Annuities - A Way to Generate Steady Retirement Income
By Rudolph Corrales, Jr.,CTA, RFA®
There are a lot of ways to get around this problem. Many people prefer to save and accumulate wealth through compounding. Some people invest in stocks, some in life insurance. And some people buy annuities.
What are Annuities?
An annuity is a financial product that provides people (especially retirees) to have a steady revenue stream after they have made regular contributions to the annuity plan. They are tax-deferred, and no taxes are levied until you start receiving your annuity payments. Once you do, annuity income is taxed like an ordinary income and not as capital gains.
For an annuity, you usually make regular, periodic contributions to an annuity plan. It’s the time where you are basically funding your annuity (or, in a way, investing in your annuity). This part of the process is called the "accumulation phase," where the amount you are paying is accumulated and put to use by the annuity providing financial institutions (usually an insurance company).
You may not have to make contributions for the whole duration of the accumulation phase. Depending on the plan, you may have to make contributions for several years and then wait for a few more years before the plan starts paying you back. Either way, you can’t touch the money once it’s in the annuity plan. This is called the surrender period of your annuity plan. If you try and take your money out from the plan, you have to pay a hefty penalty (usually 10% or up), that’s decided at the beginning. The surrender period can be anywhere from two years to twenty or even thirty or forty years, depending upon the plan and distributions.
Most people purchase annuities as a hedge for their retirement years. Especially people who don’t qualify for a sufficient defined pension (or no pension at all), or not enough assets or passive cash flows to sustain them through the retirement years. So after the accumulation phase, comes the “Annuitization phase," where the annuity plan starts paying you back. Based on your plan, they either have to pay you for a fixed number of years, like 10 or 20 years. Or, they have to pay you until you or your spouse (if they are added in the policy) is alive.
This is the most common type of annuity there is. And that’s preferred by people who need a steady income in their later years, or they want to augment their pension amount with annuity payments. But there are other types as well. For example, some annuities don't require periodic payments. Instead, you submit one large amount, and after a set surrender period, start cashing in annuity cheques. This is usually opted by people who either win a lottery or inherit a significant sum. Instead of wasting it away, they can create a regular income source for themselves with the help of an annuity.
Also, you may opt for an annuity where you receive a lump-sum amount at once, after making your contributions during the accumulation phase, instead of receiving monthly payouts.
A wide variety of annuities are available, and you may select one that suits your retirement financial goals.
Common Annuity Types
There are many different annuity types, some of which are:
Fixed Annuity. As the name suggests, they pay a fixed amount to the annuitant (the person who is entitled to collect the annuity payment). The amounts that the annuitant receives depends on a lot of factors, but it's usually just a bit higher than what you would have received from certificates of deposits. The upside is a dependable and predictable sum you will receive.
Variable Annuity. Unlike fixed annuities, a variable annuity doesn’t appreciate at a fixed rate. Rather, you can choose one (or more, depending on your plan) mutual fund from a selection that your annuity provider offers. This goes into a sub-account within your annuity, and the amount you will receive in the end will depend upon the performance of the fund(s) you chose. A lot of people like that because it has the potential to offer much higher returns than a fixed annuity, with similar contributions. But if the mutual funds don’t perform well, the risk of receiving lower payments is there as well. Many variable annuities are planned in a way that you are guaranteed certain returns, and rest is dependent upon the performance of the mutual funds. They can be considered a hybrid between fixed and variable annuity.
Fixed-Indexed Annuity. They are similar to variable annuities. But instead of being dependent upon a handful of stocks in a mutual fund, they follow an index, like Dow Jones or S&P 500. And they guarantee returns proportional to the performance of the index. It has less risk, and consequently, fewer returns than a variable annuity.
One term that you may encounter when researching or choosing variable or fixed- indexed annuities is riders. These are attached or additional benefits that can be connected to an annuity. For example, an annuity income rider may guarantee that you will receive a fixed income stream as long as you live, instead of a defined number of years. These riders are costly additions to the annuity plan and should be considered only when absolutely needed.
Annuities for People Without Defined Pensions
People who don’t have a defined pension plan can benefit greatly from buying an annuity. Since the annuity payments can make up for a steady retirement income, and help carry you through the retirement years. Since annuities are tax-deferred in nature, they can grow into pretty decent nest eggs. And they solve the problem of outliving your assets or savings since you can collect your annuity payments until your (or your spouse’s) very last days.
Annuities are a good alternative to other tax-deferred ways of growing your wealth for retirement. But like anything else in the world, it has its cons as well. They can be quite complex to understand, and if you don’t know what you are doing, you may end up buying a plan that may work out more in the annuity provider’s favor than yours. Secondly, they have hefty management and holding fees attached to them. And third is taxation. As regular income, it might increase your tax bill more than another investment vehicle would have.
Still, they make a great income source, and their stability and guarantee of payouts can help make your retirement well-financed and cozy.
THE CASE FOR WHOLE LIFE INSURANCE
By Rudolph Corrales, Jr., CTA, RFA
We are experiencing a once in a lifetime event-the corona virus or COVID-19; and the shut down of our economy. The stock market has been hit hard and is falling in a way that was not even seen during the great recession of 2008/09. This coupled with the closing of businesses has not only hit investors, but owners of businesses and workers of every economic level. But the question right now is how do we survive this economic crush from business owner to worker? For one, the federal government is passing an economic bill that will give every american a $1000.00 dollars. That certainly helps and it also depends on how long this crisis continues.
For many people, just trying to survive is the only thing on their mind; from not getting the virus to feeding the family. However, the constant need for money to sustain us is a major priority and let’s face it, the majority of people do not have an emergency fund to sustain their families needs. It may be too late to do anything now but when we emerge from this crisis-and we will-we should look to put a portion of our money in a place which is safe, easily accessed, and gains a guaranteed contractual percentage year after year. You may be asking what is that place? That place is a high cash value dividend paying whole insurance policy which was bought from the right companies. This can act as a high yield savings account, an emergency fund, and a future stream of income in later years-and that’s just some of the benefits. There are other benefits but I want to talk about the access to cash, or as I call it the emergency fund because this is what we need to have right now.
When you have a properly designed dividend paying whole life insurance policy, you have the contractual right to access the amount that you have in the cash value. A simple phone call or application and the company will put the money in your bank account or they will send you a check. In a situation such as this crisis, you don’t have to rely on the federal government or anyone else. You don’t have to worry about how you will pay for the essentials needed to get through this time. When the situation stabilizes and we are back to work we can replenish the life insurance policy but I want to emphasize that we the policy holder have control of the process, I.e., we can pay back the loan, we can pay back only the interest on the loan, or we don’t have to pay back the loan(I don’t recommend that). My point is that we have total control as to what we do with our money. That is something that you don’t have with a 401k or IRA, in fact, the government tells you how, when, and for how long you will pay the loan back or face tax consequences and penalties. Also to note that there was a study in 2018, which studied “wealth shock” that was published in the Journal of the American Medical Association. The study found that a significant loss of capital, wealth, or basically your money resulted in the premature death of those affected as opposed to those who did not suffer a loss. One way to avoid the sudden loss of wealth is to be diversified. Studying millionaires with a net worth of a million or more, we learn that they do not have more than 20 percent of their wealth in the stock market.
Whole life insurance has been beaten up by financial pundits as being arcane and not a very good investment vehicle. They claim to buy term and invest the difference in mutual funds. However, I want to emphasize that it is not an investment instrument but insurance that has been around since before the founding of our country and it also predates the Revenue Act of 1913 which created the federal tax code. Dividend paying whole life insurance has a history of paying dividends each and every year for over 100 a years through every economic crisis and recessions which makes it a stable and reliable money tool that allows for uninterrupted compounding interest that only grows exponentially over time and it provides us with access to cash even when credit markets tighten. If you're interested in such a policy as this you should get with a trusted agent that knows how to properly design a policy for maximum cash value and will place that policy with a company that has consistently and transparently performed in this manner.
I’d like to take the time to write about how NOT to become a millionaire. I say this in jest because I want everyone to become wealthy. However, in order to get you to think about this topic, I approached this article from the opposite perspective; In all my studies and research I have never read nor seen an article such as this. So I’m going to make it easy for you and give you the keys to NOT becoming a millionaire.
Financial planners and advisors have been sounding the alarm telling us that we need millions of dollars to retire but the following statistics tell us that we aren’t heeding their advice. In fact, the majority of people are doing the opposite.
There are approximately 320 million American citizens, in which approximately 11 million are net worth millionaires. This article is about this group of net worth millionaires ranging from 1 million to 10 million dollars with an average mean of 3 million dollars. That is a small number in comparison to the 320 million people previously mentioned. In this range, I didn't include the group of dec amillionaires, those having a net worth of 10 million and above which make up about 1.1 million- an even smaller number when compared to the 320 million Americans.
Dr. Thomas Stanley and Dr. William Danko studied the characteristics of millionaires for over thirty years and what they learned surprised them and everyone who read their work. When surveyed, a person was asked to describe a millionaire with such questions as:
What Type of car do they drive? Where do they live? What do they do for a living? How much do they earn yearly? What type of clothes do they wear? What kind of watch do they wear? How much do they spend on vacations? What type of home do they live in? etc. What we learn through their responses is a picture that doesn’t line up with the facts. The reality is that these millionaires live in ways that are completely opposite of what we think and believe. In the book, The Millionaire Next Door, doctors, Stanley and Danko, tell us their research suggests that we are conditioned by advertisers and marketers as to what and how millionaires live, vacation, where they buy their clothes, the type of cars they drive, etc. We also learn that 80 percent of millionaires are first generation millionaires with a majority of them having not received an inheritance.
I remember a television show in the 1980s hosted by Robin Leach, The Lifestyles of the Rich and Famous. Mr. Leach would follow the lives of various celebrities and present to the audience their extravagant lifestyles. It was powerful. He would end the show with his signature catchphrase, "Wishing you caviar dreams and champagne wishes". I remember as a young man, living in a lower class neighborhood, watching the show and believing that I could not even have a small amount of what they had. This wasn't an indictment of America, this was an indictment on what we have been told and taught-or not taught. In fact, in this very presidential election cycle democratic presidential hopefuls have people believing that you can't become a millionaire, much less live comfortably, in this country nor in this capitalistic economy. This is FALSE. Now I will tell you how NOT to be a millionaire if that is what you choose.
How Not to become a millionaire-the commandments
If you don’t want to be a millionaire, DO NOT live below your means,
(Actually spend more than you make using credit)
If you don’t want to be a millionaire, DO NOT pay yourself first by saving at least 10 percent,
If you don’t want to be a millionaire, DO NOT buy a used car that is at least three old,
(allowing the original buyer take the initial depreciation)
If you don’t want to be a millionaire, DO NOT refrain from buying the latest trends in clothing,
If you don’t want to be a millionaire, DO NOT prepare your meals at home,
(Spend 15 to 20 dollars a day eating out)
If you don’t want to be a millionaire, DO NOT refrain from going on excessive vacations,
(In fact, while your in debt go on vacation)
If you don’t want to be a millionaire, DO NOT refrain from using your credit cards and carrying a balance,
(see the first commandment)
If you don’t want to be a millionaire, DO NOT buy a home of modest means,
(millionaires homes value represent 10 percent of their net worth)
If you don't want to be a millionaire, DO NOT refrain from buying expensive jewelry,
(number one watch worn by millionaires is a seiko)
If you don't want to be a millionaire, DO NOT refrain from buying recreational toys, raptors, boats, trailers(if you do financing them is best)
If you don’t want to be a millionaire, DO NOT attempt to fatten thy purse(get a better paying job)
I could go on but I think you are get the idea. Millionaires do not live a lavish lifestyle, they live a life of accumulation-saving, and investing in assets.
Anyone in this country can become a millionaire if they plan correctly and adopt the tried and true practices of these everyday millionaires(which is also chronicled in such books as The Richest Man in Babylon, Think and Grow Rich, Become Your Own Bank, and The Millionaire Next Door). It's as simple as that. And an important part of the equation is to find a trusted advisor who will guide you along the way. This advisor should educate you on the various components of wealth building along the journey to financial freedom. However, if you don't want to be a millionaire then follow the commandments I listed and you definitely will NOT become a millionaire.