Troy Sharpe: Today, we’re going to discuss variations of guaranteed lifetime income contracts that are available in the marketplace because just like clothes, one size doesn’t necessarily fit all. Think of it like cars or flavors of ice cream. We all have different preferences, we all have different needs and things we’re trying to accomplish. Over the years, life insurance companies have become more creative and innovative with their product design which leads to more appeal across a broader audience when it comes to these particular lifetime income strategies.
We’re going to cover the variations today as well as talk about how your income can increase if you or your spouse needs long-term care benefits and also how these products can be designed to combat inflation. I know that’s important to many of you.
Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, certified financial planner professional, host of The Retirement Income Show, and a certified tax specialist as well. So far in this video series about guaranteed lifetime income, we’ve covered the guaranteed roll up. As a refresher from the last video, the fixed index annuity, when we’re looking at guaranteed lifetime income, will have two separate accounts but you make one deposit. The insurance company just tracks your money two different ways. You have your principal account then you have what we call your pension account. Could be called your benefit account or your income account value.
As a reminder, your principal with the fixed indexed annuity is 100% safe. It grows according to some external index, maybe the S&P 500 or another one, your gains lock in, your interest and your principle can never be lost. Then your principal account over here, that is your death benefit. If you pass away that is the amount of money that goes to whomever you’ve named your beneficiary.
Now, simultaneously, the insurance company will keep track of this pension account. Think of this as a lump sum or pension decision if you have that decision or had that decision with your company, with your pension. Same concept here except when you get your pension, you don’t lose your lump sum. You still have your lump sum. You still have your principle. You still have your death benefit. You just are now getting a guaranteed lifetime income. In the example we covered, the pension account grows at a fully guaranteed rate. Whatever it grows to turns into a fully guaranteed lifetime income so you still have your principal, it can still earn interest. You still have your death benefit, but at the same time, you’re receiving a lifetime income.
Day one before you put your money into this type of investment, you know exactly how much income will be provided because everything on this side is 100% fully guaranteed. There are no ifs, no ands, no buts. 100% guaranteed. Different companies in the marketplace will offer different rates of return, different distribution factors, but ultimately, the only thing that matters for most people is if I put X amount of money in and I want to take income in 3 years or 5 years or 10 years, how much will my monthly paycheck be for the rest of my life and the rest of my spouse’s life?
The variation we’re going to talk about first is the difference between guaranteed growth, which is what we just looked at with the pension account, and projected growth. Projected growth is based on the performance of the cash value. Then there’s some factor that typically multiplies your interest rate that you’ve earned to determine what your roll-up rate is or what the pension account earns. If we look at this hypothetical example here, this will be a 200% factor meaning if our cash value earns 3%, our pension account earns 6%. The principle account earns 8%, the pension account earns 16%.
It’s essentially a double from whatever we earn on our principle, on our cash value. That doubling is credited to the pension account. Then at whatever point you decide to take income, that’s how your lifetime income is calculated. In this example, I’ve run out a five-year- 1, 2, 3, 4, 5 years. -of credits. Average is about 9%. In this particular example, our cash value, because it’s 100% safe, the gains that we’ve earned on this side lock in, this is just a hypothetical calculation so $300,000 would grow to $400,000. If this side averaged 9% per year, because this side is getting double the credits of our cash value of our principle, this side is always going to be higher. The guaranteed lifetime income, if you remember, is always calculated off which side is higher.
The difference between the 7% guaranteed roll-up one that we looked at in this first example and I covered in the previous video versus this one is instead of having a guaranteed rate of return that’s static and fully guaranteed no matter what, the pension account increases in value as a function of how much interest is earned on the cash value. Now contracts in the marketplace today, you may have 150% factor, or 200%, even some 250% ones out there. The question becomes, how much are you going to earn in your pension account? Your risk is to the upside though.
Your principal’s 100% protected just like the previous version we covered so if we put in $300,000 and over time it grows to $400,000, this is the stairstep where principle and interest is locked in, your cash value, your death benefit, it’s safe and it’s protected for market losses. The pension account, though, this is what determines our guaranteed lifetime income. If we go with a projected growth, we just have to understand where the risk is. The choices are, we can get a fully guaranteed income number from the 7% roll-up, or if we want to take more upside risk to have a higher lifetime income while also having our principle protected, that choice is available in the marketplace.
Your principle is safe but your risk is the upside potential when we’re looking at the projected growth lifetime income strategies. Do you average 5% in your pension account or 10%? Well, if we average 10%, it’s much more likely you’re going to have a higher guaranteed lifetime income. If you only average 5%, well, you took an upside gamble and you lost, you didn’t pay off. You would’ve been better if you just went with the fully guaranteed 7% income rider, fully guaranteed. Some people are going to lean more towards the upside risk. They don’t want to take risk with their principle, but they are okay with some upside uncertainty in regards to how much that future income that’s fully guaranteed for life will be.
Other people say, “No, Troy, I’d much rather have a bird in the hand than two in the bush.” Everyone is different flavors of ice cream. When we start to look at these projected growth ones– Let me be clear, I’m not saying one is better than the other. They have different designs, they have different purposes. Your tastes are different than your neighbor’s. There’re options that are in the marketplace that can be utilized to customize a retirement plan and an income strategy for you and your retirement. What I want to do with these videos, though, is help you to understand what’s in the marketplace so you have an education if you are interested in guaranteed lifetime income, so you can ask good questions and you can really help to formulate a strategy that’s appropriate for your retirement.
One very important concept that we need to understand when it comes to these projected guaranteed lifetime income annuities. The life insurance company provides an illustration. You can’t get it directly from the life insurance company. You have to work with an advisor or an agent. In this illustration, you’re going to see a guaranteed column. The guaranteed column is if the projected growth never comes to fruition. This is worst-case scenario, 100% what’s guaranteed if you have zero growth for the life of the annuity before you take income. Then they’ll typically show a back testing of the lowest 10 years when it looks at how the contract grows, how it earns interest. You want to back tests that over past performance.
Important to note, past performance is not indicative of future results. We’ve seen that a thousand times. That disclosure, it applies here as well. The lowest 10 years, the illustration may show you it would’ve grown to X amount and your lifetime income is $32,000 per year. The middle scenario, whatever it’s grown to based on the hypothetical back testing, your lifetime income would be $36,000 per year. The best-case scenario based on the back testing, your lifetime income would be $41,000 a year. Well, first thing I do is I throw out the best and I’m going to focus my attention somewhere between what’s fully guaranteed in the middle scenario.
Now we have a deeper knowledge of the various indexes that are out there, the crediting rates, the likelihood of what they’re projecting to come through. If you haven’t watched the previous videos in this series, I dove pretty deep into the growth engine that supports these projected numbers in fixed-indexed annuities. There’s a link right up here with the title of the video. Make sure to watch that, but this whole series is designed to be educational and these videos are meant to be watched in sequence.
Getting back to the projected lifetime income and what we need to be aware of, we’re going to focus our attention, throw out the best, focus our attention on the middle, the lowest, the guarantee. We need to have some understanding of the likelihood of the lowest and the middle coming to fruition, but even if you don’t, we can just simply compare it to what a fully guaranteed contract is providing us at 7% interest. These are hypothetical numbers here, hypothetical deferral periods ages, but I just want to get the concept across. If the projected growth one is $26,000 guaranteed but I can get from a 7% fully guaranteed income rider of $34,000 a year, obviously, the guarantees are much stronger.
Then the lowest and the middle scenario, the guaranteed option is– I’d probably take this bird in the hand as opposed to possibly getting $36,000 or $41,000 because if I’m wrong or we don’t get the growth we anticipated, you could end up with $32,000 or $26,000. We simply compare as a very simple rudimentary method to identify the value being offered from this particular projected growth annuity. We just simply get rid of the best, compare these to what you can get with a fully-guaranteed contract, and that can help you make your decision. Now in this example, it makes sense to definitely go with the fully-guaranteed option and a lot of times in real life it does as well but there are certain conditions or certain times when it may not make sense.
It may be a more difficult decision, let’s say, if the fully-guaranteed one was $31,000 a year, and then lowest was $32,000, the middle was $36,000, the high was $41,000. Then, if our guarantees are $31,000 versus $26,000, well, we may want to take a little upside risk to have the potential for one of these higher-income scenarios being realized. It’s an individual decision at all so it also depends on your retirement plan, your income strategy, how much income do you need, when do you need that income, are we trying to replace a Social Security if one spouse passes away, or are we trying to replace a pension.
The context of everything that I talk about is within a solid retirement plan that looks at risk, investments, income, taxes, healthcare, estate planning. All of this ties together. These are nothing more than tools that can help accomplish those income goals or possibly reduce risk and provide some safe accumulation potential. Keep that in mind always that these are simply tools that we can use to help improve our retirement security, increase our income, and help us sleep better at night.
Now, some variations of the annuities that are available in the marketplace not only provide a lifetime income and everything we’ve talked about so far, but they can also provide an inflation-protected lifetime income or an income that you receive that increases over time or has the potential to increase over time. Here’s our T-Chart that we’re getting pretty familiar with at this point. We have the cash value and then we have the pension account. Just to make this brief, let’s say the pension account calculates to $32,000 a year for a lifetime income. A lot of times these inflation-protected annuities, the inflation adjustment or how much our income increases the next year is based on how much interest is earned in the accumulation value.
Some contracts out there will simply increase by the same amount of interest it’s earned. If you earn 3%, your income will go up 3%. If you earn 2% it will go up 2%. If you earn 8% it will go up 8%. Some of the inflation-protected lifetime income variations out there will give you double the interest that you earn as an adjustment to your lifetime income payment. If you earn 3%, your lifetime income will go up 6% If you earn 2%, your lifetime income will go up 4%. This $32,000 over a long period of time may turn into $40,000, $45,000, $50,000, $60,000.
Now, increasing income sounds great especially right now we’re going through a period of high inflation, but there’s a trade-off. When you have an increasing income lifetime income strategy, the income that you start out with, it’s always going to be less than you could get otherwise if we went with a maximum level guaranteed lifetime income payment. In this example, we may have the opportunity to grow our income 6%, 4%, 2% depending on the performance of the principal and the cash value side. If we would have put this same dollar amount into a fully-guaranteed maximum income contract, let it differ for the same period, we may start our lifetime income at $40,000 or $41,000, or $38,000.
I’m just conveying concepts here. Don’t take too much into all the numbers that I have up here because they’re simply designed to convey the concept, your choices, what the marketplace looks like. To simplify and condense everything that I just covered, I created this little chart. All variables considered to be the exact same. If they’re all the same, the guaranteed lifetime income contract that provides the most amount of income with no upside risk might provide us $35,000 a year. A projected lifetime income, projected growth that we talked about first, may give us a range of the fully guaranteed to the best-case scenario of $28,000 to $44,000.
Remember, we would then compare the $28,000 to what we can get fully-guaranteed because these numbers are fully-guaranteed numbers. Then consider what is the likelihood of the projected growth actually coming to fruition. Then, an increasing lifetime income annuity. These are, again, typically going to be projected growth lifetime income strategies. The starting range may be anywhere from $22,000 worst-case scenario, to $35,000 in that best-case scenario, but this income will increase over time. If you’re younger and you have longevity, you’re in good health, and you expect to live into your 90s, possibly beyond, it may be worth considering.
One other note here, there’s no rule that says you have to go 100% one way. We’ve seen clients before say, “You know what, Troy, I want to take care of my baseline spending, my needs, on a fully guaranteed basis, but you know what, this one over here, I do like the concept. You guys, I think, feel pretty good about this for my plan. Let’s put a little bit of money into something that is either a projected growth lifetime income or something that can increase over time.” It depends on the plan, it depends on what’s important to you, it depends on which flavor of ice cream you like.
Brief summary. We’ve talked about three variations of guaranteed lifetime income structures with fixed indexed annuities. The first one was fully guaranteed roll-up rate. I used the example of 7%. The second one was a projected growth example so instead of having a guarantee of 7%, the growth of the pension account is a function of how much the cash value grows. Sometimes there’s a multiplier there like 200%. If you earn 3% on your cash value, your pension goes up 6%. If you earn 4%, it goes up 8%. If you earn 10%, it can go up 20%.
I recently saw a client within four years almost double their pension account. It would have taken at least 10 years if they had the 7% guaranteed lifetime income roll-up. Now that’s not normal, we don’t expect that to happen, but I’ve seen it a few times in my career. The third one is also a projected lifetime income contract, but it has built-in inflation protection that allows your income to increase over time which, again, usually is a function of how the performance of the cash value is doing. It’s important to note with all three of these, no matter how long you live, you will always receive a lifetime income.
A really cool concept that can add a lot of value to the lifetime income strategy is what we call a long-term care income doubler. These were introduced in the industry probably about seven or eight years ago, and back then, only one or two companies offered this feature, but today there are dozens of products in the marketplace that have this feature, but not all of them are created equally so I’m going to let you know what you need to know in order to identify the best doublers from the ones where, personally, I would stay away from.
The concept is simple. Whatever lifetime income structure you have, it’s going to guarantee you a certain amount of lifetime income. The doubler comes into effect if you are unable to perform two out of six activities of daily living. This could be structured to where you’re covered and your spouse is covered, but it’s a general qualification for long-term care. Two out of six ADLs, activities of daily living. They’re bathing, eating, dressing, toileting, transferring in and out of the bed, and also if you’re incontinent. If you’re unable to perform two out of six of those, your doctor has to write a note or approve that, yes, you are incapable of performing those activities of daily living, two out of the six.
The insurance company is going to double your lifetime payment, in this example from $35,000 to $70,000 per year, typically for a maximum of five years. I think about 90% of the companies out there that offer this benefit as part of the guaranteed lifetime income package, it’s going to double your income for five years. After the five years, if you’re still in a nursing home, your income reverts back to the $35,000 per year for life so you never lose this. It’s just an increase, it’s an enhancement to your income, to help offset the bills. It’s not designed to pay for all of your long-term care. This is not long-term care insurance. It’s just designed to increase the amount of income you have coming in to help offset those bills later in life.
Now, with these long-term care doublers, there’s something very important you should understand. Every company has their own set of rules of how that money will pay out. There are two primary components. The first one is pretty basic. They all have the same. It’s being unable to perform two out six activities of daily living. Most of them are going to require a letter from your doctor. You may have to be reauthorized with a letter from your doctor every year. You don’t have to deal with the insurance company attorneys and all that stuff. It’s just, if you’re unable to perform those ADLs, your income doubles so they basically all have that qualifier.
The second qualifier, it’s very important to understand. In order to have this conversation, I have to go back through how the death benefit works here and the cash value. To keep things simple, I’m not changing these numbers here. Assuming we made a $300,000 deposit, our principal over time grows to $500,000. Our income our pension account, is always going to be higher. Let’s say that calculates to give us a $35,000 per year lifetime income. Well, how the cash value works over the next 20 years, let’s say, is the cash value will increase based on any interest earned, the cash value will go down based on any withdrawals that you take out similar to any account. If you put money into the bank, it earns interest, it grows. You take money out, it goes down.
Same concept here. You need long-term care, let’s say, at age 89. The majority of the contracts with these long-term care doublers on the marketplace., if you’ve taken so much money out that your cash value goes to zero, that means you have no more death benefit. All of these contracts will continue to pay you the $35,000 per year for life even when or if your contract value goes to zero, but there are only a couple companies in the marketplace that today, as of recording this video, once your cash value goes to zero you still have the long term care doubling feature.
No matter how long you live, no matter how much money you take out, you could take out $600,000 $800,000, $1 million dollars from the lifetime income payments over time, a 25-30 year period, and if you need long-term care in your home or in a facility, your income is still fully guaranteed to double. That’s a very impotant feature. If you’re shopping these annuities around, if you’re talking to someone and this is brought up, make sure to ask, “What happens if my cash value goes to zero? Will my long-term care benefit still double?”
Now, I want to have a discussion about generating the maximum amount of income versus generating a little bit less income but possibly having more value for your particular retirement. Two examples. Completely identical here as far as the structure, 7% roll-up 7% roll-up, we put the same amount of money in. This option over here is going to guarantee us a little bit less of an annual paycheck for life once we decide to activate the lifetime income when compared to this one over here, which gives us $32,000 versus $28,000.
At the end of this 10-year period, assuming it’s a 10-year deferral, this one, even though it gives us less annual lifetime income, the principal is much more likely to grow to a higher number. I’ve just hypothetically written this in, $525,000 versus $450,000. If death benefit is important to you or maintaining a higher cash balance, it may be more attractive to you to have not the maximum guaranteed income that we can get on the marketplace for you, but to have a good income that meets your needs while also giving you very, very good cash value, accumulation, or growth potential.
Now, if we extrapolate this out further 20 years later we pass away, with this one we may still have a death benefit of $150,000 or $250,000. I wrote in $200,000 here because with more cash value accumulation potential as we’re receiving that lifetime income, we don’t forego access to our principal just because our pension started. We still have access to that principal. It’s still our death benefit. Whereas over here, yes, we have more guaranteed lifetime income but we don’t have the same cash value growth potential so this one may go to zero.
Now, two really good contracts on the marketplace right now that offer this decision to be made, one of them does give you maximum income, modest cash value and growth potential, but this one has the long-term care doubler. Even if the cash value goes to zero, it’s still fully guaranteed to pay out. That’s another discussion to have. Yes, we don’t have as much growth potential or death benefit potential over here. We have more income with the long-term care doubler versus this one, no doubler, good income. Not the maximum amount but a higher potential to be a lump sum death benefit for your beneficiaries.
Again, one’s not better than the other. They’re just different tools that are available on the marketplace and having a plan and fitting these into the plan and having a discussion with someone you trust and is educated and knowledgeable about these strategies, that’s how you get the best plan for your retirement.
I want to bring this video to a close by sharing with you. Some of the experiences that I’ve had of why people go this direction with part of their portfolio and to generate guaranteed lifetime income in retirement. First of all, there’s a concept we talk about called baseline spending or baseline income planning. Ultimately, we’ve seen that many, many people we’ve worked with over the years, like to know that they have a certain baseline of income coming in, no matter what happens in their life. They want that to be coupled with their social security.
It may be that’s $60,000, or $80,000, or $45,000. Whatever that number is, a good segment of people we’ve worked with want to know, “Hey, no matter what happens, I’m always going to have at least $60,000 or $70,000 or $80,000. If the market does well, if the market performs poorly, it doesn’t matter because I’m always going to have that baseline taken care of and I’ll be okay.” The second reason is we’re big believers, and many of our clients are, in multiple streams of income and we want those streams of income, at least two or three of them, to be separate from the stock market performance. We need to own stocks for long-term growth. We’re big believers in the stock market.
We also are big believers in having a diversified portfolio and a diversified multiple streams of income and retirement. These guarantee lifetime income tools help to bridge that gap between depending on the stock market to generate your income and hoping for good returns long term to actually knowing how much income you’re going to have irrespective of the market performance. The third reason we see is that many of our clients want to make sure that they have enough income to help pay for medical costs or long-term care costs down the road. Inflation is going to be permanently high in those areas as we’ve seen for many, many years, so our understanding that we have a certain level of income to pay for those costs helps many people be more comfortable spending their money today and enjoying their retirement.
We’ll see sometimes the deferred income strategies deferred for a long time because you get more bang for your buck that way, but it also ensures that there’s a high level of guaranteed income later and if you add one of these doublers onto it, then you have even more income if a long-term care need arises. The fourth one is a lot of times spouses want to make sure that when one spouse passes away and they lose a social security check or a pension that they’ve pre-planned to make sure they have something to turn on, something to activate, that replaces that lost income. Social security replacement or pension replacement is a big reason we see people put these strategies in place.
Last but certainly not least, the number one reason that I see people put these strategies into place with part of their retirement funds is simply because they bring peace of mind. They bring security, they bring a stable sense of knowing that there is some secure income that is not dependent on the stock market that’s going to be there for them no matter how long they live, or if something happens to them that their spouse is going to have a certain amount of guaranteed lifetime income.
Next week we’re going to start to put it all together and talk about strategy. We’re going to talk about income strategy. Putting these together in a retirement plan. How they can complement your stocks, your bonds, your real estate. It’s all about strategy and planning with the information we’ve gained from these videos so far in this series and how we put it together in a plan. At the end of this video, also, you’re going to see a list of the videos. They’re meant to be watched in sequence so I encourage you to start from the beginning.
If you haven’t watched those, make sure to go back, watch those videos and continue to join us on this journey as you become more educated about your lifetime income and safe growth options in retirement.