The Ins and Outs of Annuities: What You Need to Know to Plan for Retirement

Full Transcript:

Ryan: And there's some people that love annuities and there's some people that really don't like annuities, and unfortunately there's just a lot of misinformation about them.

Announcer: When it comes to financial planning, you need to cut through the jargon so that you can understand how to achieve your own retirement success. This is Candid Conversations: Retirement Talk with Ryan Cravitz of Cravitz Financial & Insurance Solutions.

Ben: I'm glad to have you back on Candid Conversations: Retirement Talk with Ryan Cravitz of Cravitz Financial in Irvine, California. Today, we're talking all about annuities and what you really know because there is a lot of confusion out there about annuities probably because there are so many different types that do different things. So we want to give you each of these types of annuities, explain how they work and how they might be used in someone's financial plan. So Ryan, should be a good show. How are you today?

Ryan: I'm doing pretty good. How about you, Ben?

Ben: I'm doing well. I know annuities can be a bit polarizing, I mean, I think when you say annuities, either somebody is all form or all the way against them, it seems.

Ryan: I feel like I heard somebody say, "I hate annuities and you should too," or something like that.

Ben: Something like that. Well, I think part of that is just maybe the lack of understanding of how they all work and whether or not it might work for you. Because again, there are no bad products, there are some that won't fit you and there's others that might work for you, that don't work for someone else. So again, it's all about finding what fits your needs the most, and that's what you do with an advisor like Ryan. So we're going to take you through annuities today, and I want to go through each one of these one by one, Ryan. I want to start first with an immediate annuity. How does this one work and can you give me an example of maybe when someone might use it?

Ryan: Yeah. So an immediate annuity or SPIA, S-P-I-A, Single Premium Immediate Annuity, the way that it works is let's say you have $100,000, you give the insurance company $100,000, and in an exchange, they're going to pay you a payment, an income stream for a certain period of time. And it could be for the rest of your life, it could be for as long as either you or your spouse lives, it could just be for a certain period of time, maybe a 10-year certain annuity or something like this. The key thing to understand with these types of annuities is that when you give your lump sum to the insurance company and do this, you no longer have control of that money. And that's definitely something that is concerning about immediate annuities. If you're going to consider doing or putting your money into an immediate annuity, you really want to watch how much you're going to put into there because again, you do give up that control.

As we were saying earlier, annuities are very polarizing and there's some people that love annuities and there's some people that really don't like annuities, and unfortunately there's just a lot of misinformation about them. And when we talk about immediate annuities, this is where unfortunately there's just a lot of misinformation about them. And one of those pieces of misinformation is that, "Oh, if you buy an annuity, you completely give up control of your money." And that is true with an immediate annuity or if you were to annuitize, but what I can tell you in practice is that these options are very, very rarely used.

Ben: Okay. Well, that's a good starting point there with the immediate annuity. Now, the fixed annuity, this is one I know I think I hear most often. This one and the variable, and we'll get to the variable in a second, but what is the fixed annuity?

Ryan: So the most common here is a MYGA, multi-year guarantee annuity, so that's M-Y-G-A. And the way that it works is it's very similar to how a CD works at a bank. Now, understand again that annuities are with insurance companies, they're not with a bank, they're not FDIC insured or anything like that, they're backed by an insurance company. And the reason that I say that they're similar to a CD is that with a CD, you might go out and buy a one-year or a three-year CD or five-year CD or something like that. And at the end of that term, you go ahead and get your money back, and along the way you're able to get the interest that the CD paid. Well, a MYGA works very similar to that. So you might get it, let's say, a five-year MYGA and today rates vary, but let's say it's paying 5% per year, so you would earn 5% per year, and at the end of the five years, you could take that money and go do something else with it.

Now along the way, and this is one of the other criticisms about annuities, is that you don't have full access to the money. So depending upon the particular annuity product that you've purchase, you may have access to 10% of the account value each year until, let's say, that five years is up, and these could be three-year MYGAs, they could be five-year MYGAs, seven-year. So terms do vary, but there are different options to get certain amounts of money, such as perhaps like I said, 10% per year from these along the way. And others have provisions, like if you had to go into a nursing home or God forbid, you were diagnosed being terminally ill, you could access that money fully without any penalties, whatsoever. So there are some things there to keep in mind.

Ben: Okay. Then what about the variable annuity then? How does that one differ?

Ryan: So variable annuity is a combination of being an insurance product and an investment product. So again, it's with an insurance company, but the reason it's called variable is because your money is invested inside of different subaccounts, and subaccounts are like mutual funds, but they're called subaccounts in a variable annuity. And so, the value is going to go up or down depending upon the performance of the variable annuity. And one of the criticisms about variable annuities, and I will say that I have this criticism as well, of all the different types of annuities, this is not one that I choose to use within my practice. And the primary reason for it is that the fees on these are pretty high. It's not unusual to see fees in the range of 3% and sometimes even higher, 4% per year, it just depends upon the mortality and expense fees, the administration fees, any other rider fees, anything else that might be added on. And because of the high fees that are associated with these, I just don't see them being a good fit within my client's retirement income plans.

Ben: Okay. Well, again, this is why we want to go through this to make sure you understand what they are. They might not work for everyone, but just having a better understanding about annuities and what you really need to know is what's most important. So finally, what is a fixed indexed annuity, and how does that one work compared to the other because it sounds very similar to the fixed annuity?

Ryan: Yeah, so a fixed indexed annuity is very similar to a MYGA. The difference is with a MYGA, again, you get that guaranteed interest rate, so you know exactly what you're going to get. With a indexed annuity or fixed indexed annuity, you don't know what you're going to get year by year. The way that an indexed annuity works very simply put is it allows you to participate in the upside of a market index of a stock market index without the downside risk. So as an example, depending on the type of product that you might purchase, you may be able to participate in up to 10% or 11%, maybe even 12% of the upside of a market index without the downside risk. So let's say your indexed annuity is tied to the S&P 500 and the S&P goes up 10% for the year. Well, if you have a 11% cap on your indexed annuity, you're going to get that full 10% because it's less than the cap.

But let's say that the S&P 500 index went up 15%, you're not going to get the full 15%, you're going to get 11% because that's the cap. Now, on the flip side, let's say the S&P 500 was down for the year, well, you're not going to lose any money in these products, these are insurance products you cannot lose. So the worst that would happen, even if the S&P 500 was down 50% for the year, you're going to get a 0% credit for that year. So as an example, in this particular product, you could get anywhere from 0% in a year up to as much as 10% or 11%, maybe even 12% in one year.

Ben: All right. So we got fixed variable and fixed indexed annuity, which type do you use in your planning, is there one that maybe that you work with clients to utilize more often than others?

Ryan: Yeah, there's definitely certain products that I prefer to use. First off, again, I stay away from variable annuities. When it comes to SPIAs, I rarely use those. There are occasional occasions where it can make sense, but again, by doing that, you do give up that full control of the principle. So you really need to make sure that you understand why you're buying it and why it could make sense. And there can be some reasons why that can make sense, especially in taxable type of accounts. There can be some tax benefits due to what's called the exclusion ratio, so that's beyond what we'll get into here today. But those are going to be the exception, not the rule. The more common types of annuities that I will use today are the MYGAs, the ones that are going give you that fixed rate that you know exactly what you're going to get, and also the fixed indexed annuities.

So both of these are very attractive. And the other thing that fixed indexed annuities have is they do have the ability, not all of them, but many of the products have is the ability to add a guaranteed income rider. And the way those work is that those will provide you and/or your spouse a guaranteed income stream for the rest of your life. And I know you might be thinking, "Well, that kind of sounds like the SPIA that paid that guaranteed income." The difference is that by doing this, you're not giving up full control of your money. So usually when making the comparisons between the different options, this option I find works better most of the time because, again, you don't give up full access to that principle. So if life changes, if something happens, which inevitably does, you have some more flexibility available to you.

Ben: All right. I like to share stories on the podcast and you do a good job of sharing times where things have worked or just some firsthand experiences. Do you have anything in this realm where maybe you can think back to a client that you worked with or maybe a situation where you used one or multiple annuities to help someone meet their financial goals?

Ryan: Absolutely. Annuities can make a lot of sense within the context of somebody's retirement income plan. And I've used them for multiple different clients as a portion of their portfolio to serve different purposes. So sometimes it's to provide a guaranteed rate of return by the insurance company with the MYGAs for a portion of that portfolio. Sometimes it's to just provide that guaranteed income stream, such as, like we were talking about with the fixed indexed annuities. I had one client who had an income gap of about $3,000. So their need for income was about $7,000 a month, their total Social Security between him and his wife was about $4,000. So they had about $3,000 there that was their income gap. So what we did was purchase a fixed indexed annuity with the income rider that would guarantee that $3,000 a month would continue for the rest of their life.

The nice thing about that is that they knew that they were going to have the income that they needed every single month, they would get those checks automatically deposited into their bank account. And meanwhile, they were able to take a little bit more risk within their investment portfolio. And the reason being is that we didn't need the money that was in the investment portfolio for income. So even if the investment portfolio were to have more ups and downs along the was due to the volatility, it wasn't as important because they already knew that they had that guaranteed income on that side. So annuities can make a lot of sense for retirees or soon to be retirees. Not all types of annuities can make a lot of sense, and not all types of annuities are going to be appropriate for everyone in their particular situation, but when it fits, it can make a lot of sense.

Ben: Awesome. Well, again, if you're interested in annuities, want to learn more, maybe see if they do fit inside of your financial plan, please don't hesitate, reach out cravitzfinancial.com, that is the website. You'll find a lot of information there on Ryan and his team. But you can also get your retirement ready checkup done right now as well. But if you want to call, you can also do that 714-462-9155 is that number. And again, hopefully this will help you out and give you a better understanding of annuities. But of course, there's always more you can dive into with Ryan if you choose to do that. But we appreciate you listening to this episode of Candid Conversations: Retirement Talk with Ryan Cravitz. Please hit subscribe wherever you listen, we're on every major podcasting app and we've got another episode coming in a couple of weeks. So Ryan, we'll talk to you then.

Ryan: Sounds good. Talk to you soon.