Variable Annuities – Dangerous Time for Retirees
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American Annuity Advocates wants to help you gain some clarity. Please understand that the information you are about to read should not be perceived as investment advice, but simply as information.
The problem we all face as we near retirement is that we are, most likely, unable to recover from market losses. When we are young we have our whole lives ahead of us and plenty of time to recover from such market losses. Quite simply our investment or savings "time horizon" is long. In retirement, we simply do not have the time because our time horizon for investing or saving is short. Hence, we cannot afford to risk what we cannot afford to lose.
The five years before and the five years after retirement are critical. Retirement is the dream of hard-working Americans everywhere. But what would happen if a sharp market decline occurred just as you prepared to draw income from your retirement nest egg? You can least afford to lose any part of your principal during this time period. Those who have saved their entire lives, still run the risk of untimely stock market downturns. In retirement planning, especially as we near retirement, we need to pay attention to our investment strategy, to insure against market losses from which we cannot recover.
The following slide is titled “Hypothetical Comparison of Market Sensitive Investments to Illustrate the Difference Market timing can make”. This is for illustrative purposes only and is not a representation of future performance. The illustration is intended to show you how a market sensitive investment might function based upon the historical S&P 500 index returns/ assumptions contained in the slide. Future results may vary. This slide does not constitute investment advice.
The slide below compares the account value of client “A to that of client “B”, in an effort to show everyone the difference a year or two can make. As you can see, timing, relative to the stock market and your retirement, is an important consideration. In this slide, client A invests in a hypothetical investment linked to the S&P 500 in 1991 and retires in December 31st 2000. Client B invests in the S&P 500 in 1993 and retires on December 31st 2002.
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Can we insure against market downturns? Yes, but only if we are willing to accept moderation. We will show you some examples shortly. It is critical that savers and investors consider adapting their retirement strategy as they approach retirement, become more conservative, and shield their savings from market downturns. Perhaps retirees should invest in the stock market only those dollars which they can afford to lose. More importantly, consumers have choices. A better choice for many retirees may be a fixed or a fixed-indexed annuity.
Some market sensitive investments make promises, but you should be careful to examine the complete offer. Be careful of variable annuity promises that seem too good to be true.
You may see or hear an advertisement promising to protect your nest egg, and simultaneously promising a 5% lifetime interest rate guarantee, or a 5% interest rate/ guaranteed withdrawal benefit on your savings, and it sounds great. A 5% guarantee on your money, who wouldn't take that? The advertisement indicates you have a chance to do even better than 5% with good investment performance. Wow! The advertisements have a catch; you are still placing your savings into a market sensitive investment product with high costs. The advertisements promote market sensitive variable annuities, which provide a 5% guaranteed withdrawal benefit for 20 years or for the rest of your life, depending upon your age. You know what they say, if something seems too good to be true, it usually is. If nothing else, there is simply more to it than meets the eye. Once an individual takes a look at the costs associated with the variable annuity, compounded over time, one can see that it is very difficult to do well because the costs are too high. Once one compares these variable annuities alongside a fixed annuity or a fixed-indexed annuity with real guarantees, we believe most reasonable people will find the fixed and the fixed-indexed annuity to be very appealing.
American Annuity Advocates wants to provide clear information on annuities, and lend you perspective, in an effort to help you figure out which investments or savings vehicles are right for you. We would like to bring up one of the advertisements by a well known insurance company, which cites the five years prior and or the five years immediately following retirement. The company refers to these crucial years as the "retirement red zone®". The advertisement and the accompanying brochures promote a variable annuity with a rider to provide what appears to be a guaranteed 5% income or a 5% withdrawal benefit, providing retirees with needed income, and protection against market losses.
The point is, various variable annuity companies will make you a similar promise, "that if you invest with this particular company, in a market sensitive variable annuity, you will at least receive all of your money back". That is what the 5% guaranteed income/ withdrawal benefit boils down to, because even if your account value goes down, you will, or you may, get all of your principal back over time. It is not as complicated as it appears. Take 100% of your premium, make a promise to pay 5%, and simply pay it out over 20 years, It is easy to see that 5% divided into 100% of your premium, goes 20 times, or in this case, 20 years.
As you can see, if a variable annuity makes such a promise to you, the variable annuity company is simply giving you back your original premium over 20 years, and in that case it would be without interest. Another company may again, offer to pay this amount over your life, even if you live beyond 20 years, so you may receive, in total, more than you deposited.
However, one should consider the present value / future value of your original principal. In other words, consider the amount of interest you could be earning on your money if you were to have placed your original principal in a safe, interest bearing, fixed or fixed-indexed annuity, without the risk, and without all of the costs of the variable annuity. I hope we have enabled you to better understand the guarantees, or the promises, of the market sensitive variable annuity.
Again, we are talking about a variable annuity, a market sensitive investment product, which is simply a portfolio of mutual funds wrapped in an insurance contract with riders which have costly fees. These riders are charged every year regardless of whether or not the mutual fund has a positive or negative return. Take the time to consider the following scenario which promotes these variable annuities with a "5% guaranteed income/withdrawal benefit".
In an attempt to promote the variable annuity, the company asks that you consider the following dilemma; "If your portfolio were to suffer two years of negative performance, -19 percent and -15 percent, respectively during the five-year period prior to retirement, it would take an unrealistic 45 percent return the following year to fully recover".
To illustrate the previous dilemma, if you begin with $100,000 in your retirement account and suffer a loss of -19%, you are left with $81,000. The following year you suffer an additional loss of -15% and you are left with $68,850. What return would you need the next year, year #3, to have an account value that once again equals $100,000? The answer is 45.24 % ($68,850 x 45.24%=$100,000), which is very unlikely.
The insurance company wants you to ask yourself a question: Could you afford to be in a position, where you invest $100,000 which you have earmarked for retirement, and find yourself with only $68,850, just two years later? The company tells you outright, in the advertisement, "it would take a very unlikely 45% return in the following year to fully recover your principal. The conclusion the company wants the consumer to come to, is that you will not be able to recover, and therefore, the 5% guaranteed withdrawal benefit the company offers you is a good solution to your market fears. The point the company makes is: Wouldn't it be nice to know, that you have $5,000 coming to you each and every year, for 20 years or for life depending on your age, regardless of the markets performance? The point that American Annuity Advocates will make is that when all is said and done, there may be better retirement savings options available for you, and you don't necessarily need to place your savings in a variable annuity, nor perhaps should you.
American Annuity Advocates points to the fact that a 5% guaranteed income or withdrawal benefit, as noted previously, is simply a return of your principal over time, and it may not be a good deal. Companies who promote these products simultaneously point to the upside potential of the stock market, and also to the fear of market losses, as a reason for the consumer to purchase a variable annuity, and to take with it the costly guaranteed income or withdrawal benefit rider. If you agree to purchase the rider, providing you with 5% of your original premium annually, as income, guaranteed, it will cost you. This rider may bring your total disclosed costs to approximately 3% of your account value, each and every year, regardless of whether or not the fund made money that year. One should think about the effect of a 3% annual cost on one's nest egg.
After the previous example in which $100,000 is reduced to just $68,500 two years later, the stock market or market sensitive investments, seems a little more like gambling. The 5% guaranteed income withdrawal benefit may end up doing nothing more than costing you money, and prevent you from growing your savings. All you get back is your original principal, and you have to take that over 20 years.
We all agree in principal that preventing market losses is important, especially when your income producing years are behind you and you cannot afford to lose too much. Sure, you could get lucky, after two down years of -19%, and -15%, the market could produce a positive 45% return the next year, and you would be made whole again. The problem is, you're not really made whole yet, not if you consider what would have taken place, if you had placed your savings in a fixed annuity, earning 5% on a guaranteed basis.
If you would have placed your savings, say $100,000 at 5% for 3 years, you would then have $115,762. By contrast, if you had $68,500 after 2 years in a market sensitive investment, you would need a net return, (after all costs), in the market sensitive investment of 69% to equal the $115,762 that you could have had all along, with a 5% guaranteed fixed annuity. You also would have slept a lot better, never worrying about the ups and downs of the stock market.
In an effort to help give you clarity, when comparing the advantages and the disadvantages of both the market sensitive variable annuity and the fixed or fixed-indexed annuity, using the returns utilized by the company previously mentioned, we encourage you to take a look at the following six charts to help you see the big picture, and come to your own conclusions. Since the insurance company advertising their market sensitive variable annuity chose not to place any fees into the illustrations, we showed you the hypothetical returns both with and without fees. The hypothetical rates of return used were taken from the insurance company's brochure, and they were attempting to illustrate both early negative returns and the effect such negative returns would have on your investment, as well as the reverse, that is, how negative returns toward the end of your investment would affect your account value. The problem is, the insurance company advertising their product never introduced fees into the illustrations, and when fees are considered, you get a much clearer picture of what you may expect. The costs are simply prohibitive to growth. The introduction of a fixed or fixed-indexed annuity looks to be a smart alternative.
American Annuity Advocates wants you have a clear picture of what market sensitive variable annuities actually offer, and what they do not. Take the time to review the following charts. Again, these are market sensitive variable annuities, providing a guaranteed withdrawal benefit of 5% of your original premium, for 20 years if age 69 or younger, and for life if age 70 or older. Keep in mind that American Annuity Advocates is a proponent of traditional fixed annuities, single premium immediate, (sometimes referred to as income annuities) and fixed-indexed annuities.
A) This is what a hypothetical market sensitive investment, using an initial deposit of $250,000, with negative returns in early years, showing a 5% ($12,500) guaranteed annual income benefit and no fees taken out, looks like over time.
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B) Below is a hypothetical market sensitive investment, using an initial deposit of $250,000, with negative returns in early years, showing a 5% ($12,500) annual withdrawal for 20 years, with 3% in fees taken out. The 3% in fees, total $47,399. In reality, this chart is what you are likely to encounter if you choose a 5% guaranteed income or withdrawal benefit rider, and encounter the early negative returns depicted in the illustration. In reality, all market sensitive investments, with riders to return your original premium, have fees. These costs make it difficult to actually make money in the market, but the variable annuity does, in fact, return your original premium to you. It takes 20 years if you're 69 or younger; if you're 70 or older, the 5% is usually paid out for as long as you live, which may or may not be 20 years. We do not think this is necessarily a good deal for everyone. Consider that at age 82, the age at which the guaranteed withdrawal benefit is contractually over, the account value is "0"; the consumer will have run out of money.
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C) A hypothetical fixed-indexed annuity, providing a 5% ($12,500) withdrawal annually, with no costs or fees that apply, the 5% withdrawal is simply available via a 10% free withdrawal feature. Notice the blue arrows, indicating a "0" return when the S&P 500 has a negative return, preventing you from participating in stock market losses, and protecting your savings. A zero return is a good thing when the market goes down, especially when everyone invested in the stock market experiences not only the negative return, but additional fees or other costs on top of that. When the market goes down 10%, and the fee involved is 3%, one would be down 13%. This reinforces the safety associated with fixed-indexed annuities. The green arrows indicate a positive index return, and the upside potential of the fixed-indexed annuity. Notice that with the fixed-indexed annuity, at age 91 you have $339,000, whereby the variable annuity, at age 82, the guarantee of 5% income is contractually over and the consumer is out of money.
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D) This is what a hypothetical market sensitive investment, using an initial deposit of $250,000, with negative returns in later years, showing a 5% ($12,500) guaranteed annual income benefit and 3% in fees taken out, looks like over time. The fees total $346,063, and the insurance company that advertises this product chose to incorporate only 5 years of negative returns over a 30 year period, a very unlikely number of negative years. At the end of the illustration, it is assumed the owner of the market sensitive variable annuity has passed away at age 91 with $298,431 left in the account.
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E) A hypothetical fixed-indexed annuity, providing a 5% ($12,500) withdrawal annually, with negative returns in later years, with no cost or fees that apply, the 5% withdrawal is simply available via a 10% free withdrawal feature. Notice the blue arrows, indicating a "0" return when the S&P 500 has a negative return, preventing you from participating in stock market losses, and protecting your savings. A zero return is a good thing when the market goes down, especially when everyone invested in the stock market experiences not only the negative return, but additional fees or other costs on top of that. When the market goes down 10%, and the fee involved is 3%, one would be down 13%. This reinforces the safety associated with fixed-indexed annuities. The green arrows indicate a positive index return, and the upside potential of the fixed-indexed annuity. Notice that with the fixed-indexed annuity, at age 91 you have $554,627, whereby the variable annuity, at age 91 the consumer has only $298,431 left in the account, which is still $256,196 less than the fixed-indexed annuity. The fixed-indexed annuity wins.
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F) A hypothetical guaranteed fixed annuity maintaining principal while providing a 5% ($12,500) withdrawal annually. Keep it simple, live off the 5% interest and maintain your principal. Keep in mind, that if you need more money, you can take up to 10% of your account value each and every year. At age 91 you still have your original premium of $250,000.
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We hope we have been able to give you more clarity regarding your retirement savings options. We hope you are able to see the true advantages offered by fixed and fixed indexed annuities.
When examining chart B, the hypothetical variable annuity, with a 5% guaranteed withdrawal benefit, ask yourself a couple of questions. Do you like the rates of return of the hypothetical variable annuity, with a 5% guaranteed withdrawal benefit? Do you like the costs, the fees of the market sensitive investment, which over time add up to a lot of money? In this case the consumer paid $47,399 in fees.
Again, promises, promises! Chart B promises you can withdrawal 5% of your money, and it will last you 20 years, taking you from age 62 to age 82. Remember that 100% of your money divided by 5%, taken over 20 years, is nothing more than your savings, given back to you at 0% interest. Since at age 82 the guaranteed withdrawal benefit is contractually over, at age 83, the consumer is literally out of money. Did the hypothetical variable annuity provide a good deal to the consumer? In this instance, absolutely not. The fixed-indexed annuity in this example, shows a winning account value of $269,105 at age 82 in the fixed-indexed annuity.
Even when we compare the market sensitive variable annuity with negative returns later, at the end of the consumer's life, the fixed indexed annuity still leaves you with more money. Even though these are hypothetical numbers which we took from a brochure of a very well known insurance company, and no one really knows what the future returns of the market will be, we believe we have provided the consumer with information, and clear pictures, which the market place may have never shared with them.
Consider the fixed or fixed indexed annuity;
Do you like the guaranteed rates of return?
Do you like the safety?
Do you like the liquidity advantages?
Do you like the fact that there are no costs and no fees associated with fixed annuities?
Do you like the fact that fixed indexed annuities allow you to participate in only the upside of the market, but never the downside, thus exposing you to zero market risk? The fixed-indexed annuity will allow you to sleep better at night, because regardless of what happens in the stock market, your retirement savings are safe, and your annual gains are locked-in.
In retirement, there is a natural bias towards savings products. As we approach retirement or are in retirement, we cannot afford to lose any of our money. American Annuity Advocates believes retirement minded individuals, who cannot afford to lose any of their money, should gravitate towards growth only when accompanied with safety, and protection. Fixed and fixed-indexed annuities provide the safety, liquidity and the advantage of tax-deferred growth to help make your money last as long as you do!
American Annuity Advocates hopes the information we provide, lends a common sense approach to retirement planning. Variable annuities, consisting of mutual funds, wrapped up by an insurance contract, have fees, costs, loads, charges, etc... Many industry consultants believe these costs to be exorbitant. Retirees may find it extremely difficult to get ahead, and safeguard retirement savings, when utilizing such costly investment products. If you would like to learn more,
click here for a better understanding of all the cost associated with mutual funds, taken from Testimony on Mutual Funds before Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises Committee on Financial Services United States House of Representatives March 12, 2003
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