Hello and welcome to this week’s episode of the Her Retirement podcast. My question for this week is, What’s Better Than Bonds? Sounds kind of like the start of a knock-knock joke. But it’s no joke.
Bonds have historically played a safety role in your traditional portfolios. However, bonds are basically a bust these days. But, what’s the alternative? Well, that’s what I’m going to dig into.
Drum roll please…the bond alternative everyone should at least learn about is…Fixed Indexed Annuities.
In 2010, the National Association of Fixed Indexed Annuities (aka NAFA) decided to designate June as Annuity Awareness Month to help educate Americans on the important role annuities can play as a part of a secure retirement savings plan. NAFA is a national trade association exclusively dedicated to promoting the awareness and understanding of fixed annuities.
Annuities in general can be an integral part of your long-term retirement planning strategy, providing direction to help overcome unnecessary risks and important optional benefits that can help protect your financial future. Annuities can offer guaranteed death benefits and payment options to help meet retirement income needs, depending on the terms of your annuity contract. A key step in planning for retirement is to put strategies in place that maximize guaranteed income and protect against market risk.
Guaranteed income annuities can be part of a personal pension and protection plan that I abdicate for many women. There are several reasons I believe annuities and fixed indexed annuities can be part of what I call a simpler, smarter, and safer journey to and through retirement.
Let’s talk about why guaranteed lifetime income is important. The fact is, Americans, especially women, are living longer. There has been a significant increase in the life expectancy of 65-year-olds over the past quarter-century. Today, the average life expectancy for a 65-year-old male is 84 and for females is 86.51. This compares with 81 and 84 years respectively in 2002. While an increase of three or five years may not seem dramatic over a lifetime, it can have a significant impact on retirement security. Additionally, health care costs continue to rise. For the average 65-year-old, health care costs will be $280,000 over their retirement, further necessitating the need for lifetime income. (1)
Using guaranteed income sources to meet essential expenses helps address the issue of living longer. In addition, these income sources provide some assurance that you’ll be able to cover basic needs such as housing, health care, and food for as long as you live.
The remainder of your assets can then be directed to investments with more growth potential to help protect against inflation, rising health care costs, and market volatility. Annuities are just one potential source of income in retirement. You’ll need to consider all of your sources, such as pensions, Social Security, life insurance, your home equity, working, inheritances, etc., as well as the income you’ll be able to generate from your retirement savings such as 401ks and IRAs.
One of the misnomers of annuities is the growth potential or lack thereof. While they can protect from a market decline with zero downside protection, many Fixed Indexed Annuities (or FIAs) provide some pretty attractive growth potential. They are used as an accumulation vehicle, as well as a safety vehicle in your portfolio. They are in essence, a replacement for bonds (since bonds are doing so poorly currently) and when needed you can turn on an income stream from your FIA(s). Remember…FIAs are an alternative to safe bonds because they have no downside risk. They are not an alternative to stocks…you still need stocks in your portfolio.
With an FIA, your worst-case loss from stock market decline scenario is 0%.
Now I want to dive into a strategy for turning a 4% return into 10%. How is this accomplished you ask? By utilizing an FIA. An FIA provides upside leverage in the form of what is called a participation rate.
Participation rates allow the insurer to limit the upside potential on indexed annuities. The participation rate is a percentage by which the insurer multiplies the index gains to arrive at the amount of interest they will credit to the annuity contract. For example, an indexed annuity with a 75 percent participation rate would earn 75 percent of the index gain. If the index was up 13 percent at the end of the contract term, the insurer would credit 9.75 percent interest to the client. At this point in time, some of the leading FIA providers are offering up to a 245% participation rate, which means that if the particular index that your FIA is tied to returns 4%, you make just under 10% during that period of time. So, you have the potential to earn anywhere from 8% to 10% returns with these newly increased participation rates with no downsides. It’s a pretty crazy opportunity right now because as interest rates go up, participation rates go up as well.
If you’re wondering how long you’re locked into an FIA like this, it’s typically similar to a five-year CD. There are also seven- and 10-year products.
But once again, the beauty of these things is, even if you’re with a five-year seven, or 10-year contract term, you do have a 10% free out that you can take each year. So, for instance, if you put a hundred thousand dollars into an FIA contract, you can still take out 10% per year without any penalty. So, on a hundred thousand dollars, 10% equals $10,000 per year.
One expert I spoke to has never seen participation rates this high. And I quote, “it’s a pretty awesome opportunity.”
But experts do warn people that not all FIAs are created equal. You need to look for “client-centric” FIAs. There’s the good, the bad, and the ugly, and many annuity salespeople who are ready to pull the wool over your eyes. You need to go into an FIA strategy with your income and retirement goals clearly defined and with the right advisor who understands your big picture. Never purchase an annuity, FIA, or otherwise within a silo…like without all your stuff being integrated together.
Yes, FIAs can be complicated, but with the right retirement planner, he/she can fully explain how an FIA fits into your overall plan. The right planner will be 100% transparent about the FIA, the fees, and the overall expected result from incorporating one or more into your plan.
Retirement planning experts and retirement academics seem to agree that FIAs should outperform bonds for some time…both in terms of providing the safety effects of bonds in a traditional stock/bond portfolios and in terms of returns. I’d take even a 4% return from an FIA vs. a bond right now. Let alone a 10% return. With bonds in your portfolio, you’re losing a lot of money. You’ve lost close to 10 to 15% in your bond funds already this year. So, these are great alternatives to the bond component, the safe component of your portfolio.
But Lynn, someone might say, my investment guy is telling me annuities are bad because of high fees or that I could lose all my money.
Well, I would say that you have to understand that the investment advisor or the investment company that you’re talking with is absolutely biased because they offer only stocks and bonds. They don’t offer annuities. Right? So that’s number one. You have to think about that.
What I would ask the investment guy is how are you going to protect a portion of my portfolio against stock market decline? Can “their” bonds or index funds offer 100% of the upside of the S&P let’s say but zero downsides?
As for fees, let’s say there’s a 6% one-time fee on the annuity. Well, if your investment guy is managing your assets for say 1.5% over the course of 5 years, you’re paying him 7.5% and for 10 years, it’s 15%. The annuity doesn’t look so expensive now. Plus, you have zero downsides and all the upside of the market when it’s growing.
There are terrible, overpriced annuities for sure. There are bad products and unscrupulous salespeople in all industries. That’s why you need to get educated about how to ask the right questions and understand why you’re using the various products in your plan.
The bottom line is this, an FIA is looking like a great bond replacement right now and can offer a myriad of benefits to many people. One of the major benefits is purchasing risk protection against market risk. If safety and protecting some of your portfolio from this risk is important to you, then you should consider or at least learn about how an FIA could work to your benefit. And on the plus side, an FIA does offer growth opportunities. Additionally, because of where interest rates are right now, FIAs are particularly attractive if you find the right contract, company, and advisor who’s both insurance and investment licensed to provide you with as much balanced advice as possible. Sounds a little like having your cake and eating it too?
Thanks for listening to this week’s episode about the unique opportunity of fixed indexed annuities right now. The website annuity.org provides a wealth of information on annuities. FIA Insights.org also offers great information on FIAs. If you have any questions or want to connect with a retirement advisor about your investments or portfolio, annuities, and/or your retirement plan, reach out to me at firstname.lastname@example.org. If you’d like to see how much income you’ll have in retirement, please also ask for a free trial of my Her Retirement readiness software platform and I’ll hook you up. Here’s to knowing more and having more and getting her done.