Welcome back to “The Investor Coaching Show.” I’m Paul Winkler, talking about the world of money and investing. There was an article that Chad, one of the guys in my office, actually found, and I thought it was worth talking about.
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My frustration with the financial industry is so often that the level of education isn’t quite what I think it ought to be, and I want you to just be aware. You’ll go online and they say, “Hey, we have vetted all the financial planners in your area and we have found the best financial advisors, and all you have to do is click here.”
Basically, what happens often with any kind of advertising, you’ll have a number that you call. They say we have people that we’ve vetted and are endorsed by us. We think they’re great. You need to be really, really super careful about that stuff, because a lot of times they’ve been paid a fee to give the lead to the advisor or to the company, whether sometimes it’s mortgage companies, sometimes it’s insurance agents like health insurance or auto insurance agents, or homeowners insurance agents.
Consider the source of the information you’re considering.
You may think, “Well, this person must be good. They’ve looked at them, and sometimes they have. You just have to be really super careful. They may or may not really look that closely. They may be just more concerned about getting the fee for making the referral, so just be careful about that stuff. This article was written by a company that does this kind of thing, and they said, “You want another stream of income for retirement,” they said.
They do informational articles. They’ll say, “Well, you might want to consider an annuity. You might want to purchase an annuity from an insurance company so you’re going to receive payments back at a later date, and before buying the annuity, it’s important to know how much monthly income it might generate,” the article says. For example, how much does a $300,000 annuity pay per month, and is it enough to live on in retirement?
“How much would that pay? If I had $300,000, how much money could I get?” Well, they say, “Hey, here’s the deal.” An annuity is a financial arrangement with the company. They’re going to give you payments, and what you got to look at is how much they’re going to pay you, and they gave some numbers.
A Real-Life Example
They said, “If you’ve got $300,000, now, number one, it largely depends on when you purchase the annuity,” which is absolutely true, what age you are. If you’re much younger, they’re going to have to pay that money to you for a long period of time. Let’s say if you’re 40 years old and you’re getting an income, they’re going to have to pay that for, could be another 45 years. I mean, depending on your life expectancy, it might be another 45 years. They have to spread that $300,000 out.
Now, if you do just a straight annuity, a life annuity, they make those payments, and if you die, then that money is gone, unless you do some kind of a contingent, like a 10-year certain or a 20-year certain. In the article, they actually give the numbers for that. Now, anytime you do something where it’s a 10-year certain, what that means is, “We’re going to pay you out for life. We’re going to pay out the income for life.
But if you don’t live but five years, we’re going to do a 10-year certain. We have to pay you or your heirs for another five years.” So 10 years will be the minimum amount of time that they pay, and then you might have a 20-year certain sometimes. They’ll have different types of contracts that have those certainties, and what that does is it helps the person get over the idea that, “I could live one year, I die, and then my $300,000 is gone.” It helps people get over that.
You and your loved ones deserve to live with dignity.
I had that situation once. I was actually working with a guy, and he said, “Hey, can you talk to my mom?,” and I said, “Well, what’s the deal?,” and he said, “She didn’t have much money left at all.” I said, “Well, if something happens to her, would it bother you, the heirs, number one, if that money was gone and you didn’t receive anything?”
He said, “No. I just want her to live in dignity. I want to get as much income as she can,” and I said, “Well, this is what an annuity was designed for. You give him a lump sum of money, and they pay you out an income for the rest of your life.” Now, if you’re 85 years old, like his mom was, life expectancy isn’t huge, so therefore, the payout would be very high.
Accumulation Vehicles
It might be 20% of the account value. I think it was like 17% or something like that, as I recall. It’s been a long time, because I don’t run in these situations where an annuity really works that well, and by the way, we don’t ever do anything on commission, so it’s the incentive to sell something because commission doesn’t exist. So it’s very rare, but in this case, it was perfect.
Well, if she was only 50 years old, the payout would’ve been way, way lower as a percentage of the account value. So I hope you get what I’m talking about there. So what happens here, he says, “Well, let’s say you’re 43 and you buy this deferred annuity,” and he puts $300,000. Your income’s going to be $3,500, so somebody looking at that go, “Oh, yeah. Wow, it’s going to be $3,500 if I put $300,000 away at 43.”
The point here is they’re using it as an accumulation vehicle, in this particular case. You put it at age 43, you’re going to let it accumulate till you actually annuitize, which is the term that means, “I’m going to pay out money from this thing for the rest of my life, hand it to the insurance company, and have them pay me an income.” Well, your income’s $3,500 per month, if that’s the case.
Well, if you wait till you’re 65 to do the $300,000, it’s only 1,635. Oh, wait a minute, it makes more sense to put it in at 43, doesn’t it? It’s not explicitly written, but you kind of come to the conclusion that that’s what they’re trying to tell you here. It would be a better deal for you to buy this thing at age 43 versus age 65, but what does that ignore?
Don’t ignore the time value of money.
It ignores the time value of money. It ignores that the money could have been invested between the ages of 43 and 65, and you would’ve been dealing with a different number. If you put $300,000 at 43 versus $300,000 at 65, it almost assumes that you’re basically sticking all the money into a mattress in your house, and then you’re going to wait till 65 to go throw it in there. It’s a strangely written article.
Bill Bengen’s Research
So number one, they’re forgetting that. Now, if you take into account, and this is what Chad was telling me, he says, “Hey, look, and this is the way I see it,” and I said, “You’re right, that’s exactly the way to see it.” Which is, “What if you look at this, you say your payout doubled over a 22-year period, right?
So if you use the rule of 72, which is this neat little trick, you take 72 divided by your interest rate, it tells you how long it’s going to take to double your money. It’s just algebra. You can go and play around with the numbers and go 72 divided by X, equals 22. You can do it the other way around and come up with a number.
What you’ll be coming up with, which you’ll solve for, so to speak, is your interest rate. Well, that interest rate is just over 3%. You look at that and go, “Well, that’s terrible. I mean, what’s inflation? 5, 6%?” Now, it’s come down to 4%. That was the most recent data. So what’s your growth rate? Zero after inflation.
Inflation has come down recently.
So if you took the $300,000 and said, “Well, what if I just achieved a 7% rate of return, the worst, 30-year period in all of history?” For the S&P 500, the very worst 30-year period was at like 8%, and that’s including the depression. And that’s what he’s using. He says, “Now, you end up with 1.3 million,” in this particular case, and if you use the 4% rule.
Basically, what happened, Bill Bengen, the researcher, went back to the year 1900 and said, “If I had a 30-year retirement, 30 years, that’s how long I was going to be around, so 65. I go to 95, and let’s say I had everything,” and he used three asset classes, S&P 500, long-term bonds, and cash, those three asset categories, and, “What was the amount of income that I could take?” He came up with 4%, and you could increase it for inflation each year. That was the worst case scenario. Then, actually, what he did is he redid the study and he said, “Well, what if I diversify just a little bit more and I throw small U.S. stocks in there?”
Variable Annuities
So a little bit higher return. If you ever want to do the research on this, it’s out there, Bill Bengen’s research on income. But in essence, that’s why you often hear 4% is because of that. That’s where that number comes from, is Bill Bengen’s research on taking an income. Then, what happened is he said, “Well, that would equate to about $4,400 per month income with an inflation protection versus the 3,500,” and that was the higher of the two numbers, the 3,500, that was the age 43 number.
If you look at that Bengen number, you’re not running the portfolio down, except in the absolute worst case scenario of all time. That was where you actually were able to maintain the principle, and then the annuity, you lose it, right? So those are two very, very different things, but the point that Chad was making here was that they’re comparing apples to oranges with a deferred annuity versus an immediate annuity, because the deferred annuity, what you’re doing is you’re putting the money in and you’re using it as an accumulation vehicle. This is something that I’ve heard people say, “You know, Paul, I heard you’re always against annuities,” and I say, “No, I am not always against them.”
I don’t like using them in most cases. Many cases, I don’t like using them as an accumulation vehicle because as an accumulation vehicle, quite often, they’re not so great. Now, there are some variable annuities that I might make a case for.
A variable annuity is where you have separate accounts.
They act like mutual funds, so it’s very much like any other type of an investment, like non-qualified investment or 401(k) type of investments, where you have separate accounts, mutual funds.
They’re very, very similar, but when I use them, I prefer no load, no commission annuities, and some of those things you might get by. There are some products out there, might be 0.25% mortality and expense charges, the insurance company charges. Some of our products, actually, the mortality and expense charges go away completely in 10 years. That is as opposed to what you typically see advertised out there, which are the products that basically, you’ll see a lot of the indexed annuities and a lot of the expenses are hidden.
Be Careful with Recommendations
Some of the variable annuities, they don’t necessarily hide the expenses, but what they do is they have very high mortality and expense charges that you have to look for, and it’s not unusual to see 1.2, 1.4, 1.6%, 1.8% per year additional charges on top of the mutual fund expenses, and you look at that and go, “Wow, that’s a lot of expenses.” It can really drag down the performance if you have that much additional expense in your product, but if I were ever to make a case for an annuity as an accumulation vehicle, I would be more inclined to recommend a variable annuity with a no-load type of scenario where you don’t have much in that expense in the insurance company expense in the product.
Anyway, if I look at these types of things, these articles talking about annuities as accumulation vehicles, and then you go in, you look at the fine print here, and consider talking to the financial advisor about the pros and cons of the annuity. Well, quite frankly, when I sold annuities, or any of us that work here, a lot of us came from that atmosphere, where we sold annuities or we’re driven to sell them. I was a lousy salesperson, I couldn’t recommend them.
But what happens is that you’re going to be a lot more pro on something when you get paid a lot for it, so be very careful as to whether you’re getting advice from somebody that stands to benefit from your purchase of the product, number one. Number two, it says when comparing annuity products, pay close attention to the fees that you might pay.
Annuities can carry numerous charges.
I agree with this. This is a good disclosure, including surrender fees if you decide that it’s not right for you after all. Well, the problem that you run into is a lot of times, you can get in all day long, but getting out can be really tough.
Then, the next disclosure they put here is choosing an annuity company with a strong credit rating reduces the likelihood that the company will go bankrupt and be unable to make annuity payments. Yes, maybe, because you may look at a company at the time you purchased the product. There were some really great companies, highly rated companies in the past. I won’t name names, but they were very, very highly rated, and then all of a sudden, what happened, their investment portfolios went to heck in a handbasket, and they lost their rating.
But people had already bought the product when their credit rating was good, so you can’t necessarily count on that. Keep your eyes wide open with this stuff. This is why, I think, education is so important for investors because the less you know, the more you may fall for something you regret later.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
