When we are young we are much higher risk takers. We’ll take more risks when it comes to driving recklessly, eating unhealthy foods, and especially when it comes to investing.
As for investing a lot of people in their 30’s can watch the value of their portfolios and 401(k) drop by 30% and not bat an eye.
At that age they know two things:
- I’ve got at least two decades to go before retirement, I can ride out the market downturns.
- I’m earning an income that covers my expenses. And I’ll be getting that income for at least two more decades. My investment portfolio does not support my lifestyle at this point.
The story changes a bit as an investor enters their 40’s. They know they have plenty more work years ahead of them to build up their portfolio. But they can also see what will soon be approaching: retirement.
Sure it may be over 10 years away, but 10 years can go by really fast.
Then as an investor enters their 50’s they can definitely see retirement approaching. They begin to wonder,
“What would happen to my retirement plans if my 401(k) had another big hit like I took back in 2008?”
They start thinking about whether or not taking on the extra risk to grow retirement assets is worth it. After all, if their portfolio sustains some losses, it may mean delaying retirement beyond their original date.
Looking For Safe Places To Invest Money For Retirement
As you approach retirement you can plan on having less of a desire to take risk in your portfolio. You’ll start to think about how dependent your retirement security is on preserving your savings.
And the truth is… Your retirement security is very dependent on preserving your savings.
Why? Because when you retire and your income goes away, most people will have the following retirement income sources:
- Social Security
- Pension (if you are fortunate)
You may receive some interest income from your portfolio. But in today’s interest rate environment it can be tough because rates are low.
You may also be willing to generate some income from other sources, such as rental properties. But the fact is, most people would not want to stomach the idea of being a landlord and hoping they get their rent check paid each month.
That leaves us with the first 3 sources of income for most Americans.
Since Social Security (and a pension if you have one) is usually not enough to cover your monthly expenses other sources of income must be used to make ends meet.
This means looking at your investment portfolio. Your portfolio must serve a dual purpose:
- It must cover your income needs that Social Security and a pension do not cover.
- And your savings must grow to help you keep up with inflation throughout retirement.
Let’s talk about the second bullet point above: growing your investments to keep up with inflation. Specifically, let’s talk about how variable annuities can be used to grow your investments in retirement.
*Be sure to read to the end! I will show you how you can get a FREE annuity stress test report that will show you all the fees you are paying on your variable annuity (or will pay on the variable annuity you are considering buying). I’ll also show you how this can affect your earnings over the next 10 years.
Variable Annuities – Are They A Safe Way To Grow Assets In Retirement?
As you approach retirement you will realize that you have to do something with your 401(k). And you will very likely talk to a financial advisor about what to do.
In all likelihood your financial advisor will recommend an annuity for some portion of your portfolio. Count on it.
That’s because annuities are primarily designed for retirees. They are effective retirement products in many cases. The tricky part is figuring out if an annuity is right for you. And if so, which type will serve you best. Is it a safe place to invest your money for retirement?
So here is how variable annuities work. And you can decide if they are an effective way to safely grow your assets in retirement.
The Variable Annuity
The most popular annuity is the variable annuity. Is it a safe place to invest money for retirement?
Here’s how variable annuities work:
Step 1: You pay a premium (that’s like your deposit) to an insurance company.
Step 2: The insurance company takes your funds and invests the money in sub-accounts (those are like mutual funds inside the variable annuity).
Step 3: The funds can go up or down depending on how the market performs.
Step 4: The insurance company can give you some protections, such as a death benefit of at least your original deposit. So if the sub-accounts perform poorly and your variable annuity value goes down, at least you know that if you died your beneficiary would get your original deposit.
How Variable Annuities Are Usually Sold
The standard sales pitch for most variable annuities is this:
“Mr. and Mrs. Retiree, your money is invested in the market. So you have all this upside potential. And you know what? Even if the market goes down, we’ll at least guarantee that your original deposit will be paid to your beneficiaries if you die. So you know you can’t lose your original deposit.”
This is all true. And that’s what makes variable annuities appear to be a safe place to invest money for retirement.
But there are a couple of downsides to variable annuities.
The first is the fees.
You have to pay the insurance company for the protection of the death benefit. They charge a Mortality & Expense fee (M&E), and it can usually be about 1.15% of your account value. I have seen it higher at 1.5% as well.
So let’s say you originally deposited $100,000 into your variable annuity. If its value falls to $95,000 you would know that if you died your beneficiary would receive your original deposit of $100,000.
But you had to pay 1.15% for that privilege. In other words, 1.15% of $95,000 is $1,092.
That’s what you would pay for the death benefit of $5,000 (that’s the difference between the original deposit of $100,000 and the value it had decreased to of $95,000).
That’s a lot of money to pay for $5,000 in life insurance.
And on the flip side, if the value of your variable annuity goes up to say $105,000, you are still paying the 1.15% for the death benefit.
If you died, your beneficiary would get the entire $105,000 since that’s what your new account balance is anyway.
In other words, you’d still be paying the 1.15% but your beneficiaries would not receive anything in addition to your account value, since your account value has risen above your original deposit.
There are other fees as well, such as Administrative fees (usually about 0.15%), Income rider fees (usually around 1%) and death benefit step-up rider fees (can be around 0.8%).
The riders are optional. So you can limit your fees in a variable annuity by not attaching riders.
I have seen some variable annuities whose fees exceeded 3% each year. You may have your money invested in the market with variable annuities, but that level of fees will put a big drag on your earnings potential.
The second downside to variable annuities is lack of protection while you are alive.
While it is good to have some downside protection on the death benefit, you have to keep in mind that the downside protection only benefits your beneficiaries if you die.
But a retiree needs protection while they are alive. A retiree’s lifestyle is dependent on their portfolio to supplement their Social Security and pension income. And they need some type of protection while they are alive.
Sure, it’s great to have that death benefit on a variable annuity. But remember:
- You have to pay for it (even when your account value exceeds the original deposit), and
- You need protection while you are alive, so your portfolio can be there to supplement your income.
The third downside to variable annuities is surrender charges
The way most variable annuities work is that you must commit your money to them for a set period of time. A very popular time duration for many variable annuities is 7 years.
You have to keep your funds inside it for 7 years or you will pay a surrender charge. A typical surrender charge may start out as 7% in the first year and decline by 1% each year until it goes away at the end of year 7.
Surrender charges aren’t necessarily bad. You just need to know what you are committing to before you do so.
And what typically happens when the surrender charge goes away is that the financial advisor (the one who originally sold you the variable annuity) will recommend that you get a new variable annuity. And thus starts the surrender charge period again.
And it’s easy for a financial advisor to recommend you get another variable annuity after your first variable annuity is past its surrender charge period. It goes like this:
“Mr. and Mrs. Retiree, when you bought this variable annuity from me 7 years ago, you put in $100,000. And we had that original amount protected as a death benefit. But now your variable annuity has grown to $140,000. And wouldn’t it just make sense to get this new variable annuity contract so you can boost your death benefit up to the new amount of $140,000? I mean, you’re still paying about 1.15% each year for the $100,000 death benefit. Why not keep paying that exact same amount but have your death benefit increased to $140,000?”
And that’s how it goes. So you get another surrender charge period of 7 years.
*FYI: There are variable annuities that have no surrender charges. They are no-load variable annuities. They are used most effectively for non-qualified (meaning non-IRA) funds, and allow you to have tax deferral on your non-qualified earnings. Since they don’t pay a big salesman commission up front they don’t have surrender charges. You can move your money out of them with no surrender charges at any time. These are the only type of variable annuities I provide my clients.
Let’s Now Look At The Positives Of Variable Annuities
I’ve mentioned that variable annuities can have high fees. I have seen these fees exceed 3% in some cases.
But you can limit the level of fees you pay in a variable annuity by not attaching riders to them. The most popular rider is called the income rider. And another popular type of rider is a death benefit step-up rider. It allows your death benefit to increase beyond your original deposit.
These riders can be expensive. And if you want to save money on fees, just simply don’t include them in your contract.
Also, consider that all fees are not necessarily a bad thing. If you have studied the variable annuity brochure and you understand how the income rider works and the benefits it provides to you, you may determine that it is worth paying for.
Your next step would be to see if you are getting the best deal. In other words, you may determine that the income rider fee is worth paying for because if gives you important guarantees on income in the future. You would then want to see if you can get better income guarantees at a lower price with a different product, whether that be a different variable annuity or a fixed annuity.
Also, you may find the death benefit to be an attractive benefit that you are willing to pay for. Perhaps you want to invest some funds that you intend to leave to your heirs, and you want to make sure that they at least get your original deposit.
The death benefit could be what you want. If the account value drops below the original deposit at least you know your beneficiaries will get the original deposit. And if you had no intention of spending these funds on yourself during your life, then it won’t bother you so much.
Another positive benefit of variable annuities (and all annuities for that matter) is tax deferral. Your earnings grow tax deferred inside an annuity.
That means when it comes to variable annuities it usually makes sense to use them for your non-qualified (which is non-IRA) money.
Your earnings inside the variable annuity will grow tax deferred. Since your IRA already gives you tax deferral, you would get no additional tax deferral benefit from having it inside a variable annuity.
You would only put IRA money into a variable annuity if you really liked the other benefits it provides, such as the death benefit or income rider guarantees.
So Are Variable Annuities A Safe Way To Invest Money For Retirement?
Variable annuities have pros and cons. As far as protecting your original deposit for your beneficiaries (only after you die), they can give you some peace of mind.
Also, the income riders can give you peace of mind. They will give you some guarantees on the amount of income you can draw from the variable annuity for the rest of your life, regardless of how the annuity performs. If that is important to you, you may want to consider paying for an income rider.
As far as being a safe place to invest your money, remember that your account value can go down. That will all depend on which sub-accounts you choose to invest in inside the variable annuity.
You can make it safer by choosing sub-accounts (these are like mutual funds inside the variable annuity) that are more conservative in nature.
And while the death benefit will give your beneficiaries some protection if you die, it doesn’t give you protection while you are alive. If you are dependent on withdrawing funds from your variable annuity to supplement your expenses, then understand that your account value can go down.
The variable annuity has one foot in the insurance world and the other foot in the investing world. It gives some insurance protections like the death benefit and income guarantees. And it also gives growth potential on the investment side through its sub-accounts.
But the question you need to determine before you purchase one is if you want an all-in-one approach. When a product tries to do all things, it usually ends up not doing anything as best as it could.
It’s like a Swiss Army knife. It’s really cool to have those tiny scissors on the knife. But unless I’m out in the woods away from civilization, I’m going to use my regular pair of scissors.
If you like the insurance protection that a variable annuity provides (through the death benefit and income riders), then ask yourself if you could get those same (or better) benefits through another option like a fixed annuity.
If you like the investment potential that a variable annuity provides, then ask yourself if you can get better investment options elsewhere. You probably can.
Before you purchase a variable annuity, keep these issues in mind.
And also keep in mind that it is smart to have an annuity stress test done before you make a purchase. If you’d like to have an annuity stress done on an annuity that you are considering purchasing, then let me know and I’ll run a report for you.
In the stress test report you will see exactly what the fees are you would pay for your variable annuity, its riders and its sub-account. I’ll also show you exactly how these fees will affect your performance over a 10 year period.
This way you will know all of this before you purchase something with a 7 year surrender charge. Go in with eyes wide open I say.
To get this free annuity stress test, just CLICK HERE to get on my calendar for a 20 minute phone conversation so I can help you out.
And if you know someone that is approaching retirement that could benefit from this article then please forward it to them. We can reach more people with the message working together than I could ever do just on my own.
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