Episode # 242- Helping You Find Financial Certainty in an Uncertain World

June 12, 2020

Markets are volatile, social unrest is prevalent and concerns about the pandemic continue.  We’re living in uncertain times and many investors are searching for certainty and stability. I’m joined today by CFN Financial Planner Ryan Flurer to discuss annuities.  We detail the pros and cons of various types of annuities, the associated costs, ways they’re marketed and what role they can play in your overall financial plan.

Program Length: 26 minutes

Transcript:

The content shared on your life, your wealth network reflects the views of the host and guests of the program only and are not necessarily the views of Cordasco Financial Network or its advisers. This media production is educational in nature and should not be construed as financial, legal or tax advice or a solicitation or presentation of sale of any financial products or services. Please consult a professional prior to making any financial tax or legal decision.

Welcome to the your life, your well network, helping you find clarity and comfort for your life.

And well, now here’s your host, financial adviser and CEO of Cordasco Financial Network, Steve Cordasco.

Today, the markets are as volatile as they’ve ever been. That, coupled with social unrest and a health pandemic, has many investors like you searching for a way to create some certainty on money.

And today we’re going to cover a topic of how to position some of your assets to create more certainty in your world of investing that doesn’t have a whole lot of certainty tied to it would be to consider insurance contracts. Insurance contracts are getting extremely popular over the last few years in helping create certainty to your money. What’s that? I say insurance contracts. I meant to say annuities. But wait a minute. Annuities are a bad word. So should we be just saying insurance contracts see the topic of trying to protect your money and creating certainty, using certain types of investments to create certainty on your money has negative connotation to it because many, like you, are trained to avoid annuities and probably rightly so for most of you who might be in an accumulation phase of life. You probably need less certainty. You’re willing to take on more risk in volatile type investments, knowing that you have longevity to weather the downs, which happen a lot less than the ups. But I’m here to tell you, many people, just like you, get to a phase of life where they start to question whether or not they need as much uncertainty tied to their wealth. Based on where they are at that stage of life. So if you’re in that stage of life where you might be considering some certainty on your money.

In today’s world, it’s being magnified due to social unrest, health, pandemic and very volatile markets. But before we jump in and learn about annuities and determine once and for all if they’re bad. Let’s look at some recent data that’s relevant to anyone who wants certainty and protection on part of your wealth or a majority of your wealth. About one in seven financial advisors, or 14 percent of us said that their average client is very interested in a product with guaranteed lifetime income, although more than 40 percent of investors say that they are either very interested or already own such a product. That’s according to research by Greenwall and Associates. Additionally, 58 percent of Advisors survey said that they only recommend annuities to some of their clients of a certain age. Now, despite all the interest that investors said that they have and guaranteed lifetime income products. Now listen closely to this, according to the survey. They desire something called an annuity, much less.

The report found. So an annuity is set to pay you a guaranteed lifetime income. That’s what an annuity is. But when we call it an insurance contract. The survey says you want it more than if it’s called an annuity. It’s the same thing.

It’s like me saying, do you want a cola? And you say, no, I don’t want a cola. But if you ask me for a Coke, I’ll take it.

Huh? Why is that? It’s fascinating.

The insurance industry has known this for years, that it’s a play on words.

And the word annuity doesn’t play well with consumers. Frankly. Less than 20 percent. We’ll purchase an annuity. But yet, if you call it an insurance contract. You get to the 40 percent interest, Mark, huh? Why is that?

Has to do with the branding and labeling of the insurance industry and my point of view. I think it also has to do with the fight that goes on in the world that financial advisers and insurance representatives play in.

See? You might get fliers in the mail.

By certain money managers who say annuities are horrible. Never do an annuity. Well, that’s not true. There’s a place in a financial plan for any product that’s out there or regulators would not allow those type of products to be offered. But wait a minute, you talk to insurance people who earn their living making big fact commissions off of you. If you purchase an annuity waps, you won’t do it if it’s an annuity. So therefore, if they called an insurance contract, they earned the big fact commission because they got a higher probability. You’re going to say yes to the sales pitch. So this tug of war fight, I believe, is not doing you justice and everybody’s got to get over it.

I have asked one of my partners at Cordasco Financial Network who I worked with on a daily basis. We worked together and he helps me design strategies for investing money for people just like you in cash flow vehicles. He has a deep knowledge of the long list of insurance products, swaps. I mean, annuities, annuity products.

Ryan Floor. Ryan, welcome to today’s podcast. Thanks for joining me.

Hi, Steve. It’s my pleasure.

I would say we find 15 to 25 percent of those that we have structured financial plans have some type of flavor of annuity. It’s a piece of an overall financial plan strategy. And for some, it’s more from others. It’s a little less. For some, it’s none.

Annuities aren’t always a great fit for everybody, but when they do fit in, then they do make sense. They can provide a lot of certainty and really complement a financial plan. And I think that you’re right on there, probably around 20 or 25 percent of the folks that we help find some advantages and already have one of these.

Let’s jump into the why. When we start to see signs that somebody might be at a stage of life or in communicating with people that we work with, that there might be a need for more certainty from their money at a certain stage of life. You know, you and I go to the drawing board and we really dig into the why, because you’ve got to know what somebody wants to do with their money. And that y then determines part of the reasoning going in to putting together an investment program within a financial plan. So let’s get into some of the whys. Obviously for guaranteed cash flow. Right. That’s one of the the big Y’s.

Yeah, I would say that’s exactly right. Think of think of Social Security to that. That’s, you know, in some ways a form of an annuity. You pay it over a certain period of time while you’re working and then after you retire, it pays you back over over the rest of your life. I’m used to my salary and when I retire, where am I going to go? It makes me a little uncomfortable to know that I have to lean on just my investment portfolio. And how much certainty can I really have there?

Sometimes we find out that, hey, you know what? I’m worried about my late life care. I need something that if I need somebody to come help take care of me, that I know I have some guaranteed income coming in to help cover that. Or somebody might just say, hey, I want to build a pension, or some people want to insure their money to protect it from downside loss, like some of the volatility gone on the markets right now.

Or some people want to build a legacy for their heirs, meaning, hey, I’m going to use an annuity because it’s protection. And that’s either going to be there because I want my spouse to be able to continue that cash flow if I pass away or I want to have something that’s got a guaranteed amount that will be there for loved ones down the road. But I don’t want to buy a life insurance policy. There are different vehicles within the world of annuities. So think of automobiles. There are hundreds of different types of automobiles right now driving around on the road. There are all cars. What we’re talking about when we use the word annuity is the same as if we’re saying the word cars.

Now, what we have to do is jump into the type. That’s out there within the last decade or so.

The world of fixed annuities has tried to start to look a little bit more like variable and get a little bit cute in how they design and try to be a little bit more market centric, because if an insurance person doesn’t have a securities license, they can’t sell a variable annuity. So they had their hands cuffed and the insurance companies started to develop some fixed products that have some investment features.

So when you think of the traditional sense of a fixed annuity, you think of, you know, write a check to an insurance company and they guarantee. X percent, two percent, three percent. Spare some words like how a C.D. would work. Then at some point in the future, you can ask the insurance company to start writing you checks.

To sum it up, you’re entering into a contract with an insurance company. And what you’re doing is you’re saying, I’m going to give you a certain amount of my money and you’re giving me a contract promising me something in return for that money.

Yes. Insurance salesman, try to get cute and say these aren’t annuities. It’s a contract. So there is the broad definition of fixed and you’re going to dove into all the different flavors of fixed annuities.

So where I think I’d like to start is is talking about fixed indexed annuities. They have become a very popular product. Lots of different companies offer them and they come in all sorts of different different flavors. And the way that they’re often sold is that you can never lose money. There are times where, you know, things like fees or charges for riders and administrative fees can can take away some of that. That principle that you originally put in. But for the most part, you’re protected on the downside. But in order to get that downside protection, you, of course, have to give something up. And what you give up is you significantly limit your ability for upside. So you operate in between what are called the floors, which is that downside protection and the cap and the cap is the maximum return that you can get in a given period. A lot of times we see him around for five, maybe five and 1/2 percent, but they’ve come down as interest rates come down. People like the idea of fixed indexed annuities because it has that downside protection. But I still get upset. Where they often fall short is that when you go through bull markets, where you put you in, where you have double digit returns year after year after year, you’re fixed indexed annuity. Just very simply can not compete with the variable annuity. During that period of time, during a bear market, you will take a lot of comfort having a fixed indexed annuity, because as markets are coming down, you don’t feel that downside.

If somebody was putting one hundred thousand dollars of, let’s say, their nest egg of a million dollars, 10 percent of their money into a fixed indexed annuity, and it paid that insurance person who has to pay for all their advertising, maybe they’re on TV or radio where they’re doing steak dinners to come and sit in front of a sales pitch. They’re going to say there’s no commission. And that’s because if you put one hundred thousand dollars of your money into that annuity or one hundred thousand of your dollars are in that annuity, and therefore nothing came out like a mutual fund, which is called a load, which is a commission if you’re investing it in the markets. Therefore, they’re saying, look, there’s no commission on this, but there really is. Right.

That’s oftentimes how it’s presented. But the insurance company writes that agent a check and the insurance company has a lot of very well-educated people called actuaries who figure out how to be profitable. And like I said before, with those caps in those floors, a lot of times those rates. We’ll be squeezed a little bit because the agent has to, you know, the agent collects that commission so you get less upside on your money potentially.

Right. Because there’s a payday to the insurance person.

Right. And how about is there a penalty to get out?

If you’re not careful, you can get whacked.

Pretty, pretty good because of the commission that was paid. But we can’t call a commission because an insurance salesperson doesn’t call these things commission. So that’s a fixed annuity that is trying to give some people who want some market exposure, some market exposure with limited gains within the market for the protection of your money not going below a certain amount of what you put in any other types of fixed annuities.

One of the very popular ones is a single premium, immediate annuity, which are, you know, write a check to the insurance company and they immediately start paying you back. The other type of popular one is the multi year guaranteed annuity, which Dimler is really, really soon really to a to a city. So they come in lots of different shapes and sizes. There they have to be understood thoroughly before anybody makes a decision and don’t rush into buying a fixed fixed annuity.

Let’s jump into the variable side. A variable annuity is different from a fixed type annuity in that a variable annuity allows you to invest your money into investment vehicles like mutual funds. So think of a variable annuity, sort of like a four one K in that it’s got investment options that you can select when you put your money in and that money goes into mutual funds that you can invest in in lots of different things like international investments, S&P 500 funds, biotech, NASDAQ centric tech, all different types of vehicles. If you’re a variable annuity allows for that menu, just like your four one K allows you to make investment selections.

Here’s the difference because you are truly in a variable annuity, putting your money in to these accounts that are like mutual funds. That means you need a securities license.

To talk about it, to show it and frankly, sell it. Annuities. Whether it’s variable or fixed, are you ready for this? Are not bought. They’re sold. And that’s part of the reason the insurance industry gets such a bad name.

It’s because you need us, an aggressive sales person, to get you to do it. And if they don’t have broadness in how they’re licensed, they can’t be fair in showing you all options of annuities. So if you’re getting a steak dinner or in today’s world, maybe they’re shipping it to you and you’re eating it. Why? You’re watching a virtual presentation. Ask the question, do you have a securities license and can you show a variable annuity? They’re going to fly off the handle, tell you how bad they are and tell you they’re ugly. Most likely because they can’t sell it to you. So a variable annuity works similarly to a fixed annuity where you have a contract with an insurance company.

And what you’re doing in that contract, you’re agreeing to turn over a portion of money, a lump sum or a stream of payments into the insurance company with the anticipation in the contract that later in life you will then turn that annuity on if you want to build guaranteed cash flow.

Or take a lump sum if you want to take a lump sum or put beneficiaries on the contract so that if something happens to you later in life, the legacy moves to your heirs or if you’re self insuring for your late life care that you might want in your home or in a facility.

And you don’t want to buy a long term care policy. You can use something like a variable annuity to turn it on later for those reasons. But here’s the difference.

When you enter into that contract, you have a little bit more control on your money in that you get to pick the investment vehicles and many insurance companies will give you the option in their contract to buy some accounts, which are like mutual funds with actual mutual fund company managers. There’s some you can get Vanguard or American funds or Fidelity, BlackRock, a whole menu, just like your four one K. And then what you do is you can invest for growth.

And that’s usually what I recommend, go pedal to the metal and what you want to do is use that annuity, obviously, to try to make more than what you gave the insurance company. So if we use that one hundred thousand dollar scenario and you’re stuck between a fixed or a variable annuity.

If you give your money to the fixed annuity, which is OK, if it’s the right match for your planning, you’re going to turn it over to insurance company and accept an interest rate. They’re going to promise you if you want to get cute.

You can.

Guarantee yourself that you won’t earn an interest rate less than zero, which means you won’t lose money or you’re going to cap the maximum amount you can earn from that insurance company, which might be four percent or five percent in today’s market. But guess what? You could go a year to averting zero. And a variable annuity. What you’re doing is you’re giving your lump-sum that hundred thousand dollar to the insurance company and the insurance company saying thank you for your one hundred thousand dollars, your contract says you can now pick mutual funds or sub accounts with in our menu. And you can diversify that one hundred thousand dollars and then that money will grow in the marketplace.

Dollar for dollar minus expenses. No cap. Yes, you can end up with less than what you put in.

But if you use it.

For that cash flow down the road and your contract that you entered into says, when I turn this on, it can’t be any less than what I gave you, even though I’m taking investment risk when I turn this on for my lifetime income. It will be based on, at a minimum, that one hundred thousand dollars. So that brings us to that key phrase, right. Minus the cost. And this is one of the rubs when it comes to variable annuities that they’re expensive. And it’s a rub because guess what? There’s transparency to those expenses. When you sign into that contract, they have to make it very clear what the expenses are. So they’re seen and they could be anywhere from mid to percent range all the way up. To the four percent and even maybe higher to four and a half percent in variable annuity costs. But let’s talk about it, Ryan, if we can, the cost side of that, because you can buy an annuity that has somewhere a little bit north of two and a half percent is its fee. But then you can do add on. Benefits to that annuity called riders that you have to pay for, which could bring the fees up to closer to four, four and a half percent. Let’s talk about what some riders are.

They really fall into two categories. They’re either going to be living benefit riders. That provides some extra benefit while you’re alive or there’ll be a death benefit rider that enhances the legacy that the annuity can leave to your heirs. They they they vary dramatically across different companies.

They are. They are what makes annuities vastly complicated. And to your point, they do add extra costs anywhere from one to two percent on top of what the other charges that are already in sight.

Yep, that’s it. And it’s Paul Dimensioned. So if you want a benefit, for example, something that covers you, if you pass away many annuities, almost all have what’s called an emeny expense, which is an expense for for your death.

If you want to add a rider to it to maybe cover long term care down the road, some annuities allow you to add a long term care rider. And then some riders also give you a guarantee amount of lifetime income when you turn it on.

I think the most important aspect of it is the fact that you can cover more than just your life with an income rider. You can cover your spouse as well, which for a lot of times that’s that is one of the most important things that someone is trying to accomplish, is they want to make sure that their spouses airport after after they pass away.

One area, though, that the fixed investment does not have as an add on costs, since we are now covering cost and within the world of costs come riders which give protection in the world of fixed annuities, there’s not really investment cost in there unless you’re buying an indexed annuity, which does have some internal fees. But it’s hard for the average person to see it. But in a variable annuity, you have mutual fund type investments that you’re selecting and therefore there’s added costs to those. That’s why variable annuities are considered the more expensive type of annuity. But for that, you’re getting investment options. Now, on the tax side, if we can switch gears.

I think we should focus on on specifically those those after tax dollars, those non-qualified annuities. So if you think about, you know, if you had that one hundred thousand dollars invested in a brokerage account as you bought and sold different investments, then and if you earn money, you have to pay Applegate’s. But in a. Annuity. Those taxes are deferred. So you don’t actually have to pay any tax. So you start taking withdrawals and that can be. And that can be a powerful instrument because your annuity isn’t weighed down by capital gains tax, which over, you know, a 10 or 20 or 30 year period. That can really add up.

The money grows, tax deferred. But when you turn that on, it gets confusing. Do people still pay tax on the dollars that the insurance company sends you as part of their obligation to that insurance contract?

Yeah, you do start to pay taxes for that. But you don’t along the way. You’ll have no taxes to pay until you start taking the money out of the into it, just like an IRA.

We covered a fair amount of turf today. It’s a subject matter that really takes some planning to it. Which brings us to advisers. I always say try to work with a fiduciary. And do you work with someone who’s working from a total financial planning standpoint? For many in a time like this, who one certainty and maybe you’re there, you have to look at where an annuity fits into your total financial plan. If you want to learn more, we have an annuity review. So if you’re thinking about an annuity, be more than happy to review it for you. Because one thing we didn’t talk about today is the ratings of different insurance companies and their annuities, as well as whether or not the annuity matches the strategy they want. So we do those reviews. Maybe you’re sitting on an annuity that you had for years.

You’re not so sure about it. We’ve been more than happy to take a look at that for you, too. We’re open to have that discussion with you. Thanks for listening to the Your Life Your Wealth program. Ryan Flaugher, Ryan, thanks again for being part of the program. You’re welcome.

Steve, it’s always a pleasure to be on and thank you for listening to the Your Life Your Wealth show with me. Steve Cordasco.

If you’re interested in learning more about applying the principles we discussed to your personal financial circumstances, please visit Cordasco Financial Network at CNN Plan dot com or call our office at two one five five five eight thirty five hundred. We hope you’ll join us again next time on the Your Life Your Wealth network.