Smart Retirement Investing: Biggest Misconceptions of Fixed Index Annuities Clarified by a CFP®

In today’s video, we are going to revisit a video that I did about a year ago. It has 36,000 views and 23 comments. I’m looking for videos that do have a significant amount of comments where I can address them and answer them in one video. It’s all about the same one. You can actually go back, watch the video, understand the comments or questions that are being asked, and then the answers to those questions.

Today’s video was “Guaranteed Lifetime Income Benefits for Fixed Indexed Annuities in Retirement.” Annuities are always a controversial topic. We have some positive comments, we have some negative comments, and we’re going to go through and address most of them. First one, Missouri6014, one year ago. “This was an excellent presentation and confirms my decision to have two fixed indexed annuities, both around 250,000.” They go down here to say they performed, just like Sean said. I’m Troy, not Sean. He does say, this is a good point, this is one year ago when the market was down 20%, 30%, 40%, and he says, “I’ll probably make a zero this year, which is a lot better than a 30% drop that are the mutual funds that I’ve gotten.” I’m reading what he said there that I have. Good point.

Fixed index annuities. If you add an income rider to them, they’re just a tool to provide guaranteed income. You’re going to have your protection of principle, you’re going to have a fixed amount of income that will be provided for your life or you and a spouse for as long as you’re both living. They’re just a tool. They’re never going to outperform the market, even though they track the market. They’re not a stock market replacement. They’re a safe growth tool that can provide lifetime income. Thank you very much, Missouri6014.

Scott says, “My paternal grandfather lived to 102. Maternal aunt lived to 103. It adds a significant dimension to retirement planning.” Wanted to point this out because it’s extremely profound. It does add a very significant element to planning when you have the possibility of living a very extended life. Thank you very much for the comment, Scott. Schnell, appreciate the compliment. Joe says it’s hard to find straightforward information on the subject.

Again, thank you very much. This is the purpose of these types of videos. Annuities, they may not be right for everyone, especially variable annuities. Fixed index annuities are typically more appropriate for people, in my opinion, in retirement because you’re going to have less fees, you’re going to have more safety of principle, you’re going to have typically more competitive income guarantees, but they’re not for everyone. Understanding how the tool can be used as part of a broader plan is the purpose of these types of videos.

Voyager Probe says, “Great stuff. Follows part of the strategy advocated by Tom Hegna.” Hegna, however you pronounce that. Tom has a lot of books out there and a lot of good reading material. If you want to learn more about fixed indexed annuities, guaranteed lifetime income planning and how these tools can fit into an overall retirement plan, I do encourage you to google Tom’s stuff. He’s done a lot of research, has a lot of good points, gets paid a lot of money to do speakings. We actually reached out to his team to see if we could bring him on the YouTube channel several years ago, but they wanted some exorbitant sum of money and we just weren’t going to pay that.

Nadine Jordan says she wants to retire in Panama has a question. If this type of income helps to qualify, you’re going to have to reach out to the Panamanian government for that. We’re not able to do that. Mike says, “Decent video. Good attempt to explain a complicated product. This is the single reason I stay away from annuities. I feel I understand personal finances very well, but annuities are clearly stacked in the insurance company’s favor with too many ifs and buts. When insurance companies come out with a product that only takes a couple of pages to understand, I might consider it.”

Well valid point. It is a contract between you and an insurance carrier and the insurance carrier with fixed annuities, with variable annuities, they have to have some type of flexibility in there to protect the carrier, which protects all the consumers. Let me give you an example. First, a couple of things to point out here, variable annuities, one of the most popular variable annuity contracts in the marketplace today has a contract, a prospectus that’s over 1,000 pages in length.

Most of your fixed annuities, fixed indexed annuities are anywhere from 5 pages to maybe 15 to 20. A tremendous difference in complexity when you’re talking about variable annuities versus fixed annuities or fixed-indexed annuities. Let me give you an example here. First, this video is about guaranteed lifetime income benefits. This is when you attach a rider to the contract that says in X amount of years, it’s a deferred income annuity. You are going to receive this much money.

Contradictory to your point here, there are no ifs and buts with that. That is a 100% fully guaranteed lifetime income payout. If you hold the contract for that number of years, you deposit X amount of dollars, you will know 100% what that income is going to be. No ifs and buts there, but the insurance company does have the ability to adjust caps to adjust maybe participation rates.

From my experience, and we’ve been working with a multitude of insurance companies for many, many, many years, they’re not out to get you. Okay? 99% of these carriers they have a reputation to uphold firms like ours and others. If we see insurance companies doing something they shouldn’t do necessarily by maybe having a teaser rate to get you in and then dropping it to where it’s no longer attractive, we’re never going to recommend that company ever again.

There are some nuances within the contracts that the carriers can adjust from year to year, but it’s not for nefarious purposes. It’s simply to protect the consumer because economic conditions change. Nobody can predict the future. When it comes to some of the safe growth tools and also even some of the riskier ones like variable annuities, the insurance companies have to have some mechanisms that are built into the contracts that allow them the ability to maneuver through various economic environments.

Thank you very much for the question and the comment, Mike. Again, annuities aren’t right for everyone. They may not be right for you. Okay. The next comment here comes from JD Golf, and it’s also, again, one year ago. “For a fixed immediate annuity, what is the driver of the payout? Do long-term, say 10-year or greater bond yields determine what a monthly payout should be?” He goes on to say he’s looking to take a lump sum payout for an old pension. He sees that the payouts vary weekly, and he’s thinking about taking the option that reduces if he passes away 55% of the benefit to his wife.

You’ll get a certain amount of income. If you pass away the remainder benefit to your spouse, you’re thinking about choosing the option that she would get 55%. For this type of annuity, typically, you’re going to have multiple different choices. You could have 100% beneficiary to your spouse, 50%, 75%, all these different levels. You could also just choose a life annuity where there’s no benefit. You’re the only one that receives that guaranteed lifetime income.

Your question though is what is the driver of the payout? The simple answer here is it’s normally longer-term interest rates because unlike banks, insurance companies have very, very strict rules about what they can invest in. Insurance companies must have a 100% dollar-for-dollar legal reserve of the money they owe people. When you’re looking at insurance companies, it’s typically going to be the 10-year treasury or possibly some longer-term corporate bond index, high-quality, investment grade, corporate bond index. Usually, it’s the 10-year treasury.

You might be talking about a pension as opposed to an annuity from an employer. It sounds like you are, but the concepts are fairly similar. One thing to point out though, this video is discussing deferred income annuities, whereas your question references an immediate annuity. Where you start income within typically 30 days. Hopefully, that helps answer the question.

Lorraine P says, “What if I keep my money in CDs instead of an annuity?” CDs are a safe investment. CDs are backed by the strength of the bank that the money is deposited with. If you stay under certain limits, you have FDIC protection. Now, we just seen since you posted this comment probably three months ago, that Silicon Valley Bank, for example, and I think First Republic, two banks, that overnight essentially go out of business. The government bailed them out, completely stepped in. Without the government bailout, if you had any money in the CD that was above that $250,000 limit, you would’ve not received anything.

Another thing to keep in mind here is that there’s two big differences between CDs and annuities. The first one is CDs are taxed annually. Meaning if you make 4% in a CD, that 4% interest, assuming this isn’t inside of a retirement account, is going to go on your tax return. You’re going to pay tax on that this year, and you will be left with less money after taxes.

Annuities, fixed annuities, let’s say we compared two of them, five-year CD versus a five-year fixed annuity. Typically, because insurance companies invest in longer-term assets, they typically offer higher interest rates than CDs. It’s almost 99% of the time. If we do a comparison of the best five-year rates in CDs and fixed annuities, the fixed annuities are always going to offer more.

The taxation of the fixed annuity is tax deferred. If you make that same 4%, you don’t pay taxes on it. 4% goes into that contract. It accumulates unless you distribute it. If you distribute it, you pay tax on it. That’s the difference. You can allow it to compound inside the fixed annuity and not pay any taxes until you actually take the money out. With the CD, you have no choice.

The second big difference between CDs and annuities is that annuities can be turned into a guaranteed stream of income that you can never outlive. CDs, they renew. You have to decide what to do with your money. Annuities do renew as well and you can either take your money and go home or you can purchase another annuity to continue the tax deferral.

You always have the choice with an annuity to turn it into a stream of guaranteed lifetime income. One of the cool parts, if you do that, you get to use a little-known IRS rule called the exclusion ratio, which allows you to take interest and principle out at the same time. You may have a significantly tax-free income provided for life. It may be 50%, 60%, 70% tax-free. Just depends how much interest has been accumulated versus the principle that was put in.

Really good comment for this next one and also a couple of replies. Scott says he’s talking about indexed annuities, not SPIA’S. Run as fast as you can. First off, SPIA stands for Single-Premium Immediate Annuity. I am talking about indexed annuities In this video, which is a deferred income annuity, the tool that’s designed to make a deposit, your money’s going to be safe from market losses, and as it grows usually by some specified rate, 6%, 7%. It’s then going to give you a quantifiable amount of lifetime income that you can never outlive. It’s different from a SPIA in the sense that SPIA start income immediately within 30 days.

Robert Young replies, “I made 21% on my FIA fixed index annuity in one year because I purchased it at the bottom when the S&P had tanked. It is a five-year FIA product. It was flat last year, but even if the gain is only 21% over five years until the surrender period, I think I’ve still done well.

Many stock accounts are down 20% in the same timeframe.” Scott responds, “No way, 20% in one year! Indexed annuities are capped somewhere around four to 6% per year.”

Scott, unfortunately, you are wrong and it’s not your fault because there’s a lot of misinformation out there. Indexed annuities have an option of a capped growth rate of 4% or maybe 6%. In today’s market, they’re 12%, 13%, 15%. What Robert most likely purchased or allocated his investments to inside the FIA is what we call an uncapped index. With uncapped indexes, we’ve seen double-digit returns similar to what he’s speaking about over a one-year period. One of the best things about the fixed index annuity is those gains then get locked in.

If the market’s down the next year, you don’t lose any of your principal, you don’t lose any of your interest. Now, when Robert purchased this, interest rates were very low, so it made sense for most people to go into these uncapped indexes. A lot of the marketing against annuities leads people like you, Scott, to believe that caps are super low. You should always stay away from annuities because of the caps are low. They’re not telling you the whole story. Reminds me of Paul Harvey when he would say, “Now for the rest of the story.”

The rest of the story is that yes, you do have capped options inside some of these products that in a zero interest rate environment were maybe 3% or 5% or 4% or 6%. They also had uncapped options that allowed you to participate in the growth of the market. Very interesting dialogue here and I tend to believe Robert because I’ve personally seen it myself multiple times over the course of my career.

Two more comments here. Rbkna5 says, “Have you ever seen anything more confusing?” If you can’t explain it in five minutes, do you really think you should invest in it? Try explaining it to someone. It is written by lawyers and would take a lawyer to understand all the paperwork. I do have an annuity, but I may regret it. I’m not sure.”

Kind of confusing comment, but I do get it. Let’s put some perspective into place here. Again, variable annuities, typically 500 to 1,000 pages in that contract. Your fixed annuities, your MYGAs for example, typically 5 to 10 pages. Your indexed annuities typically 10 to maybe 20 pages, but still they’re written by lawyers. They have some moving parts. They’re not as simple as, let’s say, buying a bond.

Let’s compare it to just your normal mutual fund. If you look at your portfolio and the mutual fund every single year, you get that prospectus and you read it page by page, cover to cover, correct? No, you don’t. No one does, but you still invest in mutual funds. People still invest in all of these different tools that have contracts or prospectuses that are written by attorneys and a lot of times are hundreds and hundreds, if not thousands of pages long. It’s a trade-off. What is your risk? What is your reward? What are some of the possible outcomes? Never put all of your money into one particular basket. We’re looking at using multiple tools to accomplish certain objectives in retirement. I don’t know which annuity you own. You may regret it, you may not regret it. There are really good ones out there. There are some really bad ones out there, in my opinion. Or at least ones that I wouldn’t personally invest in and others where I would.

The last comment that inspired this video was from three weeks ago and comes from Cynthia. Cynthia says, “This is an extremely misleading [chuckles] video. It implies that you would get a 10% return on your investment. If you’re able to skip the annuity and find an investment that earns 10%, you could pay yourself the $30,000 a year starting at age 65, and at age 90 you would have over $5 million more than you would with this annuity rider. In this example, the return is less than 3.5% if you live until your expected age of 83.”

The video is not misleading. It very clearly states that your average guaranteed lifetime income from some of the better products on the market is equal to roughly about 10% of your initial deposit. Now, if you can find a 10% interest-bearing quality investment that we can make a deposit into and receive that 10%, as you mentioned in the comment, please let me know because that is something that again, I think every single one of our clients would like to invest in.

The truth is, there is no quality investment that guarantees you 10% per year. You do have a good point where if you could find that 10%, you would never need this particular tool, but since that tool that you mentioned does not exist without a significant amount of risk, I could go find an MLP, for example, or some type of oil and gas investment that pays me 10%, but that carries significant risk to not only your principle of potentially losing half of your investment, but losing half of your investment, and then that income no longer exists.

The fixed indexed annuity with an income rider, it’s simply a tool, and Cynthia, may not be right for you. For those that want to know, if I make this deposit come heck or high water, no matter what the stock market is doing, if I deposit $300,000, I’m going to have $30,000 per year, let’s say at age 65, well, that tool may be appropriate for them. That’s the purpose of this video, to help introduce you to some of the tools that are out there, but also clarify some of the misconceptions that surround them.

That was also the purpose of this video today. Guys, if you have any more questions or any more comments on the video or what I went through today, feel free to put them in the comment section below. We’ll re-look at this and if we get enough comments, I’ll make another video responding to your ideas.


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