Episode Transcript
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Speaker 1 (00:00):
Good morning to all. Craig Shillig here and this is
Safe Money. I'm here every Saturday to talk with our
listeners about financial strategies we use to manage and protect
assets safely. I've been an insurance agent for over twenty
four years. During that time, I've learned a few insurance strategies,
like using annuities as safe money harbors, or using cash
(00:23):
value life insurance to supplement retirement income. Just a reminder,
you can call our office at five six three three
three two two two zero zero if you'd like to
enroll into one of my virtual Medicare community meetings. I
give those via Zoom every month, or you can enroll
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you can email me at Craig at Craigshillig dot com
and that's my first name, Craig Craig at cr A
S C H I L l ig dot com and
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I'd be happy to send you the Zoom meeting codes. Today,
I want to talk about fixed index annuities. Sometimes they're
referred to as fias. Now the word annuity gets a
bad wrap in some circles, but let me try to
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walk you through some of the benefits of an FIA
or a fixed index annuity and indextinuity is a contract
between you and an insurance company. You pay premiums in
a lump sum or periodically, whether it be monthly, quarterly,
semi annually, or annually, and the issuer promises to pay
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you some amount in the future. The index annuity issuer
also provides a minimum guaranteed interest rate on your premiums
that you've paid them. With an indextinuity, the interest earnings
are tied to performance of an equity index, such as
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the S and P five hundred or the Dow Jones
Industrial Average NASDAQ. It depends on the annuity company. Some
will only have a few choices, and some will have many.
Some will also let you get into more aggressive investing
if you're willing to pay a little bit of a fee.
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Your interest earnings may increase if the market performs well,
but if the market performs poorly, your principle is not
reduced by market losses. You have a guaranteed floor. Indextinuities
are generally subject to a lengthy surrender charge period. Most
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fias pay a guaranteed interest rate on the percentage of
the premium you've deposited. However, if the indextinuity doesn't earn
interest greater than the minimum. Cashing in the account prior
to the end of the surrender period may cause the
investor to lose money due to that surrender charge. Be
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aware that buyers of fias are not directly invested in
the index or the equities comprising of that index. The
index is merely the instrumental. It's the instrument used to
measure the gain or the loss in the market, and
that measurement is used to calculate the interest rate. Annuity
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guarantees are subject to the claims paying ability of that
annuity issuer. The first indextinuities that were in introduced worked
very simply. The interest rate was determined by computing the
difference between the value of the index to which the
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annuity was linked on the annuities issue date and the
value of the same index on the annuity maturity date.
If the difference was negative, ie. If the market went down,
the value of the index decreased, interest was calculated using
the minimum interest rate guaranteed in the contract. If the
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difference was positive, meaning the market performed well and the
value of the index increased, the interest rate was a
percentage of the difference, but usually not the entire difference.
The insurance companies on the hook for doing the investing
and those types of tasks, so they don't let you
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have all of it. There's normally a cap involved. Participation
rates determine how much the gain in an index will
be impacted by your annuity. The indexing method is the
approach used to measure the change in an index. Some
examples are point to point high water mark otherwise known
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as look back method, or the averaging method, reset or
ratcheting method, or a couple others. With some fixed index annuities,
no interest is credited until the end of that anniversary
urn which others excuse me. With others, a percent of
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the interest is vested or credited annually or periodically, which
gradually increases as the end of the term years. Further,
some pay simple interest, while others may pay a compound interest.
These features are important, not only because having interest vested
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or credited to your annuity periodically instead of at the
end of the term increases the likelihood that you'll receive
at least some interest in during market declines. Cautionary note,
though many finde fixed indextinuities have surrender charges, which can
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be a percent of the amount withdrawn or a reduction
in the interest rate. Further, withdrawals from tax deferred annuities
before age fifty nine and a half may be subject
to a ten percent withdraw a penalty. Some fixed indextinuities
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put in upper limit on the interest rate the annuity
will earn. Some will charge an asset fee also known
as a spread or sometimes referred to as a margin,
which is a percent that is deducted from the interest rate.
The asset fee may replace the participation rate, or it
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may be added to it, and again that goes back
to It depends on the company and the type of
annuity you're using. If the gain in the index is
seven percent interest rate on the fixed indextinuity with an
asset fee of two percent, that means your net would
be five percent. If there's a ninety percent participation rate,
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the interest rate would be four and a half percent.
Fixed indextinuities, just like a traditional fixed annuity, are insurance
products that provide downside protection from loss of principle with
a guarantee that the interest earned on the annuity contract
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can never go below zero. In a traditional fixed annuity.
The interest that the annuity can earn is locked in
for the set period defined by the product, and generally
in an annual increment. In a fixed indextinuity, the return
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or rate is determined based on an interest crediting formula
or a method established by the issuing insurance company that
is linked to the performance of a market index such
as the Dow one hundred, the S and P five hundred,
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or Nasdaq Russell two thousand, just to name a few.
A fixed indextinuity is a type of fixed annuity that
uses the performance of an index to determine the interest
that gets credited. A key characteristic that makes fixed annuities
attractive is they will not lose money based on market performance.
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Fixed index annuities is no different even though its interest
its interest is tied to an index. Because these annuities
promise they will never lose money. The tradeoff is that
the insurance companies must limit the upside potential you can
get from that annuity. The different ways of calculating interest
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based on the performance of the index are also known
as crediting strategies. Each crediting strategy has characteristics that affect
how much interest the company will be paying on that contract.
These and other variables influence what fits the goals of
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the annuity buyer. Common crediting strategies include cap participation rate, spread,
monthly average, and monthly sum. The crediting strategies can be
used on a variety of different indices. Some of the
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indices are common ones that most people are familiar with,
like the S and P five hundred, the Dow one hundred,
the Russell two thousand. Others may be less common and
may be designed to have consistent returns or lower variability.
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No matter what, I'll fix it next to the annuities
use a crediting strategy to determine what the interest will
be at the end of that crediting period. Let's discuss
some reasons why people don't buy annuities. Some people have
a belief that annuities are overpriced, risk aversion around inflation,
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concern about leaving a legacy, a belief that there is
a better way to ensure against longevity. A poll of
seven to ten Americans told Tia Kraft Survey they're receiving
a guaranteed monthly paycheck during retirement is important to them,
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but only thirteen percent of those reporting to the survey
said that they actually purchased an annuity contract. Why Americans
don't buy annuities They have a belief that annuities are overpriced, risk,
aversion around inflation, concern about leaving a legacy, a belief
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that there's a better way to ensure against longevity. In addition,
these four uncertainties play into the reluctance to purchase annuities.
The four uncertainties around the annuity decision are longevity uncertainty,
spending uncertainty, investment outcome uncertainty, and decision uncertainty. Let's talk
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about longevity uncertainty first. The question always is how long
will I live? If I were to ask you how
long you think you'll live, the chances are good that
it will be longer than if I ask you when
you think you're going to die. Nobody believes they're going
to die. They're just worried about how long will I live.
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There's a study that shows that there's about a ten
year difference between the age that people think they will
live to and the age that people think that will
be when they die. What age do you think you'll live? Too?
Many investors also experience extreme aversion to a negative return
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on their investment. So even if consumers do think like sorry,
So even if consumers do things like thinking about their
life expectancy, and even if they make a very accurate
assessment of their life expectancy, they may be deterred from
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purchasing an annuity by a tendency toward what we call
extreme risk aversion. This concept of loss aversion to the
prospect of potential losses has a much greater impact on
decision making than equivalent gains. The thought of losing one
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hundred dollars is worse to them than the thought of
foregoing a gain of one hundred bucks. So for many consumers,
the decision to purchase an annuity may boil down to
the question of whether one will really live long enough
to recoup their initial deposit, and consumers may view annuities
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as risky gambles because of loss aversion. A potential loss
if they die earlier than expected may have a greater
impact on consumers annuity purchased decisions than the possible gains
if they live longer than expected. Purchasing an annuity contract
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is security, protected life income or enhanced financial security. Let's
talk about spending uncertainty. People are not comfortable with predicting
what their future expenses will be, the tendency to sharply
discount the value of future consumption and the propensity of
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seeing a lump sum as being more adequate than an
equivalent and annuitized stream of income, Estimating their monthly expenses
in retirement, adjusting those expenses to inflation, and connecting the
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future benefit to life in retirement. Let's talk about investment
outcome uncertainty. Clients are unsure how theywood benefit from an
annuity as opposed to another retirement product. Behavioral research has
shown that people tend to be overly positive about outcomes,
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especially when it comes to themselves. Optimism is good, but
so is security. Clients need to understand the long term
market ups and downs, sequence of return risk, and managing
the risks of inflation, longevity, and market volatility while they're
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in their retirement years. A good example of the behavioral
research is this third and fourth quarter of twenty twenty
four did very well. Twenty twenty four was a great
year for the SMP and the deal, but we've had
some of these great years the last few years. Eventually,
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there's going to be a market correction. You don't want
to have a market correction when you're in retirement withdrawing income.
Annuities can provide you with a protected lifetime income to
help cover basic expenses needed in retirement. Allocating a portion
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of your assets to generate a reliable income can contribute
to retirement security. Now, sometimes I refer to these as
paychecks or playchecks, because that's essentially what they are. Paychecks,
your monthly check to cover your fixed expenses, or playchecks
if you have a hobby or a certain thing you
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like to do, and that way you know that that
item is covered and paid for. Let's talk about decision uncertainty.
Many view annuities as complex financial instruments. Choice overload also
impacts the ability to make an informed decision. This then
leads to inactivity. I can help you narrow the choices
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and give you a strategy that can help you achieve
your retirement goals. Annuities aren't complicated. Remember, people like what
annuities do. They provide guaranteed income, their security. They allow
you to sleep well at night knowing that your bills
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are being paid. Some questions to ask about a fixed indextinuity.
What is the minimum guaranteed interest rate in the contract?
What is the participation rate? What is the indexing method?
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How does it work? Is there an interest rate cap?
I'll answer that right now. Generally yes, there is, but
you want to know what that cap is. Is there
an asset fee, a spread, or a margin? Is it
in addition to or instead of their participation rate? All
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contracts are different, so for some yes, for some no.
It depends. What is the term in the contract. That's
very important depending on the type of annuity you purchase.
Some will only have three year surrender periods, but some
can go ten, twelve, fifteen, depending on the type of annuity.
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When is interest credited or vested to the account? Is
interest simple or compounded? What are the surrender charges? That's important,
especially on annuities that offer a bonus. If they offer
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you a thirty five or forty five percent upfront bonus
based on your principle otherwise known as your deposit, there's
going to be a surrender charge on there. They don't
do that for free. Are there any penalties for partial withdrawals?
And that's a big one. You need to establish what
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your withdrawal rate is or going to be because if
you take more than your withdrawal you're allowed to withdraw.
That then deviates principle and you don't want to do that.
I found a chart that compares fixed index annuities to
the s and P five hundred. The dates on this
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chart ran from from nineteen ninety eight to twenty twenty three.
This is a twenty four and a half year, twenty
four and a half year chart. They have a blue
line and a red line on them. Now I know
we're on radio here so you can't see this, but
just imagine this chart talked about a one hundred thousand
dollars investment going into a fixed indextinuity compared to the
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performance of the SMP five hundred. In one year. The
SMP grew from one hundred thousand in nineteen ninety eight
to one hundred ninety nine thousand, five hundred and thirty
by nineteen ninety nine. Okay, it made ninety nine grant.
I mean, that's that's I mean, that's a nice return.
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It the eight year marker. That eight years is the
time it took for the SMP to recover back from
one hundred nineteen thousand in two thousand and seven. That
it achieved in nineteen ninety nine, because in two thousand
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and seven it crashed. Fourteen years. That is the time
it took for the S and P five hundred to
grow above one hundred and nineteen thousand, five hundred and
thirty in twenty thirteen. Two years. This is the time
period it took for the S and P five hundred
to fall below the fixed index annuity value in two thousand.
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Nineteen years is the time it took for the S
and P five hundred to surpass the fixed index anuity
value in twenty seventeen. When is the best time to
take income from the SMP five hundred? Answer twenty seventeen
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and beyond. The point to that is the money you
put into the fixed index annuity and nineteen ninety nine
is guaranteed. It's there. It doesn't matter if the market
goes up or down. It's guaranteed. The S and P isn't.
When is the best time to take income from the
fixed annuity? The answer to that is any year you desire,
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as the market never takes from your account, ie, you
have a guaranteed floor. Annuities again are guaranteed. Remember, people
don't like annuities. They like what annuities do. They like
guaranteed income. So the blue line on this chart represents
a secure income and standard of living. The red line
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represents volatile income, which may lead to volatile to a
volatile standard of living ie headaches, sleepless nights. The red
line represents the best option for growing assets over time.
That's true if you're investing in the SMP. The market
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can go up, it can go down. When it goes up,
everybody's happy. When it goes down, nobody's happy. But the
blue line represents the best option for providing a secure
monthly income during your retirement years. We live in income,
not assets. That's a key distinction to keep in mind there.
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Going back on annuities, there's several different types of annuities,
so remember that fixed index annuities are different than deferred annuities.
Fixed annuities are different than fixed index annuities. Again, there
are annuities is a general definition. It depends what type
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of annuity you're looking at getting into based on your
overall goals retirement horizon. My illustration chart shows by June
of twenty twenty three, that redline shows three hundred and
sixty two thousand thirty three dollars versus the blue lines
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showing two hundred ninety six, two hundred and seventy one
of value. However, there's no risk. Under the blue line
is the difference of sixty five thousand, six hundred and
sixty two dollars worth all the headache and agony of
dealing with market volatility. Remember, annuities again have guarantees. They
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guarantee income. In a future show, I'll discuss some specific
annuity companies and some of the different annuity products, options
and bonuses that are out there that they offer today,
So stay tuned for that. Don't forget. I give monthly
virtual meetings regarding Medicare for two different companies every month.
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In one meeting, I cover Medicare supplement plans with a
standalone drug plan. That meeting sponsor by well Mark. United
Healthcare is a sponsor. For my other virtual meeting, I
focus on Medicare advantage plans known as Medicare Parts C,
and I cover the benefits of that platform. You can
call my office at five six three three three two
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two two zero zero for the zoom meeting codes and
additional dates and times. You're also welcome to email me
at Craig at Craigshillig dot com. And that's cr AIG
at cr AI G S C H I l l
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ig dot com. And I can send you the virtual
zoom link meeting codes. This is Craig Shillig with safe money.