Annuities: Do Zero Risk Investments Exist?
Zero-risk investments, do they exist? With turmoil in the equity markets, where can I go to hide and look for fixed returns? And what money is best placed in those types of investments? Hello again, I’m Dave Dooley with Georgia Advisor Group, a full-service wealth planning firm located in Alpharetta, Georgia. Do us a favor, if you enjoy these videos, click subscribe and ring the bell below. It lets us know we’re providing valuable information to you. So, let’s dive right in.
Because of the severe market volatility, we continue to receive calls and questions related to protecting downside risk while participating in the markets. One question is: what alternatives are out there? What guardrails can I put in place? Today, I’m going to focus on equity indexed annuities because it’s a question that we receive on a regular basis.
Equity indexed annuities are fixed annuities where the rate of interest that you earn is linked to the returns on a specific market index that you choose. It’s typically set annually by an insurance company issuing and guaranteeing the contract. In 2007, the Federal Reserve Chairman Ben Bernanke disclosed that his largest financial assets were in annuities.
While the benefit of lifetime income remains a significant benefit of annuities, they have evolved dramatically in recent years to meet the increasingly complex needs of investors preparing for retirement. Though at the time in 2007 through 2009, we were heading into one of the most tumultuous markets in U.S. history, and all the banking leaders and the Fed were trying to assure the average investor not to panic and stay the course in the markets, we discovered that the Fed Chairman had the majority of his personal assets in principal-protected market losses. And once his blind trust was revealed, I found that pretty interesting.
Limra, who is a research consulting firm and nonprofit trade association, reported that in the second quarter of 2022, over $77 billion was poured into annuities, setting a new record not seen since 2008. This is the largest number ever recorded by Limra since 1995 when they began tracking annuities. The majority of those dollars were put into what is called indexed annuities or equity indexed annuities. They are projecting, with the continued conditions of the markets today, that the record will be broken once again in the third quarter of 2022, and you’re going to see those numbers relatively soon.
So why is this taking place? First and foremost is protection of principle. Most, not all, annuities protect against any losses to your principal. This brings a lot of comfort to many investors, and they call it the “Sleep Factor.” Secondly, in indexed annuities, you can still participate in market gains with limitations. Let me make that crystal clear. And at some point in the future, begin to draw a lifetime income for not only you but your spouse.
Now, are these vehicles suited for all investors and should they be part of everybody’s asset allocation? The answer is no. There are many moving parts, from caps to margins to spreads to participation rates, and of course, surrender fees being at the top of that list. But if you’re looking for market returns tied to overall market indexes with protection of principal, then you may be headed in the right direction or at least beginning to ask the right questions.
In 1995, Keyport Life introduced the first indexed annuity. It had a 100% participation rate in the market returns and a 150 basis points spread. What that meant for you was if the S&P index, as an example, increased by 20%, and you had $100,000 invested, you would receive that year 20% less than a 1.5% fee, or $18,200. If the S&P lost 20%, you would not lose a penny, and your account value would still be $100,000. If in year two, after receiving the $18,200, that index fell by 20%, your account value would remain untouched.
So what was the risk involved? Could I lose money? The answer is yes because they had a 10-year surrender period. If you needed to access your money above the 10 free withdrawals each year, you could be penalized substantially. If your balance in year three, for example, was $130,000, and you needed more than the $13,000 for emergencies, then it could cost you big to access those additional funds. So the key here was to be sure to use dollars that would not be needed well into the future.
But since 1995, a lot has changed. Where competition among carriers have added many additional benefits like lifetime income withdrawals for each spouse, waiver of surrender fees if confined to a nursing home for a period of time, or even terminal illness. So there are many moving parts. It takes a lot of diving deep into what benefits are best for you and your family and what dollars are best suited for these products.
Another caveat is the fact that these were commissionable products, like life insurance or B-share mutual funds. And because of that, many people were sold these products not because they were in the best interest of the client but rather to profit the seller. But over the years, the SEC, along with the state insurance departments, have cracked down and set rigid guidelines on disclosure to clients so they can make informed decisions before making a purchase. In addition, the insurance carriers have made it possible for registered fiduciaries to receive fee-only payouts instead of commissions, where their interests line up with the clients, by focusing on growing the assets and not just selling a product to line their own pocket.
I can attest that, having been licensed for over 39 years in this field and having been on the advisory board for one of the largest privately held insurance carriers in the United States, we spend countless hours not just designing these products for the best interest of clients but making sure, from a disclosure standpoint, that they were sold properly and ethically.
Here’s the thing, $2.5 trillion today sits in annuities in the U.S. alone. All federal retirees are paid through FERS, they refer to that as a pension. The payments are annuities paid from the federal government versus an insurance company. Most retired teachers are paid through annuities administered by either the state or an insurance company. Here in Georgia, for example, Valic, a subsidiary of AIG Corporation, administers all teacher retirements, and most not-for-profit and healthcare government entities.
So you can see for those of you who will have no guaranteed pension and rely on creating your own lifetime income, then annuities may be an option to explore in greater detail. I’ve always been an advocate for using IRA money to fund these types of products. Why? Several reasons. One, an IRA or tax-deferred account is a long-term vehicle, meaning I won’t touch it until at least 59 and a half, at the earliest, and even then will only take yearly withdrawals, so surrender fees really have no impact. How long will I have an IRA or a 401(k)? Well, you’re going to have it for the rest of your life or until you deplete the amount.
But an annuity, unlike my traditional IRA, guarantees me that I cannot outlive my income. Even if my account goes to zero, I still get a check as long as I live. And if I die, my spouse continues to receive an income on my IRA for the remaining of her life. If we both were to pass and there’s no money left in the account, my children receive nothing. But if we pass together with money remaining, the children receive the balance. So having a three to five to seven or ten-year surrender fee, not unlike a CD where you’d be penalized taking early withdrawal, if you plan well, will not have any impact on you at all.
And this is where having experts in this area to sit with you and review the advantages and disadvantages of owning an equity index annuity is important. I would tell you, from my experience and the average returns on these types of investments over a 30-year period, they range anywhere from four to eight percent on average, and most LIMRA studies agree with what I’m telling you. I’ve seen returns as high as 18% and, of course, zero based on the indexes being down from the previous year, but zero is your worst outcome.
But I would argue that returns are not the major point here. Guarantee of principal, lifetime income for both spouses, and having peace of mind that, of course, the annuity assets will outlive me is the focus. For clarification, I’m providing this information for you to get familiar with other options for a successful retirement. But it’s your responsibility to dive deep into any investments that you decide to go with and ask all the right questions. My job is to make sure you’re asking the right questions.
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