What Do Annuities Actually Do?

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Now, let's get started with Finishing Well. I love these shows with you, Hans, who's such a disciple. I mean, you study things, we get to learn. I mean, how fun is this today show is actually, you know, what do annuities actually do? And so if you'd known me, as Hans just pointed out so wonderfully, I didn't even know how to spell annuities two years ago. I still don't really, but had no concept of what they were, what they did.

But this show isn't about what they are, it is about what they actually do. What kind of tool? Is this a screwdriver or is it a can opener?

You know, what kind of tool is this? And so, you know, as I was thinking about, and I never thought about applying the Scripture this way, except God kind of just gave it to me as I was thinking about it. You know, in James chapter two, when it says, you know, faith without works, you know, is dead. And then it goes on to talk about an individual, you know, comes across somebody that's, you know, starving to death on the, you know, when they wish him well and say, well, I'll pray for you, but they don't actually, you know, try to get them some food or just, you know, walk away from it's like the prodigal. And not, excuse me, you know, the Good Samaritan story about all these people walk by and they may have prayed for him as they walked by, but you know, the one guy actually stopped and did something. And so faith is good. I have faith I'm not going to run out of money in retirement, but here we get an opportunity from my perspective, knowing a little bit more about annuities than I did two years ago, you know, and what do they actually do to provide that kind of faith to go, oh, I really don't have that worry because I know that I have the right tool for the job. I have, you know, a can opener to open my can.

It's hard to do with a buck knife. Well, yeah, I mean, we have people, most of the people that come to us, if I had to just come up with an age that is very common, it's people turning 65. Okay, they're just, they're either retired or not or thinking about it or been retired for a little while, but that's a common age and people at that point generally have some retirement savings, many of them, the lion's share of their retirement savings is in a 401k or an IRA and they've got a hunk of money. They've been accumulating it over years. A lot of them are very kind of shocked that they've accumulated this amount of money. I mean, they just kind of like all of it's there and what they've done is they've had it mostly invested in stocks typically, and they've been through a couple of market downturns and they have lived to tell the tale.

I mean, it just, so their account went down one year and it went down substantially and then it made it back the next couple of years and then went off to great new heights. A lot of them forget that they're adding to it every year through their contributions and their employer contributions, which really makes the investment side of those things look a lot better. And so here they are right at retirement and they've got this big hunk of money and they're usually pretty proud of it and it looks big to them because it's a lot of times all they got. And then we present them with the problem, which they kind of already know, is now we need to live on that money for the rest of our life. Okay, now we're going to retire or we're going to retire at some point and when we do retire, we're not going to be making income anymore, we're going to be earning social security and we give people a lot of counseling on that. Now we've got this retirement savings, which for many people is like I said, the lion's share of their savings and this has to produce an income and with a large sum of money, it's pretty easy to produce an income for a while.

But at what age do you run out of money if you start drawing down principal? So when you ask what do annuities do, what they can do and what they do for many of our clients is on a portion of their money is they provide guarantees that they're never going to have any stock market losses, it's not going to go down from year to year from anything other than withdrawals. And it also, they have the advantage if it's not retirement money of tax deferral, so they don't have to, like if you have money in the bank and it earns interest and then that interest gets credited, whether you draw it out or not, you got to pay taxes on the growth. With an annuity, you can leave the savings in there, leave the earnings in there, you don't pay taxes until you draw them out. So you got tax deferral and then the third thing that you have is you've got a guarantee of an income for life. Like at any point, you can turn on an income out of the annuity and the insurance company will guarantee you that that check will keep coming in to you or your spouse for as long as either one of you is alive. There's a lot of nice features in there, but we're still, we're talking about what they are, so what do they really do?

I mean, I want to answer the question that's in the title of the show. What do annuities actually do? And what I'm, the way I'm going to answer that is they provide an income starting at an age where you pick, which could either be right now, if you're willing to wait and every year you wait, the income's going to be larger. But starting at an age that you pick.

Yeah, it's kind of interesting. A minute ago, you said that as people, you know, get older in there and they're making those investments into their 401k, right? And at some point in time when that stops, they're not seeing the growth and they were seeing anymore, right? If they're no longer making the right now they're seeing on is, and this is kind of working in the backwards of, of what that is in that the longer you leave it in there, the more income that that's going to increase.

Well, absolutely. And then you, plus you're going to be older. So the insurance company that backs the annuity knows that, you know, if you put an annuity on a 73 year old man, he's going to live less years than a 66 year old man on average. So, so every year you wait, you get interest earnings that you don't pay tax on and you become one year older so that the guarantee that they can make is better because you have a shorter average life expectancy, even though a 73 year old man might live to a hundred. I mean, that's the risk that they're, you're transferring to the insurance company.

So to try to put this simple is you got guarantees with an annuity that you can't get out of other investment products. And so seldom do we put all or most of people's money all into an annuity or annuities. We don't typically do that. Once in a while we do. And that's requested of us sometimes, but most of the time we spread their money around.

Okay. We're going to start first with the social security and then we're going to look at the taxation that they're going to face by the other withdrawals they're going to make on the social security. So, you know, is social security going to be the majority of their income for a while? And if they can live off of that, well, that's desirable. And then that can, we can defer a lot of this stuff to let it grow even more up into their seventies before we start pulling money out of this. But many people need some money out of these retirement savings accounts to supplement their social security right away. Some people need the most they can get out of it right now to live combined with their social security.

I mean, people are all over the place in that. And so that's our first goal with people is that, you know, we need to get you the money that you need to live and then we need to show you how much taxes you're going to pay because it's only the net money that you can spend. And then we want to assure that. And that might be some of those people we're going to put almost all of their money in an annuity simply because we never put all of it, but we could put a lot of it in there just because an insurance company is then going to guarantee an income to these people no matter how long they live. And that may be what they need because they don't need the uncertainty and they don't need to face stock market losses. For many people that we work with, they don't really need any income out of their retirement savings. They're in their middle 60s. They're going to take social security when they retire and they can do fine just off of that and maybe some of their non-qualified savings, part-time work.

I mean, people are all over the place. But when we have people that don't need to make withdrawals in the mid 60s, later 60s, maybe all the way up through the early 70s, so this is going to be something. And with retirement money, you've got to start taking withdrawals at 72.

So a lot of people will plan around that age. And if we've got some years until then, well, we want to invest their money and take some risks. We want to invest part of their money. A lot of them have all their money in stocks and they want to get away from that now that they're retired because they don't want to watch their retirement dreams evaporate in a bad stock market run like we had back in March.

That's no way to live your retirement. And so what we'll do is we'll take part of their retirement savings, maybe half their retirement savings, and we'll put it into annuities. And so what do these annuities actually do for them? They guarantee an income and they guarantee no losses of money. And the longer they wait to take that income, the more it's going to be. Once they start it, it's guaranteed for life. So I know if you're like me, you're going, gee, that sounds just like my sole security. The longer I wait to take it, the more I get and I get it and it doesn't run out until I die. I mean, Social Security is, when I realized that, like, oh, Social Security, that's how that works. How cool is that? It's really the same thing.

One's a public program and the other one's a private one that you set up a lot of the same ways. I mean, when you mentioned Social Security, we have some people that are like 64 and a half, turning 65. They're coming into us. They're going to retire soon and we're setting things up and they discover that they're going to be best to wait till 70 to take Social Security. But then now they need something to live on between now and 70 when they take it. So we'll start pulling money out of the retirement savings to create a monthly income for them to live. And then we have the guarantee. We can tell you exactly what that Social Security is going to be. So sometimes we use Social Security as the annuity in the planning and then delay that.

It just depends on the people and their situation. But the whole point that I was getting at here is what annuities do is they allow us to take risks with the money that we have invested. So that once we take, like, half your money or 60 percent or 40 percent and lock it down in annuities with all these guarantees and lifetime income guarantees, putting that together with Social Security, you know you're all right, then we can take some risks and calculated risk with the rest of your money.

And there you have it. You know, it's clear that and, you know, I've experienced this since I've known you. You know, I made this advice to a close relative and watched what happened, you know, because here's somebody that I was really concerned would run out of money.

You know, it's like that was a concern as I looked at her situation to go, wow, what do we do? And actually what you set up for her was more of an accumulation, right? Yeah. Annuity. And so when we come back, there's more to this story.

Yeah. We're going to break it down and talk about the types of annuities in the second part of the show. So when we come back, you know, what really do annuities do for you?

Stay tuned. Oh, I should mention this is, I mean, Finishing Well with Certified Financial Planner Hans Scheil and brought to you by CardinalGuide.com. Contact Hans to schedule a live recording of Finishing Well at your church, Sunday School, Christian or civic group. Contact Hans at CardinalGuide.com.

That's CardinalGuide.com. Welcome back to Finishing Well with Certified Financial Planner Hans Scheil, of course, brought to you by CardinalGuide.com. Today's show is, you know, what do annuities, maybe that's a new word for you, or certainly a new word for me two years ago. What do annuities really do?

They were one of the tools in Hans' toolbox. And so there isn't just one kind of annuity, is there? There's lots.

Oh, there are. And they're, you know, we use them as tools in retirement planning, and I want you to look at them as just an alternative place to put your money or to put part of your money. I mean, obviously, people need to stay invested. If they've been invested, they need to stay invested in stocks and bonds. If they've been in them their whole career and they've built their 401k that way, then we generally recommend that they keep some of their money in that with all its uncertainty.

And most people have a desire that way. I mean, we don't really tell people what to do, but we're generally going to take people into retirement and recommend that they get much more conservative in their allocations of their money, okay? And we do that by showing them and doing a risk profile analysis of asking them a bunch of questions and then calculating where they ought to be on the risk, you know, on the risk chart, and then we actually show them where they are on the risk chart with their current investments, and pretty quickly people want to get into more fixed income stuff and more conservative investments. And as you age, that number or that percentage of risky stuff is going to go down.

You just don't want to be 80 years old and worried about what the stock market is doing, and you don't really want to be betting your income through your 80s on that either or your spouse's income. So the way we just guarantee your future is we use annuities, and there's really, of fixed annuities, there's three types of them. There's immediate income annuities, there's deferred income annuities, and there's accumulation annuity, okay? And those are really, you know, three different types of fixed annuities.

There's also many different types. There's variable annuities, and we don't offer too many variable annuities to retired people just because when you get into a variable annuity, you lose one of the key benefits. You just lose the guarantee of principle. Your money is invested a lot in stocks, and you have some guarantees from the insurance company, but if the stock market goes way down, so does your value and your annuity. So we're not, for the most part, we're certainly not on this show today.

We're not talking about those. We're talking about fixed annuities, and of the fixed, the first one, immediate income annuities. You know, what that means is if you have a hunk of money, which most people do in an IRA or in a savings that's not an IRA, and they want to essentially buy a Social Security check that starts next month, that's what you're doing. You know, if you had $100,000, and you were 65 years old, and you wanted to know how much income will that pay me for life, let's just try to make it simple, 700 bucks a month.

I mean, I'm way too simplifying this. Don't consider this a quote, but I'm about right, male or female. It's going to be a little more for males than it is for females because females tend to live longer, but you would be buying a $700 monthly income for the rest of your life. And if you live to 73, you could effectively say that you didn't do too well on that bet because you only collected from it for eight years. If you live to 100, you've beaten the house, and you've essentially collected $700 a month, way more than your $100,000 that you put in there.

So what does happen out of curiosity? So you put $100,000 in this annuity. You die the next month. What happened? Okay, well, most of those are going to come with a 10-year period certain, so your heirs are going to get the 700 bucks a month for the next 10 years.

Okay. Because you didn't make a 10-year. Now, you can buy a 20-year period certain. You can go with a no period certain. So you could, you know, we have single people do this that are people single with no kids, and they don't want, they don't really, they're not that worried about the remainder, so they want to get the largest possible amount. Then that would be a pure annuity. So in that case, nobody would get anything. But you might get 750 bucks a month for life that way or 780 a month.

Right. So I'm just, the 700 bucks a month would be assuming a 10-year period certain. Or if you were a married couple wanting this, you might only get 640 a month, but there's no period certain because it's going to keep paying the 640 a month until the second one of you dies. So, you know, if one person dies, the money keeps coming to the second one for a long life. That's the way to get you the most amount of money right now on a principal sum. That's called an immediate income annuity. It's also called a single premium immediate annuity. They have a number of different words, but when we have somebody that is not as concerned about loss of principal, because that's a concern there with an early death, and they want to get maximum income for their lump sum, there you go.

We actually don't sell that many of those, okay? I mean, what we typically sell are the deferred income annuities. And what a deferred income annuity is is an annuity where the income doesn't start right away.

It's deferred at least a year, and there's not really that much advantage to buy it and then start the income in a year. But if you go several years out, when I say several, I mean four, five, six, seven, eight, nine, 10 years, where you would take $100,000, I mean, you know, in seven, eight years, we can grow $100,000 into $160,000 or $170,000 in annuity value. I mean, and so we're gonna have a larger amount, and then you're seven years older, so we're gonna have a higher calculation on that, and you might be able to take the same $100,000 by waiting seven years.

You know, you might be able to get, you know, $9,000, $10,000, $11,000 a year for life at age 73, or for a couple, a couple might be able to get like a little bit less, but then it covers the couple on that amount as long as one of them's alive. So it's really a way to buy a future income, that's essentially what you're doing, it's like a social security check once it starts, and you're not locked into that deferral period. So if you, you know, we can sit down and show you what income it would pay you in six years, seven years, eight years, so when you actually get there, you could say, no, I don't wanna take the income yet, I wanna wait another year so I can get this amount. Or I wanna wait another two years because I'm doing okay here in my other money, or I'm spending less, or just whatever. So the longer you defer that, the more it's gonna be, and then some people never take the income of those, and they just leave it there as a savings account, and then they pass away, and then a large check goes to their heirs, or to their spouse, or whomever.

So these annuities are really tools, and so the deferred income annuity is a tool that we use to create a known income starting at a future day, which gives us more latitude if we're managing your money. I mean, let's just say we left half your money in the account where we're gonna buy stocks and bonds according to the percentages and the risks that you wanted, and we're effectively taking some risk, and we're trying to grow this amount for an unknown future needs, or for immediate income needs. I mean, whatever, it's just an account that's growing, and so we got that, and we have a risk of loss. We have a risk that you may live a long life. We have a risk that you may live a short life. I mean, there's a lot of unknowns about how your retirement's gonna play out, and then there are unknowns with your money, and especially in the investment market. So what annuities do for us as financial planners and for you as the client is they give us some certainty on the income side of the equation that we know we've got this amount and this income that we can draw on no matter what, and they give us the flexibility to invest. That make sense?

Oh, absolutely, absolutely. But there's a third kind, right? There is, and that's the accumulation annuity. They're not that much different than deferred income annuities, except in the way they're designed. They are designed to give you the best possible accumulation that you can get, and then the way you get it, the money is just through withdrawal, not lifetime withdrawals, just withdrawals. And that's actually your relative, that's what she bought was an accumulation annuity that was designed, and she's paid an interest rate on that every year, and it's based upon the performance of a stock index.

The money's not actually invested in stocks, okay? It's at the insurance company, and the principal's guaranteed, but the insurance company has themselves covered that if the index goes up substantially, then you get a substantial deposit of interest into your account. So it's designed and made most effective for accumulation. It also does not have a charge for the future income payout. So on that annuity I was just talking about, the deferred income annuity, you're paying within the annuity, there's a fee for the guaranteed lifetime income component, and you don't have that in an accumulation annuity. It's just designed for what it says, accumulate, and then it allows you to draw out 10% of the value penalty free every year.

And I think in the case of this person that we were talking about, that had a 20% cumulative feature to it, meaning that if she didn't draw it out, the 10% one year, the next year she could draw out 20%. And it's designed, so those products are designed for liquidity, and accumulation, and the best possible return that could be put in there. So, and we're gonna use those for people that don't wanna be in the stock market, they kinda want their cake and eat it too.

I mean, they want the guarantee of principle, and they wanna get some benefit of the stock market returns, but they don't wanna pay the price, which is future market loss as possible. Right, and they can get at the money as they need it, but in those cases, what happens if that person passes away? Just, it's gonna pay out the cash value of the policy. Really, in both the second one and the third one, in the deferred income annuities and the accumulation annuity, either one of those, the last two that I talked about, whatever money is left in the account is gonna be paid to the beneficiaries when they die. So in the example I gave of the person that bought it at 65, waited till 73, started making withdrawals, and then they died at 76, they've only taken three years of withdrawals, so there's still gonna be a substantial payout at their death of what's left in the account. Yeah. And in the accumulation annuity, we're just assuming they've taken nothing, and then they pass away, just the whole amount goes to the beneficiaries.

There you go. What annuities do today? Of course, this is all in the income side, right? And retirement income, one of the seven worries, which clearly I think is often one of the biggest worries people have is, am I gonna run out of money? So you can find out more about this from Hans' book, The Complete Cardinal Guide to Planning for and Living Retirement, and you can find that, of course, at cardinalguide.com, as we always tell you. Just ask Hans for his book, he'll be happy to send it to your, more importantly, obviously, we're just talking about one tool in the toolbox. Sure. And there's different tools that meet different needs, and they're very customized to you, your spouse, your health.

All these things, your Social Security income, all fit into the equation, and well worth the time to plan well is to finish well, right? Yeah. Thanks for listening. Thanks. We hope you enjoyed Finishing Well, brought to you by cardinalguide.com. Visit cardinalguide.com for free downloads of this show or previous shows on topics such as Social Security, Medicare, IRAs, long-term care, life insurance, investments and taxes, as well as Hans' best-selling book, The Complete Cardinal Guide to Planning for and Living in Retirement, and the workbook. Once again, for dozens of free resources, past shows, or to get Hans' book, go to cardinalguide.com. If you have a question, comment, or suggestion for future shows, click on The Finishing Well radio show on the website and send us a word. Once again, that's cardinalguide.com. Cardinalguide.com. This is the Truth Network.