Making Retirement Income Live As Long As You Do
Using Annuities to Make Your Money Live As Long As You Do
People today are living longer and longer lives. In fact, Hallmark cards reported that in one year they had sold more than 100,000 Happy 100th Birthday cards. The Wall Street Journal in a July 2006 article said that studies have shown that with a 65 year old married couple there is a 67% chance that at least one of them will live to age 85 and a 42% that at least one of them will live into their 90s. This longevity is of course both a blessing and an opportunity to live more, dream more, accomplish more than previous generations would have ever thought possible. But with this blessing comes a challenge, the challenge being to make sure that your money lives as long as you do.
The Wharton Business School has published a paper finding that (properly used) an income producing annuity can be a very important component in a retirement distribution plan that is built to last. Annuities are effectively life insurance in reverse. We purchase life insurance in case we do not live long enough, to provide for those we love. We purchase annuities in case we live too long, to provide for ourselves.
I will focus my time with you today on fixed annuities. They are called “fixed” because the investment risk is born by the issuing insurance company. Let’s look specifically at three types of fixed annuities. There are immediate annuities, fixed interest annuities, and fixed index annuities.
An immediate annuity is one in which you pay a lump sum to an insurance company and they immediately begin to pay you a set amount of income for a specified period of years or for the rest of your life. The upside of this type of annuity is that it can create a very reliable source of income that can (if the money used to purchase it is non-qualified money) be tax advantaged due to something called an exclusion ratio. The downside is that you lose control of the lump sum that you gave the insurance company, effectively having traded an asset for an income stream.
The second type of fixed annuity is a fixed interest annuity. With this type of annuity, you are paid a declared fixed interest rate for a specified number of years. The interest can grow tax deferred until you decide to take it out at the end of the term or with penalty free withdrawals during the term. The downside is that you are committing your money to that specified period of time (these are after all long-term products) and there would be surrender charges applied if you cashed out early or took out more than the annual penalty free withdrawal limits specified in your contract.
A fixed index annuity has the same liquidity considerations of having penalties for cashing out early as a fixed interest annuity, but it is different in that they have a unique way of crediting interest. Instead of declaring an interest rate in advance, your interest each year is credited as a percentage of an outside market index such as the S&P 500 Index. When you open a contract a record is made as to what that index is when your money is first received. Each year on your anniversary date, an interest calculation is made based upon the movement of that index. When the index goes up you are credited as interest with the gains of that index (not including dividends) up to a predetermined ceiling. That ceiling might be an annual cap, a monthly cap, or a percentage of the overall gain, but the bottom line is that there is no such thing as a free lunch. In return for protections on the downside you agree to limits on your upside. Whatever interest you earn typically locks in on your anniversary date and cannot be taken away by future market downturns.
Like all financial products, you don’t want to put all of your eggs into an annuity basket, and you want to make sure you do your homework very carefully before purchasing. One excellent guide that can help you determine their suitability for you is the Buyer’s Guide to Fixed Deferred Annuities from the National Association of Insurance Commissioners. Call my office at (304) 346-7782 or (800) 361-1792 and we would be happy to send you a copy.
Ultimately, the value of a fixed annuity is only as good as the safety that it provides. It was Will Rogers who said, “Before you tell me about the return on my money, first tell me how I can get my money returned.” Central to our understanding of the benefits of an annuity for our financial world are what I call The Four Pillars of Safety of a Fixed Annuity. Let’s take a look at each of these four pillars:
Pillar of Safety #1: Strength of the Insurance Company
The number one consideration in purchasing an Annuity is the strength of the insurance company that stands behind it. Issues such as the size of the company, the length of time they have been in business, and how conservative their investments are all considerations that you should carefully discuss and research with the financial advisor who you are working with. I only recommend large and established companies. There are a number of independent ratings agencies that rate the financial strength of insurance companies. The most well-known of these companies is A.M. Best. They rate insurers much like a teacher would grade students, from an A++ down to an F. I only recommend annuities from companies with “A” ratings or higher from A.M. Best. A.M. Best can be found on the internet at www.ambest.com and by phone at (908) 439-2200.
Pillar of Safety #2: Strength of the Parent Company
In this age of corporate consolidation, many companies in multiple industries are owned by parent companies that often are very large and diversified corporations. The insurance industry is no different, and the presence of a large, stable parent company is another reason for peace of mind with a fixed annuity. Some of the companies I work with who issue Fixed Index Annuity products are owned by insurance parent companies with assets in some cases exceeding $1 trillion.
Pillar of Safety #3: Strength of the Legal Reserve System
The insurance industry is required by the Legal Reserve System to keep one dollar in reserve for every one dollar of contractual obligations. Those reserve requirements give the insurance industry a very high degree of stability and offer the potential for a very high level of peace of mind. Because of the massive reserves of insurance companies, best-selling author Gordon K. Williamson points out that “during the Great Depression, it was not the U.S. Government that bailed out the banking industry – it was U.S. insurance companies. If there were ever a financial collapse in the United States, the insurance industry would be the second to the last entity to fold (second only to the government). This ‘second billing’ is because the government has taxing power and, of course, the ability to print money.”
Pillar of Safety #4: Contract Guarantees
In a fixed annuity product a promise is put into writing by the insurance company that you are protected against loss as long as you abide by the terms of the contract. Your principal is protected from day one, and your credited interest locks in every year. You are giving up some of your upside potential in order to protect yourself against downside risk. Remember, there is no such thing as a free lunch.
No financial product is for everyone but for many conservative savers, fixed annuities can be a vital component in taking a S.W.A.N. (Sleep Well At Night) approach to their financial world. Whether you own annuities that you have not had professionally reviewed in a long time, or whether you are considering annuities as a part of your retirement planning, give my office a call at (304) 346-7782 or (800) 361-1792 and arrange a time for us to talk. Ask us to send you a complimentary copy of Shawn Moran’s white paper, “Protect Your Retirement in Uncertain Times: Annuity Strategies to Guard Your Nest Egg and Sleep Well At Night.” Sometimes a fresh set of eyes and an independent voice can help you to make sure you are on the right track and increase your confidence that no matter how long you live, your money will live just as long as you do, and maybe even longer.
Sometimes a fresh set of eyes and an independent voice can help you to determine if you are on the right track or if changes are called for. Perhaps it is time that you asked for a second opinion when it comes to your financial health. Call our office at (304) 346-7782 or (800) 361-1792 and arrange a time to talk with Shawn Moran, either in person or on the phone. You’ll be glad that you did.