How To Use a Fixed Indexed Annuity for Future Streams of Income in Your Portfolio


Jessica Cannella: I’m Jessica Cannella, co-founder and president of Oak Harvest Financial Group and investment advisor. Today, we are going to continue our conversation on the tool called a fixed index annuity. Now, if you’re unfamiliar with the tool, I definitely recommend going back and watching our video that’s titled Achieving Peace of Mind in Retirement, and that’s going to give the backdrop for what we’re going to talk about today.

In that video, we talked about how a fixed index annuity could be used for peace of mind, otherwise known as safe growth. A fixed index annuity cannot lose money from your principle or the amount that you put into it due to market risk. That video is going to go into some detail on how that is achievable with the use of a fixed index annuity. Today, we’re going to focus on how a fixed index annuity can play a role in your portfolio.

We at Oak Harvest Financial Group and our team of financial planners, we use fixed index annuities. One, it’s appropriate. Again, no magic bullet in finance. If it sounds too good to be true, it probably is, always remember that, but there are useful opportunities to have a fixed index annuity in your portfolio depending on your goals and objectives. Today, we’re going to focus on one way to use the fixed index annuity, and that is for income, future streams of income.

I’m going to be explaining to you how an income account works in a fixed index annuity. I think it’s very important that we understand the difference between cash value, which is cash money or your amount of principle that you put in, and a benefit base, as its technical name, or as I like to call it, an income account, where you’re going to determine, or the insurance company will determine– it’s the insurance company that will determine this, what is the stream of income in the future going to be for you?

There are some tools that can give you that answer immediately. You put $100,000 in today. In 10 years, when you turn your tool on for income, you are guaranteed today to get $12,000 a year for the rest of your life. Other tools have indexes inside of their income account. Your income account indexes with the market, it’s an easier way to say that, just like your cash value. Today, we’re really going to break that down and understand how it is possible to generate a lifetime stream of income by way of use of the fixed index annuity.

I’m a big fan of very easy math, so I’m going to use $100,000 is what you initially fund your fixed index annuity with. You take $100,000 out of your investment portfolio, your IRA. an IRA would just transfer into an annuity to avoid a tax event. You fund your annuity and that is with cash value, $100,000. In your income account, some contracts offer a bonus, maybe you start off with a 10% bonus name, just making up numbers. This is always contract-specific, but for illustration purposes, let’s say there’s a nice 10% bonus on your income account over here. That’s going to immediately have your benefit base or income account at $110,000.

Now, you’re probably wondering who this dude is and why he’s over here. This is my shoddy attempt at drawing a phantom on the whiteboard because it is very important and I’ve encountered this as an advisor several times where somebody comes in, they purchase either a variable annuity which works similarly on the income account portion, or a fixed index annuity and they do not understand the difference between cash value, and phantom money is another way to think of this. I, in live appointments with my clients, will take the liberty of drawing this guy on the board as a reminder because it’s very important.

You would understand that I had a woman, who was in her 80s who was infuriated to find out that her income account was not a lump sum that she could walk away with at the end of her contract term because that’s how she understood it. She thought that for instance, the 10% bonus on the amount that was put into the cash value, that it’s credited on both the cash value which is cash money in your pocket, and the income account. It’s just the income account in this instance.

It’ll make more sense why Martha was so upset when we called the company and I explained to her that, and then they explained to her that her variable annuity did not have guaranteed cash value. Now, a fixed index annuity, that’s a big difference between those two strategy. It does. If you put $100,000 into a fixed index annuity, you cannot lose your $100 due to market risk. The same is not true of a variable annuity. That word variable means that your cash value can fluctuate up and down.

Now, back to what the income count is and why there’s a phantom on the board. There are strategies available. For instance, I’m aware of one right now. We’re independent and we have access to all different strategies. It’s extremely important that you work with an advisor and preferably a fiduciary if you are in the market for a fixed index annuity because they have a lot of small print. The general consumer will not understand which questions to ask.

If you just get Joe Schmo insurance guy who’s licensed with a life insurance company and he can sell you a fixed index annuity, it may not be the one that’s meeting your objectives and goals. I’m aware of a strategy right now, in no way suggesting this strategy, but for illustration purposes, I’m going to walk you through how it works. This strategy offers 8.25%. I’m drawing it right on the phantom because it’s a guaranteed percentage on the income account.

If you’re familiar with how the fixed index annuity works from my last video, you know that as the market does what the market does, up and down, whatever index you’re tracking within that contract, it’s going to follow the benchmark of that index. Whether it’s up or whether it’s down, the insurance company is going to give you a participation rate or the percentage of which you participate in the upside of the market in exchange for no downside risk.

Again, easy math, let’s say that the market does 10%, your par rate is 50%. It’s on the S&P 500 index that we’re looking at here, and so if the market goes up 10%, you don’t get the full 10%, that’s a big consideration with annuities. You get 50% of 10 for 5%, and that is credited onto your $100,000, making that $105,000. Now this becomes your new cash value can. You can never go below 105,000.

Now, this is important. This Phantom over here, because 5% is lower than 8.25%, you get a guaranteed 8.25% on your 110 up here because you had the 10% bonus on the income account. 8.25% on $110,000 is going to bring your new income account value up to $119,075. Now this becomes your new income account balance. You can see there’s a difference, 105, 119. Most of these fixed index annuity contracts have typical terms, or in other words, timeframes that your money is kept in the contract without penalty or fee for withdrawing it early.

Those timeframes are generally 6, 7, or 10 years. You can imagine, even when the market does– let’s say the market goes negative 10%, the biggest reasons that we do, we talked about in the last video, for using a fixed index annuity is for the safe growth, and so even when the market does negative 10%, because you’re getting 50% of the upside of the S&P 500 benchmark in this example, 50% of zero is zero, and we stay at 105. That’s generally annually.
It’s got an annual reset that the interest is credited. Sometimes, it’s two years. I’ve seen strategies where it could be up to six years, so another

fine print question to make sure that you’re going over with your advisor when you’re looking to see what strategy makes the most sense for your goals and objectives. You can see that 105 is right where we left off the year before. Regardless of whether the market does plus 10% or zero, you get the gift of 8.25 to illustrate how an income rider works on a fixed index annuity.

8.25% on $119,000, I’m going to make up some math for this one, [chuckles] and we’re going to say that that is roughly $127,000. You could see the difference between these two numbers. If you take this out, let’s say this was a 10-year strategy, you take this out 10 more years, at the end of each contract, let’s say that with the ups and downs of the market, their cash value average about 4-6% a year. Let’s say, again for easy math, that the ending balance, and this is really just to illustrate the difference between these two columns, is $190,000. This balance, because it’s designed to grow a guaranteed 8.25% on your income account, this grows to be $250,000 in the math.

If you’re an engineer out there, don’t fact-check my math. You’re wasting your time. I know this is not accurate. It’s just for illustration purposes. Generally, when you’re looking to purchase a fixed index annuity, an illustration can be made available to you so that you can see these numbers in real-time. This was an example of a strategy that offers a guaranteed gift of the ghost or gift of the phantom up here of 8.25% interest on your income account value and a participation rate on your cash value.

Big difference between these two numbers at the bottom after 10 years. You can see why Martha, my 80-year-old client who came in and had purchased a variable annuity was very upset to learn that this is not a lump sum that she can walk away with at the end of her contract term. What this is is the formula that the insurance company will use to determine how much lifetime guaranteed income does the contract owner and/or their spouse receive based off of this number.

That’s how they calculate your income rider benefit. I have not explained what an income rider is on this video. It is generally a cause that you’re purchasing within your contract, typically around 1%, 1.5% off of your cash value that you’re paying to say, once I turn this income on, it is guaranteed for the rest of my life, and generally the rest of your spouse’s life. That’s another very important technicality that you’re working with an individual or advisor that understands how to label the contract.

We tend to– like a joint contract, but that’s not a decision that you have to make until you’re up against making that decision. In other words, single payouts are generally higher than a joint, just like on a pension. That’s another really easy way to think about how to use income from an annuity. It’s just like a pension. I’ll go over a couple of key differences in a moment. You can see the big differences. You cannot walk away on the income side with a lump sum.

It’s generated this number to determine the math associated with what your guaranteed lifetime income will be. Now, whenever your contract term has expired, you are considered to be out of surrender. If you have not turned this on for income, which is a phone to hopefully your advisor and then onto the insurance carrier to make that decision or help you make it, you can walk away with a lump sum or you can reinvest these assets.

This is cash money. This is your cash value, so whether your contract term was 6 years, 7 years, or 10 years, at the end of those years, this number over here is a lump sum. There’s many different ways to use a fixed index annuity. What we’re talking about right here is somebody that needs income. Whenever we’re talking about retirement planning, income, income, income is the secret sauce of being able to retire and retire comfortably. I would argue, you can’t retire comfortably without replacing your income at least enough to afford your basic living expenses.

If we’re honest about the environment we’re in today, social security is not generally enough income in retirement to cover all of your expenses. This could be an excellent tool to incorporate. You are generally paying. There are some strategies that you’re not paying for an income rider. That’s not a reason to pick one strategy over another. It really depends on what needs are met with each strategy and what makes the most sense relative to what else you have going on in your portfolio.

There are strategies that don’t have income riders on them at all. We’ll talk about that next as a way to diversify your portfolio by using a tool that is geared just towards safe growth, or maybe as a bond alternative. I did mention earlier, I wanted to circle back to how an income-bearing annuity is similar to a pension and how they’re different. Similar, that’s easy. We all know that if we’re offered a lump sum or a pension and we select the pension option, or heck, if you win the lottery and you select the annuity option, that is paid to you, that lump sum is paid to you in installments over time, guaranteed income.

When you have an income rider, it’s the same thing, guaranteed income for the rest of your life, and generally your spouse’s life. That’s a big difference with pensions or even lottery winners, is that depending– I’ll speak specifically to pensions as I don’t know that much about how the lottery winners work. I will tell you that with a pension, more often than not, it’s a reduced spousal benefit in English. That means if your pension, as the person who worked for the company that’s giving the pension, was $2,000 a month, your spouse’s might be $1,800. When you both pass away, there is zero death benefit. You have foregone your right to your lump sum if you’ve elected to take the pension option.

Now for government employees, it more than likely makes sense to go ahead and take the pension. In most private entities where there’s a lump sum or a pension offered, it makes sense to take the lump sum because in a fixed index annuity, you still have cash value, less any income that you have taken. Easy way to illustrate that here is let’s say that on these figures, you put $100,000 in cash value.

That’s grown to $190,000 lump sum after your term has expired, your policy is out of surrender, and you have accumulated $250,000 that is in your income or benefit, a base account that your insurance carrier that recommended that has the strategy on the table for you, that you’re entered into the contract for, will use to determine what your income is. Let’s say that that income is going to be $12,000 a year, because remember, we put $100,000 in, you bought this strategy when you were 65 years old, you’re now 75 years old, and this income kicks on. You elect to take the income and you’re getting this each and every year. Your spouse is 70 years old.

Once you pass away, nothing will happen. That check just continues to come in the mail for them. You both pass away, what happens? Let’s say that the contract owner passes away two years later at age 77. They have taken $12,000 times, two years in that example, and that’s $24,000, and then spouse lives another two years, so the check continues to come in. That’s another $24,000. I like to write it out just to really illustrate what this is looking like.

Now in a lot of contracts, the caveat here, your cash value will continue to grow some. That’s another fine print thing that you want to ask, or if you have a really great advisor, they’ll explain that to you proactively that you might be still able to index with the market, keep a little bit of growth happening here, and you’ve got income coming out every year that you’ve elected to take this money.

That said, 24 and 24 is 48. We’re going to take $48,000 off of $190,000 minus $48,000, that’s the income that we have taken over the course of four years in this example. You both kick the bucket, that leaves our beneficiaries with $142,000 left in the cash value. What happens to this money? It goes to child one, child two. If you don’t have any heirs or beneficiaries, you can leave that to a charity. Another tidbit here, you want to be really conscientious of the taxation.

You can fund an annuity with a Roth. You can fund an annuity that would be tax-free dollars at your death. You can fund an annuity with an IRA, which is going to be taxes, regular-earned income tax to your heirs once they start to take money out. You can see in that instance, it may make sense for them to have an informed conversation with the options within the contract. Different contracts have different options for how your beneficiaries are able to take the funds at your passing.

Some of them force you to take it all in a lump sum, divide it by your two beneficiaries. Others can let you spread it out over five years. Again, guys, this is the importance of working with a professional, somebody that’s going to think of all these things on your behalf. That’s a big reason how fixed indexed annuities can be different from pensions, is that instead of that your pension money just disappearing, in the same example, if you had been taking your pension for 10 years and then you pass away, your spouse could get a reduction, they could get the full pension.

It just depends on your employer paying package on your pension specifically, but once you’re both passed away, there is no more lump sum left. It does not have cash value once you elect to take the pension option. Major difference with annuities and pensions. With the use of a fixed index annuity and having an income-bearing fixed index annuity with an income rider, one of the major benefits there is that when you turn on the income from your annuity, you have less suppression in your investment account or your savings account, whatever other investments that you have going on in your portfolio.

If all of a sudden, now you’re getting a check from social security for $2,000 a month, and an annuity that’s going to cover, in this example, $12,000 a year, well, that’s $12,000 less a year for the rest of your life and your spouse’s life in most instances that you have to take out of your investment portfolio. If income is important to you in retirement, you don’t have a pension or you have the choice between a lump sum and a pension, having a conversation with your trusted advisor regarding if a fixed index annuity that’s designed for guaranteed lifetime income is good for you, might be good for you. I’m Jessica Cannella. Thanks for joining me. In our next session, we’ll talk about how the fixed index annuity can be used for diversification in your portfolio. Thanks.

How To Use a Fixed Indexed Annuity for Future Streams of Income in Your Portfolio
How To Use a Fixed Indexed Annuity for Future Streams of Income in Your Portfolio

A fixed indexed annuity can be used in your portfolio for future streams of income. Let's take a moment to understand how an income rider works and how it differs from a pension.