The following is the transcript from Episode 5 of Retire Happy with Roger Gainer, a financial and business audio podcast.
Roger: A lot of people, and this is becoming more and more prevalent. A lot of people will spend more of their lifetime in retirement than they ever did working. Most people work 30, 35, 40 years, sometimes longer, but if you live to 95 or 100, and you retire at 60, and you started work at 25, well, you\’re spending more time in retirement than you are in your working life.
Clark: You\’re listening to Retire Happy with Roger Gainer, President of Gainer Financial & Insurance Services, Inc. That clip you just heard a moment ago, as a regular retire happy listener, you might have recognized that phrase before. And I want to include that, because it\’s more relevant than ever with this episode coming up. The topic is Annuities. Pros, cons, all things you need to know, and in typical Roger Gainer fashion, he shares stories and easy to understand examples of how all this works, including the variety of annuities and how this tool and these set of options is available to you in your tool belt as you\’re looking at the future to retire happy. Thanks for joining us, I\’m your host, Clark Buckner. Something interesting about this topic is, some people have so much energy, and so much emotion around annuities, and we\’re gonna jump straight into him talking about that, and in the conversation about annuities. Let\’s begin.
Roger: And I really try to take opinion out of the work that I do. I try to rely on facts, math, and science when we make recommendations, and craft financial plans. So, what amazes me is how much emotion, yes…people have tremendous emotion around this topic for some unknown reason. Annuities are just a tool like mutual funds, stocks, real estate, bonds, etc. And if you look at all of those asset classes, you\’ll find that there\’s good and bad in everything. What\’s important is figuring out if the tools fit what you\’re trying to accomplish. Does that make sense?
Clark: Right. Where do you think all of that emotion comes from when other people talk about annuities?
Roger: If you look over the performance in the stock market of the last 15, 18 years, there\’s been a tremendous amount of volatility. There\’s really good times to be in the stock market, and there\’s been some really horrendous times to be in the stock market. And inevitably, when we see corrections, particularly the correction back in \’07, \’08 and early \’09, there was a tremendous flight to safety. And a lot of investors particularly middle aged, and preimposed retired investors had just had it with market volatility. So, they were looking for reasonable returns, and guarantees. And a lot of money started moving in that direction towards annuities, towards guarantees, and reasonable returns instead of the greed, you know, and the outsize returns that people get excited about in the stock market.
And Wall Street, I believe, just needed to do something to stem the time. So, bad mouthing annuities, you know, bad mouthing your competitors, an old trick in competition. I don\’t believe in doing that, I don\’t believe that there is good and bad in these tools, there\’s just tools that are appropriate, and tools that aren\’t appropriate to create a solution for a client.
Clark: When you say annuities, they are more tools, or options to tools, they\’re financial tools. Before we talk about the different kinds, and some of the pros and the cons, can you describe really what annuities are, and what kind of tool they are?
Roger: Sure. Annuities in their purest form are a series of payments. So, if you take your social security, or if you have a pension, that\’s essentially an annuity. In fact, a lot of companies that offer pension plans will buy an annuity when one of their employees retires, and that way they transfer the risk of those payments going for a lifetime to an insurance company. And the insurance company guarantees that you can\’t outlive your payments. So, what an annuity is, is a series of payments guaranteed for a period of time, and that period of time can be as long as your lifetime. That\’s really where a lot of the power exists in these tools, is that lifetime capability. So, annuities began a long, long time ago, and you simply, you gave a chunk of capital to an insurance company, and in return you got a series of payments.
Originally it was a series of payments for lifetime, and then other guaranteed options were introduced over the decades. Most prominently, guaranteed fixed periods. So, you can buy an annuity that will run 10 years, 15 years, 20 years, or you can combine those guarantees, and say, \”I want a lifetime annuity, but I wanna make sure that in case I die right away, that my heirs get some money.\” So, you might add a guaranteed life annuity, or 10 year, whichever is greater. And that\’s actually very popular with a lot of folks, and there\’s, you know, it makes good sense. But what it does, is it gives you income that you just can\’t outlive. So, for many people that creates some peace of mind knowing that, you know, a check is coming in every month to pay the bills. So, that\’s the original type of annuity.
Over the years, there\’s a second main category of annuities called deferred annuities. And deferred annuities are simply annuities where we defer the first payment. And you can take as few payments as a single payment, in other words, after a period of time you can withdraw your money. So, in those, there\’s always an annuity maturity date, and that\’s the age which you do need to create income in the future. With most annuities that can be 95, or 100, and even today, there\’s some that go beyond that. So, in other words, you can defer your payments, and let your money grow, and the money grows tax deferred in those accounts. So, you don\’t pay tax on the interest you earn until you remove it from the annuity to spend. So, I call that annuities are taxed as spent. There\’s not a lot of assets that are tax as spend. IRAs kinda have that same characteristic.
Clark: All right. Can they grow differently in that…a matter of time, does it depend on how much money you put in? How do you create it, I guess, is what I\’m curious about? How do you create it, and what could influence the way it grows, and how much it grows?
Roger: Well, sure. Deferred annuities come in a variety of time frames. So, what I mean by that is, they all have surrender charges. If you\’ve ever bought a CD, a bank has a penalty for early withdrawal, and surrender charges are much the same. And the reason for that, it actually allows the insurance company to give you a higher rate of return, because they know your money is going to be there for a period of time. If you think about a savings account, it usually doesn\’t pay as high an interest as you can get with a CD, because in a CD you\’ve made a time commitment. And with an annuity, the longer the time commitment, generally speaking, the greater the earning potential. So, there\’s annuities as short as three years, and as long as 15, or 14 years of surrender charges.
So, what that allows the insurance company to do is to hedge with confidence your money, because your money is guaranteed in an annuity by the insurance company. So, the longer the commitment, the greater the earning potential, and the better the guarantees the insurance company can offer.
Clark: And are you putting down a certain amount of money at the beginning…if a certain amount of money you put in, how will that influence it\’s growth?
Roger: Well, some annuities have tiers, so if you put in a large amount of money they\’ll give you a higher interest rate as a reward, if you will. But there are annuities that you can fund with as little as $1,000, and there\’s others that won\’t take anything less than $25,000, or $50,000. And it really depends on the company, and the design of the specific contract.
Clark: Are there different types…I know there\’s a lot of different options. You said earlier on, there\’s two primary ones, and that was the deferred and that the other one…
Roger: Is immediate income annuity, they\’re called SPIAs in the industry S-P-I-A, and that stands for \”Single Premium Immediate Annuity\”. And that is what I was talking, that\’s what annuities originally were, and you can buy them…buy an income string that starts today, or you can buy an income string that starts in the future. Those are called \”deferred income annuity,\” and sometimes they\’re called portfolio insurance. And in the planning process, those deferred income annuities, excuse me, DIAs allow you to be a bit more aggressive in consuming your assets early in retirement.
So, what an investor will do is, I\’ve got a portfolio, stocks and bonds, real estate, whatever, but I wanna make sure that I won\’t run out of money. So, maybe at age 60, I\’ll put a sum of money into one of these accounts that says, \”All right. At 85, I want income\”. And what\’s really incredible if you do that 25 years in advance, $50,000 deposit can create an income for the rest of your life of $30,000, $40,000. That\’s pretty impressive. And so, if I say got a million dollar portfolio, and stocks and bonds, and I retire, you know, in my 60s, I wanna go on trips and travel, buy, upgrade my house, whatever it is, but I worry on the back-end, if I spend too much money now I might run out. So, this allows us to be a bit more aggressive with both our investment decisions as well as our spending decisions, because I\’ve got this insurance that will kick in, you know, a few years down the road in case I run out of money, and it\’s a supplement.
Clark: Right. So, you used an example, $50,000 that you\’ve put in, and you said age 60, and then you say you would want to take that money out at age 85. And so, what was the $30,000 to $40,000, how does that fit in, you said?
Roger: Okay. You put up $50,000 at age 60, and at age 85, you say, okay, I want to initiate the income, and now you get, you know, $30,000 or $40,000 in lifetime income. So, if you live to 110, that income continues to come.
Clark: Right, okay. I guess, when I asked a little bit further of a question with $30,000, or $40,000, it sounds a little bit less than the $50,000, or…
Roger: But that\’s gonna occur every single year. So, you\’ll get $30,000 at 85, and $30,000 at…86, 87, 88, 89, 90. It\’s so that you have income at the end of your life. It\’s not that you\’re gonna put in $50,000 and get $40,000 back. That would kinda be pointless, wouldn\’t it?
Clark: Okay. All right. I was wondering. Roger?
Roger: Income annuities…again, people, you know, for the most part are familiar with CDs, stocks, mutual funds, and you put money in, and you wait, you come back later, and you hope it grows. And that\’s how we think of these financial tools, and in light of an investment, but this is more strategic. And again, what people have to realize is the job changes when you retire. This will be the subject of another podcast, but I\’ve written about this, that what we want when we\’re working is we want our money to grow. We wanna build wealth. But after we stop working, we need income.
So, there\’s only two ways to create income. You at work, or money at work. And a lot of folks enter retirement using the same strategies they used to build their wealth. So that, you know, I\’m still invested in the stock market, it goes up and down, but our income needs are consistent. And that\’s where the annuities come in, in structuring a successful income plan for retirement, because in retirement it\’s about income first, foremost, and always. All the other risks of retirement stem from the longevity risk, and what does longevity risk mean? It means, running out of money before you run out of life.
Clark; Right. Well, okay. So, that $50,000, 25 years later you\’re getting $30,000, or $40,000, and you\’re saying that\’s per year?
Roger: Per year, as long as you live.
Clark: As long as you live, and with… I think, you and I were talking about this maybe in the first podcast, but it was about how long you retired normally around the length of life that you were working, but people are living longer now.
Roger: Yeah, a lot of people, and this is becoming more and more prevalent. A lot of people will spend more of their lifetime in retirement than they ever did working. Most people work 30, 35, 40 years, sometimes longer. But if you live to 95, or 100, and you retire at 60, and you started work at 25, well, you\’re spending more time in retirement than you are in your working life. And there\’s been a real push especially in some of the younger generations to retire early, and leave the workforce. And we\’ve chatted briefly previously about, you know, retirement is being redefined today. And I think of retirement as simply doing what you want to do when you want to do it. Whether that\’s working, or hanging out, or travel, or learning a new vocation, or a language, that\’s what retirement is.
Clark. Right. The golden years. Right?
Roger: Well, yes, but people used to look forward to the golden years as the years I don\’t work. That was it. You worked and retirement meant, I don\’t work. And that is how it was thought about for, really, generations.
Clark: Now, what\’s the normal age, or the normal time that annuities as a financial tool is something that soon will wanna look at? I know it varies for people, and this is not a one-size-fits-all.
Roger: As usual. Usually, I would say that people in their 20s and 30s, annuities are probably not appropriate. And that\’s because, it may take until, well, under current law, if you take money out of an annuity except through that lifetime income thing I talked about earlier. Before the age of 59 and a half, you will have a tax penalty on your gains. So, like an IRA, you\’re deferring your ability to access that money without the tax penalty until you turn 59 and a half. So, that is why, generally speaking, we don\’t want people in their 20s and 30s, there\’s just too much time involved before they can access the money. Now, people, and lately there\’s been some features in some of the other annuity types that will be talking about later, that make it very, very attractive for somebody in their mid to late 40s or early 50s, and I\’ll give you some examples when we get down to talking about those strategies.
Clark: Yes, I think that\’s a good time to transition. I would love to hear more about some of those strategies, and also I think while we\’re talking about that, some of those pros and cons may appear, as well.
Roger: Sure. Okay. So, when we\’re talking about income annuities, I would like to finish this topic before we go on or…
Clark: Got it.
Roger: …it\’s just gonna get way too confusing, and we\’ll get deep in the woods, and people will completely loose the train of this conversation, because it is a very comprehensive topic. And I know we\’re gonna talk about some of this today, and some of it in our next podcast. So, with an income annuity, the pros are that you get a very high reliable income stream that you can depend on no matter whether the markets are up or down, or interest rates change, or who\’s in the white house, or any of that stuff. You can count on that money coming in every month, or every quarter, or every year depending on how you wish it to come in. Most people take it monthly. It can cover your lifetime.
A lot of clients come to me and say, \”You know, Roger, I\’ve worked hard my whole life to build wealth, and this money is for me. I don\’t, you know, either I never had kids, or more frequently I raised them. I paid for college, I launched them, and now what\’s left over is for me. And so, my perfect financial plan, Roger, is to spend my last dollar on my last day.\” And if you feel like that\’s your objective, then an income annuity is a perfect solution to that. You can take that annuity to cover your basic expenses, and even some luxuries, and then whatever is left over you can just have fun with. So, that lifetime guarantee is one of the big pros to me.
You can also cover a spouse. You can add additional guarantees in case somebody dies too soon. They don\’t enjoy the longevity of it. And if you have, what\’s called a non-qualified annuity which means it\’s not an IRA, there are some significant tax advantages. I\’ll give you a quick example, I have a client, Southern California, a guy I\’ve known for years and years and years, and some of the money and the portfolio, and some of their income decisions are starting to run out. He has a sum of about $400,000 that he wants to create lifetime income for both him and his wife. They\’re in their about…he\’s 78 and she\’s 79. They\’re in great health, and they\’re going to get over 10% of that $400,000. They\’re gonna get $42,000 a year as long as they both live, and when one of them dies, the survivor\’s going to get $21,000 for the rest of their life. And this could go on for another 20, 25 years given how healthy these folks are right now.
And because it\’s not an IRA, they\’re only going to pay taxes on about 2% of that income. So, it will reduce taxes on their social security, and it opens up lots and lots of additional strategies to them. So, and, of course, it\’s guaranteed. You could spend everything in your checking account this month, and next month it\’s gonna get filled up again. The cons are that once you\’ve started income, once you exchange that $400,000 to the insurance company, if you change your mind in six months, it cannot be changed. It cannot be reversed. You can\’t go back. So, once you receive your first payment, that\’s it, you know, you\’re just gonna receive payments.
Now, most of these types of annuities have fixed payments, and that means that for these clients, the $42,000 that they get this year will be the same payment they\’ll get 10 years from now. And so, they\’re not going to get increases in their income to offset the cost of living. Now, there are other options where there are cost of living raises in this type of an annuity, but if you use this type of level payment, you could loose purchasing power over time. And of course, if markets sore and go crazy, this money isn\’t going to be available for you to invest in the market. So, if you\’re looking for a guaranteed lifetime income that you can\’t outlive, this is one of the things you should be looking at.
Clark: And with the insurance company, maybe this is a silly question, but they\’re pretty steady, right? I mean, I know with the stock market that\’s up and down, and there\’s lots of unexpected things that could happen, but with the guarantee that you mentioned earlier with some of the states that the insurance companies are in, how does that work?
Roger: Well, first of all, that\’s a great question. And if you look at American history, it was for most of the last 170 years, life insurance companies have been the go-to for safety and security. Most recently in 2008, 2009, and 2010, we saw hundreds of banks go belly up. They just, you know, they didn\’t have the financial strength and we\’re with all to survive the downturn, and the erosion of their capital base. Life insurance companies, and it takes a life insurance company to issue an annuity, are capitalized very differently than a bank. And as a result, we only lost, well, we really didn\’t loose any life insurance companies during that same downturn. And you can go back here in San Francisco during the 1906 earthquake and the aftermath. Insurance companies went out to Golden Gate Park and set up a temporary branches so that people could access cash values of their policies, so that they could use that money to rebuild.
It was weeks, and in most cases, months, before banks were able to reopen and provide access to people\’s capital. So, it\’s things like that the insurance industry has gone through, boom and bust cycles. It was the capital that insurance companies that helped lift the United States out of the great depression, and there\’s example after example. But if you look at their balance sheets, if you look at how does an insurance company capitalize itself, it has a lot of excess capital. So, again, this could get too deep in the woods, but most insurance companies have what\’s called a surplus account, and their surplus account is money that they use to provide guarantees every time they sell a new policy.
A bank is only required to keep a certain percentage of their liabilities in cash at the bank. So, when I lend money to the bank by making a deposit, they\’re gonna lend that money out to somebody, and then they can call that loan in asset, and lend against the loan they created from my deposit. And they can do that over and over again. That\’s why you might have heard that banks were leveraged 35 to 1. And what that meant is my dollar that was deposited in the bank was lent out 35 times. That means they only have about 3% cash against their liabilities. While an insurance company has to have extra cash above and beyond their liabilities.
Clark: Wow, that really makes sense. I really appreciate you diving into that. And I think you\’re doing a great job. I understand that a lot of this, it could get into the woods, but I think you\’re doing a great job with keeping us knowing everything we need to know, and keeping it easy to understand.
Roger: Well, I\’m trying hard, because this is an information learned and garnished over almost three decades of being a planner, and it was years ago. Back in the 90s when the markets were hot, that I really dug into this issue of looking for safe all…safe for all alternatives, and the history of finance, banking, etc., in this country over the last, you know, couple of 100 years. Where did the stock markets come from? How do they function, and what are the alternatives? Because things aren\’t what they always seem on the surface, you gotta dig, drill down, and I spent a career, actually more than a career doing that. I\’m kinda geeky about this stuff.
Clark: Well, it\’s your passion, for sure. And I know there are a lot of options and there are a lot of tools that are available, and there is no one-size-that-fits-all, so one thing I wanna make sure we mention before start wrapping up is the thought organizer. So, for someone who is trying to look at all of their options, what and how does the though organizer assist them in creating clarity?
Roger: Great question. I think that that\’s the place whether you work with a planner or on your own that you really need to start. You need to get in touch with, what do I want money to do for me? What do I want my future to look like? Because once you have that context, picking and choosing different financial tools becomes much, much easier. Quick example, I had a new client who was complaining about the stock market, and they weren\’t sleeping at night in the volatility, and, you know, they said, \”I have to call my broker every month and tell him to send me money, and then I have to look at what do we sell, and go through all this stuff. I just want things to be simpler. I don\’t wanna have all of this responsibility, ongoing responsibility.\” So, we used a variety of tools, and annuities were part of it to reduce their day-to-day responsibility.
Yes, they still have to monitor their money, and these other issues, and we review all that stuff, but day to day they don\’t have to worry as much, and make as many decisions about it. Because of these guarantees, there are other types of products that have different guarantees, but still are more stable, and have less moving parts than the stock market, for example. So, that\’s where the thought organizer and, please, it\’s a complementary. Go to the website, download it, use it for yourself. It\’s designed so that you can organize your thinking about not only money, but how it relates to your future.
And I\’m gonna give you a really great example of this. Recently, I had a situation where a client filled out, it\’s a new client, filled out the thought organizer, and they indicated that their primary financial objective was to create lifetime income. Income that they could not outlive, that they were incredibly conservative, and it really didn\’t wanna have any volatility in their investments, and they described themselves as a one on a scale of 1 to 10 as far as how much risk they were comfortable.
Clark: Okay.
Roger: But they had gone to a broker before they came to me, and had filled out, had the broker filled out a similar questionnaire, but it was just focused on risk tolerance not on lifestyle, not on their future objectives. And I\’ve seen this happen too many times in our industry, they ended up with a product that has a much more risk than their comfortable with, and much more expense than they should be using. And I asked them, \”Did you fill out a questionnaire about risk?\” And they said, \”Well, we don\’t remember doing that, but there in the paper work was a confirmation from the company saying, you answered that growth was your primarily objective, and that you\’re willing to take risk and you could be comfortable with volatility.\” So, because they didn\’t have a context for that decision, you know, if somebody says, \”Well, you want your money to grow, don\’t you?\” \”Oh yeah, so I can just check that box.\”
This gets into a whole different area of fiduciary versus suitability, which I\’m not gonna get into. It\’s a big political football in Washington DC, but it\’s why I operate as a fiduciary, and why we approach this stuff…before we ever talk about money, we talk about people. Because, it\’s people first.
Clark: I love that. Before we talk about money, we talk about people. It\’s a good fit for your style, I know. It\’s like your heart, and it\’s very clear. So, thank you, Roger, so much again for explaining all this, and laying it out. I really enjoyed the conversation. Do you have any final thoughts before we wrap up?
Roger: Well, just wanna mention that in our next podcast, we\’re gonna talk about deferred annuities. And these are the annuities that you get a lot of this emotion around. We\’re gonna talk about the different kinds, why Wall Street blasts them, you\’ve probably have seen in your local paper, or online, or even some television ads now and again. There\’s one particular financial advisory firm that has a whole campaign, \”I hate annuities, and you should too.\” In fact, if you pardon my language, I was shocked on marketwatch.com a couple of weeks ago to see that they had changed that to, \”I would die, and go to hell before I would sell an annuity.\” That is a very strong statement, and I don\’t understand why anybody would get that worked up about a financial product that, you know, is just the thing.
So, we\’re going to talk about deferred annuities next time, and hopefully just spell some of the myths, and offer people some of the cautions and things to look for before you consider whether an annuity is something that\’s appropriate for you.
Clark: Great, thanks, Roger.
Roger: All right. Good talking to you, and we\’ll talk to you soon.
Clark: Thanks so much for listening to this episode of Retire Happy. Be sure to head on over to gainerfinancial.com to download your thought organizer to get started. Roger L. Gainer, ChFC, California Insurance license number, 0754849, is licensed to sell insurance and annuity products in California, Illinois, Arizona, Pennsylvania, and New York. Roger L. Gainer is an Investment Advisor, representative providing advisory services through HFIS, Inc. Our registered investment advisor. Gainer Financial and Insurance Services, Inc. is not owned or affiliated with HFIS, Inc., and operates independently. Thanks again so much, and will see you next time on Retire Happy.