Should I Purchase an Annuity With Part of My Portfolio?

Our topic on this episode of the Ready for Retirement podcast is about annuities and whether or not you should have one in your portfolio.

Questions answered: What do I need to look for when determining if an annuity is right for me?  What are the benefits and cons of including an annuity in my portfolio? What strategies can I implement to improve my financial future? What is the best approach for my individual situation? 

Are you ready to start focusing on the things that truly matter when it comes to your financial future?

Key Points

• Roth Conversions
  • Roth Conversions tend to best to implement when income in a given year is minimal.
    • Example: Assume there is $3,000,000 in pre-tax accounts (401k, IRAs, etc.). 
    • Assume 7% growth and you save $100,000 a year for the next 10 years.
    • $3,000,000 would have grown to ~$14,000,000 by age 72 (20 years from the age of today’s listener).
    • RMDs (Required Minimum Distributions) would begin at age 72 and it’s estimated to be $500,000+ and rising year-after-year.
    • If current income is $500,000, this would place you in the 35% federal tax bracket (not including NY state tax) and likely a Roth Conversion wouldn’t make the most financial sense.
  • It may make sense to retire or take a year off if a Roth Conversion is the goal to limit taxes in retirement.
  • For more detail on Roth Conversions, check out Episode 54: At What Point Should I Consider Making Roth Conversions?
• Fiduciary
  • What is a Fiduciary?
    • A Fiduciary receives no commission or kickback for recommending a product; Fiduciaries must legally act in the best interest of their clients.
    • The reason most advisors are “anti-annuity” is because of the incentive to sell that product.
      • Annuities compensate advisors (non-Fiduciary) very well, with an average commission of 7%.
      • Example: If an individual puts $250,000 into an annuity, the advisor is receiving a 7% commission, which is $17,500.
      • This creates a conflict of interest because the advisor is incentivized to sell an annuity to receive a large commission. It may be great for a client, but it may also be the reason an advisor is advising an annuity.
• Annuities
  • Fixed Annuity – a fixed rate of return. 
    • Example: A 7-year annuity is paying 3.25% interest.
  • Annuities vs. CDs
    • Withdrawing funds often means the funds you put in the CD will come back to you with no penalty, but you may not receive interest (growth received) when taking the funds out.
    • Annuities often have a surrender penalty if funds are taken out before a specific period of time. 
      • Your funds are locked up unless you wish to pay a significant fee.
    • How much is a guarantee worth?
  • Fixed Annuity Example
    • Let’s assume you invest $100,000 and grow at 3.25% for 7 years and it is now worth $125,000.
      • What if you had invested these funds?
      • After 20 years, the funds would become ~$195,000.
    • If you had invested in the S&P 500, assuming a historical average of 10%, your $100,000 would have become $195,000. 
      • $70,000 more than investing in an annuity.
      • After 20 years, the funds would become ~$672,000.
    • Is the guarantee of a fixed annuity worth the potential loss of growth?
  • Equity-Indexed Annuity
    • These products are often sold with a “no-downside” spin.
      • If an annuity is tied to an index, such as the S&P 500, you are capped to a certain % of growth. 
        • If the S&P 500 rises 20%, you may be eligible for 6% or 7% of the gain, depending on the agreement.
      • The annuity company is offering you a chance to minimize losses, but is the opportunity cost of growth worth it?
      • Many annuity companies complicate products in order to sell products.
  • Variable Annuities
    • Clients who come to me with these products rarely fully understand them, and they’re confusing!
      • Guaranteed Minimum Withdrawal Value
        • You only receive guaranteed growth on your Guaranteed Minimum Withdrawal balance.
      • Example: Let’s assume you invest $100,000 into a Variable Annuity with a Guaranteed Minimum Withdrawal Balance.
        • Let’s assume the balance is guaranteed to rise 5%/year.
        • Investors often hear this and think the investment can only make money.
        • The Guaranteed Minimum Withdrawal Balance is guaranteed to be $105,000 regardless if the stock market falls 40%.
      • However, the cash balance will drop the same amount as the stock market, 40% of this example, plus the fees involved with the annuity (often 3.5%).
      • The Guaranteed Minimum Withdrawal is what you often hear of as a “rider”.
      • How is it growing by 5% and falling by 20%?
        • The level of income an annuity guarantees you is a % of the Guaranteed Minimum Withdrawal Balance.
          • They will guarantee you receive an income that rises by 5% / year.
          • What’s not guaranteed to grow is the actual investment balance itself. The investment value is decreasing with the market.
        • There is a guarantee, but with an arbitrary number you can’t walk away with.
        • You can walk away with your cash balance – surrender charge for accepting an early distribution (where many annuity companies profit).
          • You can’t walk away with your Guaranteed Minimum Withdrawal Balance.
      • Annuity companies are selling you the idea that your annuity will do nothing but increase, but this isn’t telling you the whole picture.
    • Product Expenses / Fees
      • Annuity companies charge historically high fees and having to share a % of the gains with annuity companies can drastically reduce your total return.
      • There will always be some fee; if you’re investing outside of an annuity company, there will be transaction costs and other expenses, but these are much smaller than the fees annuity companies charge, allowing you to keep more of what you earn.
    • Do you need income?
      • Having a guaranteed stream of income sounds great, and it often can be, but you may be able to create an income stream from your portfolio value, without giving up growth to an annuity company.
      • A level of income can be generated from a standard brokerage account invested in a diversified portfolio that may be sufficient on its own.
  • When Do Annuities Make Sense?
    • If you can’t stand the volatility of the stock market, a fixed annuity or equity-indexed annuity may make sense for you.
      • This is for individuals who are willing to give up significant growth in exchange for what would be a lower, guaranteed growth rate.
    • Variable annuities have tax-deferred growth.
      • Any growth on the funds inside an annuity are tax-deferred.
      • It may make sense to open up a variable annuity with your non-qualified accounts for individuals with high-income to allow for additional tax-deferred growth compared to individual/brokerage accounts.
      • Note: With upcoming tax legislation changing, you may see a rise in Variable Annuities / Whole Life Insurance policies for the tax-deferral benefits.
  • Overview
    • Disclosure: Without knowing the full financial picture of the listener, I cannot recommend whether an annuity would be most beneficial for you. 
    • From the brief information provided, it doesn’t seem to me an annuity would be needed to achieve your goals and there may be other ways to significantly increase growth by utilizing other investment & tax planning strategies.

Timestamps

1:44 – Introduction

3:50 – When Should I Do A Roth Conversion?

6:15 – How To Minimize Taxes In The Future

7:30 – Should I Purchase A Pre-Tax Annuity Tool?

8:34 – What Is A Fiduciary?

10:25 – Which Annuity Is Best For Me?

14:41 – Fixed Annuities

17:05 – Equity-Indexed Annuities

19:28 – Variable Annuities

22:57 – Annuity Fees

27:12 – When Do Annuities Make Sense?

29:05 – Aligning Your Investments With Your Financial Goals

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