement income. According to the Social Security Administration, 1 out of every 4 65-year-olds will live up to age 90.¹ That’s a lot of years to plan for, I know - but we can do it! It just requires the right plan.

INFLATION

Money loses purchasing power over time. This economic concept is known as inflation. For example, you might pay $4 for a gallon of milk today, but 20 years from now, when you are retired, that same gallon could cost double … or more. A solid retirement plan means not having to worry about whether or not you can afford that gallon of milk, or anything else you need, now or in the future. It is vital that your retirement plan accounts for inflation!

TAXES

A lot of people think of taxes as simply a cross to bear: you earn X, and you have to pay Y, simple as that.

1 https://www.ssa.gov/planners/lifeexpectancy.html

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However, you don’t have to simply pay your taxes. You can actually plan the amount of taxes you will pay. Yes, you will pay taxes, but timing out certain retirement strategies can affect the amount of taxes you’re going to owe. If you don’t take these strategies and timing considerations into account, you could easily end up paying significantly more taxes than you have to. Why would you want to hand over more of your hard-earned lifetime income than what’s necessary? For this reason, tax strategy must be a critical part of your retirement plan.

HEALTHCARE COSTS

According to the annual Fidelity Retiree Healthcare Cost Estimate, a 65-year-old retiring in 2023 could spend $157,500 on health care - even with Medicare coverage². So, what if you need long-term healthcare such as in-home nursing, or in-facility care? It’s estimated that over half (56%) of Americans turning 65 will develop a disability severe enough to require some degree of long-term care in their lifetime.³ And considering that a semi-private room in a nursing home costs an average of $8,6069 per month in America in 2023⁴, you can just imagine how pricey it might be in 20 or 30 years!

2 https://newsroom.fidelity.com/pressreleases/fidelity--releases-2023-retiree-health-care-cost-estimate--forthe-first-time-in-nearly-a-decade--re/s/b826bf3a-29dc-477c-ad65-3ede88606d1c#_edn1

3 https://aspe.hhs.gov/sites/default/files/documents/08b8b7825f7bc12d2c79261fd7641c88/ltss-risksfinancing-2022.pdf

4 https://www.genworth.com/aging-and-you/finances/cost-of-care

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It’s easy to see how, without a plan, long-term care costs could wreak havoc on even the most robust of savings accounts in a very short time. The good news is there are strategies you can employ in your retirement plan to provide for these costs. Protecting against the damage they could cause to your retirement and your legacy.

INCREASINGLY UNPREDICTABLE GLOBAL MARKET

If you have been watching your portfolio take leaps and dips and are worried about what it means for your retirement, you’re not alone. The stock market has become increasingly erratic in recent decades, with one cause being “instant information.” In today’s tech-connected world, a tragic event or sudden political shift can have an immediate effect on the market. America is no longer an isolated economy! Our businesses and markets are global and depend on worldwide supply and demand. This means anything that happens, even if it is on the opposite side of the globe can, and likely will, have an immediate effect on our economy.

Now, this doesn’t mean that the market, and marketrelated financial tools, can’t play a part in your retirement plan. It just means that your plan must take this volatility into account in order to protect your income against those frightening—and potentially damaging—ups and downs.

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STRIKE THE RIGHT BALANCE

With proper planning, retirement can be a safe, pleasant, and even a thrilling experience - if that’s what you want! You just need to create a plan based on your personal goals, assets, and expenses. Taking into account all of the potential risks of a long-term retirement.

And here’s more good news: There are ways to create a retirement portfolio based on your specific goals that also has the ideal balance of risk and safety. Providing you with enough growth to produce ample income despite inflation, longevity and expenses like healthcare and taxes. As well as enough safety to counterbalance market risks to protect your income and legacy.

Annuities can be one of the tools utilized in this sort of plan. However, not every annuity is the right one! Before you consider any annuity, you need to know exactly what you’re getting into and how it can work for you—or potentially against you.

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CHAPTER 2

INTRO TO ANNUITIES

The first thing you need to know is that there is no set definition of “annuity.” Annuities are in a broad category of financial products that are offered by insurance companies. And within this category, there are numerous kinds of annuities. Even annuities that are named the exact same can behave very differently depending on the specific contract terms attached to it.

So, let’s say a friend tells you, “I have an annuity, and I love it!” That doesn’t mean you can go out and simply buy any annuity and it will work just as well for you and your goals. You have to know all of the fine details of your annuity’s setup in order to know if it is the right product for you.

An annuity is a contract between you and an insurance company in which you agree to contribute a certain amount of money into the insurance company’s annuity. In turn, the annuity will make payments to you (for a fixed number of years, for the rest of your life, or even in a lump sum).

Because most annuities offer a guarantee of some kind of income, many people who are concerned about having enough income in retirement find them appealing.

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As we’ve mentioned, decades ago things were a bit simpler. In those days, there was really only one kind of annuity. That original annuity was less about contributing money and more about giving it to the insurance company, knowing you would never have access to that money again. In exchange, you would receive a guaranteed income stream, but that promise came with many concerns. For example, what if an emergency arose, and you needed access to your original large sum of money? Too bad.

Fortunately, annuities have changed a lot over the years. Today they are more complicated, no doubt, but they also are structured to provide a lot more benefit to the annuity owner. You can, in part, thank the Baby Boomers.

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THE STORY OF ANNUITIES

Annuities, both today and in the days when they were first created, have always had 1 key underlying benefit: helping retirees reduce their financial risk. That point becomes especially clear when you realize that annuities, which have existed since Roman times, suddenly blossomed after the Great Depression.5 This tragic event revealed just how vulnerable people are, and left them longing for ways to shore up their financial houses. Annuities suddenly became very appealing.

After the Great Depression, companies began to sell a lot more annuities. Yes, the oldfashioned kind that required you to forfeit all access to the money you’ve contributed in order to receive guaranteed income. And, as we’ve noted, giving up a large chunk of money without any hope of accessing it is not ideal, and certainly isn’t risk-free.

5 https://www.massmutualascend.com/insights/history-of-annuities

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The next innovation in annuities took some of the qualities of the conventional annuity, but made it operate a bit like a bank “certificate of deposit” (CDs). This is called The Fixed Annuity because the insurance company sets a “fixed” interest rate for each annuity at the time of purchase. This affords the annuity owner a gain on the original purchase price, and sometimes those gains can look pretty appealing. Typically, the interest rates offered on fixed annuities are higher than those offered on bank CDs, and the principal plus gains are guaranteed by the insurance company. Sounds pretty good, right? - but keep in mind those higher interest rates are often temporary. A certain time period, from 1 to 5 years in many cases, is laid out in the annuity’s contract. When that time period ends, so does the higher interest rate.

The current rates (during the summer of 2024) are right around 6% for a five-year fixed annuity. Even though it’s nothing to write home about, it’s still much better than the banks current rate, which is closer to 2%. One additional benefit over a CD is that all annuities grow tax deferred. On the one hand, fixed annuities usually offer some potential for return of premium, provided that you’ve passed the surrender period (the amount of time dictated in your contract that must pass before making penalty-free withdrawals). Beware: if you need that premium before the surrender period is up, penalties can take a frighteningly large chunk of it.

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Now we get to the “Baby Boomers.” Years ago, as this powerful group of buyers began to plan their retirements, they looked around at the increasingly unstable stock market, rising inflation, healthcare costs, and the decades of retirement ahead of them. And they decided that they needed some better options.

Insurance companies responded and introduced a new kind of annuity with greater potential for gains, coupled with the time-honored risk-mitigating benefit of annuities. This is the fixed index annuity (FIA). Fixed index annuities use the power of a process called “indexing” to give buyers the potential of earning a greater gain on their principal by participating in the stock market in a new way. We’ll get deeper into each kind of annuity in the following chapters. Right now, let’s look at why you should care in the first place.

WHAT AN ANNUITY IS USED FOR

Annuities can function as a strategic part of your retirement plan, helping you plan for the challenges we discussed in Chapter 1. Every retirement plan and retiree is different, with different personalities, goals, and worries. Some people are

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more risk-averse, or simply have fewer assets, making them less comfortable putting those assets at risk. Other people truly love the process of buying into the stock market, or have amassed enough assets that they are perhaps less worried about the risk. You have to know yourself and what will make you comfortable, because who wants a retirement filled with worry?

FACTORS TO CONSIDER WHEN DECIDING ON PURCHASING AN ANNUITY:

• You are healthy and have a family history of longevity. Remember, annuities can offer you a lifetime income that will not run out no matter how long you live. So, if your Grandparents lived into their 90s, this might be something to take into account.

• You aren’t in the best of health. Alternatively, if you already know that you have a family history or tendency toward health conditions that might require long-term care - an annuity can help you plan for those costs without risking your income.

• You worry about money. If just thinking about your hard-earned savings sitting in the rollercoaster stock market is something that keeps you up at night, an annuity could be a good option for you.

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• You aren’t sure if you have enough to retire. If you’re working with limited assets and feel that taking a loss would impact your retirement quality of life - an annuity might help offer some protection for the assets you’ve amassed.

• Budgets aren’t your thing. An annuity will provide you a set income (or part of your income), which can be a good thing if you know that you’d spend your way through a chunk of money quickly.

• You need a tax-deferred strategy to add to your retirement plan. If you’re looking for some strategies to reduce your tax burden (who isn’t?), an annuity might be an option.

• You have specific legacy goals. Annuities can offer a number of options for people who want to leave something behind for their families, or for causes they find important. Even if they don’t have an excess of savings to set aside for that legacy.

If any of the above factors apply to you, then an annuity might make a good addition to your overall retirement plan. By now you might be asking “which annuity?” Well, there is no easy answer to that question. You will hear people claim that 1 kind of annuity is the best and the only one to consider. However, the exact same annuity could be totally wrong for you based on your goals and portfolio. Finding the type of annuity and specific contract terms that are right for you is a highly-personalized decision. To that end, this book exists to give you the information you need to be prepared

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and educated when talking to a Financial Professional. Every type of annuity has pros and cons, and below are all things you need to know when deciding which annuity is right for you.

WHAT AN ANNUITY IS NOT BEST USED FOR

Just because annuities are popular options with retirees doesn’t mean that they’re right for every retirement plan. Annuities, in some cases, just aren’t the right choice. It completely depends on what you want your annuity to achieve! In some situations, a different financial product can better meet your goals. If you have any of the goals below, you might do better looking beyond annuities for a better option:

• College tuition: Annuities are “retirement vehicles” and as such, are not intended to be withdrawn prior to 59 ½ years of age. If you are preparing for college (or someone else’s college), you may want to consider a 529 plan. 529 plans will not only grow tax deferred, but in most cases can be withdrawn tax-free when used for higher education. Consult your tax professional or current financial professional for further details on 529 plans.

• Early withdrawal: Annuities can provide strong longterm growth, a reliable income stream, healthcare and legacy planning options, and a variety of other benefits … but they cannot be treated like a savings account. Annuities are long-term commitment, and if you know

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you cannot leave your money in them for the time that is required, you won’t be getting all of the benefits.

• Lump sum payouts: This is similar to the goal above. Once again, taking your money out of an annuity before the determined contract length ends will result in losing the primary benefits of that annuity. In addition, you may pay a surrender charge.

HOW DO ANNUITIES WORK?

The nuts and bolts of an annuity work like this:

1. You agree to give the insurance company a set amount of money, either in a series of payments or in a lump sum.

2. The insurance company now hangs on to your money and invests it. This makes money for both the insurance company (of course) and you.

3. The insurance company pays you an income stream, as promised in your contract, in the form of regular payments. These payments might be weekly, monthly, annually, or a lump sum.

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WHERE DO I BUY AN ANNUITY?

Annuities are insurance products, which means that they are sold by insurance companies. In some cases, however, they are also sold by 3rd-party companies and brokerage-type companies - which will sell annuities on behalf of insurance companies, much like life insurance brokers who sell policies.

GENERAL PROS AND CONS OF ANNUITIES

There are lots of them, and their numbers are increasing all the time (you can thank those Baby Boomers again). As more and more companies offer greater numbers and annuity types, your chances of finding an annuity that works ideally for your financial plans and goals increases. The growing competition has also put more pressure on insurance companies to offer better terms - so there has never been a better time to consider an annuity.

Keep in mind, annuities pay commissions, and some advisors are only licensed to sell insurance (specifically annuities). When choosing a financial professional, it’s important you feel they have your best interests in mind and are making a recommendation that benefits you first and foremost. It’s also important to work with a financial professional who has a wider product selection, as opposed to just annuities. If you decide to work with someone who can only sell insurance, I can already tell you what you will be sold… right, insurance!

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Some financial experts/bloggers advise steering clear of annuities solely because they pay commissions, and will often embellish how high these commissions are. As of August 2024, the typical commission for an annuity is around 6% to 8%. 6 One thing to also remember is the commission does not come out of your account upfront. It is built into the pricing and the benefits of the annuity. Since the insurance company has your policy for many years, they will have time to offset the commission they pay the advisor.

How can you tell when a financial professional is making the right recommendation for you or offering an annuity that’s not so bad, but also happens to pay a commission? Make sure to work with someone you trust. If you feel they are too eager to sell you something rather than listening and educating you, go somewhere else. Your financial future is too

6 https://www.annuity.org/annuities/fees-and-commissions/

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important not to take your time selecting the right advisor. It’s crucial to work with a financial professional who has committed to a licensure that mandates fiduciary responsibility. Fiduciaries are bound to recommend only products and strategies that serve their clients’ best interests. This level of protection wasn’t previously extended to insurance, since insurance was regulated by the state’s insurance commission, and not the Securities and Exchange Commission (SEC).

The US Department of Labor has new regulations (effective Sept. 23, 2024) which extend fiduciary protections.7 This means that even advisors who are not registered investment advisors are now required to prioritize their clients’ interests when it comes to insurance (and IRAs).

This is great news for those purchasing an annuity. However, annuities are still complex! Working with a fiduciary who holds themselves to a high standard in all transactions (and someone you trust) will help determine if an annuity is right for you. And if so, which one is best.

Before you decide on any financial professional (or an annuity recommended by one), you should be asking about all these issues and making sure you get answers that make you feel comfortable and protected. Above all, your advisor should be working directly on your behalf towards your long, happy, and financially sound retirement.

7 https://www.morningstar.com/retirement/final-dol-fiduciary-rule-has-arrived-heres-what-it-meansinvestors?utm_medium=referral&utm_campaign=linkshare&utm_source=link

CHAPTER 3

TYPES OF ANNUITIES

The different types of annuities can be broken into a couple of different categories based on two characteristics: 1. When you plan to start receiving your income; and 2. How your annuity earns interest.

When you plan to start receiving your income is more officially known as the annuity’s “distribution phase.” If you’re looking at an immediate annuity, that’s the kind that begins paying you income right away. No big surprise there, right?

Keep in mind that you and your needs are the most important factor in choosing whether annuity is right for your retirement plan, and if, so which one?

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If an annuity is not immediate, then it is a deferred annuity, which means that you are contributing now, but deferring the income you will be receiving. This is a longer-term solution that allows you to put your money away today and let it grow tax-deferred until you need it (we’ll discuss the tax benefits of annuities soon). So, just how does your money grow exactly? That’s the next part of how your annuity is defined - but the variance in growth is also defined by the contract terms and type of annuity it is.

Annuities are further broken down into a few different categories based on how they earn interest. See our chart on the next page.

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FOUR MAJOR CATEGORIES OF ANNUITIES

1

2

3

4

IMMEDIATE ANNUITIES

You make 1 lump-sum contribution. It’s converted into an ongoing, guaranteed stream of income for a specified period of time (as few as 5 years) or for a lifetime.

FIXED ANNUITIES

Fixed annuities allow you to lock in a rate of earning that, even over long periods of time, remains unaffected by market ups and downs.

VARIABLE ANNUITIES

Unlike the others, variable annuities are actually securities products, and like other securities such as stocks and mutual funds.

FIXED INDEX ANNUITIES (FIAS)

We briefly discussed this type of annuity earlier. Each FIA is tied to a stock market index and earns interest by participating in a set percentage of that index’s growth.

These are the basic differences between categories of annuities. Let’s go a little deeper into each type, taking a look at how they work, as well as their pros and cons.

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1

IMMEDIATE ANNUITIES (SPIA)

One type of immediate annuity is the Single Premium Immediate Annuity (SPIA), which allows you to receive income right away. There are some situations that make this an appealing choice. For example, let’s say you retire at 65, but you want to let your Social Security continue to roll up to its max amount at age 70. You might buy a $300,000 SPIA to guarantee a set amount of monthly income for the next five years until you begin taking Social Security.

Immediate annuities such as SPIAs allow you to exchange a sum of money for a lifetime of income payments. With immediate annuities, you always annuitize, which means you’re giving up all future access to that lump sum of money. And in return, the insurance company will guarantee your lifetime of income payments. With deferred annuities, annuitization is an option but not a requirement. I am going to spend a little more time on the words “annuitize”

RIDER EXAMPLES & ANNUITIZATION

Riders are a feature that you often can add to your annuity to enhance the basic benefits.

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and “annuitization” as this is an important concept to grasp. Remember, not all annuities require you to annuitize. Frankly, many these days do not. As I mentioned, annuitization means you are giving up your rights on your lump sum of money in lieu of monthly payments.

Many prospects I see are under the impression that all annuities will require you to annuitize and forfeit the proceeds. However, as you know now, that is not the case. Annuitization was fairly standard in the industry many years ago, but because of the bad reputation it gave the annuity companies, it has becomes an antiquated option. Though, it is still worth knowing and understanding.

IMMEDIATE ANNUITIES PRO

The primary benefit of an immediate annuity (SPIA) is that you can begin receiving income from them right away.

IMMEDIATE ANNUITIES CON

You took a rather large piece of wealth that you could access right now and traded it for a long-term piece of security. If you have a sudden financial emergency, it could be harder to manage than if you had kept that $10,000, $50,000 or $100,000 (or whatever amount) liquid. A fixed immediate annuity can guarantee you regular income,but it may not keep up with inflation because it’s a fixed amount.

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FIXED ANNUITIES

Unlike a SPIA, fixed annuities pay a set amount of interest (and are generally deferred, meaning the income from them is deferred) and the amount of interest is determined by your specific contract. They can either be deferred (accumulating that interest over time and paying the annuity owner at a later date) or immediate. Either way, a fixed annuity can provide a predictable and reliable income stream - or interest rate if you do not need income.

FIXED ANNUITIES PROS

Protection

When you buy a fixed annuity, you are typically able to lock in interest rates that are often higher than bank CDs for a much longer time than bank CDs allow. CDs often only offer set interest rates over a period of months to a few yearswhile fixed annuities tend to offer fixed rates for 1 to 10 year periods.

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Affordability

You could say there are no “costs” with a fixed annuity. Let me explain… The insurance company is leveraging your assets by investing them on their behalf and paying you a fixed rate per the contract. They keep the difference, which is known as the “spread.” This is similar to how banks make money. If you deposit $100,000 into the bank, they don’t sit on it; they loan it out or invest it. This is known as “arbitrage,” and both banks & insurance companies are the largest arbitrageurs in the world.

Tax Benefits

Unlike CDs that require you to pay tax on earnings each year, all annuities offer tax-deferred growth. This way, you don’t pay taxes until your earnings are distributed. For many people who anticipate paying taxes at a lower rate in retirement, tax-deferred earnings can be very appealing. Annuities also have the exceptional benefit of accelerating the growth of your earnings thanks to compounding interest.

FIXED ANNUITIES CONS

Limited Options

On one hand, you get to lock in a fixed rate for a certain amount of time. On the other hand, that rate will, at some point, go away. You’ll simply have to go back to market and find another fixed annuity that fits your needs.

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Inflation

If you buy a product that provides set interest to you—that is, interest that is set over the term of the annuity—inflation risk will be a factor.

VARIABLE ANNUITIES

Unlike fixed annuities, which pay a “fixed” interest rate, variable annuities earn a variable rate. The name of the annuity itself will often tell you how the interest is earned. If you are dealing with a variable annuity, the performance varies based upon the underlying performance of the subaccounts. Think of a sub-account like a mutual fund.

SUB-ACCOUNTS

Sub-accounts are managed separate from the insurance company, often times by large mutual fund companies like Fidelity, T. Rowe Price, Franklin Templeton, etc.

Within a variable annuity, you as the purchaser will be given approximately 20 different sub-accounts to choose from. With the assistance of your advisor, you will pick the subaccounts that meet your risk tolerance, time horizon and earnings expectation. Remember, a variable annuity is a stock market-based commitment. Just because this is an “annuity” doesn’t mean they are all guaranteed. Each subaccount has a fee associated with it like a comparable mutual

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fund would. Generally, the more aggressive the sub-account, the higher the fee.

Instead of paying a guaranteed payout based on a fixed earned interest rate, a variable annuity allows the annuity owner to place money in a set of securities. And the payout is determined by how well those securities perform.

Within a variable annuity, you may be given an option to purchase a “rider.” If you purchase a rider within the variable annuity policy, there may be a guaranteed payout. We discuss riders here and in Chapter 4.

VARIABLE ANNUITY FEES

When I work with clients and the idea of an annuity comes up in conversation, there is a comment I often hear: “I heard annuities are expensive!” While this is a generalized statement, (and I am always very cautious of generalized statements), it does have “some” truth.

In particular, variable annuities are generally the most expensive annuity type to own. That doesn’t necessarily make them a poor choice; it simply means they are generally the most expensive annuity type to own. Naturally, that must mean the advisor selling them, or the consumer purchasing them, must believe the benefits associated will outweigh the costs – right..?

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FOUR SETS OF FEES ASSOCIATED WITH A VARIABLE ANNUITY

MORTALITY & EXPENSE

RISK FEE (M&E)

The M&E fee is intended to cover the costs associated with death (mortality) of the insured along with other costs associated with the policy.

Typical cost: 1.25% per year

ADMIN. FEE

The fee charged to administer your policy, such as of the mailings you receive.

Typical cost: 0.25% per year

SUBACCOUNT FEES

The sub-account is the underlying investment that earns (or loses) money within the variable annuity. A different fee is associated with the management.

Typical cost: 1% per sub account per year

RIDERS

Optional benefit with additional cost that may enhance your policy (See Chapter 4 for rider details).

Typical cost: 1% per year

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VARIABLE ANNUITY PROS

Potential Growth

Since variable annuities place money into sub-accounts, they have the potential for greater gains as well as greater losses. Because of their growth potential, they might have a better chance of providing an income that keeps pace with inflation.

Taxes

Variable annuities are allowed to grow tax-deferred like other annuities, meaning you pay taxes only when you withdraw your earnings. This could be a considerable benefit if you believe your taxes will be lower in your retirement years.

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VARIABLE ANNUITY CONS

Loss

As mentioned above, variable annuities have no protection from loss. Your money is at risk in these investments, and it’s up to you (and your financial professional) to figure out if the potential gains are worth the risk for you. An income rider can be attached to a variable annuity, mitigating some of that loss risk (see Chapter 5 for more on this).

Fees

Variable annuities often come with higher fees than other annuity types. We have found the average around 2-3% per year and these fees are often not well understood by the owner. If you feel okay with the risk level of a variable annuity and want a product that has the potential for higher gains, then a variable annuity could be worth a look. However, again, be sure you understand exactly what you’re buying and how much you’ll be paying for it.

FOOD FOR THOUGHT

According to Nationwide figures, the average cost for a variable annuity is 3.4% per year.8 With fees this high, insurance companies may be doing a better job making themselves money than they are for you!

8 https://www.nationwide.com/lc/resources/investing-and-retirement/articles/annuity-prices

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FIXED INDEX ANNUITIES

Fixed Index Annuities (FIAs) offer 1 characteristic that sets them apart from all other annuities - and that is “indexing.” As a newer strategy, indexing deserves a deeper look. There was a time when people planning for retirement had only two options: risk or safety. They had to choose between maximizing growth (which generally comes with more risk), or optimizing safety (which typically means trading security for growth). Indexing, however, is known as a hybrid strategy. Allowing products the potential for growth while still implementing strategies that minimize risk.

Essentially, indexing is a strategy that allows buyers to capture some of the gains when the stock market is up, but to avoid losses when the market is down. This is a particularly appealing idea to people who are nearing, or are in, retirement. Having the vast majority of your savings placed directly in the stock market, and exposed to risk, might have felt like a comfortable strategy when you were in your 30s or 40s. However, if you’re in your later years and find yourself needing those savings to pay your bills and generate income for the rest of your life, that risk may be much less comfortable. If that’s the case, indexing might be a strategy you’ll want to get to know better.

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WHAT IS AN INDEX?

In the financial world, an “index” refers to a stock market index, which measures the performance of a particular segment of the stock market. For example, the Nasdaq-100 measures the performance of the largest 100 non-financial companies within the NASDAQ list. The Dow Jones Industrial Average, another well-known index, measures the stock value of the 30 largest publicly traded companies in America.

Unlike a Variable annuity that buys directly in the market, a FIA simply tracks an underlying financial index (such as the S&P 500 or the Dow Jones Industrial Average). While there are many caveats that we will address, the biggest benefit is when the market is up, you have a chance to go up, but when the market goes down, you are guaranteed not to lose.

Believe me, I have heard “too good to be true” more times than I can count! And while it may sound like a no-brainer, there are some details that I will point.

FIAs take loss out of the equation, allowing FIA owners to contribute their money with the knowledge that gains are possible, but also with the peace of mind that losses are not. For many buyers, this is a worthwhile trade-off.

This is particularly important because losses actually hurt your retirement savings more than you think, thanks to a principal called “Rate of Returns.” It works like this: you contribute $100, for example, and the very next day, the market takes a 50% loss (a big loss, I know, but it makes the

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numbers simple). Now you only have $50. Since gains are calculated as a percentage of your principal (which is now half of what your starting principal), you now have to make a 100% gain just to get back to even. Simply put, any losses will mean your principal takes a hit, meaning that you have to make much greater gains to recoup those losses. Bottom line: Any protection from principal loss is worth considering.

The reason this is all possible is because the insurance company is buying options. An option is the right to buy at a later date at a price set today. As an example, let’s say the Index annuity tracked the S&P 500 and the price of the S&P 500 is $1875 on the day of annuity’s anniversary. This means the insurance company purchased an option with a “strike price” of $1875. It does not mean your money is at risk in the S&P 500 – they simply purchased an option (which again is the right to buy at a later date at a price set today). This is exactly why it’s not “too good to be true” – your money is never at risk in the market in the first place.

Since your money is not in the market and the insurance company simply purchased an option for your money, that leaves those dollars freed up. The insurance company is now able to leverage those dollars for their benefit (using someone else’s money for leverage is nothing new, It’s called arbitrage) and banks are another great example of arbitrage in action. When you open a savings account, those dollars just don’t sit there, they are loaned out to earn interest or invested by the bank. Arbitrage not only happens

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every day at the banks, but it is exactly what is happening with your money within a fixed index annuity.

When that index earns, the annuity earns as well, but not the full amount. How much your FIA can earn is determined by the terms of your contract called crediting methods.

CREDITING METHODS WITH AN INDEX ANNUITY

The beauty of a fixed index annuity is you are guaranteed never to lose, but when the market increases, you too will increase. While on the surface it sounds simple, there are many internal calculations going on…

Before we get into those calculations, an index annuity will not credit interest like a traditional stock market investment. Rather, interest will be credited based upon your anniversary date. Your anniversary is the date your FIA was issued and purchased the underlying option. It is very common for your FIA to only credit interest on an annual basis - this is known as “annual point to point.” There are even FIAs that credit less frequently, such as once every two years and even once every five years.

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You may want to consider a less frequent interest crediting option if it’s more favorable based upon the internal calculations for crediting methods. Let’s get into those now…

CALCULATION TERMS FOR CREDITING METHODS

• A FLOOR is the least you can earn. Typically the floor with fixed index annuity policies is 0.0%, which means you cannot lose - but also, you may not gain.

• CAP, or a rate cap, is the most interest that you can earn in any given crediting period. As an example, if the cap is 8%, the most you can earn in a crediting period (let’s say one year) is 8%. If the underlying index earns 10%, the most you can earn is 8%.

• THE PARTICIPATION RATE is the percentage of the cap in which you participate (let’s again assume your cap is 8%). If you have a participation rate of 100 percent, you can still earn a maximum of 8%. However, let’s say your participation rate changed to 50%, now the most you can earn is 4% (50% of 8%).

• A SPREAD is simply what the insurance company will deduct prior to crediting your interest. If you have a spread of 2%, you would keep everything the underlying index earned, minus the spread. If, however, the interest earned is less than the spread,

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they typically will only retain the earned amount, and will not charge you the difference – thus the name given: “spread” and not “fee.” As you can see, you don’t earn the full gain of your index, but that is a trade-off for the risk protection you receive.

• ANNUAL RESET (also known as “ratchet”) refers to the time period over which gains in the index of an FIA are credited. Annual reset offers loss protection since gains are locked in each year. Annual reset is such an attractive feature that it is often paired with other less desirable features, such as caps and participation rates (see below). So, it’s important to understand how the various aspects of your contract can affect each other.

• HIGH WATER MARK is a crediting method that looks at the index’s performance over a set time period (often the anniversaries of when you purchased the annuity), and then credits the annuity based on the highest index levels, as compared to the index level at the start of your term.

• POINT TO POINT is a crediting method that uses 2 exact points, the beginning and end of a set time period, to calculate interest to be credited. That time period, however, can be a monthly or a yearly point to point. Although, don’t be confused: both types typically credit interest annually.

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• AVERAGING is an index calculation method that involves arriving at an average by using specific points in the index, which are typically daily or monthly.

• MONTHLY SUM is a value determined for each month by subtracting the index’s value at the beginning of the month from the value at the end. All 12 values for each month are then added up: if the result is a gain, that amount of interest is credited to the annuity (depending on the cap, spread, participation rate, etc.), and if the value is negative, the annuity takes no loss, but is credited no interest.

• INDEX TERM is simply the period during which an annuity’s interest is calculated. This period could be every year or every several years, depending on how the annuity is set-up.

Although this is not an exhaustive list, it will give you an idea of how these various contract specifications affect one another.

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THE OTHER SIDE OF INDEXING

Indexing can be a beneficial strategy, and is attached to many financial products that can potentially make a smart addition to a retirement portfolio. Although just because you see “indexed” as part of the name of a financial product, it doesn’t necessarily mean that the product is the right one for you. For example, in some cases, these products, including FIAs and Indexed Universal Life Insurance, can be presented as though they will earn much higher rates of return than they actually do. Also, in the case of Indexed Universal Life Insurance, if your index doesn’t perform well, then your earnings could potentially not cover the premiums of the policy, ending up costing you money rather than earning it for you.

INDEX ANNUITY PROS

Guaranteed Against Loss

Having a guarantee against loss is the single largest benefit to an FIA. While the stock market may produce larger gains over time, the peace of mind knowing you can never lose is hard to beat.

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Upside Potential

Unlike a fixed annuity, a Fixed Index Annuity (FIA) earns its interest based on the index it’s attached to, rather than earning a set amount of interest all the time. As a result, FIAs have the potential to earn higher returns over time.

Riders Available

Income riders offer guaranteed income payments for life and are an option with most FIA’s. Long-term care and confinement riders, which double your income, are also becoming more and more popular.

Fees

We listed fees as both a pro and a con. The pro in regards to fees is with FIA’s is they tend to be much less than the fees associated with variable annuities and are generally around 1% per year.

INDEX ANNUITY CONS

Complexity

FIAs vary widely in both their setups and their contracts, so, understanding exactly what you’re buying is incredibly important. A trusted financial professional can make this a lot easier, assuming they know what they’re talking about.

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Limiting Contracts

An FIA won’t fully participate in the gains of the index it’s keyed to, but some FIAs get to participate more than others. This is why it’s important to understand even the tiniest details of your contract, and how they are going to affect your annuity’s value and your income.

The bottom line is this: It’s crucial that you understand the terms you’re agreeing to, as well as all of the pros and cons of any product you’re considering.

IN SUMMARY

• Fixed annuities earn a fixed interest rate.

• Variable annuities are stock market-backed products.

• Fixed Index Annuities (FIAs) are tied to a stock market index and will not lose value based on the market.

• Riders. Even though a “rider” is not an annuity type, it is a feature that you can add to your annuity to enhance the basic benefits. We have devoted a section to riders as they are an optional benefit that can be added to the three annuity types listed above.

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CHAPTER 4

RIDERS

A rider is often an optional feature that you purchase from the insurance company. In reality, it is simply additional insurance you are buying to provide a specific benefit. As an example, if you have homeowners insurance, which insures your home against loss, you may purchase an additional rider to provide higher limit protection for your jewelry, gun collection, etc. The additional rider will of course cost more, but provides you additional protection.

There are typically more riders associated with variable annuities than other types since there are more moving parts. However, riders are fairly common with all annuity types, and you may not need every rider offered. Conversely, not all annuities offer all rider options.

RETURN OF PREMIUM RIDER

“Return of Premium” is a rider that guarantees to make you whole in the event your policy value is lower at some predetermined point in the future. As an example, let’s say you place $100,000 into a variable annuity. Since it’s a variable annuity, you understand the performance is tied to market-based investments and you may lose money. The insurance company may offer a return of premium in which they guarantee on every 10th year anniversary (as an example), if your account value is lower than your principal

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paid, they will “refund” the loss and bring your account value back to the original $100,000 you started with.

Keep in mind; a rider is additional insurance protection you are buying, and the insurance company is not in the business of losing money. The insurance company knows the odds of your policy value being lower in 10 years than it is now is slim to none. However, if you want odds that are not in your favor, the insurance company will gladly sell it to you for an additional cost of around .15%

DEATH BENEFIT RIDER

Most annuities are offered with a “standard” death benefit, which is simple to understand. Whatever your account value is at death is passed to your beneficiary –simple! There are other types of death benefit riders that aren’t as common and are not available on all annuities. A true death benefit rider will guarantee to grow the principal value at a predetermined percentage regardless of what happens to the underlying annuity itselfspecifically for death benefits only.

As an example, let’s say you contribute $100,000 into a fixed

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index annuity with a death benefit rider that grows at 5% per year. Since your $100,000 is in a fixed index annuity, it earns interest based upon the underlying index such as the S&P 500. Let’s assume the S&P 500 was negative each year over a 5 year period. With a fixed index annuity, you will still have the $100,000 as an account value. However, the “death benefit” value will be $127,000 (5% compounded for five years). Likewise, if the underlying index outperforms the death benefit growth of 5%, your beneficiaries will receive the higher value.

If you like the thought of knowing the amount of growth your beneficiaries will receive, you can purchase this rider for about an additional 1% per year.

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GUARANTEED MINIMUM INCOME BENEFIT (GMIB) RIDER

Refresher: A GMIB requires annuitization, and annuitization requires you to forfeit your principal in lieu of monthly payments.

In our experience, GMIB’s are much more common with variable annuities than other annuity types.

A GMIB guarantees, regardless of sub-account performance, an income stream you cannot outlive. The annuity company will pay an interest rate that is guaranteed based on the original principal – the money has to be used as income (periodic payments) and not a lump sum withdrawal.

Assuming your variable annuity has a 5% GMIB rider. You expend $100,000 and 5 years later you decide to start drawing income. Let’s assume your sub-accounts lost money and your account value is worth $75,000. Your income value, however, is $127,000 (5% compounded for 5 years). Since you have the GMIB rider, the insurance company will allow you to annuitize and receive payments (lifetime income) based upon the higher value of $127,000.

Note: You cannot take the $127,000 in this example as a lump sum. If you wanted a lump sum, you would receive the $75,000 value minus any applicable surrender charges.

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GUARANTEED MINIMUM WITHDRAWAL BENEFIT (GMWB)

Did you notice the slight word change? “Withdrawal” instead of “Income.” With a withdrawal benefit, annuitization is not a requirement. With withdrawal benefits, the insurance company will calculate your payment amount based upon the life expectancy they’ve determined for you (actuarial tables). They will then make a payment for the remainder of your life.

A withdrawal benefit, like an income benefit, gives you the flexibility to “activate” your payment at a point of your choosing. As an example, if you are 50 years old now, but you don’t need income until you retire at 60, you can defer that benefit and allow it to grow.

The payments from the withdrawal benefit are (generally) guaranteed for life. So, if you live until 150 years of age, you still get paid. GMWBs are becoming the norm and typically provide much more flexibility than the GMIBs. GMIBs were, in large part, what gave annuities a bad name. Especially when they kept the principal upon death, which isn’t the case with GMWBs. If you would like guaranteed income you cannot outlive, you can purchase this rider for around 1% per year.

IMPORTANT

NOTE: Keep in mind that the account value and withdrawal benefit (or income benefit) are two completely different values. You cannot take your income benefit as a lump sum.

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SINGLE LIFE OR JOINT LIFE PAYOUTS WITH THE GMWB RIDER

You, as the annuitant (annuity purchaser), can choose if you would like single payout or joint payout in regard to your income payments.

If you choose single, your payment will be based upon your life expectancy alone. This will obviously increase your payment over a joint payout since there is only one life to account for in the calculation of your payment. If you choose joint, your payment will be determined on both of your lives. The insurance company will be liable for making that payment to 1 of you. The chances that 2 people live longer than 1 are obviously quite large. Thus, the insurance company will reduce the guaranteed payment amount, and may even increase the fee for this option. Remember, insurance companies are simply big bookies playing and betting the odds!

Which option is right for you completely depends on your circumstances. There are many factors that need to be considered, such as longevity, health issues, life insurance, money needs, age(s), etc.

Note: With many of the newer annuities, you don’t have to decide whether it is joint or single until you start taking the income.

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LONG TERM CARE/WELLBEING RIDER

This is becoming a large concern for the aging population. With the advancements in medicine and care, we are living substantially longer lives than our ancestors. Consider the average age of death for a man in 1920 was 53.2,9 but the average age in 2022 was reported as 74.8 years.10 Going forward, it is predicted that if you or your spouse are 65 today, the odds of one of you living until age 90 is 25%.11 Not only are people living longer, but the cost of health care is often the sole reason to retire or not to retire. I’m confident in saying government-controlled health care will lead to a further surge in cost, but I digress.

9 https://www.statista.com/statistics/1040079/life-expectancy-united-states-all-time/

10 https://www.cdc.gov/nchs/fastats/life-expectancy.htm

11 https://www.ssa.gov/planners/lifeexpectancy.html

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Annuity companies see a “value add” proposition and are offering this feature within their policies. They are often not as restrictive as traditional (and costly) long-term care policies. Keep in mind, there are different versions of this rider with slightly different caveats, so I will simplify for understanding’s sake! With a well-being rider, you will also need to purchase a GMIB or GMWB rider. The insurance company will simply double your income if you are ever confined. As an example, if you are receiving $1,000 per month from your GMWB and are confined to your home, the insurance company will simply double that payment to $2,000 per month.

YOUR ANNUITY RIDER OPTIONS

INCOME RIDER

When considering using an annuity with an income rider as part of your retirement income plan, the main question to ask is this: what combination will give me the greatest possible income? The answer to this depends on the annuity type, terms, costs, and income rider therein.

You can purchase an income rider on a variety of deferred annuities, but often they are an option with FIAs or variable annuities. We’re going to take a look at how income riders specifically work with these two types, since they can be the most complicated, but also potentially beneficial, options.

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INCOME RIDER EXAMPLES

Let’s say you have $100,000 and you need it to generate income for the rest of your life. You decide to buy a $100,000 annuity from an insurance company. Since you know you want to generate income from your annuity that you can’t outlive, you are considering including an income rider as well.

What if you didn’t add an income rider?? Your annuity could run out of money. That’s the bottom line. If you purchase $100,000 in an annuity and, 10 years later, start withdrawing $20,000 per year, eventually you will use up your principal. Even with the growth your annuity may experience, it’s doubtful that your principal could last for the rest of your life if you are drawing a significant amount of income from it. If you are using the annuity to plan for other retirement needs, such as long-term care or legacy planning, that might be just fine with you. Remember, your goals have to come first, and then you should select financial strategies that help you achieve those goals.

Now let’s take a deeper dive at how your annuity would work with an income rider. With an income rider, there will be 2 values associated with your annuity. The account value, which is your principal plus the interest (from either the underlying index or sub-accounts depending on annuity type) and the benefit base, which is your principal plus the rider interest, (which is a guaranteed flat rate known as the “roll up”).

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By selecting an income rider, you add the benefit base. The benefit base is the value the insurance company will use to calculate your lifetime income payment. The benefit base, however, is not actual money and is not available as a lump sum withdrawal. The benefit base is simply an amount the insurance company will use to calculate lifetime income payments. This is important because it’s a major point of confusion for many people who are considering annuities, or who already own them. The benefit base does not represent the actual value of the annuity (see “Roll-Up Rate” below), and that’s okay, because when you buy an annuity with an income rider, your goal should be to draw a lifetime income from that annuity, and not to draw the entire principal value as a lump sum.

Starting Account Value: $100,000

Ending Account Value: $100,000

Starting Benefit Base: $100,000

Ending Benefit Base: $160,000

Income riders cost an extra fee, usually 1% or 2% (calculated in various ways, by month or by year, depending on your contract), and there is no reason to pay that fee if you aren’t planning to use the account for lifetime income, right? Right.

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ROLL-UP RATE

This is the guaranteed rate at which your benefit base will increase. This amount doesn’t represent the cash value of your annuity, but that doesn’t mean it’s not important. It can have a big impact on how much income your annuity will pay you.

ROLL-UP RATE EXAMPLE

Here’s an example: Let’s assume you placed $100,000 into an annuity and purchased an income rider with a roll-up rate of 6% simple interest. Let’s also assume the annuity you purchased was an FIA, which is guaranteed against loss. Lastly, let’s assume you don’t need income for 10 years and during those 10 years the market lost each and every year.*

If you were to call and cancel your contract, how much would you get back? Right, $100,000.**

If you were to die and wanted this money to go to your kids, how much would they receive? $100,000. If you were to start drawing income, what value would be used to calculate that payment? Right, $160,000. What’s more, the Roll-Up Rate only applies during the accumulation phase of your FIA. Once you begin the distribution phase—by turning on your income stream—your benefit base stops earning money and starts paying it instead.

*Example does not account for any applicable fees or taxes

**There may be surrender charges applicable

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HOW YOUR INCOME IS CALCULATED

To understand how your income is calculated, first you need to know about a few key concepts:

GUARANTEED PERIOD

Not all annuities automatically pay income for the rest of your life. The Guaranteed Period defines exactly how long your income will be paid. You could have a Guaranteed Period of a certain set of years, say, the next 30 years, and if you pass away during that time, your beneficiary will receive the remaining years of income. You could also have a Guaranteed Period of your lifetime plus a certain number of years, which can be a good option for guaranteeing spousal income for your lifetime plus survivor benefits - which can extend your guaranteed income through the lifetime of a surviving beneficiary. All of these different options can affect the amount of monthly income you receive.

ACTUARIAL PAYOUT

This number has a big effect on how much income you will actually receive. The Actuarial Payout number is determined by a series of complicated calculations about how long you might potentially live, and therefore, how long that income bucket needs to last. Insurance companies don’t take chances if they can help it. So let’s say that at the age you decide to turn on your income stream, your Actuarial Payout

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number is 5. That means, depending on the terms of your rider you’ll receive 5% of the benefit base for the rest of your life, even if the underlying investment performed poorly.

INCOME RIDER FEES

As mentioned earlier, income riders cost money. And it’s important to understand what you’re being charged and how it will affect your income payment.

Using all of these factors, the insurance company will determine how much annual lifetime income they can offer you based on your expenditure. Working with a trusted financial professional who can help you compare the offers of various annuities from different insurance companies is the best way to ensure that you’re getting the highest possible income.

Note: It’s all about the income. If you don’t need income from your annuity, you don’t need an income rider.

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KEY QUESTIONS TO ASK

In learning about your rider, here are a few very important questions to ask:

• What percentage growth of roll-up can you expect?

• Is the roll-up compound or simple interest?

• Is there an upfront bonus associated?

• What is the fee associated with the rider?

• How long does it roll-up, and is it guaranteed for that entire period?

• What percentage of my benefit base will I receive, and is it tiered by age?

CHAPTER 5

RISKS OF ANNUITIES

We’ve spent a lot of time covering how annuities work and, more specifically, how they can work for your retirement plan. Now it’s time to shine a light on the dark side: the risks of annuities. Some of these we’ve mentioned, but this is your retirement we’re talking about - the risks cannot be ignored. Every financial product has benefits and risks. To create a retirement plan that will ensure your comfort and security, you need to:

• Understand all of the risks and benefits of the strategies in your plan

• Know that, for you, the benefits outweigh the risks.

So let’s take a look at the risks of annuities head-on...

THE INSURANCE COMPANY

If you choose to buy an annuity, you’ll be buying it from an insurance company. Even if you use a 3rdparty broker to make the deal, the issuing insurance company is responsible for the annuity itselfmanaging the contribution and paying your income. There’s no FDIC insurance on insurance products, so doing your research on every insurance company you do business with is a never-skip step! Check all of the insurance company rating services (some to check include A.M. Best, Moody’s, Standard & Poor’s, Fitch

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and COMDEX). COMDEX actually combines rankings of the other 4 listed agencies. Also, know that insurance is regulated state-by-state, not nationally. So, check with your state regulators or insurance commission about any specific insurance company you’re considering buying from.

INFLATION RISKS

Anytime you commit to a set income, you have to keep in mind that inflation is going to erode the spending power of that income, no matter what you do. That’s why any income strategy needs to include a plan for inflation. Social Security generally gives a Cost of Living Adjustment (COLA), but annuities do not often include this kind of adjustment automatically. Annuities can come with inflation protection, but this comes at an additional cost and often reduces your income initially.

SURRENDER PERIODS AND PENALTIES

We all know that insurance companies are in the money-making business. They offer annuities because these offer a way to bring in a foreseeable cash flow, providing them with predictable flows of money. In order to achieve these reliable flows of incoming (and outgoing) cash, they need to encourage buyers not just to contribute their money, but also to leave it there. That’s where surrender periods and penalties come in.

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Typically annuities allow for a 10% per year penaltyfree withdrawal. However, if you were to take out more than the free amount before the surrender period, you may pay a steep penalty. Liquidity needs to be given serious consideration.

It’s important to remember that an annuity doesn’t operate like a demand deposit account, such as a savings or checking account. You choose an annuity for the potential of higher returns, and those returns depend on your being able to leave your money in the annuity for a certain length of time. Surrender charges are one of the reasons you may not want to place all of your savings into an annuity. By working with your trusted financial professional, you can determine the appropriate asset mix that is right for you.

LIQUIDITY

We’ve mentioned this before, but your retirement plan—and all of the strategies in it—must work with your goals and your personality. You might be a person who cannot sleep at night unless you have a certain amount of money in the bank - or at least accessible in case of an emergency. Maybe you only need a basic emergency fund and that’s it. Either way, liquidity is an important consideration in your retirement plan. As we’ve mentioned, most annuities do allow some liquidity. Plus, many contracts allow you to remove the earned interest on a monthly basis. What’s more,

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if you need total access to your premium (known as a return of premium clause), that is also possible with some annuity contracts, though this comes at a steeper cost. There are also riders to give you access to your premium or additional funds if you are hospitalized, undergoing a life-threatening illness, subject to a permanent or extended stay in a nursing home, or other major calamities that affect you financially.

COMMISSIONS AND FEES

There is a risk with virtually every financial product, which is another reason you always want to get a clear, transparent answer when you ask exactly what you’re paying for. If you are working with a financial professional who is making a commission, that doesn’t necessarily mean you are getting bad advice. Although, wouldn’t you be more comfortable if you knew up-front that the professional is being paid that commission? This way, you could weigh your decision accordingly (with, perhaps, a 2nd opinion).

Fees can be another challenging issue with annuities, as some certainly do charge more than others. Fees should never be hidden! You should be able to see exactly how much you’re paying for the management of your annuity and how often, as well as any rider or service fees.

All of these risks exist and should not be ignored, but

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that doesn’t mean you shouldn’t consider an annuity as a potential strategy for your retirement portfolio. As mentioned earlier, there are risks with virtually every financial product on the market. What matters most is that you are aware of and comfortable with all the risks and benefits. And with the help of a financial professional you trust, you’ve accounted for those risks in a well-balanced portfolio that meets your unique needs.

PROTECT YOURSELF

It’s pretty easy to see that annuities offer almost limitless options for addressing the challenges of retirement income planning, but they also come with some pretty vast complexities. In order to protect yourself, be sure that before you buy anything, you’ve covered all of these key steps:

• Work with a financial professional who is independent and experienced. Not only is it critical that you work with someone who can explain all of the various terms of any annuity clearly, but also, you want an expert who can help you shop around. Comparing as many options as possible is one of the best strategies you can use to ensure that you get the right annuity for your goals.

• Focus on the end result. The actual amount of income you will receive (or spousal income, or death benefit, etc., depending on your reasons for buying the annuity)

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is the important thing. That number, based on actual contractual terms, is the number to focus on. You might be surprised to learn that it’s considered ethical (by some annuity agents) to talk to potential annuity buyers about hypothetical returns, rather than explain the exact contract and hard numbers. Don’t allow this! You deserve to know exactly what you can depend on.

• Buy from a company that you can trust. Unlike bank products, annuities are not FDIC insured, so don’t just research the type of annuitiy you are considering, but also do research about the insurance companies you’re considering buying them from. Talk to your financial professional about each insurance company’s ratings before making any final decisions.

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CHAPTER 6

BENEFITS OF ANNUITIES IN RETIREMENT PLANNING

Simply put, annuities provide some major benefits that aren’t available from other financial tools. If those benefits line up with a retiree’s unique goals and personality, then an annuity could be a good option. Let’s take a look at what some of those benefits might be:

SECURITY

Perhaps one of the most prevalent reasons to consider an annuity, as mentioned before in this book, is security. Many people are simply not comfortable with the high rate of volatility in the stock market today, and they prefer to place at least a portion of their savings into something more secure. Annuities allow this, while also providing some growth. Which means retirees don’t have to give up all of their potential upsides in order to gain some peace of mind.

TAX BENEFITS

Many people consider the tax benefits of annuities one of their greatest attributes. Specifically, the interest on annuities grows tax-deferred, which allows the overall value of annuities to grow faster than if tax had to be paid monthly, quarterly, or annually on earnings.

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Annuities can also be purchased with post-tax money. Which means that the annuity owner will owe taxes on earnings only upon withdrawal (retirement, typically). Many other options don’t offer this tax-saving strategy, and for many retirees lowering tax liability during retirement is a big plus.

ESTATE PLANNING OPTIONS

As insurance products, annuities must have listed beneficiaries. This creates a framework and structure for estate planning, but it also, if structured properly, allows that money to pass to beneficiaries without the money being subject to probate. Because of their unique structure, annuities also offer options for parents, grandparents, etc. who want to provide for dependents who might not benefit as much from a lump-sum inheritance. Just as annuities can provide long-term, reliable income for retirees, they can be left behind to provide long-term and reliable support to beneficiaries as well.

NO CONTRIBUTION LIMITS LIKE IRAS AND 401(K)S

IRAs, Roth IRAs, and 401(k)s all come with contribution limits, some more severe than others. Retirees can only put so much into these savings vehicles, and then they have to find another retirement savings tool to use. For that reason, annuities are an option many people turn to when they’ve maxed out their IRA or 401(k) contributions.

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FLEXIBILITY

Annuities allow retirees a myriad of planning options. They can provide a lump sum of cash or a reliable flow of income much like Social Security or a pension. They offer planning options for a lot of the difficult challenges that come with our longer retirements and volatile stock market. Annuities provide ways to plan for long-term care, spousal income, and estate or legacy planning, etc.

HOW TO DECIDE IF AN ANNUITY IS THE RIGHT FIT FOR YOUR PLAN

Whether you’re considering annuities or not, when creating your ideal retirement plan, there are almost countless options with a vast array of choices, structures and complexities. The most important decision you’ll make is finding a financial professional who can help you take the potential of all those options and expertly fit them together into a retirement plan that fits your needs. However, not all financial professionals offer the same services. They do not all have the same experience nor follow the same ethical guidelines.

So, how do you tell what kind of professional is right for you? It’s always a good idea to get referrals and do interviews with a number of advisors. You’ll know when you click with someone, and that’s important - but to guide your interview, here are a few key questions.

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BE A KNOWLEDGEABLE ANNUITY BUYER

1. Is your financial professional independent? Many financial representatives are considered captive. Captive means they are limited to only the products and services their broker/dealer organization authorizes. The easiest way to learn if they are limited, is to look at the disclaimer (fine print) on their business card or website. If it says “Member FINRA” you know they have a series 6 or 7 license, are captive to their dealer, and sell investment products for commissions.

2. Also, many advisors are only licensed to sell insurance & annuity products. If they are only licensed to sell annuities, you will receive very biased advice.

3. Have the benefits been clearly discussed? Make sure your financial professional explains your options in a clear and concise manner and provides direct, honest answers to your questions.

4. Have the fees been clearly discussed? All annuities have fees, and a fee discussion should be part of your conversation. If you are not being provided direct answers to your questions regarding fees, it may be time for a 2nd opinion.

It’s important for you to be comfortable with not only the product that you are purchasing, but also in the financial professional you are choosing. There are many choices when it comes to financial professionals, and you can use competition to educate yourself and weigh your options.

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FOOD FOR THOUGHT

If a financial professional tells you they are a fiduciary, but they “hate annuities” and never really use them, can they really be a true fiduciary?

With this pern as a partner in your retirement planning, you’ll feel less stressed knowing you have put together a long-lasting retirement plan.

You deserve to have a financial professional on your team who can help you:

• Organize your assets and determine how to produce income from them.

• Structure a diverse plan that will provide a lifetime of income that meets your needs and goals.

• Select the financial tools that meet your specific goals and comfort level.

• Create a plan that minimizes your tax liability.

• Navigate retirement challenges, such as long-term care, spousal continuance, legacy/estate planning, or any of your other concerns.

Above all, your retirement plan should never be a source of worry. You should always understand every aspect of it and know how it works to keep you comfortable and secure - no matter how long you might enjoy your retirement years!