Annuities and How They Can Fit into Your Retirement Plan

{9 minutes to read}  What seems to be top of mind for many people my age (I’m 61 years old), is retirement planning and the effect of inflation and market volatility. How are people going to navigate this difficult period that we’re going through? There is a lot of fear on the street with inflation and recession and the market being down. I want to share some ideas about retirement planning, using products that were developed by actuaries — actuarial science products — annuities, and how they can fit into someone’s retirement.

Annuities get a lot of bad publicity for whatever reason, which I think it’s unfortunate because they could be used to help in so many ways. One of the things that we urge our clients to do is some smart planning and think about their retirement as a cash flow issue. We all need X amount of dollars every month to cover our expenses. Some of those expenses are fixed such as our mortgage, and some of them are variable, like vacations.

We like to have our clients develop a plan where a good percentage of those fixed expenses, especially, and hopefully some of or maybe even all of the variable expenses, are covered with programs that provide guaranteed income for the rest of their lives. These include Social Security payments or a pension plan through their employer that provides a monthly income. We see less and less of these as in the eighties, when 401(k}s came out, employers moved away from the old defined benefit pensions and started giving their employees the ability to save money for their retirement, lowering the amount of money the employers provided for the employee.

If you’re fortunate to have one of those types of plans, your Social Security or your pension will guarantee you have income for life. That is something that can create a feeling of tremendous security. Stress is lowered and studies have indicated that people that have a higher percentage of their expenses covered by guaranteed income for life, live longer because they worry less about money.

Let’s take a hypothetical example: You have a million dollars, and you are a conservative investor. You have that money sitting in a bank account, and right now let’s say, you’re going to earn 2% on that money. You would generate  $20,000 a year of taxable income. If, however, you took that same million dollars and placed it into what we call an SPIA, a Single Premium Immediate Annuity, you would be able to get approximately a 6.9% payout, meaning that million dollars instead of generating $20,000 a year would generate $69,000 a year.*

The downside to these types of annuities is that the capital goes to the insurance company. That’s why a lot of people sometimes don’t want to buy these types of products. But they can be set up where there’s a guaranteed cash refund, so even if you passed away the next day, the balance of the million dollars that wasn’t paid out would go to your named beneficiary, or you could have that income continue for 10 years. While you’re alive, you would have $69,000 a year rather than $20,000 a year. On top of that, not all of the $69,000 would be taxable income. A good percentage would be part of what we call your exclusion ratio or what the insurance company is giving back to you, in the form of your principle.

It is a great idea to consider. If you’re in a situation where you don’t have that high percentage of fixed income or variable income expenses covered by your guaranteed income for life, consider buying a single premium annuity, or what we call a deferred income annuity, which is a kind of an interesting play. Let’s say, for instance, you’re 61 years old like I am, and you’re planning on retiring at age 70. The five years before retirement, and the five years that start at the beginning of your retirement, are the most important years for determining the success of your retirement strategies.

The reason for that, and any major downturn in the market where you have your money invested, let’s say it was right before or right after you started retirement. If you started retirement in 2022, you would’ve been withdrawing money out of that portfolio, and simultaneously, experiencing a negative market rate of return, which would create a very quick decumulation of your portfolio. This would lower the income amount you can generate initially, and could, over time, potentially run out of money.

There is a general rule of thumb that about 3-4% of your portfolio is all you should spend down. In other words, if you have a million dollars in securities, you should only be pulling out 30,000 – $40,000 a year. If you put some money into an SPIA or even one of these DIAs, which is very similar to an SPIA, you would be waiting five years. For instance, a 60-year-old who waits five years before receiving the money would be able to get $85,000 per year at age 65. And again, a good percentage of that would be a return of principle, so it would not all be taxable. Not only are you going to experience that sense of security by having a higher rate of return, a higher payout rate, and better cash flow, but you’re also removing that amount of money from the risk spectrum. We recommend that people consider taking some of the money out of their risk-based investments, where it’s invested in the market, and put it into an account that has guaranteed income for the rest of their lives.

When we do the planning, there is an interesting study we always ask people to do. They go to a website called, Livingto100.com. This is a website that was developed by a doctor that calculates your life expectancy.  Not a general life expectancy which is an average for everybody, but your life expectancy, based on your lifestyle, your health, and your circumstances. Now, why do we recommend people do that? Because one of the biggest risks of retirement isn’t just the inflation and market risk but is longevity risk. If you are a husband and wife and you’re 65 years old, there’s a very good chance that one of the two of you will be alive in 30-35 years. That gives you some perspective on how much risk you’re going to be experiencing with different market cycles and inflation as time progresses because you can’t just plan for 10 to 15 years anymore.

The annuity concepts and the actuarial science behind annuities provide protection, not only against market volatility and inflation but also against longevity risk. My wife’s grandmother lived to 103. My cousin lived to 102. Most people don’t plan for that extended period of retirement time.

And lastly, having a good percentage of your income to cover your monthly expenses, allows you to live with less stress. Another interesting study is that people that have more income, have less stress, and therefore live longer. These market and inflation risks are all multiplied by longevity risk. The longer you live, the more risks you’re going to experience. Cash flow is king. And these products are designed to provide the very best cash flow possible. You’ve seen that bumper sticker, “I’m spending my children’s inheritance.” Well, buying an annuity, in essence, allows you to spend your children’s inheritance, and good, smart financial planning advises you to cover the annuities with life insurance.

For instance, I’m 61 years old. I already have a million dollars of life insurance that allows me to annuitize a million dollars, knowing that I can spend my million by generating the highest possible income from the annuity and still leave my million dollars through my life insurance and whatever is remaining from the cash refund or 10-year certain annuity that we choose.

If you’d like to learn more about this very interesting and timely subject matter, give us a call, send us an email, and ask us for a proposal. Take a look at how these programs can add value to your retirement strategies and help you live with less stress and more guarantees.

* There is no assurance your experience will be similar.

Registered Representative offering Securities through American Portfolios Financial Services, Inc. (APFS) Member FINRA/SIPC. Investment Advisory Services are offered through G&G Planning Concepts, Inc. which is not affiliated with APFS.  Strategic Wealth Advisors Network and Gassman Financial Group are not affiliated with APFS.

Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc.(APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk, and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors.

This material is for informational purposes only. Neither APFS nor its Representatives provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions. American Portfolios Financial Services, Inc.(APFS) and American Portfolios Advisors, Inc.(APA) are not affiliated with any other named business entities mentioned.

Annuities contain certain fees, risks, limitations, and restrictions. Withdrawals may be subject to ordinary income taxes and, if made prior to age 59½, may be subject to a 10% IRS penalty; Surrender charges may also apply. Please consider the charges, risks, expenses, and objectives carefully before purchasing an annuity. The prospectus contains this and other information and can be obtained from a financial professional. Read carefully before you invest. Guarantees apply to certain insurance and annuity products and are subject to product terms, exclusions, and limitations and the insurer’s claims-paying ability and financial strength.