Retirement Planning - Redefined

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Ep 28: Understanding Annuities - Variable and Fixed

February 4, 2021

This is part 2 of our annuity mini-series. We focus on two types of annuities on this episode which are the variable and fixed deferred. John and Nick explain what are significant about each of these and how they may fit into a retirement plan.

Helpful Information:

PFG Website: https://www.pfgprivatewealth.com/

Contact: 813-286-7776

Email: info@pfgprivatewealth.com

Disclaimer:

PFG Private Wealth Management, LLC is a registered investment adviser. All statements and opinions expressed are based upon information considered reliable although it should not be relied upon as such. Any statements or opinions are subject to change without notice. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investment involve risk and, unless otherwise stated, are not guaranteed. Information expressed does not take into account your specific situation or objectives and is not intended as recommendations appropriate for any individual. Listeners are encouraged to seek advice from a qualified tax, legal, or investment adviser to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.

Transcript of Today's Show:

For a full transcript of today's show, visit the blog related to this episode at https://www.pfgprivatewealth.com/podcast/

Marc Killian: Hey everybody. Welcome into the podcast. Thanks so much for hanging out with us today as we talk investing, finance, and retirement with John and Nick, once again, here on the airwaves with me on Retired Planning Redefined.

 

Marc Killian: We're going to pick up with our conversation on annuities. We are doing this series, or this session, on annuities and we're going to talk about fixed deferred annuities, as well as variable annuities today on the show. But before we get into all of that, let's say hey to the guys. Nick, what's going on, buddy? How you doing?

 

Nick McDevitt: Good. Good. Just we're in the new year now and things are off to the races for sure. It's been a hectic start to the year.

 

Marc Killian: What races? We don't know, right?

 

Nick McDevitt: Yeah. Yeah, yeah. Yeah, that's true. Been a hectic start to the year, but looking forward to the new year.

 

Marc Killian: John, how about yourself? You're doing all right?

 

John Teixeira: Yeah. Doing good, just busy. And like Nick said, it's been an interesting three weeks to start out the year to say the least.

 

Marc Killian: I don't know if you guys saw that meme that says, "I'd like to cancel my subscription to 2021. I tried the seven day free trial and I'm not happy with it."

 

John Teixeira: Yeah.

 

Nick McDevitt: Yeah. I've seen ones too where it's like, "This is week 54 of 2020.

 

Marc Killian: Something like that, yeah. Pretty interesting times that we're continuing to live in.

 

John Teixeira: Actually, my wife, I got the vaccine, first one, yesterday.

 

Marc Killian: Oh, did she?

 

John Teixeira: She's a nurse, so she was nervous a little bit, but also excited that she could just not have to think about it once she gets the shot. I think it's six months to a year, roughly, that they say the immunity from it... To be determined, but I think six months at least [crosstalk 00:01:36].

 

Marc Killian: I hear depending on which company you get it from, it's a series of shots and they say maybe you might feel bad for a day or two after it. How'd she do?

 

John Teixeira: Not too bad, although last night we were putting one of the kids to bed and she comes in and she's like, "Hey, where's your EpiPen?" I'm like, "EpiPen? What do you need that for?" Her throat started feel like it was tightening up, but it went away within 30/40 minutes, so that was it. Honestly, shes doing well and-

 

Marc Killian: Good.

 

John Teixeira: She's doing good.

 

Marc Killian: Good. Good to hear. Certainly interesting. Obviously, the virus itself affects so many people different ways and then apparently the vaccine does the same. My business partner, his wife's a nurse and same thing with her. She got the shot a couple of weeks ago and had a really bad headache was her side effect from it, but I think that was about it. So, you just never know how it's going to affect everybody, so I'm glad to hear she's doing well and be curious to keep an eye on that, as we move along, how the vaccines and all that stuff's going.

 

Marc Killian: But for now, like I said, let's talk about annuities. Let's get into part two of this. I mentioned at the top of the podcast kickoff, we're going to talk about two types today: fixed deferred and variable. So let's start with fixed deferred, guys.

 

John Teixeira: Yeah. So, fixed deferred annuities, recapping what we went through last time, anytime you get into an annuity, you really got to look at the company you're going with because the guarantees are based on the issuing company and how strong they are. But just go over a fixed deferred annuity.

 

John Teixeira: It's very simple, similar to a CD issued by a bank, just issued by an insurance company. You have a guaranteed rate. There are some that just give you a minimum interest guarantee where they'll say your minimum interest is 1%, but it can fluctuate based on some factors. The most popular ones that we typically use are where there's a multi-year guarantee where it will say, "Over five year period, you're getting 2.5% or 3% over that five-year period."

 

John Teixeira: Typically,... I say typically because there's always some outliers... typically, no fees, again just comparing it to a CD, no fees on it. You're just getting your 2.5% for that five year period or three year period, whatever you pick. We typically find that these rates are normally a little bit higher than CD rates, so it's very competitive in that space. "Just looking for something just very simple. Let me just get a fixed rate. I don't want to worry about any of these other moving parts. I just want a fixed interest rate with no risk."

 

Nick McDevitt: Yeah. And I would add to that from the perspective of... from a functionality standpoint, as far as how the rates are fixed, there are some similarities with CDs. But it is important to understand that CDs typically have FDIC coverage or insurance because they are issued from a bank up to the limits that the FDIC provides, whereas the guarantees and the CD are going to be from the insurance company.

 

Nick McDevitt: So, we know that that's a concern that people have when they bring it up or talk about it, so we always like to point that out. And then, on top of that, from the perspective of keeping in mind that annuities, by rule, by default, they have limited access to money until 59-and-a-half or after. So, if it's money that somebody is using that is a non-retirement account and they're younger than 59-and-a-half, it's important to make sure that they remember that rule, that 59-and-a-half rule.

 

Nick McDevitt: But the positive is that it does provide tax deferred growth. In other words, you don't get a 1099 from the bank or from the insurance company every year on your interest like you would in a non-retirement account if it was in a CD. So, the rates, the taxation, and the protection side of things are some differences between those.

 

John Teixeira: Yeah. And also, and just going back to what we talked about in the first annuity session, there are surrender periods on this. There are surrender charges, which will make them different than CDs. So just, if you need a recap of that, just go to our last podcast and we went through the basics of annuities, which is going to apply really to the fixed, the variable, and the index, which we'll be going through.

 

Marc Killian: All right. A lot of times when people think about different financial products, we often hear about the three qualities of money where you're looking for growth, safety, or liquidity. And every different kind of vehicle provides different things. Often, when we think of annuities, we think of maybe the growth and the safety aspect, but without some of that liquidity you guys were talking about.

 

Marc Killian: But again, since there's different kinds of annuities, you want to check and see really what the pros and cons are going to be for your specific situation. So, a fixed deferred might be something that worked really well for you and your situation, but again, you want to go through that with an advisor. And then, the variable, this tends to get more of the bad rep, I suppose, so break down some of it on the variable annuities for us, guys.

 

Nick McDevitt: Sure. Essentially, what a variable annuity is and what it does is it combines the structure of being able to invest in mutual fund-like investments, where in a variable annuity they're called sub-accounts. So it combines that with the chassis of an annuity, which provides tax deferred growth on the growth of the account.

 

Nick McDevitt: So, these became a little bit more popular back in the 80s where you would have high-income people that were looking to save additional money; maybe they were maxing out their 401k plans, or their retirement plans at work. They are in a high income, maybe a high income state or just, in general, high federal tax bracket, and so they were looking for additional ways to invest their money and they would use the variable annuity contracts to provide them with that tax deferred growth on the dollars and not get a 1099 each year on their investments. And so, over time, as tax rates changed and really became a little bit more favorable over the last 20 or 30 years, the popularity of the contracts became less than less.

 

Nick McDevitt: And then, what the insurance companies did was they started to add different riders and different guarantees onto these contracts, almost like an additional layer that comes over the top, that provided some additional guarantees to really just incentivize people to use them. And so, John, if you want to talk a little bit about some of those guarantees, and really the reason why many people that really have owned them over the last 10 or 15 years own them?

 

John Teixeira: Yeah. I'll start with some of the less common ones and we'll end with probably the most common, and Nick does a good job expanding the income ones. But they have somewhere, basically, your principal's guaranteed and not so popular anymore, but I've seen some contracts where you might get in today and they'll guarantee your principle payment over a 10 year period.

 

John Teixeira: So example, you put in 100,000, they guarantee you over the next 10 years if the market goes down, you'll at least walk away with your $100,000, so you get a principal guarantee and they'll have a term period where they'll put that guarantee. So example, year nine, your account's at 80 grand; you put in 100. Once you're at the 10 year anniversary, they just give you your 100,000 back.

 

John Teixeira: There are some death benefit guarantees to it where we've seen some contracts where, again, your principal payment has a death benefit, so if the market drops, you at least get what your principal payment was. And then, there's actually some riders where the death benefit will increase automatically irregardless of what the market is doing. What's very popular maybe about 10 years ago was long-term care riders on this where they'd put, if you qualify for long-term care insurance... so, lose two of your six ADL's... the annuity would kick in some type of income for long-term care expenses. Those have really dwindled down over the last few years because of just the cost for facilities.

 

John Teixeira: Nick, I'm not sure if you see too many of that nowadays. I know I haven't seen any good ones, but I'll let you talk on if you've seen any good long-term care riders on these contracts.

 

Nick McDevitt: No, I haven't seen that that much and really the main rider that we see on the different contracts are what are called guaranteed withdrawal benefits or guaranteed income benefits, sometimes referred to as GMIB or GMWB. When we do our classes, we really try to harp on these from the perspective of just explaining how they work. And really, in this sort of venue, this sort of avenue, what we would just recommend to people is that if it sounds familiar that you have a variable annuity, and/or a variable annuity with some sort of income rider that you know guarantees you some income, it's good to have somebody help you review that contract and make sure that you understand how it works.

 

Nick McDevitt: So essentially, there's just like anything, there's both sides, and then the truth is in the middle somewhere. These sorts of contracts, they can be good and, just like anything else, some are better than others. There are some contracts that have really held up over the last decade, 12/15 years, that have been beneficial, even to the extent where insurance companies will offer incentives to the contract owners to essentially try to buy them out because the guarantees are good.

 

Nick McDevitt: So essentially, what happens and just to use an example, let's say that you have a deposit of $200,000 into the contract and the insurance company is going to go ahead and offer a rider that has a guaranteed appreciation on that initial deposit. Usually, it's either a simple interest or a compound interest, so that's important to know. Because some companies might say, "Hey, we offer 7% growth on the rider," but it's simple and over time a 5% compound could beat that. So, it's important to understand how that works.

 

Nick McDevitt: And then, at a certain point in time, they offer a guaranteed withdrawal amount off of that guaranteed appreciation amount. So just to use basic numbers and try to help people understand how it works, let's say you deposit that 200,000 and over a 10-year period, which is usually the maximum growth period of those riders, that goes ahead and it doubles over the 10 years. So the guaranteed appreciating amount on the rider goes to 400,000 and then maybe they guarantee you a 4% withdrawal rate on that. So, it's the 4% on the 400,000, so that'd be about 16,000 a year.

 

Nick McDevitt: Normally, the way that those will work is that that 16,000 a year is guaranteed for your lifetime; so even if the underlying account balance goes to zero, the income is guaranteed for your lifetime. Some of them also will offer a guaranteed income for both lives, so if you are a married person, for you and your spouse.

 

Nick McDevitt: So, where people will get a little bit confused is that they may assume that that 400,000 number is their money, is like the real money, and if they wanted to cash out in year 10 or 11, that they can actually cash out that 400,000 number, and that's usually not the case. Usually, it's the underlying value, which inevitably because of expenses and things like that is going to be lower. So in this situation, it could be something like 300,000, which is the actual... what we'll often call real money. So, just like anything else it's really important to... We really just emphasize and harp on the fact that it's important to know what you have; it's important to understand how it works; it's essential to know how it impacts your overall plan.

 

Nick McDevitt: So with these contracts, we do think that they can be a fit in many people's plans, especially if maybe there's not a pension or something like that. So it's important to understand how they work; make sure that the guarantees that you thought are built into it; and make sure you understand how it factors into your plan. I would say, from the standpoint of pitfalls to avoid where we've seen people really get into trouble are if they put too much of their nest egg into it. We typically recommend a maximum of 20 to 25% of investible assets into something like this. If you're going to do it because of some of the negatives. John, if you want to jump in on just some of the negatives overall, so that people understand the things to look for?

 

John Teixeira: Yeah. Devils are in the details on these things. You just need to understand your limitation to your money in some of this, where some negatives we've seen is where someone's doing their withdrawal benefit and they try to take extra money out, more than what the guaranteed amount that's on the contract, or what they're supposed to. It could really mess with how long the money's going to last at that point, or what your minimum pension benefit's going to be: your income withdrawal. So that's something to really understand. That's why Nick was saying, "You don't want to put too much into this because if you need access to money, this is not where you want to go." You almost want to set it up and if you're going to do the income withdrawal, just forget about it from a accessing standpoint, more than what your income withdrawal is. So, that's something to be aware of these.

 

John Teixeira: Why these typically get a bad rap and Mark, I know you mentioned at the beginning, it's really the fees. When you put a income benefit on this, you can look at anywhere from 3 to 4% overall in fees. So there's a mortality expense fee, [Jim's 00:15:22] throwing out some averages, could be 0.95%. There's an admin fee, could be 0.2. The investment you're going into could range anywhere from 0.3 to 1%, and then the rider itself, which is that guarantee, can range from 0.5 to 1.4.

 

John Teixeira: So you could see that when you start adding all that up, it really makes a big difference, or really adds up a big amount in the fees. Not saying that's necessarily bad; it's just important to understand what you're in and how it works for you.

 

Nick McDevitt: Just to follow up on that, the fees are usually coming out of the performance, not out of the riders, so that's important to understand. And again, just like anything else, it's important to understand how things work and how it fits into your overall plan, and just get an analysis on it, and making sure that it's working how you expect it to.

 

Marc Killian: Yeah, exactly. At the end of the day, we're doing a little session here on annuities, a couple of episodes on this, but like any financial vehicle, you want to make sure it's the right fit for you by working with an advisor. You can learn some information and certainly get a good working knowledge. Many folks do not want to understand the complete nuts and bolts, and that's why they turn to an advisor. But finding the right one for you and the right product for you is paramount really in anything that you do.

 

Marc Killian: So, as always, before you take any action, you should check with a qualified professional like John and Nick at PFG Private Wealth. You can call them at (813) 286-7776; that's (813) 286-7776; before you take any action. If you've got some questions, you can also go to the website: pfgprivatewealth.com. Shoot them an email that way; contact them that way at pfgprivatewealth.com.

 

Marc Killian: Don't forget to subscribe to the podcast. We'll be doing another episode on annuities here, coming out very soon. So, subscribe to the podcast on Apple, Google, Spotify, whatever platform you'd like and that way you get new episodes as they come out, as well as can check up on some past episodes. It's Retirement Planning Redefined. Search that in any of the boxes or any of the apps... excuse me... as you'd like to, whether it's Apple, which is probably on your phone already. Apple Podcasts or Google Podcasts, already pre-installed on your phone most of the time. Just open up those apps, type in Retirement Planning Redefined. You should be able to find it that way, and that's another way you can subscribe.

 

Marc Killian: And that's going to do it for us this week here on the podcast around annuities. Again, we were talking about fixed as well as variable. If you've got questions, reach out to John and Nick: (813) 286-7776 for John, for Nick. I'm Mark. We'll see you next time here on the podcast.