Hello everyone. This is Brent Chavez of Aequitas Equitas Investment Group. I’m coming to you from beautiful and historic Bedminster, PA. I just want to talk a little bit today about something that is very frustrating to me as an adviser, and has frustrated many investors and many people that have been in my office with these investments… and that is an income rider that is found on variable annuities and fixed indexed annuities.
They position these riders as if the individual is going to get a guaranteed return of six, seven, sometimes even eight percent. And the problem is that the average investor doesn’t realize what this guarantee actually means. What are they getting?
Well, I just recently came across an advertisement for a Transamerica variable annuity. It looks to the inexperienced eye, that you’re going to get 7.2% return guaranteed for 10 years. And in the advertisement it says: “Double your withdrawal base. For those looking for retirement income, Transamerica Retirement Income Max, available with the Transamerica variable annuity, delivers. Designed to be straightforward and flexible retirement income that can double your withdraw base in just 10 years.” Then big bold letters, it says: “More confidence, 7.2% compounding growth.” And again, if you don’t know what you’re looking at, it looks like man, they’re guaranteeing to double my money over the next 10 years.
But what really is that? What does that mean to you as the investor?
Well, you need to understand, it’s just a very expensive rider that the insurance company puts on to your principal that you initially invest with the company. And so, you end up having a cash value in your policy, and then you have a hypothetical amount in your policy – I like to call that your Monopoly money, because it’s not real. You could never withdraw that complete value no matter if you’ve been in the policy for 10, 20, or 30 years. It’s just really hypothetical numbers, not your real cash value. And so, the company rolls up this hypothetical number in your account over a 10-year period, and they guarantee they’re going to do it, in this case, at a 7.2% rate of return or doubling your money. But the reality of it is, your real cash value, most likely, will be much less. So if you say at the end of the 10 years, this contract is a 10 year contract, you want to walk away, you’re going to go to insurance company and you’re not going to be able to take out that guaranteed 7.2%… you will be able to take out your cash value instead. When you really dig in and look at what that means for individuals – again, it gets positioned that you can live on this guaranteed income no matter what happens in the market, you’re going to be able to have this guaranteed lifetime payment.
So, at first blush this may seem good to the investor, that they’re going to have this guaranteed payment, no matter what happens. But when you dig in and look at the math of what is actually happening… it’s not that great. So, if you have $100,000 for example, that rider is going to cost you a minimum of $1,350 a year. If you want to have it set up so that you have a joint life set up on this contract, well it’s going to be 1.45%. So, $100,000, you’re looking at $1350 a year for single life. You’re looking at $1450 for this rider on a joint life contract. Then, when you add in the fact that you again are going to pay, within the advertisement for this Transamerica annuity, you’re going to pay anywhere from .20 to 1.9% M&E fee on top of the 1.35 to 1.45, you’re going to pay an average investment fee for having deep investments, which are going to be mutual funds, within your annuity with their average investment cost being about 1%. So, you can have 1.45%, plus another 1% for your investment and you can have a 1.90, on top of that, the M&E fee. Also, there is a $50 policy fee a year. And so, you’re looking at 4.35%, to have this product.
So, you can imagine the returns that you’re going to need to get to be able to overcome all these costs that you have coming up out of the investment money. And then on top of it, with inside this advertisement it says that, that 1.35 or 1.45, is based on your hypothetical pile of money, your funny money pile. So that’s most likely going to be higher than your real cash value. And they mentioned that with inside the ad that your real money, your real cash value can be substantially less than your income rider pile of money. And so, you could be, as a percentage of your asset, paying a substantially higher amount than 1.35 or 1.45, and contractually they can increase that 1.35 or 1.45 an additional .75 during the life of you having this investment with them. So, you could have 1.35 to start and then they come in and add .75… so now your income rider is a 2.1, we get into a bear market, your value of your portfolio goes down by 30%. And so, you could see you could be at 2.5 or 3%, just with this one rider.
Then say everything goes great. You get through the 10-year period and your money income value is doubled – you gave them $125,000; you have $250,000 sitting in this variable annuity. Well, now here comes the second part of the payout to you. So now, at that point, if you’re age 64 and you want to start this income for life, you get a 4% payout. If you’re 69 you get a 5.25% payout. If you are 74, you get a 5.4% payout. And on and on, up until 80, which is the max, and that is a 5.75 withdrawal rate. And, your joint life withdrawal percentages are lower – so you pay more for the rider and you get to withdraw less. But we’ll just use the example of that first one or two withdrawal percentages.
So, you have a benefit base of $250,000, you gave them $125,000. So, we’ll just say for argument’s sake, your cash value is $200,000 – and I’m probably being liberal by saying you’ll have $200,000 in this type of investment after 10 years, because that would mean you’d have to net a 4.8% return. And again, you could have up to 4.3% just in fees on this product. So, I think it’s very liberal to say you could have $200,000 in this particular investment.
So, you have $250,000 – and by the way, that income rider you’re paying is on the $250,000 not the $200,000 you have in cash value – and they start a payout on that $250,000 at 4% single life… that would be $10,000 that they would pay you a year.
Okay, so now let’s do some math. So, if you were to take that 4% payout, or $10,000, how long could, if you took that money, if you took your $200,000, stuck it under the mattress and just paid yourself that guaranteed income rate? Well, $200,000, again, divided by the $10,000 that they’re going to be willing to pay you, is a 20-year payout. So, you could go take your money, stick it under your mattress and pay yourself, and not pay 1.35% to do it, 20 years. Now if you can just add a 4% return over 20 years, guess what? You could pay yourself that income, that same guaranteed amount for 20 years, and still have $200,000 under your mattress.
Well, let’s look at if you were 69 and you started to take a withdrawal payment out. Well, you could take out of that $250,000 benefit base, you could take $13,125 out. And so again, if you were to just have $200,000 in your account and do the math and you divided by that $13,125, they will pay annually to you, you could pay yourself that money for the next 19 years. So, you’re 69, you add the 19 years that you can pay yourself, that takes you to 88. Again, if you could just get a 5.25% return over the next 19 years with that same $200,000… you could make those same payments to yourself and have the $200,000 for yourself.
So, we see where we’re going here. And that’s if you don’t take any additional monies out of this policy. You have to remember when you do start this income payment, if you withdraw anything, this $200,000 that you have in cash value, when you need some of that, if you take any of that principal out, that’s going to lower that benefit base that they pay to you.
And, in fact, inside this advertisement they have that if you take out too much additional money out of your cash value or your real money pile, and this contract goes to zero because of that, you would then end this contract, your income would stop and the contract would come to an end. So, that’s another loophole that you have got to consider, another potential problem. What if you need a large sum of money? Well, at the very least, it’s going to affect the annual or monthly payout that they give you on this money.
So, we can see very quickly why this is something that you have to look at very closely. Maybe as an individual investor you want to feel warm and fuzzy about having a guaranteed income payment and making sure that you know you can always count on that. But, the reality of this is, and research is showing, that most people in retirement aren’t even spending what they have.
BlackRock had done some research. In Forbes magazine, March of 2018 there was an article titled: “Are retirees spending too little?” It said there: “Despite all the talk of a retirement crisis, BlackRock, the world’s largest asset manager, says it’s research shows that many retirees aren’t spending enough of their money. In fact, BlackRock says most current retirees still have 80% of their pre-retirement savings after almost two decades in retirement.”
And you can look and see all over the internet multitude of articles written about this matter that retirees aren’t spending their retirement money. In fact, they don’t even want to take RMD’s a lot of times. So, if they don’t even want to take RMD’s, do we really want to pay for a ridiculously high-priced rider to guarantee you some income payout for life? Again, that would be up to you, but I think there’s better ways to do this and much less costly ways to make sure that you have the right amount income or guarantee income that you would like to have.
And so again, you can see, this is something that a lot of people get caught up in and we just don’t want you as an investor to be fooled by what can seem to be guarantees of your principal and returns on your principal, when in fact they aren’t. This problem isn’t just in the variable annuity world, these withdrawal guarantee riders; we see them in the fixed indexed annuity world too, they’re just as bad. They will make it seem as if you’re going to get some guaranteed return on your principal, but actually it’s the funny money pile as I like to call it – a hypothetical pile of money, Monopoly money, and that the payouts are going to come from your actual cash value, which in most cases, are going to be substantially lower in the payout period. And again, they’re going to come with very expensive riders on the fixed indexed annuity side. With a fixed indexed annuity, the difference there is your principal base is guaranteed each year; where with a variable annuity, your principal has no guarantees. So that could add some nuances to how your money grows, how much money you have as a cash value base. But that’s again going to be individual or specific to the various contracts from the various companies.
So, we can see a very frustrating process, it can be very misleading, very tricky to understand what you have. But before you make that decision, please make sure you understand exactly what you’re getting, how you’re going to get paid out and then just think about the math. At the end, when you want to take this money out, really what does that mean to you? How long would your money last if you stuck it in a mattress? And in most of these contracts we see, whether it’s a fixed indexed annuity or a variable annuity, you could stick your lump sum under your mattress and get a payout from 16 to 22, 23 years without having to get a penny in return on your investment.
So again, I don’t think that it’s prudent to spend 1.35 or 1% or whatever the various charges are in the various products – they guarantee something that actuarily has been worked out in favor of the insurance companies – I don’t think that is a prudent thing to do with your hard-earned dollars when you factor in what just a 1% difference in return or cost can do to your retirement funds.
Well that’s it for today. In our future podcast, we’ll be looking at some differences between variable annuities and fixed indexed annuities, the pros and cons of both. In the meantime, if you have any questions feel free to reach out to me. We look forward to speaking with you again. This is Brent Chavez, coming to you from Aequitas Equitas Investment Group in Bedminster, PA.
