Fixed Indexed Annuities – Episode 116

This transcript was auto-generated and may contain errors.

[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. We’ve got my co-host and bestselling financial author, Kim Butler with us today, and we’re going to be really looking under the microscope at fixed indexed annuities. These used to be called equity indexed annuities, but the term equity sounded too much like the stock market. So the SEC stepped in and said, you can’t say that anymore. So fixed indexed annuities are sold by, first of all, we need to get this straight

[00:49] by insurance agents. So as much as it sounds like an investment vehicle, technically we’re talking about an insurance product. And let me bring in our expert here. Hey Kim, how are you? Very fine. Thank you. You know, the terms even confuse me and I’m an insurance agent and it cracked me up when they were making the change. We I was going to say it’s they, the SEC is not us from the term equity to the term fixed because the term indexed already indicates that there’s something going on stock market slash mutual fund like related. Now annuities have what are called separate accounts and they don’t actually have actual mutual funds. They have something kind of like mutual funds and that’s where the index term comes

[01:41] in. But where on earth does the fixed term come in? Well, there is usually a floor rate and part of the money from the annuity is invested in a fixed account. So you have a bottom, which in today’s interest rate world can be relatively low, maybe 1% or whatever. Generally there’s a time period where you can’t touch the money, which is called the accumulation phase, and this is generally 7, 10, 15 years. And then you have a part of that annuity that is buying options on a specific index. Traditionally it’s been the S&P 500. So you have purchased options on the S&P 500, but those options cost money, which means you can’t get full participation. So most annuities give you no more than 50% participation, which means if the stock

[02:38] market goes up, you invest $100,000. The stock market goes up by 10%. You would think you would have 110,000, but if you’re capped at 50% participation, you have 105. Or there’s a maximum cap on the rate itself, which means, you know, they say max rate of 4.5%. So you’d have 104,500. Even if the stock market went up by 80%, these caps kick in. And I don’t think most people fully understand that. I mean, it’s not necessarily a bad product. I would say that there’s been a lot of misunderstanding in the sales process. Well, and I’d like to tackle the other side of the story too, which is the fixed side of the story, because though they may identify this minimum floor of, say, 1%, that’s before expenses.

[03:34] And annuities have a lot of expenses that exist because of the guarantees and the promises that they make and attempt at making. So you have, I think it’s typically called M&E expense, management, and what does the E stand for? Do you remember? I don’t, sorry. I can’t remember either. Maybe I’ve got the term wrong. You can tell I don’t sell a lot of them either. But the expenses have to be subtracted from the floor. And so one of the biggest misunderstandings that I find that clients have is that they think the floor is solid and that they think they cannot go negative on these funds. But in actuality, they could because the expenses taken from the floor could cause a value on the account to be less than zero.

[04:28] In other words, a negative impact where principal was actually eroded. Well, and there’s two separate values in the account. There’s the value if you leave the money in there and annuitize it. And then there’s the value if you want to access the actual principal itself. And this can be very confusing because one of the biggest sales promotional tactics is to give you this bonus up front. Let’s say a 5%, maybe even a 7% bonus up front so that your 100,000 looks like 107,000. But if you look at the contract, you have a 20 year cancellation fee in there that if you ever tried to pull the money out, you would pay more than the bonus that they gave you. Only that bonus that they put in there is only if you keep the money in for

[05:22] a specific period of time. Usually it’s 7, 10, 15 years or more. And only if you annuitize the annuity, meaning you turning it into a monthly cash flow stream rather than accessing the money. And I mean, how many of us that have money sitting aside would like to know that if things got bad or things got really, really well, that they could grab their cash? I mean, that’s how I think these things are sold. And people think, well, you know, I have half a million dollars in annuities. You know, you have half a million dollars in annuities and you find a chance to buy a five million dollar property in Jamaica for 500,000. I mean, you’re not going to get it out. Right. So I looked up M&E and it’s mortality and expense.

[06:12] I had the M wrong also. So my apologies. So M&E is mortality and expense fees. And then, of course, there’s administrative fees. And then there’s also what you’re talking about, which are the surrender period fees or surrender charge fees. They’re sometimes called. And what’s interesting to me is that this is a product from the very same type of insurance company that we talk about all the time, which is the mutual life insurance company. Now, stock insurance companies offer these as well. But this comparison of an annuity, which is clearly not a liquid product compared to a life insurance policy, which absolutely is a liquid product. It just interests me the extreme differences, even though they’re from

[07:00] the same company and they often get lumped together and I’ll often have a client say, well, I have that whole life annuity thing. No, no, no. It’s a whole life insurance policy that’s very different from any kind of an annuity. And it’s not that annuities are bad. It’s just that in so many cases, you could probably do better with your money, especially if you got really clear on the goals that you were interested in. So in our world, we break those goals down into three categories. You either want your money liquid, in which case it has no business being an annuity. And as everybody’s aware, we prefer whole life insurance cash value to store emergency opportunity money. Or you want your money to earn an income.

[07:50] Now, the single premium immediate annuity can cause your money to earn an income, but that is not really a viable product to buy until you’re in your 80s and 90s. Our preference for earlier income, somebody in their 60s or 70s, is the bridge loans. And then the third thing that you want your money to do is grow. But we want real growth, like close to double-digit growth. And I don’t think even the indexed annuities are creating that these days, are they? No, I mean, in the environment that we’re in now, I mean, if you have an annuity you purchased maybe 15 years ago, there may be some guarantees in there that were made while interest rates were high and the market was up. Most of those, unfortunately, were not contracted.

[08:42] They were allowed to literally change the rules of the annuity year by year as they move forward. So there’s very few out there. And I would say that your chance of buying one today with the experiences that we’ve recently had that has your best interest at heart and your ability to earn a rate of return higher than inflation, whether it’s fixed or whether it’s indexed, is slim to not. Well, and you said something super critical there, and that is that the insurance company can change the deal. They can change the M&E fees. They can change the administration fees. They can change the cap, which is the amount of interest that you could get on a maximum level. They actually have a maximum. They can change the floor.

[09:37] They can change the participation rate. Was there anything else that they can change? I mean, pretty much. I mean, you are, I mean, as pro as we are on insurance companies, it’s bad. Sounds really bad to be talking about annuities. And I don’t really want to even call them as bad. I just want to call them as in, I don’t think most of the people who buy them understand them. And, you know, if you understand exactly what you’ve gotten and you believe it meets your needs, then by all means, purchase an annuity. But there are probably better alternatives. Yeah, very well said. So it’s that we’re seeking best, not just good. And again, get really clear on what you’re looking for. Are you looking for income?

[10:23] Well, then look for alternative ways to create that income. Are you looking for growth? Well, look for alternative ways to create that growth. Are you looking for liquidity? Look for alternative ways for having stored liquid cash. And if you don’t find any alternatives, then an annuity, I guess, could be considered a viable product. I’ll admit it isn’t for me personally. And so consequently, it isn’t for most of our clients. But there’s always exceptions. There’s always a time that it might really solve a problem for somebody. And again, making clear that we’re talking about the general category of deferred annuities, often called fixed indexed annuities or sometimes even just a fixed annuity, which operates just with the basic interest rate,

[11:07] doesn’t have the options. So they may have a little bit less cost, but they also earn less in terms of a rate of return. And we are not talking about the single premium immediate annuities, which are viable for either somebody in their 80s and 90s or for somebody in their it’s still late 70s or early 80s to convert their life insurance policy to. I want to talk about that just for a minute as we wrap up here, because that can be a really strong transaction where you’ve got somebody, maybe a spouse has passed on and there’s just a single person left. Maybe they’ve already got some insurance policies that they’re leaving for children and grandchildren and even great grandchildren. Maybe they’ve even got some insurance policies they’re

[11:56] leaving to their favorite charities and they have an insurance policy that they really want to get income out of. It may be better at that stage of the game, again, late 70s, 80s, 90s, to annuitize the insurance policy. And what that’s going to do is give you an amount of money somewhere between the cash value and the death benefit, not as high as the death benefit, but that converts to an income stream immediately, a single premium immediate annuity. They’re going to take that cash value, create that income stream and you can have it pay over a certain period of time so that you don’t feel like, oh my gosh, if I die yesterday, then I’m leaving all this money at the insurance company. You can have it pay to a certain period of time

[12:46] where it would pay you while you were living and then pay out to a charity or a grandchild or what have you for say 10 years or 15 years or whatever period of time you wanted to pick. There’s even immediate annuities that have the specific provision of paying out all the principal. So you get a monthly check and then however long it takes to pay out all the principal. So that’s a way that you remain in control. And that’s really the basics of what we’ve been talking about here is that with deferred annuities you’re losing control. With regular life insurance you’re gaining control. And with single premium immediate annuities you can gain a measure of control that will, at least in our minds, enable you to check off

[13:33] the fifth of those seven principles of prosperity that we talk about so much. The fifth one being control and making sure that you are staying in control of your dollars, not turning them over to the advisor or the insurance company. Super. So I guess our message today is try to avoid the sales pitch, try to avoid the sales brochure, make sure you understand exactly what this product will do, what it won’t do, and more importantly, the ability of the company you’re dealing with to change the rules as you move forward. If you understand those three things and you’re still comfortable making that contribution to an annuity, I have to say contribution because I don’t think I can classify it as an investment,

[14:22] then maybe it’s the right tool for you. We just hopefully will supply you with some questions that will make you think about it first. Sounds great. And if you have additional things that we can help with, we’re more than happy to share information on our alternatives. The best thing to do is go to partners, number four, prosperity.com, slash ebook, and you can sign up for the audio and regular PDF version of the book called Financial Planning Has Failed. And there’s some information in there about annuities and more importantly, about what we recommend instead. So again, that’s partners, number four, prosperity.com, slash ebook. Thanks again, this is new BS Money Guy, Todd Strobel, who’s special guest,

[15:09] Kim Butler for the Prosperity Podcast. Thank you all and see you again soon. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.