The Danger with High Expectations
Over the past few weeks I have come across a couple proposals from other advisors that have revealed something of a trend throughout my career. Certain annuity illustrations can be made to produce spectacular numbers and it’s fine if someone chooses to believe those results will happen but more realistic expectations will give you a plan with more certainty. I’m going to show you how to put these types of projections in perspective so the most optimistic outcome is really good news, rather than anything less being a disappointment.
About a month ago I saw an illustration for a variable annuity with a lifetime income rider and additional death benefit. Then this past week I ran into a similar illustration of an index annuity with guaranteed income payments that increased each year based on the growth of an external market index. Each produced exceptional results and my problem is not with the contracts specifically, rather the consequences of it not working out that way. Lower than expected income or a depleted remainder account value could leave you in a bind at the worst possible time.
This is something I’ve dealt with for years with all types of financial vehicles from mutual funds to insurance policies. I hear crazy claims and see ridiculously high projections that are often based on questionable assumptions. When people realize the truth and find that the proposal is not very realistic they are disappointed. An alternative plan may be more reasonable but it’s not exciting enough and they just stop trying to find a solution. Worse yet, many people disregard my advice and go forward with the proposal anyway.
In this case, whether it be the variable or index annuity, what concerns me most is that for either plan it wasn’t the annuity that made it work. Both plans worked well because the market period used in the illustration was one of the best performance periods in history. If expectations are based on that period then there would have been no reason to use an annuity because either person would have been much better off keeping all their money in the stock market.
The variable annuity had fees close to 4% and the index annuity has capped gains. Without the fees or cap rates, growth for either individual would have been substantially better. The market period used was from 1988 thru 2018 so it’s not a matter of cherry picking the perfect data, it’s just that the last 30 years was pretty outstanding. Almost the entire exponential part of the stock market’s curve happened since the late 80s. Fine by me if you think that’s going to happen in the next 30 years but if you’re so sure about it then don’t even mess with an annuity.
Just about everyone on this list has benefited greatly from saving during the best years in the stock market. There have been plenty of pain points but the market always bounced back and climbed even higher. Whether it will continue for the next 30 years remains to be seen but the reason most of you are here is because you think it might not.
We all use past results to predict future performance but it’s important to simulate plans over poorly performing market periods as well and not everyone does that. I feel that’s the key to setting your expectations at a reasonable level and I recommend it as an approach to evaluating any overly-optimistic plan.
Both the variable and index annuity showed guaranteed minimum outcomes. This is what you know the insurance company will do no matter what. Each contract showed a guarantee based on 0% growth over the contract term and the results for both would be devastating, or the kind of thing that would happen in a very dark economic time period.
Since I don’t think we are headed for the apocalypse it is reasonable to assume some growth in the future even if it doesn’t match the substantial returns from the past. What I told each of these people is to take the average of the best outcome possible and the guaranteed minimum. For both annuities this would mean lower starting income but not below the guaranteed minimum and smaller annual increases with a lower remainder benefit.
If the average of the best and worst case scenario is appealing then base your expectations on that. There will still be variability in the outcome but your plans will not be derailed by sub-standard performance. In a worst-case scenario you’ll at least have income when everyone else is looting grocery stores and the best case will exceed your expectations. It’s much more reasonable than planning for the best only to be disappointed or trapped when it doesn’t work out. Give me a call if you need some help creating a plan grounded in reality.