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Retirement is the biggest purchase you’ll make in your life

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Clearly, if Americans expect to cover most of their retirement expenses with sources of guaranteed income, they are going to have to fund more of this from their own savings. Recent stock market volatility has brought concerns about retirement savings and income into sharper focus. Adding to those concerns, thanks to the Federal Reserve holding down interest rates, our savings have not grown for five years.

Retirement is the biggest purchase you’ll make in your life – bigger than your home and the cost of every vacation you’ve taken.  Retirement will last many years and there are numerous unknowns.  For a married couple both age 65, one is expected to be living at age 90…and reaching 100 or more is no longer rare.  No doubt you’ll face many financials risks.

Sequencing your withdrawals”- Guaranteed-return places like annuities that offer principal protection, tax-deferral and conversion to a guaranteed lifetime income should not be overlooked to avoid spending down when your investments have losses.

It seems that every financial journalist and fee-only advisor I come across hates annuities, but unfortunately many of them don’t understand them well enough to be giving advice on them.  I admit that annuities can be very confusing, but they also offer some very attractive income benefits that will prevent you from outliving your money – guaranteed. Show me a stock or a mutual fund that can promise that?

Immediate income annuities, longevity annuities and indexed annuities offer income benefits that can either be setup to pay for an individual or a couple (for a joint payout, the benefit is usually lower).  How much you get all depends on the insurance company, type of annuity, amount you have to invest, and when you start taking the money.

Fixed-indexed annuities (sometimes referred to as indexed annuities) offer attractive features such as principal protection and guaranteed income benefits. Since the market collapse of 2008, indexed annuities have become much more popular. With indexed annuities, your principal is protected in years the market loses money no matter how steep the losses.

Where Indexed Annuities Really Flourish is the availability of Income Riders -.If you’re tired of seeing your investments rise and fall with the Dow Jones, then an equity indexed annuity might be a good fit.  You want to diversify. You might be a strong believer in the markets, but a little certainty never hurt anyone. Taking some money and locking it up in annuity with a guaranteed income rider could make sense.

A Fixed Index Annuity (FIA) is a fixed annuity with an interest rate that is linked to the performance of a stock index (the S&P 500 for example). Some insurance companies also give you the ability to get guaranteed future income account growth between 5% and 8% annually through the income rider.

An income rider on a fixed or fixed indexed annuity allows a retiree to build a secure retirement income. The issuing insurance carrier guarantees the payout provided by the income rider for the life of the annuity owner, as well as bearing all of the investment and longevity risk on the guaranteed payout — which means that the consumer is completely protected from these risks.

Some annuity carriers even provide for the income to substantially increase in case the annuity owner is confined to a nursing home, further sheltering the annuity owner from risk. In addition, the annuity owner retains access to the annuity’s remaining value and continues to reap the benefits of interest credits to the annuity’s value.

The income rider is optional and there’s usually a fee associated with it, but for the right person, it can be one of the best retirement prizes ever invented. The reason: an income rider can guarantee a great income that will last your whole life, whether you live to be 85, 95, or 125. The income rider is such an attractive benefit that nearly 3 out of 4 fixed index annuity purchasers elect this option.

If you have five to ten years before you actually need to draw income. Income riders are a viable option for those that want to avoid the market and want to have a guaranteed income stream at retirement. With the income account increasing each year for each year that you’re not touching it, this can be a huge benefit for someone who has a chunk of money that can invest it and sit on it for a few years.

Beware: The Benefit Base- is the annuity’s value that GLWB Guaranteed Withdrawal Payments are based upon. This is a separate value from the account value, and it is only available by taking Guaranteed Withdrawal Payments. If you have a fixed index annuity with an income rider that pays 6.5% compounded, it does NOT mean that you are making 6.5% annually on your money.

Rather, the rider guarantees that the insurance company will credit 6.5% to a separate income-only account. That’s a difference you need to understand. This income account value can only be taken as income, and only by the initial contract owner. Again, a guaranteed lifetime income or withdrawal benefit is typically optional on a fixed annuity, and is added to the annuity by a rider. Whereas the annuity has an accumulation value to determine the death benefit or annuitization, the rider also adds a second value: the income value.

Accumulation Benefit- With income riders, the income value is completely separate from the accumulation value. It typically grows at a fixed rate of interest, and when the retiree elects to start taking lifetime withdrawals, a payout factor is applied to the income value to determine the guaranteed annual withdrawal.

If the accumulation value is higher than the income value when the policyholder decides to withdraw the income, then the accumulation value is used in the payout calculation instead. Once the amount of guaranteed withdrawal is calculated, the retiree may withdraw that amount from the annuity every year for life.

A common feature on GLWBs which guarantees that the Benefit Base will grow by a specified percentage (4% – 12%), as long as the annuity contract is held in deferral and lifetime income payments are not taken. This percentage is not a bonus or a guaranteed annual return on the base contract. It can only be realized if the annuitant holds the policy in deferral, and is usually limited to a specified number of years (usually ten).

Say that a 60 year old invests $250,000 into an IA and wants to start taking a guaranteed monthly benefit, (assume 4%) they would have a $10,000 ($250,000 x 4%) guaranteed annual income for life.  Where income riders get even sweeter.  If you’re a 60 year-old individual that has $250,000 to invest but doesn’t plan on retiring until 65 or later, then the income benefit riders becomes that much more attractive.  Insurance companies will give an additional credit to the income account that, in turn, gives you a potential higher payout when you need it.  Let me explain……

A 60-year old may get a 5% income credit increase each year up until the day they decide to start taking their money. That means that the insurance company will add 5% a year to original deposit (in this case $250k) each year. Once you start taking your income, the payout will be the amount in your income account multiplied by the withdrawal percentage based on your age.

The table below illustrates this over a 10 year period.


1          61         $262,500           $10,500

2          62         $275,625           $11,025

3          63         $289,406.25      $11,576.25

4          64         $303,876.56      $12,155.06

5          65         $319,070.38 (5% payout begins)        $15,955.51

6          66         $335,023.89      $16,751.19

7          67         $351,775.08      $17,588.75

8          68         $369,363.83      $18,468.19

9          69         $387,832.02      $19,391.60

10         70         $407,223.62      $20,361.18

The 5% income credit is for hypothetical purposes. Each insurance company will have their own set interest rate.  Recently, I’ve seen anywhere from 5% all the way up to 7%. Another thing to consider is that the maximum withdrawal percentage is typically lower if you’re looking for a lifetime guarantee for you and your spouse.

While taking these withdrawals, the retiree is provided with two very valuable guarantees.

  1. Although the annual withdrawals are deducted from the accumulation value, the additional interest (declared or indexed) continues to be credited to the accumulation value, and the retiree retains access to the remaining accumulation value at all times.
  2. Even if the annual withdrawals ultimately deplete the accumulation value, the issuing carrier must continue making the annual payments as long as the retiree lives.

Outliving your money – this is the greatest fear of most retirees and is called longevity risk, the risk your retirement money will fall short or be depleted before you’ve run out of time.  If your family has a history of longevity, outliving your money might top your list of retirement worries.  With people now living well into their 80s, and often into their 90s, it’s a legitimate concern.

The only true guaranteed source of lifetime income comes in the form of an annuity.  One benefit of income annuities is that they can take some of the guesswork out of retirement planning. For example, it’s easier to figure out how to make a retirement nest egg last until these payments begin than it is to figure out how to stretch it over an uncertain lifetime.

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Saturday, November 15th, 2014 Wealth Management

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