We do love it when someone refers a family member or friend to us. Sometimes the question is, “How can we introduce them to you?” Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.
Here are this week’s items:
Portfolio Update: Murs and I have recorded our portfolio update for July 17, 2023
This Week’s Podcast – Annuities or CDs – What You Should Consider
In this Episode of the Secure Your Retirement Podcast, Radon and Murs discuss the similarities and differences between annuities and CDs and the best one for retirement planning. In as much as CDs and fixed index annuities are similar, CDs are best suited for short-term investments, while annuities are best suited for long-term investments.
This Week’s Blog – Annuities or CDs – What You Should Consider
“Annuities or CDs?” is a question many folks are asking because interest rates on CDs are the best they’ve been in a long time. In this article, we’ll cover both annuities and CDs to help you better understand which option is right for your current retirement planning strategy.
“Annuities or CDs?” is a question many folks are asking because interest rates on CDs are the best they’ve been in a long time. In this article, we’ll cover both annuities and CDs to help you better understand which option is right for your current retirement planning strategy.
Wait. CDs? They’re No Good, Right?
We haven’t talked about CDs for a long time. Interest rates weren’t that attractive in past years. Most people were lucky to receive 1% to 2% returns. Clients who want to reduce market risk can, at the time of posting this article, go out and get a 1-year CD at 5.5%, or a 5-year CD at 4.5%.
With returns like this, we have a lot of people questioning why they would put their money into an annuity – especially a fixed annuity.
First, we need to consider putting the funds into the right place for your retirement focused plan. You have a lot of options when investing, including the following three main categories:
1. Growth
You can put your money into growth assets, such as equities, because they have the highest return potential. These assets would include things like ETFs, stocks, and mutual funds.
These funds need to remain in the market for some time and have the risk of volatility. Markets go up and down all the time, and your funds will follow this trend, too. You do have the potential to lose money with equities, but we do have controls in place to limit these potential losses.
2. Safety
If you want to have a good rate of return without the risk of losing money on it, you’re now in the following territory:
These investment vehicles protect you from market losses, so you don’t need to worry about that, but you may earn less with a fixed option.
3. Cash
Easy money access. If you need liquidity, this is the avenue that you’ll want to choose because it gives you access to the money without penalties when you need it.However, you will not receive a high rate of return.
Keeping this in mind, we’re going to expand on the second category, “safety”, because that’s where the discussion of CDs vs. annuities really exists.
Interest Rate Risks of CDs and Annuities
CDs and annuities are the “hot topic” right now. Interest rates have gone up due to inflationary measures and banks are now able to offer better rates on CDs than they have in a long time. The Fed’s goal is to tame inflation, and when it does go down, interest rates will also come down.
If you buy a CD today at 5% and allow it to reach maturity, you can choose to:
Take the money and put it back in a CD
Take the money out and put it into other investments
CD renewals will allow you to buy the CD again at current market rates. It’s very likely that rates will come down and you may have a CD rate of 3.5% or 4% at renewal – or lower. Two years from now, CDs may be 2% or 1.5%.
These lower interest rates are your “reinvestment risk”.
We like the idea of putting a portion of our client’s money into the six-month or one-year CDs, if they know they’ll use these funds in the next year and will need to access them. In the meantime, they will receive a nice return on their investment.
Fixed Indexed Annuities and Their Potential
Fixed Indexed Annuities (FIAs) are driven by interest rates, so just like CDs, the interest rates have gone up in the last year. The key difference between a CD and an FIA is the length of the contract you receive. For an annuity, the term is longer, such as 10 years.
You may receive a 4.5% – 5.5% interest rate on CDs for 1 year or more. Over the past 10 years, FIAs with no riders or fees have had returns of 4% – 6%. Compared to CDs, this range for annuities was much higher.
In today’s market, because of higher interest rates you can receive an FIA that averages 5% to 10% over a 10-year period. However, you may have some years with 0% returns.
How does that work?
Annuities are linked to an index. For example, S&P 500:
S&P 500 rises 10%, so you earn 10%
Next year, the S&P 500 drops over 10%. Since you are protected from market losses in an FIA, you do not lose any money in that year.
Fortunately, FIAs often have many index options that allow you to diversify your potential and gain more opportunity.
We believe FIAs are really a bond alternative, as they are both conservative and protect against risk. Bonds in 2020 – 2022 hurt portfolios more than they helped.
Clients often look to bonds to make 3% – 5%, but FIAs offer:
Greater return opportunities
Principal Protection (protection from market losses)
Of course, if you have money that you want to park for a year and then use the money, put it into a CD and make your 5% return. However, for long-term investments and the potential to make more money, it often makes better sense to go with an annuity.
Annuities are longer-term, but the reward is more consistent. CDs are shorter-term and, while they have their place today, will see rates go back down as inflation falls and interest rates follow.
Do you want to read more about how to secure your retirement?Click here to view our latest books covering this topic, or schedule a call with us.
You understand what an annuity is, how it works, and what the advantages are, but do you know how to implement it into your portfolio?
In this eighth and final installment of our “Annuities – Why Ever Use Them” series, we’re sharing how to use an annuity as part of your retirement portfolio.
You can watch the video on this topic above. To listen to the podcast episode, hit play below, or read on for more…
A quick summary
Before we dive into how you can incorporate an annuity into your portfolio, there are some things to be aware of. We’ve already covered these points in detail in other articles within this series, so do visit our blog to find more information about anything covered below.
We prefer fixed index annuities over variable annuities because you can lose money in a variable annuity.
Fixed index annuities protect your principal, so your investment is guarded against market volatility.
Fixed index annuities are linked to an index, such as the S&P 500 – they earn interest depending on how the index performs.
You can choose from a range of strategies for how you want to receive interest, for example a cap or a participation rate strategy.
If you use a cap strategy set at 5%, for example, and your index earns 10% over an annual point-to-point reset, your annuity will earn a maximum of 5% interest.
If you use a participation strategy set at 50% and your index earns 10% over the reset period, you’ll earn 50% of the index’s 10% growth (5% interest on your annuity).
There are liquidity restrictions, so we recommend using an annuity as part of a more diverse portfolio.
Most annuities allow you penalty-free access to 7-10% of your money in any given year.
Annuities often have a surrender charge that applies for a set number of years.
Why choose a fixed index annuity?
Most people use an annuity as part of their retirement portfolio for two reasons. First, a fixed index annuity gives you complete safety and still grows your investment at a good rate of return. A fixed index annuity is not affected by market downturns and is protected against risk. So, if your main concern is safety, an annuity would be a good option for your portfolio.
The second reason is income planning. There are a few ways to get guaranteed income in retirement, including taking a pension and Social Security. A fixed index annuity is a straightforward addition you can make to your guaranteed income sources that lasts for the rest of your lifetime.
Implementing an annuity in your portfolio
We’re going to use an example to demonstrate how to build an annuity into your retirement portfolio. In this example, we’re going to be using hypothetical figures and a fictional retiree, Mary. Please bear in mind that while these figures are representative of fixed index annuities, these are not accurate rates.
Mary is 60 years old and has $1 million of IRA/401k savings. She wants to retire in 7 years time, at the traditional retirement age of 67. She’s calculated how much she spends on her essential needs, wants, and legacy money each month, and discovered that she needs $4,000 of guaranteed income a month to cover her essential needs alone.
Social Security will give Mary $3,000 a month. She doesn’t have any other forms of guaranteed income, so Mary is looking for a way to get an extra $1,000 a month.
What is your risk tolerance?
One thing we talk to all of our clients about is risk. Knowing what your risk tolerance is can help you make decisions about your portfolio that you’re comfortable with. So, before we can advise Mary about finding that additional $1,000 per month, we need to understand how much risk she’s willing to take.
There are a few different ways that you can make a return and manage risk. Banks, for example, have essentially no risk, but the rate of return is very low. Money markets in general are well below 1% currently. So, while there is no risk, there is also hardly any return.
However, if you look at the stock market, this is the complete opposite. There is potential for incredible returns, but also huge losses. Annuities, on the other hand, give a good rate of return, but there are liquidity issues. Your total investment won’t be easily accessible to you. This is something to be aware of in case liquidity is a concern for you.
Let’s go back to Mary. To find out Mary’s risk tolerance, we’d have a conversation with her about how much she’s prepared to lose. Take her $1 million, for example. If we’re talking in percentages, a 10% gain or loss might be something Mary is willing to accept. But if we convert that into dollars, a $100,000 loss may be too much for Mary. In this case, we would keep discussing figures until we land on a percentage that Mary is comfortable with.
Once you understand how much risk you’re prepared to take, then you can decide how to build a portfolio that suits you.
How to construct your portfolio
Mary’s risk tolerance helps her decide that she wants to invest 50% of her $1 million in the stock market and 50% in a fixed index annuity. This gives her roughly $550,000 of liquidity. Mary still needs that extra $1,000 of guaranteed income a month, so she puts $150,000 into an income-based annuity. At age 67, this will start providing her with a lifetime monthly payout of $1,000. Now, she has complete peace of mind that her essential income needs will be covered when she reaches retirement age.
In terms of Mary’s portfolio, she still has $850,000 left. So, to achieve that 50/50 split, Mary could invest $350,000 into another fixed index annuity. She’s got the guaranteed income coming from her first annuity, the second one will be to give her that risk-free growth that she wants. The remaining $500,000 will go towards the stock market as she wishes.
So, where will Mary’s portfolio get her by the time she retires? If the $350,000 in her annuity earns 4%, it will grow to around $480,000. Meanwhile, if the $500,000 that she invested in stock market earns 7%, it will have grown to over $1 million.
The final piece to this portfolio is her remaining annuity, which will start generating $1,000 a month of guaranteed income to add to the Social Security payments of $3,000.
However, one thing that we need to consider is inflation. Mary’s expenses are now $6,500 a month. So that original $4,000 of guaranteed income no longer completely covers her essential income needs. But, thanks to Mary’s growing investment portfolio, she can afford to withdraw from her accounts to cover that extra cost.
Inflation and other costs can drastically impact your retirement plan, but we can use our system to adjust numbers and show you exactly how your funds could play out in different scenarios. We can illustrate what happens to your money if you want to withdraw more at the beginning of your retirement than you do later on, or if you want to purchase a second home, for example.
Overall, Mary’s retirement plan shows that her funds last throughout her retirement, and well into her 90s. Constructing a portfolio that’s safe, liquid, and has income, can give you this same security and peace of mind that you don’t need to worry about your retirement finances. But, please remember, this is based on an illustration only.
If you want to learn more about using an annuity as part of your portfolio, please do reach out to us by booking a complimentary 15-minute call. We can give you individualized advice about annuities and constructing a portfolio that’s right for you.
Annuities can be a safe way to grow your money – but they’re not without their limitations.
In our “Annuities – Why Ever Use Them” series, we’ve talked a lot about the advantages of using a fixed index annuity. However, there are always drawbacks. So, what do you need to be aware of?
If you’re thinking about purchasing an annuity, there are two main limitations to consider. The first is how liquid your annuity is, and the second is surrender charges. In this post, we’re going to explain how both of these limitations work, how to avoid them, and what you can do to balance your portfolio.
You can watch the video on this topic at the top of this post, to listen to the podcast episode, hit play below, or read on for more…
Annuities: the need-to-knows
Here’s a quick review of what we’ve covered about annuities in our series so far:
There are two different types of annuities, deferred and immediate. Immediate annuities can provide you with income from the moment you set them up, whereas deferred puts your money aside to grow. In this series, we’re talking exclusively about deferred annuities.
Deferred annuities can be either variable (where you invest in mutual funds, so there is risk involved) or fixed (principal guaranteed with no risk). Our focus is on fixed annuities.
You can get a traditional fixed annuity, similar to a CD, where the insurance company gives you a fixed rate for a set number of years.
Or you can get a fixed index annuity. Here, your interest is linked to the performance of an index, such as the S&P 500.
A fixed index annuity earns interest through a cap or a participation rate.
If you use a cap, and set it at 5%, for example, then if your index increases to 10% over an annual point-to-point reset, your annuity will increase by your cap amount of 5%.
If you use a participation strategy and set it at 50%, then, if your index increases by 20% over the reset period, your annuity will increase by 50% of the index’s 20% growth (so, 10%).
There are three reasons why people choose a fixed index annuity: safe accumulation, guaranteed income, and death benefit.
When an annuity is part of your portfolio, you need to know how accessible your money is. An annuity should never be the be-all and end-all of your portfolio. It should be one part that’s helping your money grow safely and securely, while other parts give you access to your money if you need it.
Annuities are not entirely restrictive. Most annuities allow you a penalty-free withdrawal. For the majority of annuities we recommend, this is usually between 7-10%, but it can vary. So, if you have $100,000 in an annuity, up to 10% of that ($10,000) is easily accessible to you.
But if 10% of your annuity isn’t enough to cover you in an emergency or you need frequent access to more liquid funds, what are your options?
We never suggest that you put all of your savings into an annuity because of their limited liquidity. Having unrestricted access to a fair amount of funds is paramount in retirement, so instead, we suggest splitting your money as part of a wider strategy. You could put 50% of your savings into an annuity, and the other 50% into stocks, bonds, ETFs, mutual funds, or another completely liquid asset.
So, if you have $1 million of savings and split it equally between an annuity and a fully liquid asset, you could have $550,000 of easily accessible cash. This equates to your $500,000 as a liquid investment and 10% available from your annuity.
How surrender charges affect your annuity
If you need more money than your penalty-free withdrawal amount allows, you may be subjected to a surrender charge. This is a period where you will have to pay a penalty to withdraw more than your limit. Let’s use an example to demonstrate.
Say you have $100,000 in your annuity, with a free withdrawal amount of 10% (so, $10,000), but you need access to $11,000. The 10% that you withdraw will be penalty-free, but that extra $1,000 will be subject to the surrender charge.
Insurance companies use surrender charges because they’re giving your investment guaranteed protection against market volatility. This comes at a cost to them as, to do this, they have to make long-term investments of their own. If you need to withdraw more money than they’ve prepared for, they will incur penalties. In essence, a surrender charge is a way of passing this penalty to you.
Most annuities that we work with have a surrender charge schedule lasting anywhere between seven and twelve years. Typically, these charges decline over time until they no longer apply, but this means they will be much higher in the initial years. So, if your annuity has a 10-year surrender charge schedule, you might face a surrender charge of 12% in the first year, 8% in the seventh year, and 0% in the eleventh year – as you’ll be out of surrender.
Your overall portfolio must ensure you have enough liquid assets so that you don’t have to worry about accessing cash or these surrender charges impacting your finances. There are pros and cons to every investment and limitations to how they work. So, how can you build a balanced portfolio?
The three elements to investing
There are three main elements to any investment strategy, safety, liquidity, and growth. No investment can suitably provide you with all three, but most investments give you two. So, how can different investments satisfy each element?
If you’re concerned about safety and liquidity, then a money market might be the right investment for you. Bear in mind that it will not give you substantial growth.
If you want liquidity and growth, the stock market could be a suitable solution. It has lots of growth potential but isn’t going to give you safety because there’s also the chance that you could lose money.
If you prefer growth and safety, we recommend fixed index annuities. As we’ve seen in this post, they have limited liquidity, so it would be wise to use an annuity alongside another type of investment in order to give you a better amount of liquidity.
Remember that every investment has its limitations. But by thinking about these three elements, you can decide what is most important to you. You should keep these elements in mind when picking your own investments or work with a financial advisor to build a portfolio that covers all three bases.
If you want more information about preparing your finances for the future or retirement, check out our complimentary video series, “4 Steps to Secure Your Retirement.” In just four short videos, we teach you the steps you need to take to secure your dream retirement. Get the free series here.
Your retirement years are considered the golden years of your life, giving you the chance to relax and spend time with your loved ones. However, in order to maximize your experiences, you need to start preparing for retirement today.
If you are in your 60s, developing a thorough plan for your retirement is essential. That is why we have put together our top five tips to help you prepare.
Identify your retirement starting point
The first thing that you need to do is to identify your starting point. To do this, you need to collect as much information as possible such as bank accounts, income, and outgoings. With this information, you can then break this down into three key categories:
Essential Needs (such as rent, food, etc.)
Wants (such as those dream trips with your family)
Legacy (the money you want to leave behind or donate)
By breaking this information down into these categories, you will be able to have a clear idea of the amount required for your retirement. When developing this information, you should also take into consideration your social security, the age you would be looking to retire, and when you want to start taking your pension.
Know your destination
Once you have your starting point, you should then think about the destination and everything you want to achieve during your retirement. Think about the goals that you want to achieve and how you want to live. Do you want a new car every few years? Do you want to become a member of a golf club? An annual holiday with the family, perhaps?
Whatever it might be, make sure you know what you want to ensure you can fulfill this golden period of your life.
Build a retirement roadmap
With your start point and destination created, you now need to build your retirement roadmap. This is the plan that you will follow as you save towards, and live through, your retirement.
When building your retirement roadmap, it is really important that you know your income and outgoings. One thing that many people forget to do when building their roadmap is to factor in taxes and the rate of inflation. Without doing this, you can quickly find your savings erode faster than you were expecting.
Plan for retirement roadblocks
Even the best-laid roadmap can experience a roadblock, so it is crucial that you factor unexpected costs and issues into your plan. For example, another market crash such as that experienced in 2008 or a sudden deterioration in your health can see your savings depleted.
That is why it is vital that you constantly monitor your roadmap, making those small adjustments to keep you on track. When it comes to healthcare, you should also consider carefully whether you will be able to self-insure or whether you will need an insurance policy in place.
Retirement cruise control
While for the most part, careful planning and preparation can mean your retirement can effectively run on cruise control. However, just like you would in real-life when driving a car, you still need to be ready to take over as the road ahead changes.
From a potentially volatile market and inflation to economic and political impacts, keep your eyes on the road ahead and adjust accordingly.
Are you ready to prepare for retirement?
If you are thinking about your retirement and want to start taking steps today to ensure you are in the best possible position, then we are here to help you. Our ‘4 Steps to Secure Your Retirement’ mini-series has been designed to take you through the preparation stages step-by-step, ensuring you are able to be in the best possible place.
If your Social Security benefit or pension won’t provide you with enough guaranteed monthly income to keep you comfortable in retirement, an annuity can help.
You can watch the video on this topic further down, to listen to the podcast episode, hit play below, or read on for more…
There are often limited resources for securing guaranteed income in retirement, but if you have or are considering opening an annuity, you may be able to access an “income rider”. An income rider is an additional annuity feature designed to guarantee income for the rest of your life.
In this post, we continue our “Annuities – Why Ever Use Them” series by diving into how a fixed index annuity provides guaranteed income using the income rider.
Our annuities series is a comprehensive guide to this complex product. If you want to learn more about annuities, we encourage you to read the posts on our blog, listen to the episodes on the Secure Your Retirement podcast, or follow the links below to watch them on our YouTube channel:
We believe there are three reasons why you would want to add a fixed index annuity to your portfolio. The first is good accumulation. Fixed index annuities accumulate similar to a bond, but with the added benefit of no downside risk. The second is the death benefit, and the third is guaranteed income.
Before we discuss how to get guaranteed income from your annuity, here is some high-level information to help you understand how annuities work, the different types, and why we recommend a fixed index annuity.
Deferred annuities are either fixed or variable.
Variable annuities are linked to market investment through buying mutual funds. The rates are often high for variable annuities, and they come with risk. To make a decent return on your variable annuity, you have to overcome these fees and more.
Fixed annuities have guaranteed principals, meaning you cannot make a loss, which is why we prefer them.
There are two types of fixed annuity, traditional and indexed – both guarantee your principal.
The traditional annuity is similar to a CD (certificate of deposit). You give your principal to an insurance company, and they provide a return based on a fixed rate for a number of years.
With an indexed annuity, your return is linked to an index such as the S&P 500 or the NASDAQ. Even though indexes can fall, your principal is guaranteed, so the worst a fixed index annuity can earn in a year is zero.
The crediting methods for fixed annuities are based on a point-to-point annual reset. For example, if you open an annuity on January 1st, 2021, you’ll earn your interest on January 1st, 2022.
If you have a fixed index annuity, your interest will be calculated depending on what strategy you use. This could be a cap or participation strategy. To learn more about caps and participation rates, read our blog post, Fixed Index Annuities: How They Work and Things to Consider, or watch the podcast episode.
Our “Annuities – Why Ever Use Them” series covers many of these points in much greater depth, so if you have any questions about how annuities work, please visit the other articles on our blog.
A fixed index annuity is our recommended option, especially for retirees who need access to a higher guaranteed income.
Why guaranteed income is important in retirement
When planning for your retirement, you want to ensure that you have enough guaranteed income to cover all of your essential income needs. Your income needs fall into one of three categories:
Essential: anything you need to pay for, e.g., your water bill
Wants: anything that isn’t necessary but gives you a better quality of life, e.g., vacations
Giveawaymoney: for gifting to your children or a charity
We believe that at least your essential outgoings should be covered by your guaranteed income.
Most retirees have two guaranteed income sources, their pension and Social Security. Beyond this, there are limited options to secure guaranteed income. One option is to add an income rider to your fixed index annuity.
The cost of a fixed index annuity income rider
Adding an income rider to your annuity gives you a lifetime income benefit. This is a powerful tool to help you take care of your essential income needs and grant you continued access to your principal. But, if you’re aiming for your highest guaranteed income, you’re going to have a fee.
There can be two different types of fees with an income rider. The first is a clear-cut fee, where the insurance company will charge you a percentage of your principal. This is usually around 1%. The second is a built-in fee, where you won’t be charged directly, but you will see a reduction in return.
How a fixed index annuity income rider works
A fixed income annuity already accumulates money for a death benefit. The income rider income generation is separate from this. Bear in mind that this income value is not lump sum money. If an insurance agent tells you that their annuity can give you 6% growth, this rate is for income purposes and isn’t available as a lump sum.
Let’s use an example to demonstrate. If you have $100,000 in a fixed index annuity with an income benefit growing at 6%, in roughly ten years, your annuity will be worth around $200,000. You cannot take this as a lump sum – this figure is a calculation based on how much income the annuity generated. That 6% growth-rate of $200,000 equates to $12,000 a year of guaranteed income. That’s $1,000 a month guaranteed income for the rest of your life, generated by the fixed index annuity income rider alone.
Suppose you’ve calculated your essential income needs at $4,000 per month, but your Social Security will only give you $3,000. In that case, we can work out how much you should put in a fixed index annuity with an income rider to guarantee that extra $1,000.
The income rider creates, in essence, a pension that you cannot outlive. Even if your annuity account’s value decreased to zero, you would continue to receive payments through the income rider.
Why an income rider could suit your future
If you’re married, you may want the guaranteed income to last for the entirety of both yours and your partner’s lives. You can choose to have survivorship, but this will decrease your monthly income, similar to a pension.
You do not have to decide whether your annuity income rider is dual or single life until you start taking income. This is a plus point for annuity income riders as it offers flexibility for the future. If you set up an income rider today but won’t need your income for the next five or ten years, you won’t have to choose dual or single income until you’re ready to take it.
In most cases, you can start taking income from your annuity after a year. But, just like a Social Security benefit or pension, the longer you wait, the higher your income will be.
How could an income rider increase your guaranteed income?
We understand that annuities are a complex and often confusing product and visualizing how they suit your situation can be difficult. If you’d like to see how an annuity could benefit your specific retirement plan, we can help.
Our advisors can show you how an income rider could impact your guaranteed income when you book a complimentary 15-minute phone consultation. On the call, we can discuss how an annuity would work for you and how it could help you meet your essential income needs. If you want to speak to a team member, book your call today.
Money accumulation is paramount as you approach retirement. However, high-risk, high-reward strategies may no longer suit your approach, as many retirees become increasingly risk-averse.
If you have savings that you want to grow risk-free, there are some options available to you. CDs, bonds, and money markets are safe, low-return ways to increase your savings over time. But fixed index annuities could provide a much greater return and are entirely risk-free.
In this post, we share the benefits of a fixed index annuity and explain how insurance companies avoid risk while growing your money.
Annuities are complex; however, they can be beneficial to a retirement portfolio if you understand them. That’s why we’ve created our “Annuities – Why Ever Use Them” series, to answer all the common questions about the pros and cons of annuities.
You can watch the video on this topic at the top of this post, to listen to the podcast episode, hit play below, or read on for more…
This post is the fourth installment in the series, so we encourage you to listen to the first three episodes to learn more about annuities. Find them on our Secure Your Retirement podcast, read the posts on our blog, or follow the links below to watch the episodes on our YouTube channel:
As we dive into the details of how annuities work, it can be useful to have a foundational knowledge of different annuity products. For a quick, high-level overview, here are the main types of annuities and their key characteristics:
Immediate annuity: is a quick and simple way to get an immediate income stream. You give money to an insurance company, which redistributes it back to you as income. For example, if you bought a $100,000 immediate annuity, the insurance company could begin giving you $500 a month for the rest of your life.
Deferred annuity: is tax-deferred with some surrender penalties. Deferred annuities can be either variable or fixed and must be committed to for a certain period.
Variable annuity: you can use a variable annuity to invest in the stock market. Typically, variable annuities are used to buy mutual funds. There are fees, and a lot of risk involved as the market can fluctuate and so can your annuity’s value.
Fixed annuity: is tax-deferred with a principal guarantee, so unlike a variable annuity, you cannot lose any money. However, your money can still grow. Fixed annuities can be broken down into two types, traditional and index.
Traditional fixed annuity: similar to a CD, you lock your money in a traditional fixed annuity for a set period at a fixed interest rate. It’s a risk-free way to grow your money.
Fixed index annuity: this grows your money using market links. You may be tied to an index like the S&P 500 or the NASDAQ. You’ll receive a portion based on the index’s performance over an annual point to point reset. This means if you start your annuity on January 1st 2021, how the index performs between January 1st 2021 and January 1st 2022 will determine what interest will be credited to your annuity.
We’re going to focus on fixed index annuities in this post. We’ll break down how insurance companies can guarantee your principal even when your annuity is linked to market performance and explain why it’s a win-win for you and insurance companies.
2. How to earn interest on fixed index annuities
There are two ways to earn interest on a fixed index annuity, either through a cap or a participation rate.
A cap prevents your principal from reducing due to market volatility. So, if you set a cap at 5%, and your annuity’s index earns 10%, then your annuity will only grow up to 5% in that year. However, if the market falls, you cannot earn a negative rate of return, meaning that your money will not decrease below your guaranteed principle or any increases from previous years.
Participation rates are similar, but instead of using a cap, they increase your principal by a percentage of how the index performs. For example, if your index earns 10% and your participation rate is 50%, then you’ll earn a 5% rate of return.
We dedicated an entire podcast episode to explaining how caps and participation rates work in detail. To learn more about earning interest on fixed index annuities, please watch the episode.
3. How insurance companies guarantee your principal risk-free
Caps, participation rates, and a guaranteed principal mean that fixed index annuities can look almost too good to be true, and you may question how they benefit the insurance company.
Some of the most popular questions we get about fixed index annuities are, “If the index drops 20%, does the insurance company have to me back the equivalent of my loss? or “If my cap is 5%, and the index earns 10%, then does the insurance company keep the extra 5%?”
The answer to both questions is no. So how do insurance companies guarantee a rate of return on your principle without putting themselves at risk?
Here’s an example. You have $100,000 to put into an annuity with an insurance company. The insurance company manages billions of dollars and earns 3% on its total assets. They want more people to invest with them, so they try to attract new policyholders with a return rate of 2.5%. This might not be the most attractive rate to all potential investors, so they take the 2.5% and create a futures contract.
A futures contract is a legal agreement to buy or sell an asset at a predetermined price in the future. For example, if you wanted to buy a company’s share at $100, but the current price is $150, you could set up a futures contract to only buy a share when the price hits $100.
In the case of an index fund annuity, the insurance company takes the 2.5% and puts it into a futures contract related to your index. This futures contract might state that if the index increases, then the insurance company will participate. So, if the index goes up, then the insurance company can provide you with your agreed participation rate. However, if the index is down, then that 2.5% is lost, but it has no negative impact on your principal.
Caps work in a very similar way. If your cap is 5%, then the futures contract will expire at 5%. This will give your annuity a 5% rate of return, and the insurance company will not participate above 5%, meaning that they won’t be pocketing any extra money if the index continues increasing.
If the index is down in either case, then neither you nor the insurance company will lose anything, but you won’t earn a rate of return that year. The worst an index fund annuity can do is earn a zero rate of return, but there’s potential to earn a much greater amount, risk-free.
4. Why we recommend fixed index annuities for retirees
Compared to bonds, CDs, and money markets, fixed index annuities are a good alternative to safely accumulate your money. They have no-risk and are much safer than investing in the stock market, but they have more earning potential than lower-rate products or accounts.
We highly recommend adding a fixed index annuity to your retirement portfolio, but only if you understand how they work.
We appreciate that annuities are complex and can be difficult to fully understand. If you have any questions, please reach out to us. We can discuss how annuities can work for your individual retirement plan and answer any further questions you may have. Start by booking a complimentary 15-minute call with a member of our team today.
You may never have considered a fixed index annuity, but is it something you should look at for your retirement plan?
Many people think annuities are too complicated. That’s why throughout our “Annuities – Why Ever Use Them” series, we’ve tried to answer the questions which may have led you to dismiss them in the past.
In this post, we’re focusing on fixed index annuities, specifically how interest is credited on them. We’ll also recap some general advice on annuities, so you can stay informed about how they work and what they can offer.
What are annuities? A quick recap
If you’re unsure what annuities are, how they work and the benefits they offer, be sure to go back to part one and two of our “Annuities – Why Ever Use Them” series. It’s worth understanding the basics before we launch into the more complex areas of deferred fixed index annuities, which we’ll cover in this post.
As a quick recap, here are some key points to be aware of:
Annuities are generally used for one of two reasons: as a safe money alternative or as a fixed source of income in retirement.
There are two main types of annuities: immediate and deferred.
Immediate annuities are when an insurance company sets up an income stream based on your retirement assets.
A deferred annuity is used as both a safe money alternative and an income stream.
Deferred annuities have two types: fixed and variable. We wouldn’t recommend variable, as there’s a risk you could lose money.
Instead, we always suggest declared rate or fixed index deferred annuities.
A declared rate annuity offers a fixed rate of return over a set period; it’s often compared to a bond or a certificate of deposit (CD).
A fixed index annuity is when the rate of interest you earn varies in line with an index, such as the SMP500. This is a great option because you can benefit from upswings in the market without the risk of losing money.
We appreciate that’s a lot of information to take in. If you’re at all confused by how different types of annuities work, we’d encourage you to read parts one and two of the “Annuities – Why Ever Use Them” series.
Alternatively, listen to episode 26 and episode 30 of the Securement Your Retirement podcast, where we cover these topics in detail. They’re available on your usual podcast app or on YouTube.
What is an index cap and how does it affect a fixed index annuity?
Now we’ve covered what you need to know about annuities, let’s continue our conversation about how interest is credited on a fixed index annuity.
In part two of “Annuities – Why Ever Use Them,” we talked about the annual reset and how it relates to the interest you earn. Think of this as a reset point for the interest-earning period; it varies depending on the terms of your contract but usually happens every 12 months.
The beauty of a fixed index annuity is that any interest you earn is guaranteed and will be credited to your account on the annual reset. This then becomes the starting point for the new interest-earning period.
However, there are a couple of other things to note about interest crediting on a fixed index annuity, including the “index cap”.
The index cap is the maximum amount of interest you can earn in an interest-earning period, as a percentage sum. It’s set by the insurance company who controls your annuity and is based on a range of factors, including the overall financial outlook.
To help you understand how an index cap works on a fixed index annuity, here’s a simple example:
You put $100,000 into a fixed index annuity
The insurance company sets a 5% index cap
The index performs well over your interest-earning period and is up 15%
The index cap means you’ll make 5% interest
The interest is credited during the annual reset
You now have $105,000, which is guaranteed and will never fall
This is just a simple example to show you how the index cap dictates the interest you earn on a fixed index annuity. Whether it’s the SMP500 or the NASDAQ; no matter how strongly an index performs, you’ll only earn interest up to the index cap.
It’s worth remembering that you can’t lose money on this type of annuity, even if the index performs poorly or goes negative. Any interest made is guaranteed, so whatever you earn is yours to keep – making a fixed index annuity a powerful way to grow your retirement fund.
What is the participation rate and why does it matter?
Something else that affects the interest you can earn is what we call the “participation rate”. This is a percentage sum, set by the insurance company, which essentially decides how much money you should make from an index.
To show you how the participation rate works and how it affects the interest you’ll earn on a fixed index annuity, here’s a basic example.
Let’s say you pay $100,000 into a fixed index annuity with a 50% participation rate. This means you’ll earn 50% of what your index makes.
So, if an index made 10%, you’d get 5%. If it made 12.5%, you’d make a 6.25% return.
Participation rates vary widely and are one of the first things we look for when finding the most lucrative fixed index annuity deals. Insurers offer lots of different rates, with the majority falling in the 80-90% range, though they can be higher or lower based on a range of factors.
Do you want to put your money in a fixed index annuity? We can help
The world of fixed index annuities can be complicated, with lots of options and things to consider. But if you think this sounds like the right direction to take with your retirement plan, we’re here to help.
Our experts have years of experience in helping people set up and manage a fixed index annuity. And with the potential to boost your retirement assets by a considerable amount, taking advantage of our knowledge and expertise is certain to be worth your while.
We’d also like to reiterate that while annuities may sound complicated, they have been around for a long time, with billions of dollars passing through them each year. Through our “Annuities – Why Ever Use Them”series, we want to get you thinking differently about these products, so you can make an informed decision on where to put your retirement assets.
Are you ready to take the next step on your retirement plan? Book a complimentary 15-minute call with a member of our team to discuss your retirement goals today.
