Frederick M. Orentlich also famous as Fred Orentlich is a one of the best finance professional. Contact him for any kind of finance relates service like health insurance; invest in best life insurance plan to get tax free profit.
In today’s discussion about annuities and
their place in one’s portfolio I would first like to focus on the typical
concerns and priorities my clients express to me regarding their financial positioning
in relationship to their retirement and other financial needs and goals.
First, in framing this discussion, it is
important to note that my typical client is of a more mature nature and is
either planning for retirement or already in retirement, thus their priorities
tend to be more conservative than their younger counterparts. More specifically,
my clients are usually over the age of 55 and have been savings toward their
retirement for at least 15 to 20 years. A good number of clients express the
need to re-allocate their portfolio in a more conservative direction to protect
some of the assets from market loss and feel it crucial to lock in some of
their gain to help insure a successful retirement.
When many of my clients began their working
careers, company pensions were far more prevalent, thus the mindset regarding
retirement savings was very different. During their careers many of my clients
saw a gradual yet substantial paradigm changes toward providing for one’s own
retirement needs, due to the preponderance of employers that discontinued
retirement and pension plans, combined with the advent and expansion of IRA’s
and 401ks. For many people this change toward increased self-sufficiency put
them at a substantial disadvantage as to the amount of precious time they have
or had to prepare for retirement when compared to many of their younger counterparts
whom more recently entered the workforce. Today most people beginning their
careers have the advantage of knowing early on, that they must prepare for
their own retirement and are acting accordingly. Additionally, as our
population is enjoying an increasing lifespan the amount of assets needed to
sustain a longer retirement can be daunting. In addition, this longevity may also
increase one’s need to have some financial resources earmarked for health care
expenses associated with the varying needs of the elderly. Consequently, the
need to accumulate sufficient assets might cause some to people to take on more
risk, than might be prudent.
A particular concern that many of my clients express about their
retirement savings is the volatility of the financial markets, and of course
the potential of market loss.
Many of them sustained substantial market loss during past market
corrections, especially during the 2000 and 2008 corrections. Some expressed
losses of up to 50% and more, during certain time frames. When considering
market loss, I believe it is wise to consider the real-world mathematical
challenge in recovering from that loss. If a person sustains a substantial loss
of 50%, it can take them more time to recover (break-even) than some people
consider. As an example, using the simple amount of 100,000.00, if the market
corrects by 50% the 100,000.00 could be reduced to 50,000.00, then if the
market rebounds by the same 50% (over a number of years) a person could end up
with 75,000.00, not their original 100,000.00. Thus, to recover from a 50%
loss, one would need a 100% gain just to break even! This truth once understood
can cause people to be more concerned about averting substantial market loss,
especially if that person is older and has less time to recover from such a
loss. Based on the reasons stated above many people approaching retirement or
already in retirement are looking for a way to earn a good return, but
critically, without the risk of market loss. The most common “safe” options of
CD’s and Money Market accounts may not produce sufficient gains to both grow
one’s retirement assets sufficiently, and to compensate for inflation. Although
we have recently been experiencing below average rates of inflation, many are
concerned that this may change in the future.
Over the past decade certain types of
annuities have become increasingly popular amongst retirement conscious people,
and I would like to address the different types of annuities and discuss
whether they might be an appropriate part of one’s portfolio. An annuity is a
financial product available through insurance companies. There are many types
and uses for annuities, and they vary in purpose, features, safety and return. Instead
of taking many pages to illustrate the various types and aspects of annuities,
I will discuss them in basic categorical terms. My explanation will be focused
on how different annuities address the growth and distribution of the funds
deposited, in relationship to the need of safety, growth and longevity that
many people have.
First, I will separate annuities into two separate categories. The former
category is variable annuities and the latter Is fixed annuities.
A variable annuity which is categorized as a security, generally
produces gains based on underlying investments such as mutual funds. Many
variable annuities also offer fixed accounts whereby an investor can allocate
funds which instead of participating in the underlying mutual funds, will often
receive a fixed rate of growth for a certain period of time. The rate at which
the fixed account grows varies by product and will often be similar to current
money market rates. A concern that some people express is that variable
annuities not only grow based on the underlying investment choices but can be
reduced when the underlying investments produce losses. Market gains or loss
can of course vary by investment and time frame, but if a person is looking for
protection from market loss in order to preserve those funds, this aspect needs
to be considered. Another consideration is that variable annuities often carry
substantial fees and charges. The fees can lower the products yield and are usually
charged even if the annuity produces a loss. Some of the fees associated with
variable annuities are for riders that can provide certain benefits. Some of
these include a death benefit and income rider, which we will discuss.
The other category of annuities is the fixed annuity. There are
several types of fixed annuities, but what they all have in common is
protection from market loss.
Some fixed annuities offer a guaranteed rate of growth for one year
or several years. The type of fixed annuity that offers a guarantee rate of
return for multiple years is known as a MYGA (Multi Year Guaranteed Annuity).
These annuities have a “time frame” during which the rate can be guaranteed, similar
to a CD. Unlike many CD’s a MYGA, will often allow a client access to some of
the funds during the guarantee return period, this is known as a “Free
Withdrawal”. Although free withdrawal amounts vary by product, a 10% annual
free withdrawal is fairly common. If a client were to withdraw more than the
allowed free withdrawal, they would be subject to an Early Surrender Charge on
the excess funds withdrawn, that exceeded the free withdrawal amount.
As a simple example, if one is allowed a 10% annual free withdrawal
and withdraws 12% during the year, just the 2% over the free allowed amount
would be subject to a surrender charge.
Commonly, the Early Surrender Charge percentage decreases over time
until it is no longer applicable at which time all funds may be available
without any penalty.
Another type of fixed annuity
is known as a SPIA, which is an abbreviation for Single Premium Deferred
Annuity. This type of annuity is usually purchased to convert that asset into
an income. The annuity will often have a choice of income payout periods which allows
a for an income for a specified period of time or for the lifetime of the
client and the clients spouse. If a lifetime income is selected the product may
offer a provision that payments are made to the named beneficiaries if the
client, or client and spouse were to pass before all of the funds are paid out
to them.
Although the guarantee of a lifetime income that you cannot outlive
certainly has appeal and fits in some cases, several of my clients raise a
concern that the asset is not accumulating growth in the traditional sense when
this type of SPIA annuity is purchased. Another concern raised is that once
this type of annuity is purchased, the client does not have access to the asset
if they changed their mind in the future and wanted to withdraw a lump sum.
The next type of fixed annuity is known as the FIA, or Fixed Index
Annuity. This type of annuity has become very popular as it offers some unique
advantages.
First, the product offers clients gain based on indexes, many which
are market based. The indexes vary and be based on the S&P 500, NASDAQ, Dow
Jones, bonds, commodities, and real estate. Certain products offer Volatility
Control Indexes, which may combine the growth of a combination of the above. A
Volatility Control Index will often shift its allocation daily or monthly based
on the movement and volatility level of varying underlying assets. This method
can often produce a more consistent and less volatile growth pattern. The
client generally has a choice of indexes and can change indexes in the future
at the end of each index period. The index periods are most commonly one or two
years. In addition to being able to change indexes over the years, clients can
also allocate to a combination of indexes, thus using more than one index
simultaneously. The financial professional that recommended the product would
generally also recommend which indexes to choose and help the client with
changes, if any, over the years.
There are three advantages regarding how FIA’s lock in gain and
protect you from market loss. To summarize the first two points, when the index
produces gain at the end of each index period, that gain is locked In and
cannot be lost. As an example, if the person deposited 100,000.00 into an FIA,
and the index produced a 10% gain during the index period the account value
would be 110,000.00. If during the next index period the index sustained a
market loss whether it was 1% or 50%, the client would not sustain any market
loss at all! Not only would the original 100,000.00 have been protected but the
full 110,000.00 would have been protected, as the gain is locked in once credited,
and that higher amount becomes the new floor and cannot be subsequently reduced
based on market loss.
The third and very important advantage is the Index Reset Feature.
This can become quite beneficial during the times that an index sustains a
loss. As an example if a client’s index does sustain a market loss at the end
of any index period, the client again is not subject to that market loss and
still keeps any past gains, but very importantly, if the index started at 2,800
and decreased to 1,400 by the end of that index period, the client could
benefit as they get to start the next index period at out at 1,400. Thus, the
client could participate in the subsequent gains (rebound gains) that are
typical after market losses, but without ever having participated in the market
loss in the first place!
The amount of gain an index produces can be adjusted by any
participation rates, caps and spreads that the insurance company is offering in
conjunction with that index.
When searching for the best products for my clients, I start with
hundreds of products available thru many different insurance companies. Along
with the national FMO’s I am associated with, I do research and comparisons of
many product choices. I start my search by looking for products that are offered
by highly rated carriers. Next, I look for products that offer low fees or no
fees so more of the gain remains with my clients. Then I look for the best
index choices which often point me to Uncapped Indexes, thus the amount of gain
is not capped, and the clients could experience more upside, sometimes far more.
Based on the client’s needs I consider available riders which can
produce benefits in the area of providing a guaranteed lifetime income,
enhanced death benefits and other benefits.
There are some FIA’s that offer Income Riders that can be of
benefit. Some products charge a fee for the income rider while others do not.
The Income Riders may offer a level income for the rest of the persons life
(and spouse) or an increasing income. The increase in income can be based on a
certain annual percentage or can be based on index gains.
When comparing a Fixed Index Annuity (FIA) with an Income Rider, to
the typical Single Premium Immediate Annuity (SPIA) there are some obvious
differences. First, in most cases when a SPIA is chosen it is a lifelong
commitment in that the client (and spouse) can receive a lifetime income, but
they cannot change their mind down the road and access their funds, whereby
with an FIA which includes an Income Rider the client can change their mind even
if they have begun receiving the guarantee income stream and access the
remaining funds, subject to any remaining surrender charges.
Next, the (FIA) with an Income Rider has the opportunity to grow
based on the gains produced compared to most SPIA’s which do not offer that
sort of traditional growth. When looking at a traditional SPIA, the return if
any would often be based on the length of time the client and spouse live.
If a person needs or desires an Income Rider, some of my top choices
are income riders allow for the guaranteed income to continue to increase with
market gains. These products have the potential of providing an increasing
lifetime income that can be very substantial when compared to other products. As
an example, if a person’s annual income was at $2,000.00 per month and there
was 10% gain at the end of the index term, the income would increase to
$2,200.00 and stay at $2,200.00 until further gain is locked in. If during the
next index period, the index sustained a loss (because the stock market had a
downward correction) and at the end of that next index period the index was
down any percentage, just like in the previous discussion of market loss, your
income will not decrease at all. The reset feature also applies to your income
in that, when the market goes down and your income stays the same for that
period, when it’s time for the next period, your starting point is reset to the
actual current level. Thus, if the index is down at the end of the period (no
matter how much) you actually restart at that “down point” and get to take
advantage of the gains that ensue. It has been typical that after the market
has a correction as in 2000 or 2008, we have strong years of growth (sometimes
called rebound growth). So, if you don’t sustain a loss of income during the
drop, and then we have several years of possibly better than average growth in
the indexes, your income would keep growing at the end of each index period as
the index increases. As an example, you start at $2,000.00 per month, and the
index produces a 10% gain and you are at $2,200.00 per month, then the market
declines for a couple years by 50% you would still be at the $2,200.00 per
month income, then whenever the index produces gains you will go up by that
percent from the $2,200.00. So, if the index produced gains of 20% your next
income level would go to $2,200.00 x 1.2 = $2,640.00, then if it did the same
thing by end of the next index period, you would be at $3,168.00 per month as
the gain percentage is calculated by the last (highest) income level. In this
example because of the Reset Feature, it is possible that the client’s income
has grown from $2,200.00 to $3,168.00 per month and the market still has not
even gained back what it lost.
In conclusion, depending on a client’s
needs and goals, the appropriate type of annuity can be an important part of
their portfolio. Whether the goal is to protect some of their funds from market
loss, grow their funds at a consistent rate, participate in market gains
without the risk of market loss, create a guaranteed income that cannot be
outlived, provide a hedge against inflation, or a combination of these
attributes, the right annuity can be an integral part of one’s portfolio, and
certainly deserves careful consideration.
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