Annuities: Safe & Secure

A secure retirement is a dream of everyone who worked hard for years.  Yet after two brutal bear markets (2001-2002 and 2008-2009) retirement plan investors in 401(k) plans saw much of their lifetime retirement savings get walloped.

After the chaotic stock market of the past few years, capital preservation and sleeping well at night have trumped most other things. For investors dependent on interest payments for income, especially those near or in retirement, the current environment is challenging, to say the least.

The bottom line is that today’s retirees face greater challenges than ever, with diminishing sources of income, longevity risk and volatile markets that have eaten away much of their retirement portfolio.

Low yields mean low income, which has investors concerned about risk as they try to figure out how to augment their investment earnings without taking too big a gamble.

This doesn’t resonate if someone is trying to live off the investment income of a certain amount of principal. At 2007 rates, for example, you would have needed $1 million in government bonds to generate an income of $50,000 a year. Today, you’d need nearly twice that much.

It is often tempting to risk it all for the promise of a high return on your investment but you must remember that with great reward comes great risk and most of the time your security is simply not worth that particular risk.

You just can’t count on companies as we’ve seen big-name firms run into serious trouble in the last several years, including some big-name companies that were established nearly a century ago (Bear Stearns, Lehman Brothers, Enron, Worldcom) wind up defunct.

If you decide to delve into the realm of stock market investment you should be aware that every transaction costs money, that you need to thoroughly research the ins and outs of this type of investing, and that you are taking a substantial risk with your retirement investment.

History provides many lessons for all of us. There remains a need for retirement products that address volatility and attempt to generate consistent, absolute returns.  The idea of income planning, unlike other financial-planning concepts, is natural and comforting to many Boomers approaching retirement.

Perhaps they have gotten used to receiving two paychecks a month for 40 years or more. Remember the peace of mind that a steady income gave you during those years. Why would you want to give that up when you retire?

No amount of accumulated assets can replace the comfort created by a steady and guaranteed income for life, particularly an income that has built-in inflation hedges.

401(k) legislation was passed and rules crafted in the late 1970’s/early 1980’s. This 401(k) legislation was rooted in the belief that permitting investors to have more input on numerous aspects of their retirement savings was a good thing. 

These aspects included segregating each individual retirement account, offering the choice to save (defer) or not to save, ranges of deferral amounts, the ability to modify those deferral amounts, investment election choices, portability, loans and much more.  There were, however, no guarantees.

The “guarantee” was resurrected for retirement plan savers in the form of annuities. Unlike Bear Stearns and Lehman Brothers, the insurance industry has its own “insurance” in the event that one of the companies runs into financial difficulties and defaults.

Policyholders can rely on the insurance guarantee funds of the various states, to the extent that they are available. While this is not the same as a Federal guarantee, no state life insurance fund has ever let one of its members renege on its claims. The state funds typically get other stronger insurers to takeover the failed companies’ policies.

With CD rates at all-time lows, ultra-conservative investors are looking to annuity plans as a place to secure a higher return on their retirement nest egg.  Annuities that have guaranteed income benefits attached to them are appropriate for a large portion of the population. Additionally, the Fixed Indexed Annuity product has solved the market volatility problem.

What Does Standard & Poor’s 500 Index – S&P 500 Mean?

The S&P 500 is one of the most commonly used benchmarks for the overall U.S. stock market. An index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.

Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor’s. The S&P 500 is a market value weighted index – each stock’s weight is proportionate to its market value.

An indexed annuity pays out a rate of return on your money that’s tied to an economic index, such as the S&P 500. It’s considered a hybrid of the fixed and variable types because you receive a minimum guaranteed payment, but can also enjoy a higher return when there are gains in the broader market.

In a study conducted at Wharton School by authors Marrion, Babbel and VanDerPal’s, Real World Index Annuity Returns, shows that, based on data from 15 Fixed Indexed Annuities issuers, Indexed annuities outperformed conventional investments during much of the past 10 years —a  period when the S&P500’s cumulative return has been roughly zero.

The five-year annualized returns for indexed annuities, from 1997 through 2007, averaged 5.79%, compared to 5.39% for taxable bond funds and 4.73% for fixed annuities. From April 1995 through 2009, indexed annuities beat the S&P 500 over 67% of the time and a 50/50 mix of one-year Treasury Bills and the S&P 500 79% of the time.

Starting in 1997 through 2004, during eight five year periods, their data shows, the indexed annuities they looked at, offered an average annualized return of 4.19% to 9.19%, with no negative years. By contrast, an investor in the S&P500 would have seen four positive five-year periods and four negative ones.    

The question is how do Fixed Indexed Annuities maintain such an apparently even keel? In a bad equity markets, their substantial bond component offers downside protection. In rising equity markets, their equity option component increases in value.

Investors in Fixed Indexed Annuities therefore don’t need to fear the bears and aren’t as slavishly dependent on the bulls. Or, as the authors put it:  “By eliminating the prejudicial effects occasioned by significant stock market declines, and locking in returns annually or biannually, there is less of a need to try and capture large upside market swings to recover from the declines.”

Besides insulating investors from volatility, the-authors say, Fixed Indexed Annuities do, contrary to certain media reports, offer liquidity (penalty-free withdrawals of at least 10% a year) as well as tax-deferred compound growth.

The usual definition of safe money is money you cannot afford to lose. AnnuityNews.net defines a safe money place as one where your principal is protected from loss as long as you follow the initial guidelines, and if you do decide to take your money and leave, you know pretty much what leaving early will cost.

The opposite is a risk money place where if you decide to take your money you don’t know what you will get back. It could be more than you put in – risk money places offer the potential for much higher returns than safe money places – but it could also be less than you started with or even zero. 

Knowing how to make money, knowing what to do with money once you have it, knowing how to keep people from taking your money away from you, knowing how to keep your money for the long term, and knowing how to make your money work for you- is of vital importance in the quest to achieving financial freedom.