Annuities Are Only Giving Me My Own Money Back
Being in the Insurance Industry over the last 20 plus years and offering products that directly compete with the products being provided by Financial Advisors, there are several objections that I routinely hear from people looking at Annuities as an alternative to keeping their money at risk in the Market. Recently I had someone say they heard that Annuities are only giving me my own money back. This is one that always intrigues me, as it has an element of truth but also is very misleading. Let me explain.
First of all, when you have money in the Market, and you are taking money out systematically, that is also your money-your principal and any gains that are still in the account. Many Financial Advisors recommend using the 4% Rule for withdrawing your money safely in retirement. The reason for this Rule is to, hopefully, not outlive your money, but there is no guarantee. If the Market keeps going up every year and you are only taking out gains, then you are in good shape. But if the Market takes a 40-50% correction (as it has done twice since 2000), or maybe a couple of smaller corrections in the 20-30% range, then you must re-evaluate how much money you should be withdrawing. A typical Bear Market (unlike the correction last year due to Covid and shutting down the World) takes 4-5 years to get back to the previous high point.
Contrast this to a Fixed Indexed Annuity, which is linked to market performance but not subject to market losses. These products will participate in market gains but not in market losses. Also, these products will lock in gains. For example, if someone experienced a 10% gain or more in a year (of which I have had many over the last decade) and the Market crashed by 50% the following year, that gain in the Annuity is locked-in, never lost, and is now part of the principal waiting for the next up year in the Market. However, the next up year, while everyone with money in the Market is starting at a lower Index AND account value, my clients are benefitting from the lower Index value to add more gains to their account value that never went down! Using the 4% Rule for withdrawals, we can demonstrate that even if these annuities only captured 40% of the S & P Index upside over the past 20 years, you would still have been able to withdraw several hundred thousands of dollars more from the Annuity than directly investing in the Market. While also have several hundred thousand dollars more left in the account to continue to draw from or pass on to your beneficiaries. I would be happy to demonstrate this to anyone interested in seeing the Charts! The Annuity accomplishes this with no fees whatsoever while the money in the Market is paying fees of 1-2% annually whether the Market is up or down!
In the examples above, we still have uncertainty about our lifetime income. Theoretically, the Market could have 20 straight down years, and withdrawing 4% a year would wipe the account out with no further income in either scenario. And it doesn’t have to be 20 down years to have this happen; that is why the 4% Rule is not guaranteed.
But Annuities can guarantee you will not run out of retirement income or have to reduce your lifetime income. In the old days, people heard about annuitization, where you give your money to the Insurance Company in exchange for a monthly paycheck. There would be nothing left for any heirs, even if you died in just a few years after starting to receive income. That option is still available with all annuities but is rarely employed. That is where you could genuinely say that Annuities are only giving me my own money back.
Today, most people use Income Riders, an optional feature in these annuities that can have a fee, usually in the 1% range. This fee provides you with something of value different from the admin and trading fees that come out of your Market accounts. For example, Suppose you do not need to start income immediately. In that case, that income account could be guaranteed to grow at a certain percentage of interest each year (e.g., 7% compound) and is also guaranteed to pay out lifetime income at a guaranteed amount no matter how long you live. There are even options to have the increasing income keep up with inflation. At the same time, with these riders, your account value is still yours, and any up years in the Market will add to your account value, so there is the possibility for more funds to be left for heirs if you live a short time in retirement. However, if you live a long life and outlive your funds, you will still be getting your guaranteed monthly “paycheck.” With the Rider, you also have the option to take out additional funds or take all remaining funds and do something else with your money, even after starting income. Compare this to a Pension, or Social Security, the ONLY other vehicles that guarantee lifetime income, and you can see why people who have these products love them! A Pension can only be passed on to a spouse with no access to the principal, and Social Security does not pass on to anyone.
In conclusion, as per the title of this article, indeed, you are only getting your own money from an annuity, but that is true no matter where you put it. Consider a 60-year old that has $1,000,000 set aside for retirement to start in 10 years. He could leave it in his 401K and hope the Market does well for the next decade and then start taking his 4% withdrawals. Another option could be to put it in an Indexed Annuity with an Income Rider guaranteed to grow at 7.2% a year. In this case, the income account would be guaranteed to grow to $2,000,000 by age 70, and with a payout rate of 5.5%, he would be guaranteed $110,000 a year of lifetime income, regardless of Market performance! On the other hand, if the Market happened to have a significant correction anytime in the next decade, his $1,000,000 in his 401K could still be at $1,000,000 or even less when he needed to start taking his withdrawals. In that scenario, using the 4% Rule, he would only be withdrawing $40,000 a year from his own money.
From my perspective, If I want to draw lifetime income that I do not have to worry about, I would rather have a 1% fee that guarantees growth for my money while I am waiting to start income, allows me to take out more than the 4% annually (in many cases more double that), allows me to pass on funds left over to any stated beneficiaries, and protects me in case I live a really long life and do outlive my money. In fact, if you do outlive your money, then you are actually living off someone else’s money– the Insurance Company, which has agreed to continue paying you that monthly income as long as you live!