There is nothing wrong with high expectations in retirement but annuities are not where you should place those expectations. Annuities are meant to stabilize a portfolio and produce reasonable outcomes, regardless of external factors. Even still, insurance companies and marketing organizations have continued to create index annuities with exceptionally impressive performance. I don’t trust it for several reasons and that’s what I plan to explain today.
Roughly ten years ago, the first performance-based income annuity came on to the market. Rather than a contract that had guaranteed income increases each year, future income would now be tied to the performance of the index options. If the account doesn’t grow then guaranteed income doesn’t increase. Many of you have seen these contracts but know them by a specific name. I get requests to evaluate these all the time so my explanation needs to be put into writing. Allianz, who has two such products now, has received plenty of my attention. They were the first that I know of but now several more companies have joined the niche.
A rated companies that carry this type of product are:
Big deal if I missed a couple. The point is not to list them all and also remember that B rated companies are excluded. I don’t sell those, no matter what.
Each contract is a little bit different but the purpose is the same. Some have a required time period for deferral while others allow you to take income at any time. Some have enhanced death benefits and others have long-term care enhancements. I’m going to show you one contract to point out my biggest complaint but remember that any of the others may provide slightly different benefits.
The reason I’m showing Athene is because I am appointed with the company and have sold this contract one time. The details are pretty straightforward, you get a 25% bonus on the income value at issue and 175% of interest earnings annually are also credited to the income value. If the contract grows you’ll see a tremendous amount of income potential. This contract requires a ten year deferral to capitalize on the income bonuses but it also continues to credit interest to the income value. The illustration not only shows a high level of guaranteed income but also shows substantial income increases over the years. This is where I have issues.
Everyone needs to first focus on the guaranteed portion of the illustration. This is what you know will happen in the worst case scenario. Now, of course the contract will grow to some extent so you can expect it to be higher but it’s not guaranteed. In this case, the contract is 51 years old and he wants to start with $800,000 and wait 11 years until he takes income. Below is the first page of the guaranteed illustration…
Three columns are highlighted. From the left is Lifetime Income Withdrawals, Benefit Base and Accumulated value. The benefit base is enhanced by the 25% bonus, the accumulated value doesn’t change because there is no growth and no fees and the lifetime income withdrawals are simply a percentage of the benefit base, depending on the age at which income starts. Like any annuity, the insurance company is paying the contract owner back with his own money.
The hypothetical illustration is quite a bit more dramatic. For simplicity I used a NASDAQ index that resets every two years. It remains static throughout the contract which doesn’t represent reality but it’s all we are able to do with an illustration. Performance is exceptional, both the benefit base and accumulated value grow very well throughout the deferral period. See the link below…
The same columns are highlighted. Substantial growth leads to substantial income. In this example he receives almost $50K more annually just based on performance. From there the account continues to credit so income increases by a healthy margin every two years. It’s amazing but allow me to explain why this will probably never happen.
Getting to the $91K income level is one thing but by the next year it increases more than 12% to $103K. That is one hell of an inflation adjustment! Sorry, but it’s not how annuities work. Many people hesitate to buy index annuities because they are worried that the insurance company will reduce rates over time and growth will not be what is expected. When growth is tied to a long-term liability for the company, by way of guaranteed income, there is a greater chance it will happen.
The company will control the liability and will adjust rates so it never gets out of hand. Take a look at the second page of the hypothetical illustration. I highlighted the year in which the owner turns age 78. In the previous year, the lifetime income withdrawal almost completely depletes the accumulated value. But the income increases by more than 12% once again. No money is left in the account, the insurance company has collected no fees and income is still increased by a substantial amount. It continues to happen every year for the life of the contract. Yeah right! No actuary would ever design a contract to work this way. The insurance company will manage rates in the contract to make sure it doesn’t get out of hand like this.
Do you have guaranteed income? Yes. Will the contract be better than the guaranteed minimum? Most likely. Will it perform just like the hypothetical illustration? I seriously doubt it. It’s obvious to me but a lot of people go through with it anyway, believing they struck it rich with an annuity. Only time will tell if it works out but I’ve never seen one that came even close.
The sample contract is one that I have sold once. I used the hypothetical maximum to show this contract had more potential than any other on the market at the time. I was careful to manage expectations, however, and after two years the contract is doing just fine but it’s nothing more than a reasonable level of guaranteed income waiting for my client in another eight years. He also only put about 10% of his assets in the contract.
That’s my recommendation. Don’t do it with a substantial portion of your retirement funds. If you want to give it a shot then don’t put all your hopes on it. If it doesn’t work out you might be in a tight position. New products are coming on the market all the time and there’s a sales pitch to go along with every single one. If you’d like to review something or show you something more reasonable then get in touch. Make an appointment or give me a call.