Ep. 128 -Should I Consider an Annuity in My Financial Plan?

Have you been considering purchasing an annuity as part of your financial retirement plan? An annuity is an insurance product that you buy from an insurance company and is very advantageous. 

When purchasing an annuity, it is important you evaluate the insurance company just like you would a financial advisor to determine its financial background for the safety of your money.

In this episode of the Secure Your Retirement podcast, we talk about annuities, what they are, and their benefits for your retirement plan. We explain an annuity’s income benefits, bond alternative, and tax deferral advantages. 

In this episode, find out:

  • Ensure you evaluate and choose a strong insurance company when purchasing an annuity.
  • The legal reserve system – a regulatory safety mechanism that ensures your money with an insurance company is protected. 
  • The qualified and non-qualified money and how to understand your buckets in each and what makes the most sense to purchase an annuity.
  • Why your after-tax money can make sense if put into an annuity for tax deferral. 
  • The tax benefits of purchasing an IRA annuity. 
  • How you can structure annuities to provide you a guaranteed income you can’t outlive.
  • How to use the annuity as a bond alternative so you don’t worry about bond volatility. 
  • How to use an annuity to tax defer on non-IRA money and invest in the market very low. 
  • Understanding an income rider in annuity and its benefits to your retirement plan. 

Tweetable Quotes:

  • “We like working with stronger rated insurance companies that have some good financial background to them.”– Murs Tariq 
  • “There’s no reason in going to an insurance company in the very beginning that’s not already highly rated.”– Radon Stancil


If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Here’s the Full Transcript:

Radon:It’s a pleasure to talk to you today on our retirement in action episode. And today, we’re going to talk about a topic that we get asked about all the time. In fact, we have done a whole series on annuities. We’re going to talk about it a little different direction today, and really what we’re going to answer the question to is, does an annuity fit within my financial plan? That’s our question. So, Murs and I talk all the time about needing a financial plan focused on retirement, around that idea, because the goals are way different when I’m getting close to retirement or I’m in retirement. So, the question is, should I have an annuity in my financial plan if I’m 10 years into or close to retirement or already in retirement? That’s the major question.  
 We’re going to break this down into a few different categories and that way we’re tying it together. So, we’re not going to go into an extreme amount of detail on a specific annuity, we’re looking at this high level, big picture. So, the very first thing that we’re going to talk about is basically this idea of safety, in all essence, the insurance company, and what should we consider on that. So, Murs, can you get us going in that topic?  
Murs Tariq:Yeah. So, with annuities, the first thing you have to realize is that when you’re buying an annuity, when you’re thinking about purchasing one, actually, it’s an insurance product, so you are buying that annuity from an insurance company. And when you’re going down the line, just like you’re going to evaluate the financial advisor that you want to work with, you’re also going to be evaluating the insurance company as well. We like working with stronger rated insurance companies that have some good financial backgrounds to them, have the ability to withstand anything that’s going to come at them.  
 So, there’s multiple ways that you can look up an insurance company, there’s rating system that put them in the A, AAA, B, C category. And so, when you’re talking to maybe an insurance agent or your advisor, and you’re talking about this idea of an annuity, I would definitely bring up the question of, well, how strong is the insurance company? And then there’s another big concept that I think it’s very good to understand. Banks, when you have your money in the bank, you are protected by what’s called FDIC. Insurance companies have something you could call similar that is, it’s basically called the legal reserve. So, that offers some protections as well. And I think, Radon, you do a great job of telling the story of how the legal reserve works. I think if you want to run through that in just a couple minutes.  
Radon:Yeah. The idea behind the legal reserve system is really been around well before the great depression. But the idea was is that we want… The United States said they want to have a system in place, because insurance companies, a lot of times are using guaranteed terminology, whether that be life insurance or for this, an annuity, what is it that needs to be in place to make sure that the person who is the consumer are protected? And under the legal reserve system, and I’m going to talk high level just so you can visualize it. In all essence, insurance companies inside the United States pretty much say, if we’re going to operate as an insurance company, we then are going basically work together.  
 Which means if one company were to go into a bankruptcy scenario, then the other insurance companies would be deemed to go. And whether they split up those assets or whether or not another insurance company buys over those assets from the other insurance, whatever that might be, that is what we have seen occur. When an insurance company gets into trouble, usually they’re going to get split up and all of those different monies that were there for the consumer are going to go to a different insurance company. Your contract cannot change. Your contract stays intact.  
 But in all essence, the other part of this is the reserve part of it. And when you think about this idea, it really helps you understand the safety element of an insurance company. An insurance company is required to have a certain amount of reserves in place based on what they owe back out to consumers. Those reserve requirements are very significant. It is not leveraged like a bank would leverage their reserve. And that’s the reason why a bank has to have FDIC. They leverage very heavy to what they have in deposits and then they loan out a bunch of money. Whereas an insurance company, if they owe money back, they’ve got to have reserves to back it.  
 Once those reserves get into a position of concern, you’ve got 50 plus insurance regulatory systems in all the different states that are saying, “Hey, we’re all watching you.” And so, if you’re with a big insurance company and they’ve all got these different regulatory systems in place, and they start to see a financial problem, they’re going to tell that insurance company to have to stop selling other insurance products until they can get their reserves back up. So, there’s lots of safety mechanisms, and it is not a scenario where you all of a sudden, overnight wake up and find out that an insurance company’s in trouble. It is usually a very slow process, so it gives us time to react.  
 I let people know that from a safety standpoint, for a fixed insurance product, I mean, you’re very, very safe with an insurance company. With that being said, though, there’s no reason in going to an insurance company in the very beginning that’s not already highly rated. So, we do believe in getting a highly rated company. All right, let’s switch topics. And let’s talk a little bit about the tax issues. Now, the tax benefits of an annuity really are only a topic around what we call non-IRA money. So, Murs, can you just talk about the two types of money that could go into an annuity and what the tax implications are on that?  
Murs Tariq:Yeah, so, basically, you’ve got qualified money and non-qualified money. Qualified is your retirement plans, your 401(k)s, your IRAs, stuff that’s been tax, deferred, you haven’t paid the taxes on that money yet. And then you’ve got non-qualified, which is money that is basically after tax that has other tax type of treatment to it, like realized capital gains and dividends that may cause you a tax issue. So, the first thing you want to do is understand what your balance of money is. Is the majority of your money in IRAs and 401(k)s, or do you have a mix of all the different types, from IRAs to Roths that are tax free, to non-qualified like brokerage accounts?  
 So, once you know what all your different buckets are, then we can start having a good conversation around what makes the most sense when it comes to purchasing an annuity. What Radon was saying is that, with your brokerage account type of money, your after tax money that you’ve basically accumulated over the years, that can make a good amount of sense if you put that into an annuity, because now that money is growing tax deferred. So, say you put in a chunk of money, and there are a $100,000, the taxes have already been paid on that and any growth after the fact is deferred.  
 So, unlike in a brokerage, if you buy or sell something in there, you’ve got some capital gains to deal with, or if a stock is spinning off a dividend on a yearly basis, you’ve got dividends to deal with. So, you’re always getting some type of taxes in the non-qualified type of account. So, if you’re looking ultimately for tax deferral, an annuity can make a good amount of sense there, because you won’t get that 1099 every single year.  
 On the IRA side, let’s say you just have the majority of your money was building up in 401(k)s, we can take that money and roll it over into an IRA annuity. Think about what an IRA is. An IRA is pre-tax money, you’ve never paid any taxes on these dollars. And so, every dollar that comes out is going to be fully taxable. It’s going to be added to your income for the year. So, the majority of people are not want to going to heavily withdraw on an IRA. So, what we’re going to talk about here in a second, annuities have some liquidity restrictions to them. And so, for that reason, IRA money also fits really well because nobody’s taking out 10 to 15 to 20% of their IRA in a given year. You want to keep that number low to keep your taxes a little bit lower. So, couple considerations when it comes to what type of money you have and what makes the most sense for your situation based off of the different buckets of money that you may have.  
Radon:All right, let’s talk a little bit about the why. I always think that it’s important for us to think about why we’re doing anything when it comes to using a financial tool and an annuity is a financial tool. So, we’re going to look at some ideas behind why I might use them. Let’s talk about this in three categories. One is income planning, two is a safety alternative, or a bond alternative, and the third area is tax deferment. So, the first two, primarily we’re focused around for most people, IRA, 401(k) type money. And most people view that money as money that they want to live on, or provide an income stream for them at some point in the future.  
 So, you can structure annuities that will provide you a guaranteed lifetime income that you cannot outlive. It’s going to always be there. It’s an annuity. We make that lifetime income there. And if it’s an IRA, then yes, you’re going to get taxed on that, but you already understood that concept. So, we say this, if a client has enough assets, they are only going to be withdrawing out of their assets two to 3% a year at retirement age. Doing the income benefit on an annuity probably does not make sense. Why? Because if I add that feature, I’m going to have a lower rate of return or a fee. In all essence, still equals a lower rate of return.  
 So, there’s no a reason to pay for that benefit if I’m already got enough assets that I don’t need to have that money be guaranteed. So, income planning is something that we need to discuss, and we use our retirement financial plan in order to make that decision or help you to make that decision. The second area is bond alternative. This one we use quite bit. And the idea here is that I can structure an annuity that will give me a decent rate of return, but I don’t have to worry about the volatility of the bond market. The annuity, the insurance company takes away that volatility. I transfer, in essence, the risk to the insurance company.  
 So, if I’m looking at assets and we do a risk conversation, and let’s say a person’s threshold is lower, then we might not be able to invest all the money in the stock market in bonds. So, we use the annuity as a bond alternative because we can set the annuities up so that they make a decent rate of return, but we would never lose due to market volatility in a down year. The worst case I would have there is a zero. So, again, that helps me balance risk. Risk conversation is huge for us. We talk about it with every single client. We review risk all the time. We want to make sure that you have peace of mind and that you can leap throughout retirement, not have to worry about going to bed and worrying about whether or not you’re going to have enough money tomorrow.  
 The third area is tax deferment. The tax deferment side, Murs has already mentioned it for a second, but basically that is not IRA money. So, let’s say I’ve built up a sizable brokerage account, I’m having to pay taxes on that, on my dividends, I’m not using it. Or every time I sell something, I’m paying a long term or a short term capital gain, then we can put that into an annuity that allows us to invest in the market, very low to no fees, almost. Very low, but I can invest in the market. I’m a 100% liquid, but I get tax deferment. We really have to look at the why we’re doing it. But when we look at the why, we get a lot of our answers taken care of.  
 So, I hope that gives you some of those thresholds, but we want to just wrap it up here in this last little part. And I think what we want to talk about is how when we’re viewing the annuity and our income plan, again, can we just talk a little bit about, maybe Murs, how the income rider works? We’ve already said this probably doesn’t apply for folks unless they’re having to pull out more than around 3% of their assets, but could you just give us a quick synopsis of an income rider and what the benefits are?  
Murs Tariq:Yeah. So, an income rider is going to be something that is attached to the overall annuity vehicle. And so, the way that we like to look at it is say, you’ve got really two sides to annuity. You’ve got one side that is basically your account value, and then you’ve got another side that is essentially the income account value. The income account value, but let me go back. The account value is going to grow, based off of whatever interest the annuity has the ability to earn. So, whatever that percentage is, it’s going to grow. On the income account value, you’re going to get a little bit of a step up, whether that’s a fixed rate, like maybe a six or seven or an 8% fixed rate type of deal that you can count on. It’s guaranteed by the insurance company. And that side of the contract is going to continue to grow by that every single year or maybe a multiplier of your interests.  
 So, maybe your account value made 5%, but your income account actually gets seven and a half or maybe 10%. So, the income account value is structured to grow, really, to outpace the account value growth. Now, how are they able to do that? Well, when you signed up for this income rider, you basically said that I need the insurance company to guarantee me at some point in the future some lifetime income. And it has to last the rest of my life, potentially even the rest of my spouse’s life. And so, what the insurance company is willing to do is to give you this better growing income account value side, in all essence, but they say, this is not a lump sum value. This is not something that you can withdraw all at once. We signed up for being able to pay you out over your lifetime.  
 And so, that’s a very high level S to how it works. Typically, someone is going to purchase an annuity, and then if they have an income rider, you’re going to wait three to five to maybe even 10 years before you actually touch it. That’s called the deferring period before that lifetime income really starts to kick on and really works well for you. And like Radon said with that, when you have those riders, something to consider is that there may be a fee attached or your interest potential on the account value side may go down a little bit.  
 So, a lot of moving parts, but at the end of the day, we feel annuities, income rider or not, they can be very advantageous to a financial plan. Our whole process is let’s talk about it, let’s see if it makes sense, let’s build out the retirement financial plan, and then we start to evaluate can an annuity fit into the overall plan. So, I know we’ve given you a lot here today, but I hope you found it somewhat enjoyable and also informative.  
Radon:All right. And just make sure you remember that if you’ve heard all this and you’re thinking, “Oh, my God, that was a lot,” go to our website, pomwealth.net, go to the blog log page. We have an article written on this very topic, so you can read it and look at all those notes. We hope you have a great week. We’ll talk to you next Wednesday.