Most retirees I meet are being sold annuities that promise 6 or 7% returns.
If your like most retirees, then you’re probably concerned with running out of money in retirement and might be considering them as an option.
I can’t blame you. Facing the idea of running out of money in retirement is down right stressful…
Have you ever heard the mantra, If it sounds too good to be true…it probably is?
While I understand the concern, I want to challenge these products a bit more.
In today’s post I’m going to show you THE CATCH, and explain why a 7% guarantee might only give you a return of less than 1.5% per year for the rest of your life.
Don’t get me wrong, at no point does the insurance company lie about what they are offering you. In fact, everything they print and sell is carefully reviewed by their lawyers and regulators to make sure it’s true.
How can they truthfully guarantee 7% and at the same time pay you far less?
The basic way they work is that they have a rider that gives you 7% for ten years. A rider defined – “is an add-on provision to a basic insurance policy that provides additional benefits to the policyholder at an additional cost.”
If you start with 100k, in 10 years, you have about 170k guaranteed in this “rider value”. This is the value they use to calculate your income in the future.
But that’s not the actual withdrawal account value!
With a fixed indexed annuity your money is only growing in positive market years with a limitation on how much it can actually earn. Many contracts in today’s environment are only able to earn about 3%.
So if the market goes up 15%, you only get 3%. That’s great for the insurance company right?
And if it’s a variable annuity tied to the market you have potential for growth, but the fee level on your account is so high, it won’t perform to the same level as less expensive investments.
Once you add up the M+E expense, the subaccount expense, the rider expense, the administrative charge, taxes, etc. You might end up with 3-4% or higher fees on your investments!
And to make it worse, the only way the rider value will increase after the 10 years is if your withdrawal account value catches up or goes higher.
So regardless if it’s a variable annuity or a fixed index annuity, with the fees and performance limitations, that ends up being very unlikely.
What we are really left with is the rider value most of the time.
And here’s where they get you…
You can’t actually walk away with 170k.
If you want to take your money out you have two choices, take it in little lumps or GIVE UP the guaranteed 7% and go with your actual investment results, minus all those fees.
There are often no guarantees on this calculation of your return and you could even lose money depending on your investment results.
You’re probably thinking, “I wasn’t going to spend this all at once so it doesn’t matter that I have to take it out in chunks. I certainly don’t want to give up that 7% guarantee!”
You’re right, you don’t want to spend your entire retirement at once, but what you probably don’t realize is what you earn after the first ten years with one of these riders, once you start spending your money. The answer is essentially zero.
Once you start taking an income off of that 170K, that amount, and fees, and expenses can eat into your actual account value and spend it down much faster than normal.
One common recommended withdrawal rate is about 4% if you don’t want to run out of money. The problem is that the amount they’re withdrawing can be 5, 8, 10% or more when compared to your actual account value.
So if you continue at that withdrawal rate, you’ll have guaranteed income for the rest of your life, but your real account value will most likely hit ZERO, very quickly.
And if your real account value isn’t growing, then your income will most likely never increase as well. Meaning every year after you start taking withdrawals your real cost of living will increase, but your income most likely will not.
To summarize, you get 7% for 10 years and then most likely 0 for the rest of your life. And, If you cancel the contract, you don’t get the 7% guarantee.
When it comes to spending your money, usually they will only let you take from 4 to 6% per year. They will, however, keep paying you for as long as you live.
Which sounds like a good deal.
But here is where it gets tricky.
If you were to withdraw 4% a year, your income can last 25 years. Because 100 divided by 4 is 25. Without any risk or market exposure, your income can last 25 years at 0% growth.
So if we think about your income growing at 7% for 10 years, and then never earning another dime.
In essence, you’re most likely getting ten years at 7 percent and then 25 years at 0 percent. If you live that long.
Turning 100,000 into $170,000 over the course of 35 years is only a 1.5% return.
Now, do you see that these annuities have a lot of hidden features and catches that make them less attractive?
Until next time,
Robin Dolezal, CFP®
PS: If you want to understand what it will take for you to retire with the income, freedom, and lifestyle you truly desire, then it’s time you went through a planning process designed to help you achieve your goals.
We work directly with you to make it happen, answer any of your questions, and even challenge you to think differently about your situation.