Fundamental Purpose of Annuities

I had planned to run this case study before last week’s episode fell in my lap.  Several people had suggestions as to how I could handle the case last week and I felt as though it was certainly worthy of a follow up.  I came to realize that both of these would work together as a follow up to the previous episode.  The biggest lesson you’ll get by looking at both of these is that one solution does not work for everyone.  That’s kind of the point of all this information so that people will learn to think differently about solutions and pay less attention to the novices that come with a one product answer for everyone.  Unfortunately that’s the majority of advisors, although there are exceptions.

The first case was with a new client who desperately wanted a guarantee.  Over the first year of retirement, stock and bond markets had fluctuated a fair bit.  Every time the market moved one way, Fidelity would increase or decrease his monthly withdrawal.  Sometimes he had a little extra and sometimes he was a little short.  If he could get steady predictable payments it would take a lot of stress out of his life.  Fidelity had him on a withdrawal based on a fixed percentage of assets.

To get a fixed payment it took about 60% of his portfolio to guarantee that income for the rest of his life.  It was important to him to never have to worry about it and he was motivated enough to make a big commitment.  I got the business because I was able to save him money by getting more income than his baseline request for about 10% less than both Fidelity and other agents had shown him.  That’s why I get paid to figure things out.  The remaining 40% of the portfolio can be used for continued growth, inflation protection, planning changes and whatnot.  This is the fundamental purpose of annuities.

In the next case you should notice that management companies also have different solutions for every person.  The gentleman from last week’s episode was taking a fixed dollar amount from his portfolio.  This carries more risk than the fixed percentage method because the withdrawal doesn’t change with market fluctuations.  Fixed withdrawals in down markets will compound losses and in this case using an annuity would seem to be more beneficial and it is, but it’s harder to prove and like the case before requires adequate motivation from the consumer.  You have to want an annuity.

Proving a good use, like in the first case is the best way to go about it but it’s harder with the fixed dollar amount method.  The only hole you can poke in it is ‘market risk’ which is a big one but it requires sufficient motivation to do so.  I know this can be run through any number of simulations and an annuity will prove to give more stability, growth and overall simplicity to the retirement picture for this guy.  Remember, at age 62 he has a $96K income gap with a current plan to delay social security until age 70.  At that point, social security will provide all but $43K of his annual income needs.  This represents significantly more risk in the early years so that’s where my primary focus is.

You may remember that playing with the numbers gave me an incredible solution.  He could take social security now at $31K per year and buy an annuity that makes up the $22K difference at age 70.  It costs only $160,000 to do that and the early payments from social security will return $248,000 of income over the next years and pay for his lifetime after that.  Investing $160K to get an extra $2500 per month now dramatically reduces risk on the portfolio and represents an internal rate of return of nearly 11%.  Pardon me saying that it’s an incredible return and an initial first move that he should definitely take.

Will this put to rest the criticism from those who disagree with me when I recommend taking social security as soon as possible?  Probably not…

Further commitments to an income annuity will depend entirely on his desire to guarantee the outcome.  I’ve had several suggestions with most saying it would be appropriate to cover the whole social security gap with income now so that he only needs to bridge the next eight years from his portfolio.  That is probably the safest play and quite doable with about 25% of assets.  Only a couple people requested more info about the case and it’s not something I feel the need to share, nor did I ask for permission. If you were one of those who felt he was out of position then please realize he didn’t ask you for advice and it’s not your job to figure out the whole thing.

I like this one because I got a lot of feedback from others including advisors.  Although I didn’t have the time to talk to everyone about the details, it confirms that there are a lot of ways to get things done.  The long-term income gap is only $43K and it’s only a larger gap for the first eight years.  That would significantly reduce risk and offer the most long-term security.  A couple people suggested using the Flex Strategy with a MYGA but that would cost too much.  I thought about it but it doesn’t always work the best.

This underscores the reason why this takes so much work and experience to figure it out.  There are lots of ways to solve retirement problems.  Some people have the choice between several options while others find an advantage with one specific strategy.  Above you’ll see two different sides of the spectrum.  It’s not easy for you to find the right solution for yourself by reading this because your situation is different.  If you want some help getting it done then give me a call.


Episode 126: The Fundamental Purpose of Annuities

Last Updated on February 24, 2024 by Bryan Anderson