Jason and Bob discuss the pros and cons of annuities.


Below is the full transcript:


Announcer: Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. Now, here is your host, Jason Parker.

Jason: America! Welcome back to another round of Sound Retirement Radio. So glad to have you tuning in today. This is episode 109, and it’s my good fortune to have Mr. Bob Harksin on the program with me this morning. Mr. Bob!

Bob: Good morning, Jason! It’s a beautiful day today.

Jason: It is beautiful. Bob, the episode, episode 109. Today we’re going to be talking about annuities, the good, the bad, and the ugly. We’re seeing a lot more money flow into annuities these days because they produce a guaranteed cash flow, and in some cases, we’ve seen annuities producing cash flow anywhere from 5% to 7% on the immediate side, and that’s a lifetime guarantee, and that looks pretty attractive for some people in this low-interest-rate environment. Now, when I talk about 5% to 7%, I want to clarify that because I think that can, sometimes, people be misled with understanding … We’re talking about the amount of income that’s being generated from a pool of money. It’s not a rate of return like you would get on a bank CD or something like that.

Bob: Exactly.

Jason: Yeah. It’s the amount of cash flow that’s being produced. But cash flow is important. This is one way you can do it, and I want to start the morning right, and I think there’s two ways we can do this. The first is with a verse, and we want to renew our mind, and so I’ve got one here for us. This comes to us from Proverbs 19, verse 20. “Listen to advice and accept discipline, and at the end, you will be counted among the wise.” That’s awesome, Bob. I don’t know about you. I like listening to advice, but accepting the discipline, that’s …

Bob: Eh.

Jason: Can we just take the advice without the discipline? You know?

Bob: Sometimes they go hand in hand, so … That’s how we learn!

Jason: Bob, I understand that you took it upon yourself … You’re so tired of my bad jokes that you found one yourself and you’re going to share it with us this morning.

Bob: Well, it is, and it’s one that a friend had told me a while back, but … This 95-year-old man goes into his doctor for a routine physical, and the doctor checks him out. At the end of the appointment, he says, “You know, you’re in great shape, so on your way out, why don’t you set an appointment for a year from now for your next physical?” He goes, “A year from now? I don’t even buy green bananas.” Ba-dum-ch!

Jason: “A year from now? I don’t even buy green bananas.” Oh gosh, Bob. I’m glad I’m not the only one with bad jokes.

Bob: Well, I’m working hard to keep up your standard.

Jason: But at least when I lay a goose egg, you at least laugh along with me. I just sit here and look at you, like, “What are you talking about?”

Bob: Maybe it’s because you didn’t get it right away. It was one of those intricate jokes, so it took some thinking.

Jason: Let’s talk about annuities, Bob. Episode 109. Now, I want to let our listeners know; we’ve been doing a series of webinars this year. We just did one on retirement planning, and Heather, my operations officer, reminded me, because we were going to do another one on retirement planning. Then she said, “Jason, you said you were going to do one on annuities in October,” so I have to backpedal a little bit and change our focus for the retirement webinar that we’re going to be doing in October. It’s going to annuities. The title is “The Good, the Bad, and the Ugly,” just like this show today, and that’s really what I want to talk about. Bob, let’s start out with big picture: what is an annuity?

Bob: An annuity is a form of an investment, and it can be couple ways. One is a deferred annuity. A deferred annuity is where you put money in a regular basis or in a lump sum, and at a future time you turn it into a stream of income, and in that class, there’s ones that are based upon market values. You invest, like, in the stock market and what we call sub-accounts like mutual funds, and other ones will be fixed annuities that pay a fixed rate of interest or are based upon some sort of an index with some guarantees on both sides. It’s a pretty broad term. Now, there’s also what’s called …

Jason: Can you make that any more confusing, Bob?

Bob: I’m trying.

Jason: Can we just take a little bit of mud and …

Bob: I think the point is there’s a great diversity in annuities, and there’s the kind that you put money in and you hold over time, and then you turn into income later, and there’s some that you take a lump sum and it turns into an immediate income, like you mentioned earlier.

Jason: Is it possible to have an annuity and not take income from it?

Bob: Absolutely. One of the things is that annuity defers your taxes on the growth inside if it’s not inside of a retirement account.

Jason: So they’re tax deferred.

Bob: They’re tax deferred and …

Jason: And they can be used like a savings vehicle …

Bob: Absolutely.

Jason: If people don’t want income, they can just let the money grow in that account, and then at the end of the term, if they haven’t used it for income, then they can just take it as a lump sum.

Bob: Lump sum. They can take it as as stream of income over time, a lifetime, all kinds of different options.

Jason: So, I think one of the challenges … And that’s one of the reasons we’re going to be doing the webinar on this is because there’s so many … When you use the term “annuity”, you’ve got immediate annuities, deferred income annuities, fixed annuities, fixed indexed annuities, variable annuities, a lot of these different varieties all under that one term, and sometimes what happens is people take all of these different contracts, because an annuity’s contract driven. It’s something that’s issued by an insurance company, and I think that’s an important point that we need to make sure people understand, but they take ’em all, and lump them together, and they say, “I hate annuities, and you should too,” without really looking at the terms of the different contracts that are being presented and what the purpose of them are. Let’s transition out of what is an annuity to why do you find that people are using annuities today?

Bob: Well, I think folks want to have some sense of a guaranteed income at a future point in time, so they might use it partially to defer the income till later, and then take it at a later date when their tax bracket might be a little bit lower. Or a lot of annuities come with guarantees, minimum guarantees of income at a future date, so they want to be able to plan and say, “I know that I’ll have this much income at this point in time, but it might be better depending on the type of annuity.” They also might say, “Look, I’m looking at the CDs,” which you affectionately call Certificates of Disappointment, and say, “I’ve got this lump sum, and they’re only paying a quarter of a percent.” Well, sometimes a fixed deferred annuity can outperform a CD as a savings vehicle.

Jason: If you’re looking for safety and you’re looking for something that’s going to just have no market risk associated with it, something like a fixed deferred annuity might be something that somebody wants to look at as an alternative to something like a bank CD. Obviously doesn’t have the same type of guarantees that a CD does with FDIC insurance and those types of things, but …

Bob: Absolutely.

Jason: Something that could be considered. What about the interest-rate environment, Bob? In this really ultra-low-interest-rate environment, which is, boy, I have to tell you, I mean, we hear the Federal Reserve coming out, and we get this mixed story, “Hey.” It seems like they’re getting a little bit more bullish on interest rates. Maybe we’re going to see another interest rate increase, but then at the same time, we hear that housing is softening and that … The Fed, you would think if the economy is as strong as everybody wants us to believe that it is, that we would have seen some more interest rate increases. Now they’re talking about kicking it down the road till December. Is this a good time? And from an interest rate perspective, is it a good time to purchase an annuity?

Bob: Well, it depends on what your alternatives are. If you have a need for some sort of a guaranteed or a better interest rate than you can get at a bank, a fixed annuity would be a great alternative. I think it’s also if you’re looking for something that might participate in some of the market upside but none of the downside, an indexed annuity might be a good place. It also, I think, can become a great place, possibly, as a substitute, for a bond fund, because bonds are way overpriced and we can see significant drop in … If you have a mutual fund bond fund, you could see a significant drop. They’re at risk too, because bonds are all-time highs right now, so it can be a nice substitute for some of the fixed income portions of a portfolio.

Jason: At the same time, you wonder if this low interest rate environment is the news normal. We can look at Japan and say, “Boy, they have been fighting this battle with deflation for a long time now,” and they are leading the charge on all of this quantitative easing, and pegging their ten year bonds at 0%. They’re doing some pretty radical things over there to try to stimulate some growth, and it’s just doesn’t seem to be catching on the way that they’d like it to and it seems like they’re always have to pull more arrows out of their quiver. Is it possible that American could be moving in that same direction, that we could be stuck in this ultra interest rate environment, and if we are stuck in this low interest rate environment, how does something like an annuity stack up today? Maybe the questions becomes how do you structure the annuities to take advantage of the interest rate environment today, but then also be prepared for higher rates in the future?

Bob: Well, I think you structure it based upon the type of contract you choose to get. If you choose a fixed annuity with a fixed interest rate, it is what it is. You’re going to get what it is whether it’s a five-year or seven-year term, whatever. I think the other option is if you used an indexed annuity that can participate in some of the market upside, but have no downside, then over time, you would probably do better than a savings account or even a fixed annuity. There’s no guarantee but it’s a way to participate and see an increase in the value that annuity that would outpace other savings vehicles.

Jason: You’re talking about money that you’re not using for income. You’re just talking about a contract that’s deferred, that’s growing, that has the ability to earn interest, and then you decide when you take the interest out of the account, basically.

Bob: Right, and as you talk about often is we want to diversify over time, so we would have our money in buckets, and we want some of it many later on in life at a higher risk, but some of it where we’re going to have is going to be safe, but we know there’s going to be some growth to it, and that becomes part of the nearer term income, but not maybe necessarily what we’re going to take right now.

Jason: Getting back to this idea that we always come back to. Retirement’s all about cash flow. It’s your income that will determine your lifestyle in retirement, not necessarily your net worth. There’s a lot of different tools today that can help people produce income from a portfolio. You can use a total return approach where you just say, “Hey, I’m going to take 3% or 4% out per year. You can use dividend pay in stocks, and live off the income. You can use basket of bonds and life off the interest that’s being generated by those bonds. You could buy some of these alternatives like real estate investment trust or master limited partnerships or preferred stocks or utilities companies that pay pretty high dividends, so there’s a lot of different way to generate income, and annuity is one tool that you can use to produce cash flow, and like you just said a minute ago, time is the cure to the [inaudible 00:11:34] the stock market.

 Whatever tool you’re going to use, from a planning perspective, that’s not as important, but as we look at that spectrum from safe versus risk, something like an immediate annuity or a deferred fixed annuity is going to be really pushing the safe side of that income equation. You’re not taking a lot of risk with something like a fixed annuity or a single premium immediate annuity. Those are usually guaranteed. You always want to know the financial strength of the insurance company that you’re working with, but getting it back to this idea of time, you stack, so if we’re concerned the interest rates are going to go up in the future, maybe what we do is we create income from an annuity for five years, and then say, “Hey, the next pot of money that we’re going to need five years from now …” We’re not annuitizing all the money at once, so that if we are in a rising interest rate environment and we have the ability to take advantage of those higher interest rates in the future, and again, a lot of different ways to generate income from a portfolio.

 I think the reason annuities are in the headline so much these days is because we have 10,000 baby boomers retiring every single day. You’re hardly getting compensated anything at a bank for your certificates of deposit. You can’t just buy municipal bonds and live off tax-free income. Treasury bonds are paying barely 2%, and so people are hungry for the cash flow because they’re ready to transition into retirement, and they need to live off of that portfolio and you can still get somewhat of decent income stream off of your assets by … The other thing I think that makes annuities attractive is that if you choose one of these lifetime annuity contracts, then you have the mortality credits that come into play. Well, Bob, what does it mean? If you a lifetime annuity, what does that mean for our listeners?

Bob: Well, I think a lifetime annuity would function very much like a pension.

Jason: What is it guaranteeing them though?

Bob: Well, it’s guaranteeing them an income for life, regardless of how long you live. Now, on the downside is if you don’t live a long life, then it may not have been the best decision that you did, but the key is that you don’t outlive your money.

Jason: That’s what people are attracted to.

Bob: Exactly, so …

Jason: They say, “Hey, I can get a 5%, 7% cash flow of guaranteed pension and I could live to 110 years old. It doesn’t matter. That company’s going to pay me my income every month, regardless of how long I live and so it helps alleviate that concern of running out of money in retirement, and that’s what mortality credits are, right?

Bob: Exactly, and the older you are, the higher the payout, so as you get later on in life, and you say, “I need to have some of my income guaranteed, and I don’t want to run the risk of the stock market going up and down, or running out of money, then I can take some of that money and say, ‘I know I will get this money for the rest of my life.'”

Jason: You can even, in some instances, have those annuities underwritten, so if you are in poor health, and you’re older, not only do you get a higher payout because you’re older, but you can also get a higher payout because of your poor health.

Bob: Exactly.

Jason: That can help people generate even more income.

Bob: Getting back to the idea of a pension, if you’re an individual who works for the federal government, maybe you’re not married and you have a pension, it goes away when you pass away. At least with annuities, you can put a fixed guarantee on it that will pay out for at least certain amount of time, so if you have beneficiaries and you die young, it will pay out for a certain amount of time.

Jason: One thing I really want our listeners to understand here is that there’s a lot of different financial vehicles. Our job is not to be pro-annuity or anti-annuity. We’re not here to say we love annuities and we’re not here to say we hate annuities. Our job is to say, “Here’s a contract that can produce cash flow for people.” How does that work within the context of a retirement plan with all of the other pieces like social security, and the other investments, and other pensions and those things, and then is it really appropriate for their situation based on how comfortable they are with risk? It is not our job to love or hate these different tools. We serve intelligent people.

 Our job is to help educate them about how they work, what they do, and whether or not it’s appropriate for them, and I’m always cautious when we do shows about annuities, Bob, because there’s a lot of guys out there that are insurance licensed. They don’t operate as fiduciaries. They don’t operate the same way that we do, and the only tool that they have in their basket of financial vehicles to help people with is an annuity contract, and so they’re going to go out and they’re going to take this show that we’re doing and they’re going to say, “Listen, Jason Parker with Sound Retirement Radio and Bob Harkson, certified financial planner, they’re saying that annuities can be good,” which they can be, but that’s not the point. The point is every financial tool has to be evaluated on its own merits and, like anything, annuities, specifically, are contract-driven.

Bob: Well, I have a question for you. Let’s say you’re someone who purchased an annuity seven or eight years ago. How do you know what you have, and if it’s a good one or a bad one?

Jason: That’s a great question and annuities that were purchased seven or eight years ago, because what happened just recently was the mortality tables changed. See, every couple of years, the insurance companies get together with an organization that looks at life expectancy and because life expectancy has actually gotten longer, people are living about two years longer, the layout on newer annuities can be lower than the payout on those older annuities, so sometimes if people have one of these older annuities, it makes sense to hold on to, because they’re going to get compensated based on the old mortality tables, but other things, Bob, people were sold an annuity that didn’t need one, and one of the disadvantages … We should talk about why annuities can be such a hated financial tool, but some annuities out there can carry some really high fees, and some of them have some language and some terminology that people don’t really understand.

 They get sold on this idea that they’re being guaranteed a 7% return on their money, and that’s not what’s happening. These contracts can have these things called “income riders”, and the incomes riders may be helping an income account value grow, but that income account value’s not a true … It’s not a death benefit in most instances. There are some nuances there, so again, it comes back to the contracts, but I think the appropriate thing to do is to sit down with a financial advisor that has created a retirement plan for you. Look at those old annuities and say, “Do those older annuities serve a purpose in the context of my plan?” If they do, keep them, but if it was just something that was sold to you, because you went out for a chicken dinner somewhere and somebody sold you on the idea that you should own an annuity contract and it’s not appropriate for your situation, then I’d say you should dump it and do what’s right. You can’t make that decision without the plan. What are your thoughts?

Bob: Well, you and I have met with people where we look at some of these old annuities and they’re saying, “it hasn’t performed well,” and “I was told I could do better,” but then you look at the terms of the contract, and you say, “Yeah, but look at the guaranteed income you can have at this point or at this point in your life, so our recommendation might be you keep this one. Now, for us, as financial advisors, if you were doing it for our sake, we might want to move into something else, but that fiduciary doesn’t do that. A fiduciary looks at that, and says, “What’s in your best interest?” It might be in your best interest to keep it. It might be in your best interest to get rid of it. We do that based on objective information, based upon a retirement plan for your life.

Jason: If somebody comes along and says, “I hated annuities and an annuity’s never appropriate. It’s not the right thing for you, and you got to get rid of it,” even if it is the best thing for you. That, to me, says that that person is not really acting in your best interest. What they’re doing is they’re acting in the best interest of their company to say, “I want to take and I want to manage those investments for you, and to me, that’s very frustrating, because these are guys that claim to be acting in the best interest of people, claim to be operating in a fiduciary capacity, and a fiduciary means that if that contract that somebody owns is the best for their situation, you have to act in their best interest, which means you have to tell them to keep it. You don’t tell them that in every situation, you hate annuities, and you move annuities.

Bob: Absolutely.

Jason: It’s infuriating to me.

Bob: It is.

Jason: That’s bad advice. That is bad advice by people that go out and use strong language to get people to move money to their firm so that they can charge them a fee for managing the assets.

Bob: Particularly if they’re not looking at in context of where your other income’s from, what your lifetime retirement plan is. It’s inappropriate.

Jason: It is, so it just gets back to if you really want to do a good job, make a decision based on what’s the purpose of the money. What’s the purpose? Why’d you buy the annuity? How does it fit into the overall plan? There are times when those things really stink. They’re really bad.

Bob: Absolutely.

Jason: One of the reasons annuities generate probably more complaints, especially variable annuities, because those are the ones that they still have volatility associated with them. They have the market fluctuations. Usually if somebody’s buying an income annuity, an immediate annuity, they know exactly what they’re getting. They’re saying, “Hey, insurance company, I’m giving you this much money, and you’re guaranteeing me guaranteed income for life.” Nobody’s ever making complaints or very few people make complaints on those, because they understand exactly what it is they’re getting. Where they make complaints are on these more complex contracts that sound like one thing but then end up doing something different than what they originally thought.

 I want to remind our listeners: you’re listening to episode 109. You can go back and listen to all of these programs archives for your enjoyment at soundretirementplanning.com. I also want to encourage you. We’ve got a webinar coming up on the good, the bad and the ugly. How do you take these annuity contracts and pull them apart and just help understand whether or not they’re appropriate for you. That’s our next webinar. It’s going to be coming up in October, and so we want to encourage you to sign up for those. We’ll try to remember to record them, but occasionally we mess up and we forget to hit the record button, so by all means, make it to the live webinar. We’ll answer your questions. If you own an annuity and you have some questions about the contract that you purchased, bring those questions to that event. I think it would be a great place for us just to help maybe answer any general questions that people have.

Bob: Our goal is to help you make the best decision.

Jason: Now, Bob, why do you think people do hate annuities? What is it about them that they hate so much?

Bob: Well, a lot of times what they thought they understood is not what they were sold or they were clearly explained what it was, and then they forgot and then they look at it and then they read on the internet. Where we have to be really careful is when we pick up bits and pieces from the media, it’s very easy to form and opinion, so we’ve had clients come in and say, “I don’t want annuities. They have very high expenses.” Well, maybe some variable annuities do, but other annuities don’t have expenses, so be cautious of what you read on the internet, and what you hear are opinion of other people, and sit down and get the facts.

Jason: Well, I’d like you to back up there too, because you said some annuities don’t have expenses. There’s always some kind of cost, right?

Bob: Absolutely.

Jason: Insurance companies aren’t doing this for free. They’re in business to make a profit, so there’s some kind of cost, whether it’s a liquidity cost or a surrender charge schedule. There’s going to be something that says that the insurance companies are going to make some money off of that thing. They’re not in business to be charitable organizations. Well, with that, I just want to remind our listeners we’ve got this webinar coming up. Everything you ever wanted to know about annuities, we’re going to cover the pros and cons of annuities. We’re going to be uncovering annuity fees. How some people are using annuities in a retirement cash flow plan. Should you hate all annuities? We’re going to be covering how to avoid being sold an annuity. If you’re going to buy an annuity, go buy one, don’t be sold something that you don’t need. How to know the strength of the annuity company that you’re working with. Why some annuities can help have more retirement income with less risk, and just also understanding what the purpose of the annuity is. Bob, an annuity can be like a bad word for some people, and I get back to this idea that retirement should be done the way you want it done, and so one of the questions we always ask is are there any tools you don’t want to use? With that, we’re out of time, Bob. Until next week, Jason Parker signing out.

Bob: Bob Harkson signing out.

Jason: Thank you for being here.

Announcer: Information and opinions expressed here are believed to be accurate and complete. For general information only and should not be construed as specific facts, legal or financial advice for any individual, and does not constitute a solicitation for any securities or insurance products. Please consult with your financial professional before taking action on anything discussed in this program. Parker Financial, its representatives or its affiliates have no liability for investment decisions or other actions taken or made by you based on the information provided in this program. All insurance-related discussion are subject to the claims paying ability of the company. Investing involves risk. Jason Parker is the president of Parker Financial, and independent fee-based wealth management firm located at 9057 Washington Avenue Northwest, Silverdale Washington. For additional information, call 1-800-514-5046 or visit us online at soundretirementplanning.com