Retirement Planning Core4: How To Achieve Peace of Mind In Your Retirement with Jessica Cannella

Jessica Cannella: Hi, I’m Jessica Cannella, Co-founder, and President of Oak Harvest Financial Group. Today, I wanted to chat with you a little bit about our core four framework, which is a blend of investment management and financial planning. I really wanted to focus on that very first pillar, the peace of mind pillar, when it comes to retirement and retirement planning, peace of mind is paramount. I’m sure that everybody is experiencing a little bit of fear right now with what is going on in the market, especially if you don’t have a great understanding as to what safe tools are available to you.

In today’s interest rate environment, unfortunately, gone are the days where we can just put a chunk of change in our savings account and get a nice 3% or 5% yield back scot-free with no market risk. Also, our bond market is not let’s say it’s less than ideal yielding you know, 1.5%, 2.5% barely keeping pace with inflation. Where we look to provide peace of mind in retiree’s lives when it becomes appropriate based on their own set of circumstances might be in the insurance industry, and specifically, through the use of a tool known as I like to call it the A word because there’s a lot of misconceptions if you have not been educated, the bad A word that I’m referring to is annuity.

There are several different types of annuities out there in the marketplace. Today, I wanted to focus on one that we use here quite often, again, when it is appropriate. It’s not a magic bullet, but we use here at Oak Harvest Financial Group called a fixed indexed annuity, a couple of things about fixed indexed annuities. They are known for safety, that word fixed pertains to the fact that your principal value, or the amount of money that you fund your annuity with from the outset, cannot be reduced due to market risk, they are 100% safe from market risk, that’s that word fixed.

The word Index refers to what we’re going to dive into today, which is the ability for your principal to grow as it indexes with the upside of the market based on index options available within your contract. Now, these strategies are offered through insurance companies. Remember the old childhood fable, the three little piggies with the big bad book that would huff and puff and blow your house down? Well, we liken that to the financial industry and we call the insurance industry, the brick house. The reason that we call it the brick house is that it is rock solid.

Even in a financial crisis insurance companies by their nature, how they are structured have to have a dollar-for-dollar reserve. That’s very important when you’re talking about investing a lump sum of your hard-earned dollars into a strategy like a fixed indexed annuity is that these insurance carriers they have a contractual obligation that if they have, in our example, $100,000 of your money, they have to have it on reserve for you to the tune of $100,000. We know that in the banking industry, it is the FDIC insurance that is up to $250,000 per account, very different roles for the insurance industry, fixed index annuities are very safe.

Now, there are many considerations to be aware of that we’ll cover today when you’re considering the purchase or utilizing a strategy like a fixed index annuity. I say this all the time with my clients on meetings and prospective clients, there is no magic bullet in finance, and an annuity is no different. The specific kind of annuity that we’re going to talk about today, again, is the fixed index annuity.

Now one of the most noteworthy things about a fixed index annuity is that you’re going to have the option to participate in the market upside in exchange for no market downside or no market risk to your principal, the amount of money that you put into the contract. You will have what we call a par rate or participation rate par rate is short for participation, which is going to pre declare what the percentage will be that you can participate in any one of the index that your contract is following.

For the sake of easy math, and illustration purposes, we’re going to say that in this example, our index is the S&P 500 and we have a 50% participation rate. This would be, depending on how you look at it, a consideration or benefit of a fixed index annuity. I call it a consideration is that the insurance company says, “Hey, we’re not going to allow you to participate a 100% in the market upside in exchange for no market risk.” They’re in the business of making money. No secrets there. We’re going to hold on to 50% of whatever the upside is but, in years, where the market does not perform or is down, you will not lose any of your principal.

Again for easy math, we’re going to follow this example here that a client puts $100,000 into their fix and annuity contract in the year 2022. We’re recording here in July. I’m going to say from July 2022, you put a $100,000 into this type of contract. A year later, it’s called point to point on your contract anniversary date. It would then be July of 2023. Let’s say that the S&P 500 yields 10% from the point in time, July ’22 to the point in time 12 months later in July ’23, positive 10%. Now, remember the participation rate is 50. I like to do a little bullet point right here illustrating that you’re not going the full climb up with the market.

You’re going halfway up for 50% participation rate or 5% interest credited to your original investment of a $100,000. What’s really cool about a fixed index annuity is that your new principal every year that interest is credited to your account, it locks in and that’s called an annual reset. Now in the fine print depending on what contracts you’re investing in, you want to be cognizant of how long is the reset period.

We’re going to use the example of annual so 12 month period whatever interest is credited becomes your new principal protected value. In this example, just a quick recap, the market goes up 10% from July 2022 to July 2023. When you’re sitting down and reviewing your contract with your advisor, it’s positive 10%. You get 50% participation on that S&P 500 index for 5% interest credited to your initial investment of 100,000.

That’s going to put you at 105,000. Every year that interest is credited to your account. What I love about the fixed and index annuity tool is that your new principal-protected value locks in and that is called an annual reset. Now in the fine print of whatever contract that you are purchasing with whichever insurance carrier, you want to make sure that you understand how the reset works. This one is an annual reset.

In English, every 12 months when interest is credited from point in time to point in time in our example here July 2022 to July 2023, our new principal protected value is no longer 100,000. It’s now 105,000 and in certain contracts, it’s very important that you have your advisor explained to you. Is it an annual reset? Is it a two-year reset? Is it a three-year reset? I’ve seen as high as six-year resets. That’s very important.

What that means again in English is that your interest will not be credited. If it’s not an annual reset, it won’t be credited to when the clock starts again. If it’s two years interest is credited every two years. If it’s six years, in every six years taking a total average of whatever the index performed over that six or two year or one-year period. I digress. Let’s look at what happens in a down year.

Now next the contract is annual reset. Now we know what our principal value was at the end of July of 2023. Now the clock starts again and now it goes from July 2023 to July 2024. Let’s say that the market does what the market is doing right now. It’s going down. It’s been turbulent. When we look at July 2023, through July 2024, the S&P 500, we’re in a recession and it goes down negative 20%.

What happens? Nothing. This is a defensive tool. You are staying at 105 for the year 2024. Your principal locked in from the year previous. The market did negative 20. We mentioned there is no market risk. That means 0% of zero is zero. You get zero interest credited, big goose egg, and your principal protected value sticks at 105. I’ll take this moment to tell you that it’s the zero years that would be purchasing this product or this type of strategy.
Fix and next annuity is not a tool because you want to aggressively grow your portfolio. You’ll have some growth along the way. Typically, over a 10-year period you can expect to average between 4% and 6%, year over year. That includes some zero years and if you’re lucky, some double-digit years and we’ll look at that instance next.

This is a defensive strategy this is the piece of mind pillar in our core four frameworks. This is the strategy where you want to say, “I don’t want my money to go down in the bad years,” and we’re going to look at a graph that’s on our website on Oak Harvest Financial Group.com after we run through this illustration so that you can see over a long period of time an 18-year timeframe, how this strategy actually, based on this criteria, has performed over an 18-year time horizon.

Picking up where we locked off here, now we’re looking at the clock starting again for our annual reset from 2020 to July of 2024, going to July of 2025. Let’s say that we are coming out of the recession and when we know when that generally happens that we, oftentimes have a couple of good years after that. Let’s say the market goes up 25% on the S&P index, and we get 50% for our participation rate of 25%. That’s a whopping 12.5%, credited to wherever we left off for compounding interest that’s very powerful. On our 105, because that’s where we left off in our down year in 24.

Now we get credited 12.5% on 105 which brings us to a new principal protected value of 118,000 and some change but for easy math, I just wrote 118,000. This will bring me to another point. I feel like sometimes annuities get a bad reputation because of a lack of explanation at the forefront. What I’m referring to here is there a cap? We talked about a floor. The floor is this, there’s no market risk. You cannot go below zero, the example we gave in the year 2024.

Also, in the fine print with some of these insurance companies, you want to understand is there a cap? Is there a ceiling to my upside potential? I’ve seen this quite often where it might say, “Okay, yes, you’re going to get your participation rate at 50% on whatever the S&P 500 index performs point to point, and as long as that number does not exceed 10%, you will get that interest credited, 10% being the cap.” Now we tend to look for strategies that do not have caps because these double-digit years are very important. When we’re looking to average four to 6%, we want to nail it out of the park when the opportunity, especially coming off of a zero year, is there for the taking.

It’s not typical that you’ll average double digits in this type of strategy but it is also very possible that you can. Having the flexibility of not being pigeonholed to a ceiling of your upside potential, becomes very important and it’s something that, you really want your advisor to be forthcoming about how your specific contract works before you purchase it. You get the gist here. This will bring me to another point of fix and next annuities, a big consideration on a fixed index annuity. You can see that it’s gradually going to grow over time. Time is one of the biggest considerations when we look at utilizing this tool.

Typically, a fixed and index annuity has a 10-year term, six, seven or 10 years. Now, 10 years is a commitment. It becomes very important that you understand what are you getting into for 10 years because it becomes very expensive by way of fees or surrender charges or you’ll hear it called an exit fee. They’re assessed by the insurance company if you break the contract term. Effectively, the insurance company wants to know, in exchange for giving you a participation rate on an index with no market risk, typically low or no fees. We’ll discuss that more in a moment. How long can they hold your money for? Because these insurance companies have been doing this for decades.

In fact many of them are still enjoying bond returns from the 80s, because they know how long, they can hold onto your money for. That is extremely important that you’re not putting too much money into a contract that you’re going to have to have for 10 years. I’m going to talk to you a little bit about how the surrender charges or exit fees work to give you some education around that.

That is extremely important that if you are considering the use of this tool that you understand, what it is that you’re signing up for, how long you’re signing up for it, and what the cost is to you to get out of it. We’ll jump over to that in just a moment. I wanted to show you a continuation of how this works. I promised on our website, you can check out a graph here. I’m going to show you where to grab it from. You’re going to go under the knowledge center and under annuity education. Some great articles here frequently asked questions.

I love this article it illustrates what we just covered it’s called the power of zero. It assumes the same criteria that we just covered in my little whiteboard illustration. Only, now we’re looking at an 18-year time horizon. When I say it assumes the same criteria, I’m referring to the participation rate being at 50%. Using $100,000 as our figure, and then what we’re looking at here is a red line, which represents the S&P 500, and then the green line, which is indexing with the S&P 500 without the downside. You can see that following the red line, it’s a turbulent ride it’s following the ups, and downs of the market.

I like to explain this in meetings with my clients in plain English. I like to think of this illustration as two guys are outside, and they’re comparing their lawns, and they get on the topic of finance, the market’s turbulent, and the neighbor A says, “Hey, Bob, how’s it going? Your grass is greener over there. How’s your portfolio doing?” He says, ‘Oh, it’s 1998 I’m doing great. Following the S&P 500, I’m in an index fund, and I’m taking the climb up.” Then George, across the way said, “Oh, okay, well, I didn’t make quite as much if you can see these figures it’s 120 and 115, because my advisor has me in this tool called a Fixed Index Annuity.”

If it wasn’t explained correctly, as the market is going up, and you’re only recouping, and I say only, but you’re recouping 50% of the market upside, you might be a little bit upset if their neighbor, Bob, is making more money in his portfolio, just in the S&P 500. We’re going to assume that both of these individuals are retired. The year 2000 happens, and now George is probably pretty upset if he’s talking about the neighbor couple years later, and Bob is telling him my portfolio is up over 130,000, how’s you doing, and he’s hanging around 125.

In the very next year, 2001 we had the .com bus911 happen, and we have a crash in the market. Bob is probably feeling a little bit queasy, especially if he’s retired, that his portfolio is basically cut in half. George is probably feeling pretty content that he stayed locked in at 125, and for three years, you can see until the market started to rebound that he stayed at 125 for three years.

For three years, he went in, reviewed his contract statement with his advisor, and they informed him that you received zero interest credited. Again, I’ll take this opportunity, this is why you would consider purchasing this strategy, or utilizing it in your portfolio because it’s those zero years that are really important, and for this reason. When Bob finally starts to climb back up, he’s starting at a much lesser value than George across the way, who has left off at 125,000, and then gradually took the climb back up.

Right about when Bob, is probably feeling pretty good in 2007, and his portfolio has exceeded his initial losses over here, or his gains before the crash of [unintelligible 00:18:51] the year 2007 and he’s feeling back on top of the world. We all know what happens in 2008, and it’s really sad to see that his investment goes back down to a hundred thousand.

In retirement, it’s not so much the money that hurts, because if you’re still working, these are buying opportunities that Bob has had along the way if he has earned income coming in, once you’re on a fixed income, or you’re having to turn all of your nest egg that you’ve accumulated, and you’re having to distribute it back to yourself, this becomes really painful, and it’s not so much the dollar amount, it’s the time. It’s that time is our most important investment element.

You can see that he’s right back where he started, in 1998, 10 years later, he has lost 10 years in retirement, and $45,000. Whereas George, across the way we using the Fixed Index Annuity tool has steadily, and Shirley climbed up with the S&P 500 when the market is down, he recruits zeros in his accounts but he stays level, he goes sideways instead of down, up, up, down. Over time, you can see that– Another way I like to explain it is that the fix and index annuity is performing like the turtle and the S&P 500 is the hair. It’s a race, and the slow and surely turtle wins the race in this illustration.

Check out this article on our website. Very informative. You can read a little bit more about functionally how the fixed and index annuity works. We’re going to jump back over here and talk about some of the considerations. We talked about caps. We talked about– Compound interest is another one. The example that I ran through in the example on that chart, there is compound interest available, not always in a fixed and index annuity. That again is something in the fine print that you would want your advisor to be upfront with you about.

Fees. I put a question mark next to fees because often there are no fees in a fixed index annuity or very low fees. The reason for that is it’s a very consumer-friendly option. It’s also, I believe, one of the reasons that you won’t hear about a fixed index annuity or how it could be a benefit to you in your portfolio from big brokerage firms or banking institutions because there are typically not ongoing fees paid to your advisor. I say typically because as the interest rate environment has suffered over the last 10 years, interest rates have been very low.

These insurance companies have begun to assess low fees. I say low to me, that means south of 2%, generally around 1%, 1.25, 1.5% on your cash value or the amount of principal that you put into your contract. One of the things I hear from different people is that you want to stay away from a fixed and index annuity because your advisor gets paid a big fee and that’s not incorrect.

Your advisor is representing an insurance carrier. There are licensed agents. These insurance carriers, many of them use their marketing budget. In other words, money that they would’ve otherwise used to do commercials, glimpses, and mascots, to explain how their strategies work. That would be a pretty ineffective use of those marketing dollars. In other words, [unintelligible 00:22:31] is not getting the message across everything I just explained. I feel like if you’re not seeking this information out, a 32nd commercial spot would not do its due diligence with all of the fine print to explain what we just ran through today.

In exchange for– Basically, they repurpose their marketing dollars that they would’ve otherwise used, like our big household name insurance companies that sell you auto and property insurance. These life insurance companies use that budget to compensate or commission license agents to recommend when appropriate and determine if a prospect is suitable to be in one of these strategies. That is in the form of a commission, and generally, is a percentage of whatever you have allocated into the strategy. This is very important as a consideration.

First and foremost, it does not come out of the account owner’s money. If you put a hundred thousand dollars into the contract, your advisor’s commission is not coming out of your $100,000. It is very important though, that you work with a reputable, preferably fiduciary that knows what they are talking about and has options all over the place and is not pigeonholed to just one insurance carrier with one or two strategies. There’s a lot of crap products out there. It’s all should be very goals based because you don’t want an advisor picking their commission.

The most important thing when it comes to your money and deciding if a fixed and index annuity is right for you is the amount that you’re going to put it in. I mentioned a couple of moments ago that an advisor is generally compensated on the amount that they put into the strategy. Let’s say you have a million-dollar portfolio. An insurance company might allow the agent or advisor to put up to 80% of your $1 million into a 10-year term strategy and they are commissioned on the amount that goes into the strategy.

Why is this a conflict of interest if it’s not explained to you? Because you probably don’t want to put 80% of your liquid net worth, which I’ll cover in a moment, um, into an annuity. If your advisor or insurance agent cares more about their own retirement, they might put as much of your hard-on dollars into this strategy as possible because it’s going to increase their commission.

It’s generally based off of a percentage of what goes into the strategy, that does not mean that you should rule out a fixed index annuity. It’s okay to get paid for the hard work that an advisor does to explain. It does mean that you should really do your homework on which firm and which advisor or insurance agent you’re working with. I have a list of questions as you’re interviewing your advisors that really digs deep into some annuity conflicts of interest so that you can feel very informed as the consumer if you are considering this type of strategy in your portfolio. I mentioned liquidity, and that’s something that I wanted to talk about between these two.

There is often called a free withdrawal feature or a liquidity feature built into these contracts, and it can be generally somewhere between 5% and 10%. On $100,000, you put it in, and for 10 years generally beginning about the second year of the contract, again, this is a fine print thing. We want to be sure that we are being educated by our advisor on how this works. Let’s say in Year 2, you can withdraw somewhere between 5% and 10%. 10% is pretty typical from what I have seen, so 10% of $100,000 is $10,000. That other $90,000 that you put in the contract for 10 years is illiquid.

Otherwise, subject to what we call a surrender charge table. Now, I’m going to explain this in theory. Again, fine print thing here. If you decide to do a strategy like this on your policy delivery, your statement page, it will give you exactly what the surrender schedule is, but this is the easiest way I feel to explain it. This is very important, so I like to make it pretty memorable for my clients. Okay. The first line is representing percentages that the insurance company will charge you for accessing more than 10% of whatever your principal value has grown to after Year 2.

Generally, in the contract, the bottom line is representing in what year you are in the contract. I mentioned that typically fixed index annuities have a 10-year term. If you need to access your principal beyond the 10% free withdrawal feature in Year 2 the next dollar over the $10,000 in this example would be dinged at 8% paid to the insurance company. That’s pretty hefty. That’s why this amount is extremely important relative to your portfolio. In the fifth year, you are subject to a 5% penalty of whatever this has grown to less the 10% free withdrawal feature.

Now, I say what this has grown to because let’s say in Year 5 your $100,000 is now $125,000. You can withdraw 10% of whatever it’s grown to in whatever year you’re withdrawing. The next dollar over is subject to wherever you land on this surrender charge schedule. At the end of the 10 years, you are 100% liquid and you have zero surrender charges, and your advisor will talk to you about options. You can oftentimes leave your funds in the annuity contract. The timeframe doesn’t reset, but it can keep growing on the cash value side just like we talked about earlier.

Again, that’s fine print, it just depends. You can re-shop it. You can invest it into your investments portfolio, but the insurance company wants to know how long can they hold onto your money in exchange for in this example 50% of market upside, 0% market risk. How long do they get to hold onto the money before it is 100% liquid. Again, typically that’s a 10-year period. This is extremely important that we cover surrender charge or exit charge fees. Today, we covered a lot of information about a fixed index annuity, and I’m hoping that, on the next video, we can cover more about how we use fixed index annuities.

Today, we really just covered the inner working and things like surrender charges, participation rate, and how a fixed index annuity might fit into your portfolio. If you found this video informative, or you have questions, feedback, something else that you’d like me to dive a little bit deeper into drop a comment below, give the video a thumbs up and ring the notification bell so that you know when new content is being dropped.

Summary
Retirement Planning Core4: How To Achieve Peace of Mind In Your Retirement with Jessica Cannella
Title
Retirement Planning Core4: How To Achieve Peace of Mind In Your Retirement with Jessica Cannella
Description

Explore the Oak Harvest Core4 strategy, focusing on the Peace of Mind Allocation. Core4's highly effective framework is integrated into your Oak Harvest retirement plan allowing us to tailor the risk and reward potential of your entire portfolio to meet your comfort level, generate income, and provide opportunities for growth.