The pro’s, the con’s, and the critical questions you need to know before you go swimming into retirement By Jeffrey B. Junior ©2019. 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 an annuity • 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: The information published in this guide is not intended to offer estate or financial planning, tax or legal advice. This guide is not a recommendation to purchase an annuity. You are strongly urged to consult with an estate or financial planning, tax, or legal adviser to determine if an annuity is a suitable purchase in your financial situation. Annuities are not deposits of or guaranteed by any bank and are not insured by the FDIC or any other agency of the U.S. government. All annuity guarantees are subject to the financial strength of the insurance company. Copyright 2019©
Contents INTRODUCTION BY JEFFREY B. JUNIOR
CHAPTER 1: THE RETIREMENT INCOME PUZZLE 5 CHAPTER 2: INTRO TO ANNUITIES 9 CHAPTER 3: TYPES OF ANNUITIES 16 • IMMEDIATE ANNUITIES (SPIA)
• FIXED ANNUITIES
• VARIABLE ANNUITIES
• FIXED INDEX ANNUITIES
CHAPTER 4: RIDERS 29 CHAPTER 5: RISKS OF ANNUITIES 38 CHAPTER 6: BENEFITS OF ANNUITIES IN RETIREMENT PLANNING 41 CHAPTER 8: HOW TO DECIDE IF AN ANNUITY IS THE RIGHT FIT FOR YOUR PLAN 43
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Introduction by Jeffrey Junior I became a financial advisor for a reason. Well, it was more like a series of reasons that all came together to show me that there was a real need in the world that I was particularly equipped to fulfill. It started with my parents. My dad, a business owner and former mayor, and my mom, a registered Flight for Life nurse, set the bar for service and social responsibility high. I wanted them to be proud. Perhaps that’s part of the reason—besides the fact that I needed a surefire path to help me grow up—that I enlisted in the Marine Corps immediately after I graduated high school. I was stationed in Okinawa at age 18 and later served in the Marine Expeditionary Unit during Desert Storm. Throughout my military service and college career, I was learning about a lot of different ways I could serve my community and country, but it wasn’t until another one of those reasons stepped in that I clearly saw, for the first time, where I could do the most good. My father passed away suddenly when I was 20, a difficult experience that taught me many things, but paramount among them were the importance of insurance and the power of compounding interest. That’s when everything became clear to me.
TRAJAN WEALTH, LLC© BECOMING A FINANCIAL PROFESSIONAL The experience with my father’s untimely passing taught me many things, but one that changed my life and direction in particular. Money, I learned, is not just about work or savings or what you can buy. It’s actually about safety, protection and fulfilling your dreams and those of the people you love. It’s about creating the life you want, protecting that life during the years when you get to retire, and protecting the life you’ve created for the people you leave behind when you die. Money can do a lot of magical things, but only if you know how to take care of it. Unfortunately, taking care of your money is one of the most challenging, complex, bewildering things that most people face. That’s why I decided to become a licensed financial professional. Helping my clients navigate the multifaceted world of financial planning so that they can create safe, comfortable lives and futures for themselves and their families—that is what I’ve dedicated myself to. First, I became a licensed financial representative and began building my business. I eventually became the vice president of a broker-dealer and ultimately, a firm principal responsible for not only my business, but also for the business of over twenty other advisors. But once again, I was learning. As I gained more experience as an advisor, I realized how much my licenses—which licenses I chose to hold—mattered and why. I decided to let my general securities license lapse in order to function as a “fiduciary,” a designation that holds me to a higher standard. It means that, while I always worked in the best interest of my clients, those clients would now have a binding, legal promise that I would always put them first. Unlike a general broker, who can recommend the products that are merely suitable (but often come with the highest commissions), I have committed myself to recommending only the products that work in my clients’ best interests.
FI DU CI AR Y
\DEFINITION\: A fiduciary is a legally appointed person 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. The highest legal duty of one party to another, it also involves being bound ethically to act in the other’s best interests.
Today I am an investment Advisor Representative and hold a Series 65 license. I also hold life & health licenses, allowing me to help clients work insurance products into their financial plans. Together, these two licenses empower me to provide my clients with the range of tools necessary to build and protect their ideal future plans in the evermore complicated financial world we face. Page 2
TRAJAN WEALTH, LLC© THE FINANCIAL CHALLENGE It’s easy to look at the days of pensions wistfully. It was so simple then. There was no health insurance in most cases; people just paid their doctors. There were no 401(k)s, IRAs, overnight global stock market meltdowns. People just worked for one company their entire careers, and when those careers ended, checks would begin to show up in their mailboxes every month. Okay, so it wasn’t quite that simple, and certainly not for everyone. But suffice it to say, things have become a lot more complicated. Today, pensions are mostly relics. Instead, you are the person responsible for amassing enough assets to last you for the rest of your life, a life that could last decades longer thanks to the fact that we are, in general, healthier than ever before. Once you’ve amassed those assets, you are also responsible for figuring out what to do with them. Those assets become tools that you can and must use to build the financial house of your dreams, a place you want to spend your retirement and one that, should it be necessary, can protect the people you love in case you aren’t able to do so. That’s where so many people get stuck. They work. They save. They want to create a blueprint for that financial house, and so they start to look around. They go to the Internet to search for advice. They visit the bookstore. They ask their friends. It takes no less than a few hours—a few minutes, even—to discover that there are no clear answers. Everyone has a different, and vehement, opinion about how to plan your financial future, and all of those opinions conflict. In fact, there is no one answer. You are the answer. Your goals are the only ones that matter when planning your financial blueprint, and any plan you make, with or without a financial professional, has to start with you: your needs, your goals, your circumstances. Creating a blueprint that will achieve your financial goals will not be simple either. It will require the coordination of several different strategies and tools, all timed to kick in at the right moment. You’ll want to find a trusted financial professional to help create and execute that plan, but you will also need a personal understanding of some of the key strategies you might use. A clear idea of each tool you might use is always necessary because, remember, while we absolutely can create a financial plan that achieves your goals, nothing is simple in this world. 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!
TRAJAN WEALTH, LLC© The unvarnished, but necessary truth that you must understand is this: every financial tool and strategy has both risk and reward. In order to put any tool to use, you need to know how it can help you and how—if you don’t use it properly—it could hurt you. Annuities are no different. They are widely misunderstood financial planning tools that can provide an excellent way to save for retirement, provide protection for your family, and mitigate some of the risks of living a long life of leisure after you stop working. Think taxes, longevity, healthcare costs … the list goes on and on, and we’ll get to that. But annuities also have some very specific rules and factors that must be considered, some types of annuities having even more than others. If you don’t know what they are, they could very well become termites in that ideal financial house of yours. I won’t allow that, and this book will help prepare you so that you have the knowledge to protect yourself, too.
THE END OF IRISH PENNANTS Today, I’m president of Trajan Wealth, but my military training and experience that served me so well decades ago are still with me. When you work with us, you can be sure that your financial plans will have no Irish Pennants—a naval term that means a loose end of a line, or a hanging thread on clothing. Often, young soldiers wonder why all of the constant, rigorous inspections of their lockers, beds, living quarters and especially their uniforms are really necessary, but quickly—very quickly—they learn that it’s often the small things that 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 that might start the unraveling of the plan we’ve built. You can count on my military eye and my fiduciary commitment. Now, how about we get to work on your future? -Jeffrey B. Junior
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THE RETIREMENT INCOME PUZZLE When I meet with new clients, or potential clients, understandably, 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 retirees face. See, just like there is no one 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 affect how long your money will last, and therefore how much you need. But in addition to those things, 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, or 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.
TRAJAN WEALTH, LLC© One way to begin determining a goal income that we can base your retirement planning on is to look at what you’re spending now. A quick Internet search will tell you that a lot of people believe you need 70 or 80 percent of your pre-retirement income to retire, or some other amount, but again, there is no magic number. You need to be comfortable with your income, and if you are comfortable now, we at least know that 100 percent of your current income is a good place to start. With a solid idea of how much you earn each month, and how much you spend, we have a goal. If we know you need $5,000 per month for example, and we know the amount of your savings we have to work with, we can then figure out, using various retirement income tools such as annuities, mutual funds, Exchange Traded Funds (ETFs), etc., if you indeed have enough assets to generate your required income. But then it gets a bit more complicated. Today’s retirement 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.
COMMON RETIREMENT RISKS
LONGEVITY The good news is that you will most likely enjoy your retirement for a much longer time that the generations before you. Your grandparents might have planned for 15 or 20 years of retirement, but you live in healthier times. You need to plan for 30 years or more of retirement income. According to the Social Security Administration, one out of every four 65-year-olds will live to 90¹. That’s a lot of years to plan for, I know, but trust me, we can do it. It just requires the right plan.
INFLATION Over time, money loses purchasing power, an economic concept called inflation. You might pay $4 for a gallon of milk today, for example, 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, either now or in the future, and so your retirement planning must account for inflation.
1 https://www.ssa.gov/planners/lifeexpectancy.html Page 6
TRAJAN WEALTH, LLC© 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. But you don’t have to simply pay your taxes. You can plan the amount of taxes you will pay. Yes, you will pay taxes, but certain retirement strategies, and the timing of when to put those strategies into play, 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 hardearned lifetime income than is really necessary? For that reason, tax strategy is a critical part of your retirement plan.
HEALTHCARE COSTS According to Kiplinger, the average 65-year-old couple could pay as much as $240,000 out-of-pocket healthcare costs during retirement2, and those are just standard healthcare expenses. But what if you need long-term healthcare, such as in-home nursing or in-facility care? Many people will. In fact, 70 percent of people 65 and older will require some kind of long-term care in their lifetime3. And considering that a semi-private room in a nursing home cost an average of $6,235 per month in America in 20104, you can just imagine how pricey it might be in 30 or 40 years. 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 that there are strategies you can employ in your retirement plan to provide for these costs and protect against the damage they could cause to your retirement and your legacy.
INCREASINGLY UNPREDICTABLE GLOBAL MARKET If you, like so many other people, have been watching your portfolio take leaps and dips and worrying about what that means for your retirement, you’re not alone. And you’re not imagining things. The stock market has become increasingly erratic in recent decades, and there are good reasons for this. One cause is instant information. In today’s tech-connected world, a tragic event or sudden political shift (think Brexit) can have an immediate effect on the market. America is no longer an isolated economy: our businesses and our markets are global and depend
2 http://www.kiplinger.com/article/retirement/T027-C000-S004-ease-the-pain-of-health-care-costs-inretirement.html 3 http://longtermcare.gov/the-basics/who-needs-care 4 http://longtermcare.gov/the-basics/who-needs-care/ Page 7
TRAJAN WEALTH, LLC© on worldwide supply and demand. That means that 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 market-related financial tools, can’t play a part in your retirement plan. It just means that your plan must take that volatility into account in order to protect your income against those frightening—and potentially damaging—ups and downs.
STRIKE THE RIGHT BALANCE What does all this add up to? Basically, retirement is likely to be a long journey, and it can be a safe, pleasant, or even thrilling one, if that’s what you want. You just need to create a plan based on your personal goals, assets and expenses that also takes into account all of the potential risks of a long retirement. And here’s more good news: we can do exactly that. There are ways to create a retirement portfolio based on your specific goals that also have the ideal balance of risk and safety to provide you with enough growth to produce ample income despite inflation, longevity and expenses like healthcare and taxes, but also enough safety to counterbalance market risks and protect your income and legacy. Annuities can be one of the tools in exactly that sort of plan. But not just every annuity is the right one, and before you consider any annuity, you need to know exactly what you’re getting into, how it can work for you and how—if you don’t understand every aspect of your annuity—it could work against you as well.
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INTRO TO ANNUITIES The first thing you need to know is that there is no simple definition of annuity. “Annuities” is a broad category of financial products that are offered by insurance companies. Within that category, there are numerous kinds of annuities. Even annuities that are called the same thing can behave very differently depending on the specific contract and terms attached to it. So let’s say a friend says to 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 retirement goals. You have to know all of the fine details of your annuity’s setup in order to understand if it is the right product for you. Okay, but what is an annuity? An annuity is a contract between you and an insurance company in which you agree to invest a certain amount of money in the insurance company’s annuity. In turn, the annuity will make payments to you, either 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. Decades ago, as we’ve mentioned, things were a bit simpler. In those days, there was really only one kind of annuity. That original annuity was less about investing 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 a lot of 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 about that, but they also are structured to provide a lot more benefit to you, the annuity owner. You can, in part, thank the Baby Boomers.
TRAJAN WEALTH, LLC© THE STORY OF ANNUITIES Annuities, both today and in the days when they were first created, have always had one key underlying benefit, and that is helping investors reduce their financial risk. That point becomes especially clear when you realize that annuities, which have existed since Roman times but made up only a tiny part of the financial services industry, suddenly blossomed after the Great Depression.5 This tragic event revealed to people just how vulnerable they were and left them longing for ways to shore up their financial houses. Annuities suddenly became very appealing. After the Great Depression, though, companies began to sell a lot more annuities—the oldfashioned kind that required you to give up all access to the money you “invested” in order to get your guaranteed income. And, as we’ve noted, giving up a large chunk of money without any hope of accessing it is not ideal, and it certainly isn’t without risk. 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, named this because the insurance company sets a “fixed” interest rate for each annuity at the time of purchase. This allows the annuity owner a bit of gain on the original investment, 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, but keep in mind those higher interest rates are often temporary. A certain time period, from one to five 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 (within the time frame of writing this book) are right around 3 percent 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 maybe 1 percent. One additional benefit over a CD is that all annuities grow tax deferred. 5 http://www.nber.org/papers/w6001.pdf Page 10
TRAJAN WEALTH, LLC© On the one hand, fixed annuities do 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-fee withdrawals. But beware: if you need that premium before the surrender period is up, then the penalties can take a frighteningly large chunk of it. Now we get to the Baby Boomers. As this powerful group of buyers began to plan their retirements, they looked around at the increasingly unstable stock market, rising inflation and healthcare costs, and the decades of retirement ahead of them, and they decided that they needed some better options. Insurance companies were listening and soon, they introduced a new kind of annuity with greater potential for gain coupled with the time-honored risk-mitigating benefit of annuities. This is the fixed index annuity. Fixed index annuities (FIAs) use the power of a process called “indexing” to give investors 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 into the following chapters, but first, 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 more risk-averse, for example, or simply have fewer assets and therefore are less comfortable with putting those assets at risk. Other people truly love the process of investing in the stock market, or they have amassed enough assets that they are less worried about the risk, perhaps. You have to know yourself and what will make you comfortable, because who wants a retirement filled with worry?
TRAJAN WEALTH, LLC© A FEW FACTORS THAT MEAN YOU MIGHT WANT TO CONSIDER 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 Grandma and Grandpa 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 roller coaster stock market is something that keeps you up at night, an annuity could be a good option for you. • You aren’t sure if you have enough to retire. If you’re working with limited assets and 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 (and who isn’t?), an annuity might offer one 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 (or several) of the factors above apply to you, then an annuity might make a good addition to your overall retirement plan. But now you must be asking, which annuity? There is no easy answer to that question. You will hear people claim that one kind of annuity is the best kind or only kind to consider, but the exact same kind of annuity could be totally wrong based on your goals and portfolio. Just like every other part of retirement planning, the selection of which kind of annuity and contract terms will be right for you is a highly personalized decision. To that end, this book exists to give you the information you need to understand all your options, so that when you go to your financial professional to make a decision, you will be educated and prepared. Every type of annuity has pros and cons, and these are all things you need to know if you want to decide which annuity is right for you. Page 12
TRAJAN WEALTH, LLC© WHAT AN ANNUITY IS NOT BEST USED FOR Annuities are popular options with retirees for all the reasons above, but just because they are popular doesn’t mean that they’re right for every retiree or every retirement plan. Annuities, in some cases, just aren’t the right choice. It totally depends on what you want your annuity to achieve, and in some situations, a different financial product can meet your goal far better. 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 long-term 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 investments, and if you know 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 is up 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 a set amount of money, either in a series of payments or 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, which might be weekly, monthly, annually or a lump sum.
WHERE DO I BUY AN ANNUITY? Annuities are insurance products, which means, of course, that they are sold by insurance companies. In some cases, however, there are also third-party companies, brokeragetype companies, that will sell annuities on behalf of insurance companies, much like life insurance brokers who sell policies from various life insurance companies. Page 13
TRAJAN WEALTH, LLC© 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 types of annuities, 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 interest 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 less limiting product selection other than 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! Some financial experts/bloggers advise steering clear of annuities solely because they pay commissions and often embellish how high those commissions are. As of the writing of this book, the typical commission for an annuity is around 6 percent to 7 percent. 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 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? Foremost, 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 important not to take time in the selection process of your advisor. Work with a financial professional who has committed to a licensure that requires fiduciary responsibility.
6 https://www.dol.gov/ebsa/newsroom/fs-conflict-of-interest.html Page 14
TRAJAN WEALTH, LLC© Fiduciaries, as they are often called, are legally obligated to recommend only the products that are in their clients’ best interest. However, this is where it gets a little hairy. The fiduciary standard only applies to securities (stock market based investments), not insurance (The Department of Labor ruling6 may change this in years to come, but not as of the writing of this book). Insurance is regulated by the state’s insurance commission and not by the Securities and Exchange Commission (SEC). If you are a registered fiduciary (like Trajan Wealth) you have to register your insurance business as an outside business activity (OBA) on form ADV, which is filed with the SEC. How do you like those acronyms!? That said, insurance inherently provides for a conflict of interest. Working with a fiduciary who holds themselves accountable to the same standard, as well as someone you trust, will certainly help determine if an annuity is right for you, and if so, which one. Before you decide on any financial professional (or an annuity recommended by one), you should be asking about all of these issues and making sure you get answers that make you feel comfortable and protected. Above all, your advisor should be working on your behalf only and toward your long, happy, financially sound retirement.
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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? If an annuity is not immediate, then it is a deferred annuity, which means that you are investing now but deferring the income you will be receiving. This is a longer-term investment solution that allows you to put your money away today and let it grow taxdeferred (we’ll discuss the tax benefits of annuities soon) until you need the income. So how does your money grow? 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.
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?
TRAJAN WEALTH, LLC© THE FOUR MAJOR CATEGORIES OF ANNUITIES
IMMEDIATE ANNUITIES You make one lump-sum contribution. It’s converted into an ongoing, guaranteed stream of income for a specified period of time (as few as five years) or for a lifetime. Withdrawals may begin within a year.
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. The principal investment and a specified interest rate are both guaranteed.That rate typically decreases (possibly significantly) after a set time period.
VARIABLE ANNUITIES Read carefully: Unlike the others, variable annuities are actually securities products and like other securities such as stocks and mutual funds. These annuities can, like other securities, offer the potential of higher returns, but also offer the loss protection typically associated with annuities. They also often come with higher fees than other types of annuities.
FIXED INDEX ANNUITIES (FIAS) We briefly discussed this type of annuity in “The Story of Annuities” earlier, but to recap: each FIA is tied to a stock market index, and it earns interest by participating in a set percentage of that index’s growth.
These are the basic differences between the categories of annuities, but now let’s go a little deeper into each type, taking a look at how they work and their pros and cons.
RIDERS Even though a “rider” is not an annuity type, it is a feature that you often can add to your annuity to enhance the basic benefits. We have devoted a chapter to riders as they are an optional benefit.
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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.
RIDER EXAMPLES & ANNUITIZATION
I am going to spend a little more time on the words “annuitize” 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.
GUARANTEED MIN. INCOME BENEFIT
GUARANTEED MIN. WITHDRAWAL BENEFIT
Does Not Require Annuitization
Many prospects I see are under the impression all annuities always require you to annuitize and forfeit the proceeds. But, as you know now, that is not the case. Annuitization was fairly standard in the industry years ago, but because of the bad reputation it gave the annuity companies, it is an antiquated option but one 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 a set amount of regular income, but because it’s a fixed amount, it may not keep up with inflation. Page 18
TRAJAN WEALTH, LLC© 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 years, while fixed annuities tend to offer fixed rates for one to ten year periods.
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 the fixed rate per the contract. They keep the difference, which is known as the spread. This is similar o 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 and 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, including fixed annuities, offer tax-deferred growth, so 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.
TRAJAN WEALTH, LLC© FIXED ANNUITIES CONS Limited Options On the one hand, you get to lock in a fixed rate for a certain amount of time, but 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.
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 “sub” or separate from the insurance company by (often times) large mutual fund companies like Fidelity, T. Rowe price, Franklin Templeton, etc. Within a variable annuity, you as the investor 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 investment. Just because this is an “annuity” doesn’t mean they are all guaranteed. Each sub-account has a fee associated with it like a comparable mutual 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 invest 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 based upon the rider. We discuss riders here and in Chapter 4. Page 20
TRAJAN WEALTH, LLC© VARIABLE ANNUITY FEES When I work with clients and 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 has “some” truth. Variable annuities in particular 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 outweigh the costs – right!?
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.
The fee charged to “administer” your policy, such as of the mailings you receive.
The sub-account is the underlying investment that earns (or loses) money within the variable annuity. A different fee is associated with the management of each.
Optional benefit with additional cost that may enhance your policy. (See Chapter 4 for rider details)
Typical cost: 1.25% per year
Typical cost: 0.25% per year
Typical cost: 1% per sub account per year
Typical cost: 1% per year
TRAJAN WEALTH, LLC© LICENSING REQUIREMENTS FOR VARIABLE ANNUITY SALES Since variable annuities are a “security,” they are regulated by the Financial Industry Regulatory Authority (FINRA). A broker selling variable annuities must have either a securities series 6 or series 7 license and a state insurance license. This is different than the agents selling fixed annuities and index annuities. Since fixed and index are not a “security” (subject to market loss), the agent does not need a FINRA license.
LICENSE DIFFERENCES PROFESSIONAL ONLY HAS AN INSURANCE LICENSE CAN SELL
PROFESSIONAL ALSO HAS A FINRA SERIES 6 OR 7 LICENSE CAN SELL
ü Fixed Annuities
ü Fixed Annuities
ü Fixed Index Annuities
ü Fixed Index Annuities
ü Variable Annuities
VARIABLE ANNUITY PROS Potential Growth Since variable annuities invest 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.
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 3-4% per year and 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 potential for higher gains, then a variable annuity could be worth a look. But, at the risk of repeating this Page 22
TRAJAN WEALTH, LLC© over and over, be sure you understand exactly what you’re buying and how much you’ll be paying for it.
FOOD FOR THOUGHT According to Morningstar figures, the average cost for a variable annuity is 3.4% per year. With fees this high, insurance companies may be doing a better job making themselves money than they are you.
FIXED INDEX ANNUITIES
Fixed Index Annuities (FIAs) offer one characteristic that sets them apart from all of the 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 and safety. They had to choose to maximize growth, which generally comes with more risk, or to optimize safety, which typically means trading security for growth. Indexing, however, is known as a hybrid strategy: it allows products the potential of growth while still implementing strategies that minimize risk. Essentially, indexing is a strategy that allows investors to capture some of the gains of the market when the market is up but to avoid losses when the market is down. This is a particularly appealing idea to people who are nearing or in retirement. Having the vast majority of your savings invested directly in the stock market, and therefore totally exposed to risk, might have felt like a comfortable strategy when you were in your 30s or 40s and had decades to bounce back from losses, but if you’re in the years when those savings need to pay your bills and generate income for the rest of your life, that kind of risk exposure often doesn’t seem quite so comfortable. If that’s the case, indexing might be a strategy you’ll want to get to know better.
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, measure the value of the stock of the thirty largest publically traded companies in America.
TRAJAN WEALTH, LLC© Unlike a Variable annuity that invests 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 goes up, you have a chance to go up, but when the market goes down, you are guaranteed not to lose. I have heard “too good to be true” more times than I can count, and while it sounds like a no-brainer, there are some details that I will point out shortly. FIAs take loss out of the equation, allowing FIA owners to invest their money with the knowledge that gains are possible, but also with the peace of mind that losses are not. For many investors, 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 make an investment of $100, for example, and the very next day, the market takes a 50 percent loss (a big loss, I know, but it makes the numbers simple!). Now you only have $50. Since gains are calculated as percentage of your principal (which is now half of what your starting principal was), you now have to make a 100 percent gain just to get back to even. Put simply, any losses mean that your principal takes a hit, and that, in turn, means 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 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 every day at the banks, but also, 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. Page 24
TRAJAN WEALTH, LLC© 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. The reason you may consider a less frequent interest crediting option is because it may be 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 percent, 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 percent, the most you can earn in a crediting period (let’s say 1 year) is 8 percent. If the underlying index earns 10 percent, the most you can earn is 8 percent. • THE PARTICIPATION RATE is the percentage of the cap in which you participate. Let’s again assume your cap is 8 percent. If you have a participation rate of 100 percent, you can still earn a maximum of 8 percent. However, let’s say your participation rate changed to 50 percent, now the most you can earn is 4 percent (50 percent of 8). • A SPREAD is simply what the insurance company will deduct prior to crediting your interest. If you have a spread of 2 percent, you would keep everything the underlying index earned, minus the spread. If, however the interest earned is less than the spread, they typically will only retain the earned amount and will not charge you the difference – thus the name given: “spread.” Not “fee.” As you can see, you don’t earn the full gain of your index, but that is a trade-off you make for the risk protection you receive.
TRAJAN WEALTH, LLC© • 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 each year, gains are locked in. 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 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 uses two exact points, the beginning and ending 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, but don’t be confused: both types typically credit interest annually. • AVERAGING is a index calculation method 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. Then all 12 values for each month are added up: if the result is a gain, that is the amount of interest credited to the annuity (depending on 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 list isn’t intended to an exhaustive list, it will give you an idea of how these various contract specifications affect one another.
TRAJAN WEALTH, LLC© THE OTHER SIDE OF INDEXING Indexing can be a beneficial strategy, and it is attached to many financial products that can potentially make a smart addition to a retirement portfolio. But just because you see “indexed” as part of the name of a financial product, that 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.
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 fee’s 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 fee’s associated with variable annuities and are generally around 1% per year.
TRAJAN WEALTH, LLC© 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.
Limiting Contracts An FIA won’t participate fully 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 based upon the market • Riders. Even though a “rider” is not an annuity type, it is a feature that you often 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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RIDERS A rider is often an optional feature that you are purchasing from the insurance company. In reality, it is simply additional insurance you are buying to provide a certain 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 or your gun collection. The additional rider is of course going to 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 and 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 as the insured whole in the event your policy value is lower at some predetermined point in the future. As an example, let’s say you invest $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 will guarantee that on every 10th year anniversary (as an example), if your account value is lower than your principal 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 percent.
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 itself specifically for death benefits only.
TRAJAN WEALTH, LLC© As an example, let’s say you invest $100,000 into a fixed 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 5 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 around an additional 1 percent per year.
GUARANTEED MINIMUM INCOME BENEFIT (GMIB) RIDER Refresher: A GMIB requires annuitization – 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 invest $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 their life expectancy of 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” or turn on 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 percent per year. IMPORTANT NOTE: Keep in mind, the account value and withdrawal benefit (or income benefit) are two completely different values. You cannot take your income benefit as a lump sum. Page 31
TRAJAN WEALTH, LLC© SAMPLE ANNUITY ILLUSTRATION
Athene AscentSM Income Rider Athene AscentSM 10 Bonus 2.0 Annuity Supplemental Illustration Owner/Annuitant: Assumed Issue Date: Assumes Initial Premium Amount of:
Valued Client December 24, 2018 $250,000
Issue age: 55
The amounts shown below assume the Level Income option and no withdrawals are taken prior to the commencement of Lifetime Income Withdrawals. If you take a withdrawal of any type prior to commencing Lifetime Income Withdrawals, the Lifetime Income Withdrawal amounts shown below will be reduced. However, rider charges will not reduce Lifetime Income Withdrawals. Once Level Income has been started, the guaranteed Lifetime Income Withdrawal you would receive is locked in assuming you do not take any excess withdrawals. If you take an excess withdrawal, the Lifetime Income Withdrawal amount will be reduced and in some situations your Lifetime Income Withdrawals could terminate. Single Life Level Income Deferral Years
Beginning of Year Age
End of Year Age
Beginning of Year Income Base
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 20 25 30 35 39
55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 75 80 85 90 94
56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 76 81 86 91 95
$287,500 $312,500 $337,500 $362,500 $387,500 $412,500 $437,500 $462,500 $487,500 $512,500 $537,500 $550,000 $562,500 $575,000 $587,500 $600,000 $662,500 $662,500 $662,500 $662,500 $662,500
Guaranteed Lifetime Income Withdrawal
Annual Income if Confined * Must meet eligibility requirements
3.60% 3.70% 3.80% 3.90% 4.00% 4.10% 4.20% 4.30% 4.40% 4.50% 4.60% 4.70% 4.80% 4.90% 5.00% 5.10% 5.60% 6.10% 6.60% 7.10% 7.10%
$10,350 $11,563 $12,825 $14,138 $15,500 $16,913 $18,375 $19,888 $21,450 $23,063 $24,725 $25,850 $27,000 $28,175 $29,375 $30,600 $37,100 $40,413 $43,725 $47,038 $47,038
$20,700* $23,125 $25,650 $28,275 $31,000 $33,825 $36,750 $39,775 $42,900 $46,125 $49,450 $51,700 $54,000 $56,350 $58,750 $61,200 $74,200 $80,825 $87,450 $94,075 $94,075
This example assumes you have elected single life income to start at age 55. In this example, the annual Lifetime Income Withdrawal you would receive Most annuity companies able toWithdrawal provide anis locked illustration showing the riders in action. Above is $10,350. Once started, theare Lifetime Income amount in assuming you do not take any excess withdrawals. Therefore you would is a continue to receive $10,350 in all subsequent years. Similarly, subject to the stated limitations below*, if the annuitant is confined to a qualified care hypothetical example of a 55-year-old saving $100,000 into an annuity with GMWB and a confinement facility and meets all eligibility requirements, assuming no excess withdrawals, the annual Lifetime Income Withdrawal amount is locked in once you commence Lifetime Income Withdrawals. Thus, if you are eligible at any point after the commencement of Lifetime Income Withdrawals, you would rider. receive an annual Lifetime Income Withdrawal of $20,700. • Look at deferral year 0, the income base is $110,000 – this particular annuity pays an upfront 10% bonus. • Look at deferral year 1, the income base is $116,600 – this particular annuity grows at 6% Refer to your Certificate of Disclosure for important information on how withdrawals prior to and after the commencement of Lifetime Income Withdrawals impact your Contract. Lifetime Income Withdrawals can be elected in any Contract Year in which Lifetime Income Withdrawals are compound. available as presented on this statement. Lifetime Income Withdrawal amounts are shown as annual payments. For monthly payments, simply divide amount shown by 12. Taxable amounts withdrawn prior to age 59½ may be subject to a 10% IRS penalty in addition to ordinary income tax. • Look at deferral year 5, the income base is $147,204. If you want to start drawing income within The Enhanced Income Benefit is limited to 60 months and will not continue in the Extended Income Guarantee Phase. Additionally, the Enhanced Incomethe Benefitinsurance Waiting Period must be met. Additional and$147,204 restrictions apply.by the income percentage (internal this year, company willrequirements multiply DB# 3.4.109/SYS# Server v1.1.1550.68072 actuarial calculation) which is 4.5% in this example and your income will be $552 per month. Page 1 of 1 page This illustration is not valid unless accompanied by the base illustration. 12/24/2018 11:28 AMif the owner Prepared for to Quickbe Illustration #1 Also in this example, were confined to a skilled care facility, their income would double to over $1,100 per month. *
TRAJAN WEALTH, LLC© SINGLE LIFE OR JOINT LIFE PAYOUTS WITH THE GMWB RIDER You as the annuitant (investor in the annuity) can chose if you would like single payout or joint payout in regard to your income payments. If you chose single, your payment will be based upon your life expectancy alone. This will obviously increase your payment over joint since there is only one life to account for in the calculation of your payment. If you chose joint, your payment will be determined on both of your lives. The insurance company will be liable for making that payment to one of you. The chances that two people live longer than one is quite obvious. 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 on the odds. Which option is right for you completely depends on your circumstances and there are many factors that need to be considered, such as longevity, health issues, life insurance, money need, ages, 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.
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 56.37 but the average age today, for men who live to age 65, is 84.38. 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 percent9. Not only are people living longer, but the costs of health care are 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. 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 generalize for understanding’s sake. With a well-being rider, you will need to purchase a GMIB or GMWB rider as well. 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 $2000 per month. 7 https://books.google.com/books?id=O6czAfzuJvoC&lpg=PA218&dq=life%20expectancy%20united%20 states%201920&pg=PA218#v=onepage&q=life%20expectancy%20united%20states%201920&f=false 8 https://www.ssa.gov/planners/lifeexpectancy.html 9 https://www.ssa.gov/planners/lifeexpectancy.html Page 33 TrajanWealth.com
TRAJAN WEALTH, LLC© 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 type of annuity, the terms of that annuity, along with the terms and cost of the income rider. 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 specifically at how income riders work with these two types, since they can be the most complicated, but also potentially beneficial, options.
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. But hold up. What if you didn’t add an income rider? Your annuity could run out of money. That’s the bottom line. If you invest $100,000 in an annuity and, ten 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 two 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.”
TRAJAN WEALTH, LLC© 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). 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.
Account Value = Real Money
Benefit Base = Monopoly Money
Income riders cost an extra fee, usually one or two percent (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.
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 just because it’s not the actual value of your account 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
Let’s give you an example: let’s assume you invested $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.**
Starting Account Value: $100,000 Ending Account Value: $100,000 Starting Benefit Base: $100,000 Ending Benefit Base: $160,000
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—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
TRAJAN WEALTH, LLC© 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, or even of 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, after all, if they can help it. So let’s say that at the age you decide to turn on your income stream, your Actuarial Payout number is 5. That means, depending on the terms of your rider you’ll receive five percent 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 investment. 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.
TRAJAN WEALTH, LLC© 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 are they tiered by age?
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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, but 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 third-party broker to make the deal, the issuing insurance company is responsible for the annuity itself and all the things you bought it for— managing the investments 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 don’t-ever-skip step. Check all of the insurance company rating services (some to check include A.M. Best, Moody’s, Standard & Poor’s, Fitch and COMDEX, which combines rankings of the previous four agencies). Also know that insurance is regulated state-by-state, not nationally, so check with your state insurance commission or regulators 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.
TRAJAN WEALTH, LLC© SURRENDER PERIODS AND PENALTIES We all know that insurance companies are in the money-making business. They make long-term investments like annuities because they 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 investors not just to invest their money, but also to leave it there. That’s where surrender periods and penalties come in. Typically annuities allow for a 10% per year penalty free withdrawal. If however, 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 reasons you may not want to invest 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 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, 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, subjected to a permanent or extended stay in a nursing home, or other major calamities that affect you economically.
COMMISSIONS AND FEES This is a risk with virtually every financial product, and that 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
TRAJAN WEALTH, LLC© commission, that doesn’t necessarily mean you are getting bad advice. But wouldn’t you be more comfortable if you knew up front that the professional is getting a commission? That way, perhaps you could weigh your decision accordingly (with, perhaps, a second opinion). Fees can be another challenging issue with annuities, as some certainly do charge more than others. No fees should ever 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 be aware of any additional fees you’re paying for riders or other services. All of the risks exist and should not be ignored, but 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 wellbalanced 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) 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 to explain the exact contract and hard numbers. Don’t allow that. 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 just like you want to do your research about the actual annuities you are considering, you also want to do your 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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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 in a more secure investment. Annuities allow that while also providing some growth, which means retirees don’t have to give up all of their potential upside 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. 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 investment 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, reliable support to beneficiaries as well. Page 41
TRAJAN WEALTH, LLC© NO CONTRIBUTION LIMITS LIKE IRAS AND 401(K)S IRAs, 401(k)s and 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 have maxed out their IRA or 401(k) contributions.
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, for example, spousal income, and estate or legacy planning.
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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 is custom-fit to your needs. But not all financial professionals offer the same services, have the same experience or 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.
TRAJAN WEALTH, LLC© 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 investments 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 second 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 is a lot of choice when it comes to financial professionals and you can use competition to educate yourself and weigh all of your options. With that person as a partner in your retirement planning, you’ll feel less stressed when you know you have put together a long-lasting retirement plan.
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?
TRAJAN WEALTH, LLC© 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. • Solves for the retirement challenges, such as long-term care, spousal continuance, or legacy/estate planning, that keep you up at night. Above all, your retirement plan should never be a source of worry. You should understand every aspect of it and know how it works to keep you comfortable and secure no matter how long you might enjoy those retirement years.
For more information about annuities and other retirement planning options, please visit www.trajanwealth.com. We’d love to answer all of your questions and help you create the plan that will help make your retirement dreams come true.