Last year at about this time I got a call from Roger and it inspired me to make his situation the subject of a newsletter. A few years prior he had put a plan into place based on advice from a CFP and had started to question the plan. He found this website and wanted my opinion. There wasn’t much I could do for him except cross my fingers and hope it all works out regardless of the limited potential he now has.
You can read that story here: I Can’t Believe a CFP Designed This Plan
I was thinking about it because I am three weeks away from a client review for a couple that started about the same time as Roger and the two situations were roughly similar back in 2016. The difference between the two plans will underscore the importance of blending safety and growth potential. The events of the past year have made me grateful to have clients that are adequately protected but still able to capitalize with substantial profits.
So let me tell you about Lee and Barb. I met them in early 2015 while spending the winter in Puerto Rico. They were each 59 years old and had planned to retire in four years when they could collect social security. With a combined $900K in two 401(k)s and a projected income need of $30,000 annually I determined that retirement was possible. In order to hit the goal they had to protect assets but they also needed growth for discretionary spending and inflation protection. The asset to income ratio was right on the line but there was no choice but to blend protection with growth potential.
If you remember back to early 2015 you might recall plenty of uncertainty in the markets and economy. It was only two years after the S&P 500 had recovered from the calamity of 2008 so there was a mix of people who were relieved to have stayed in the market and those who got out at the wrong time and had been too scared and unsure of what to do. It was the perfect time to add some assurance but keep open the possibility for continued growth. That was about the same time Roger’s CFP had him put everything in cash and annuities. If I only had a time machine…
Lee and Barb had their assets in a 50/50 mix between corporate bond funds and market index funds. Aside from a short visit with a Ken Fisher rep the only other plan they’d seen was a recommendation to put $600K into a deferred index annuity with an income rider. Boring, right? That contract would have perfectly hit the income goal in four years so it was suitable but I felt they would be leaving too much potential on the table and I also knew that an annuity would work well with far less investment in the beginning.
The solution was simple and the reasoning obvious. Swap the bond funds for and index annuity with no income rider and no fee for maximum growth. It actually took less than half with $400K going into the annuity. The remaining assets could float with the market and in four years, withdrawals would come from the annuity if market assets were down and just the opposite if the growth side had done better. With a seven year annuity contract, in a worst case scenario, they could pull income via free withdrawal for three years until the contract was surrender free, at which point all assets would be rebalanced depending on portfolio weight at the time.
The first year was pretty weak on both sides. The market was more or less flat with the annuity growing about 1% and the market doing about the same. However, in early 2017 the market was well into another good run and the annuity came in for a 5% yield and the market investments were up about 15%. Things were looking good for Lee and Barb and they considered taking some gains and protecting them but with no real need I didn’t think it was necessary. The market continued to race forward and in 2018 the annuity had another modest return in the neighborhood of 5% or so but the market assets had grown to nearly $700,000 after an exceptional 2017. Lee decided to retire early and Barb made a plan to follow him in a year, which was also earlier than planned. In doing this they activated part of their long-term plan and shifted $200,000 to more stable blue chip stocks with a history of consistent dividends. This would reduce risk a bit more and provide for some diversification and consistent income to take pressure off other parts of the plan.
It was a good call to go a little more conservative because the market had some losses in 2018 and they held steady with the rest of plan given no reason to overreact to the modest correction. I’m excited to talk to them again in a few weeks. If things hold the market side of the portfolio will be valued at more than $900,000 after a historically exceptional 2019 and the annuity is looking at a yield of close to 8% which will lock in a value of about $480,000. Without a specific calculation I can tell that’s a blended yield of roughly 12% over four years.
I remember writing about Roger’s story last year and saying something about how I would have done things differently four years ago and it occurred to me that this was a great example of why it’s important to stay consistent. Obviously it’s not the annuity that gave Lee and Barb all the great performance but it was the annuity and the overall strategy that allowed them the opportunity.
If you were to do things the same as Lee and Barb I can’t guarantee the same results over the next four years but I do know if you do it right you’ll see that happen at some point. Any other annuity strategy would have cost too much to achieve the above results and some advisors would even have you put so much in there that you’d have no real growth to look forward to.
I’d rather see you succeed than me so my goal is simple. Prove that you need to protect just enough for a backup plan while leaving plenty available for maximum potential and flexibility in the future. With rates staying stubbornly low, it takes just a touch of creativity to find an alternative that doesn’t lock up your money for the long term.
Enjoy your weekend!