The Incredible Power of

It was the second day of the retreat and already by 8:30am the energy was electric in the room. 

People were excited and eager to learn more and apply what they were learning.  

As P.B.D. walked into the room, he immediately sat in a stool and began writing on his whiteboard. 

“Yesterday you learned about building on the right foundation”. 

“By definition a home’s foundation is the load-bearing portion of the structure, typically built below ground”.

“A proper foundation does more than just hold a house above ground. At a minimum, it also keeps out groundwater and moisture, insulates against the cold, and resists movement of the earth around it”. 

“Oh, and one more thing: It should last forever”.

P.B.D then explained that the I.B.R.P. Plan that we learned about the day before – the first foundation leg – not only kept the financial house standing upright, it sealed your financial house against financial eroding elements like inflation, losses, and costly health changes.

“The next leg will not only reinforce your first leg, it will allow you to create a guaranteed lifetime income stream that you can never outlive! But you must first understand it and how it works, so you can know how to use it effectively.”

Guaranteed Income…For Life?

If you’re interested in creating financial independence and freedom, you’re likely trying to figure out how you can afford to stop working, continue to pay your bills and support your lifestyle for the rest of your life. 

Well, there is one option that many people are considering: 

Annuities. And to be more precise: Indexed Annuities.

“It’s hard to avoid advertisements that knock annuities. In fact, once you start doing online research about retirement, the warnings and diatribes will follow you to your inbox.” P.B.D. rattled off.

And he’s right.

The truth is there is a real lack of unbiased information out there on indexed annuities. It seems like it’s either over hyped sales pitches from insurance agents or, Wall Street people bashing the heck out of them.

As with most things, the truth is somewhere in the middle. Hopefully this section will clear the air on some of the confusion.

Annuities 101

To be fair, I know that certain annuities are overly complex. On the other hand, some are elegantly straightforward in their purpose and design. So, it’s just wrong to dismiss a category like annuities without investigating and understanding all the products or services within that category.

Annuities are another form of retirement savings, just like IRAs, 401(k)s, stocks, bonds, mutual funds and savings accounts. They’re tax deferred, and come in a variety of types, with fixed, variable and indexed being the most common.

  • Fixed Annuities act like a savings account. There is a certain amount deposited in the account, and that money earns interest. The interest is added to the value of the account and helps the account grow over time
  • Variable Annuities act more like a mutual fund. The annuity holder selects the accounts they want to fund the annuity and puts a certain amount of money into each of those accounts. They make money based on how well those funds do. These investments, generally a mix of stocks and bonds, could lose money in the market.
  • Indexed Annuities act like a hybrid of fixed annuities and variable annuities. This newer type of annuity allows investors a shot at higher gains when the stock market is up and guaranteed minimum returns when the stock market is down. 

Additional riders can be purchased to enhance your annuity allowing things like guaranteed increases for life, expanded length of payouts, the ability to turn your annuity on and off as needed, and even double or triple your income. 

Many times these are called “Hybrid” Annuities.

Indexed Annuities are still relatively new in the financial industry, as it first gained attention in 2008. Annuities are also becoming quite popular as a type of personal pension plan. 

Annuities are also available for those who don’t have current retirement plans in place, but would like to begin one. This even includes individuals who are nearing retirement age.

Annuities are thought of as being best for people who have large amounts of money, and who can afford to diversify their retirement portfolio. Typically, this describes older individuals that have accumulated some nice savings. 

But is that the only demographic that can benefit from an annuity?

Investors in their 20’s, 30’s, and 40’s don’t always look to annuities as a place to put their money, most younger people who are forward thinking about saving for retirement beyond their work 401k plans use traditional IRA’s to save, but deferred annuities that guarantee lifetime income in the future can be very good for them too.

A What Kind of Annuity?

So first let’s talk about the term “Hybrid Annuity”.

The term Hybrid Annuity means exactly this:

“An Indexed Annuity with an optional Income Rider”.

They mean exactly the same thing. “Hybrid Annuity” is simply a hyped-up marketing term. It’s not an actual product and in fact the insurance company compliance departments usually don’t like the term Hybrid Annuity.

NOTE

The definition of the word “hybrid”; of mixed character or, composed of mixed parts.

So put simply, here are the 3 “mixed parts” which composes a Hybrid Annuity:

  1. Immediate Annuity (an annuity that pays you income immediately)
  2. Fixed Rate Annuity (an annuity that pays you a fixed rate of return like a Bank CD).
  3. Index Annuity (an annuity that links your interest to a stock market index)

The Insurance companies developed and combined these products a few years ago because consumers were looking for these top 3 types of annuity products:

  1. An annuity that guarantees income for life but allows you to maintain control of your money in case your needs change.
  2. An annuity that allows the chance to earn more than the bank with no risk to your principle.
  3.  An annuity that distributes an exact income amount every year for life.

Hence the term “Hybrid” ….

So setting aside the confusion, here are the facts about what a Hybrid Annuity is:

  • It’s an indexed annuity with an optional income rider.
  • Your actual annuity value earns interest by being linked to a market index.
  • Your Income Account grows independently of your actual annuity value (growth rate varies).
  • At some point in the future you can turn on your guaranteed lifetime income.
  • The longer you wait the more guaranteed income you get.
  • The income is guaranteed for life.
  • You maintain control. You can start and stop the income if you need to.

The Power of an Indexed Annuity

The advantage of an Indexed Annuity is that you can’t lose your money, regardless of index performance, unless, during the early withdrawal charge period, you withdraw money, surrender your contract or annuitize your contract.

Simon invested $100,000 in stocks that make up the S&P 500® index. Over a 10-year period, he faced a dramatic market. Because his investment didn’t offer downside protection, the value of Simon’s investment, after dividends and taxes, decreased to $86,451.

Jerry purchased an Indexed Annuity with a purchase payment of $100,000. Since a Fixed Indexed Annuity protects against market declines, his contract value grew steadily over a 10-year period, increasing to $140,916.

While past performance does not guarantee future results, with an Indexed Annuity, you can be certain that your money will be protected if you hold the Annuity through the early withdrawal charge period.

Pros & Cons of Annuities

With any investment, it’s wise to consider the pros and cons before deciding which choice is right for you. I’ve listed both the “pro’s and con’s” of each major type of annuity below:

  • Fixed
  • Variable
  • Indexed

FixedPros

  • Simple: Unlike variable and indexed annuities, fixed annuities have no complicated formulas for determining the amount of money you will receive in income payments. The rates and any changes are spelled out in the annuity contract.
  • Predictable: Since everything is agreed on in the contract, you know what to expect. You don’t have to worry about whether an investment portfolio or the stock market are performing well. The interest rate is spelled out and guaranteed in the contract.
  • Lowest risk: Since the interest is not dependent on the performance of investments or stocks, you don’t have to worry about losing money when stocks and other investments do badly. This is especially important for retirees, who can’t afford to lose the money they need to pay living expenses.

Cons

  • No frills: The main disadvantage is fixed annuities do not have the potential that riskier annuities have of yielding greater interest rates if an investment portfolio or stock index does well.
  • No inflation hedge: Growth is fixed and may not keep up with inflation. That means their actual value may decline over time.
  • No capital gains tax rates: Money withdrawn from annuities is taxed as ordinary income. It does not get the benefit of lower capital gains rates.
  • Penalties for early withdrawals: If you try to withdraw money from a fixed annuity, or any annuity, before you are 59 ½, you will pay an IRS penalty.
  • Surrender charges: If you don’t like the interest rates when they are reset, you can face hefty surrender penalties if you want to withdraw your money early.

VariablePros

  • Possible Inflation hedge – If your investment portfolio performs well, you have the potential to see an increase in your payments, enabling you to better keep up with inflation.
  • Tax deferral – You don’t pay taxes on earnings until you take the money out of the annuity.
  • Initial investment protection – Usually the annuity company will guarantee you will have access to the money you invested, even if you make no interest if your portfolio does poorly.
  • Death benefit – If you die before you start receiving payments, your beneficiary will receive a payout from the annuity company.
  • Payments for life – You have the option of receiving payments for the rest of your life, even if your portfolio performs poorly and you exhaust your principal investment. You may have to pay extra for this option.

Cons

  • No guaranteed return – Unlike fixed and indexed annuities, there is no guarantee that you will earn interest on your investment. If your investment portfolio performs poorly, it will affect your income.
  • Taxed as income – When you withdraw your money, the earnings are taxed as income, not at the more favorable capital-gains rate.
  • Complexity – Because they can be complicated, some investors may become confused about the provisions of variable annuities. This has led to what regulators say are questionable sales practices making variable annuities a leading source of investor complaints to the (FINRA).
  • Surrender charge – If you take some or all of your money out of your annuity earlier than the contract allows, you usually will have to pay a surrender or withdrawal charge. This charge can be as high as 10 percent early in the contract. Some annuities allow you to withdraw small amounts – typically 10 percent or less – annually.
  • Mortality and expense risk charge – This is the charge to cover guaranteed death benefits, guaranteed income for life or guaranteed caps on administrative charges. These fees can be 1.2 percent or more a year.
  • Administrative Fees – These cover record keeping and other administrative costs.
  • Sales commission – The agent who sold you the annuity may receive extra compensation for the sale.
  • Underlying fund expenses – These cover expenses of the subaccounts in which your money is invested. This can be more than 1 percent a year.

IndexedPros

  • When stocks in your index, such as the S&P 500, rise in value, your payments increase.
  • The added increase in yields may serve as a hedge against inflation.
  • If the stock market tanks, you don’t lose money.
  • Index gains are locked in.
  • May provide better rates than certificates of deposit.

Cons

  • Your gains will be capped and won’t reflect the entire increase in the value of stocks.
  • High fees cut into your gains, meaning you might not make more than if you invested in something safer, like bonds.
  • Fees are tough for the purchaser to figure out. They’re often not spelled out clearly in the contract.
  • Sales commissions are high and may not be clearly disclosed.
  • The cap in the increasing value may be lowered in later years of your contract. Likewise, the percentage of the gain you may receive in the index value may decrease along the way.
  • As with other types of annuities, these come with steep surrender charges if you want to get out of the contract early

“But…Is An Annuity Right For Me?”

A female voice asked in the back. 

It was Linda. 

Later I found out Linda is a divorced Marketing Consultant with two teen age children in her mid to late 40’s. Being that she’s been self employed most of her career, Linda won’t be getting a huge pension when she retires.

Matter of fact, she won’t be getting any pension. 

Her biggest concern was that she’ll need income from IRA/401(k) to supplement Social Security.

“OK. Then let’s talk about some of the questions you might be asking yourself” said P.B.D. with a curious smirk. 

Here are some that most intelligent people would be asking themselves at this point” he added.

  • Is an annuity right for me?
  • What if I make a costly mistake?
  • Where can I get help to understand how annuities work?
  • Who can give me some unbiased, factual, honest information so I can decide for myself?

With one eyebrow raised he asked Linda “Am I close?”

Linda nodded with approval.

“Well I’ve got a simple question for you instead.” he added. “One that will really get to the heart of the matter.”

“Would you like to turn a portion of your savings into a guaranteed income for life when you retire?”

“If you answered “no” then an annuity is not for you.”
“If you answered “yes”, or “I think so”, or “maybe”, then stay with me and you will find the answers to the questions you’re asking yourself.”

REAL Guaranteed Income

The #1 reason to put some money into an indexed annuity with an income rider (Hybrid Annuity) is the guaranteed income you will get at some point in the future. This helps people stop worrying about depleting their IRA or 401(k) balance too soon or running out of money.

If you don’t need or don’t want some level of guaranteed income from your IRA/401(k) or other savings at some point in the future, then you should not put one single penny into an index annuity with an income rider. 

An annuity by itself may be ok, but why pay for an income rider if you don’t need income? Invest in a Hybrid Annuity based on what it will do for you, not what it might do.

But Don’t Believe The Hype…

One guy jumped up and said “That’s interesting. I just ran into an advertisement online claiming that I can earn an 8% guaranteed rate of return on my money for the rest of my life. They mentioned I can get it by using a special kind of Annuity.”

“So…based on what you’re saying, is it true?”