It used to be to be that retirement income planning consisted of using bond “ladders” to provide guaranteed income that could keep up with inflation without taking any principal risk. Since 2009, the world that included risk free bond income capable of keeping up with inflation has disappeared and it doesn’t seem likely to return for years, and perhaps decades.
There are solutions to safe retirement income capable of keeping up with inflation, but bonds are no longer part of that picture. One alternative is a relatively new type of hybrid annuity known as a Fixed Index Annuity. These annuity structures have fixed the problems typically associated with annuities-fixed index annuities are low or no fee, and are inheritable, usually outside of your estate and therefore not subject to estate taxes.
Astute financial planners are using Fixed Index Annuities more often as bond substitutes. Why?
1) Annuities pay income as long as you live.
2) They can be used to protect against stock market declines.
3) There is no investment risk to principal.
4) They often fit well into a larger financial plan designed to protect future income, discretionary spending, and legacy goals.
5) They can be stacked like bond “ladders” so that you get a “raise” every few years, similar to the old bond ladder structures.
The short video below does a good job of explaining how Fixed Index Annuities work. Below the video I’ve outlined what this type of annuity is good at and what it isn’t, as well as addressing several annuity myths. Please feel free to reach out through the contact page if you have questions or if you are wondering if a Fixed Index Annuity might fit into your retirement plan.
It may be informative to know that Ben Bernanke, former Chairman of the Federal Reserve, has over a million dollars of his own money invested in annuities.
What Fixed Annuities are good for:
1. Guarantee the income needed to successfully retire.
2. Removing or reducing retirement risk due to stock market fluctuations.
3. When you need to protect your principal, and conservative growth in your portfolio is enough.
4. Minimizing or eliminating the need to make withdrawals from your stock & bond investments.
5. Can defer taxes on investments.
6. Low or no fees.
What Fixed Annuities aren’t good for:
1. Aggressively increasing the size of your investment portfolio.
2. Leaving a legacy to the next generation (unless you aren’t health enough to get term life insurance).
3. Keeping up with the stock market.
4. Short term money — if you need the money in less than 10 years, an annuity is not a good solution.
5. All of your retirement money.
What’s the bottom line? When you retire, the assets you have accumulated over time need to begin providing the income you need over and above social security in order to live the lifestyle you want. If you are like most people, you still need some kind of growth in those assets to bridge the gap between your social security and your expenses, but you can’t (or don’t want to) take the risk of losing 50% of your money in a market crash. If you are like most people, the right annuity can take a lot of stress out of the future.
There are many annuities out there, but many aren’t great solutions. How can you figure out which annuity will work for you? Most people fixate on the “guaranteed” return rate but in fact this is just one part of what’s important in an annuity. There are other pieces of the annuity that are every bit as important if not more so than the guaranteed return rate such as distribution rate, or what you get take out in the form of income. It’s also important to deal with an insurance company that is financially strong and will be around in the future. Avoiding unnecessary fees is important as is making the right index selection.
Annuities can appear complex, but the most important thing to focus on is the cash flow you will get from them in your retirement years. A Fixed Index Annuity is really most useful when used to protect income for basic living expenses.
Myth #1: All annuities are loaded with expensive fees.
There are several kinds of annuities and some of them are rightfully known to be loaded with expensive fees, like variable annuities. Annuity fees come in several shapes — some annuities have administration fees, ownership fees, and/or management fees in addition to caps and surrender charges. Typically, when you see this many fees you are looking at a variable annuity, which isn’t usually a good solution for most people.
On the other side of the spectrum are fixed indexed annuities. There are no annual fees or management fees with most fixed indexed annuities which greatly reduces their expense. Instead, indexed annuities usually offer a choice between a spread or a cap (or sometimes both play a role). A cap is just what it sounds like – a cap on the performance of your annuity – the insurance company takes whatever performance is above your cap to offset their expenses. A spread is similar – the insurance company collects money by taking a set percent difference, or “spread” between what your annuity gets paid and what the index it is tied to does.
Caps and spreads typically cost investors considerably less than annual or management fees and that’s why many financial planners consider fixed index annuities an important tool in reducing their client’s risks in retirement. Fixed index annuities do have surrender charges for taking money out of the annuity ahead of schedule. Typically this charge falls every year your investment stays in the annuity until it finally hits zero.
Myth #2: The person I’m working with says Fixed Income Annuities keep up with the Stock Market.
This is not true. When an annuity is linked to an index like the S&P 500, your annuity will be credited part of that index’s annual performance, subject to whatever cap or spread your contract offers you. Your money is never invested in the stock market. Rather, your annuity will be credited whatever performance you are due according to your agreement. This is actually one of the benefits of a fixed index annuity — because it is not invested in the stock market, it doesn’t go down when the stock market falls, even if the market falls 50%. But when the market is up, depending on what index your annuity is linked to, you will participate in a portion of that upside. This gives typical fixed index annuities more potential upside than other interest pegged investments like CDs, many bonds, or money market accounts without sacrificing safety.
Myth #3: If I die before I use my annuity, the insurance company takes all my money.
Not true. Fixed Index Annuities pay your beneficiaries the remaining benefits and some even give your beneficiaries the choice of taking the money in a lump sum or over a period of time. Best of all, these payments take place outside of probate and are usually not considered to be part of your taxable estate.
Here are a couple examples of how real people are using annuities to protect their retirement and get the lifestyle they’ve earned.
Still have questions? Send me an email through the contact page and I’ll get back to you with a thoughtful response as quickly as I can.
To Smarter Investing,
Chief Market Strategist
ACI Wealth Advisors, LLC
Process Portfolios, LLC.