A year ago, I bought a fixed indexed annuity (FIA) from Eagle Life. On my first policy anniversary, the price of the S&P 500 achieved an 11.97% increase in price from my date of purchase. Because I selected a one-year crediting period with a 4.5% cap on the S&P 500 and added a lifetime income rider, my return after the rider fees came to 3.3%. Cue the annuity critics – especially the FIA critics that often point out that these products greatly limit the upside potential. Since I earned less than 30% of the upside, my situation seems to be a perfect example of why some avoid recommending FIAs. In fact, I could have earned more by just buying money markets or a CD. So, why am I happy about this? The answer lies in the income rider that came with the policy.
Before recommending an annuity to your client, you must first decide what is the primary goal of the annuity? Is it tax-deferred growth with principal protection or income? Annuities are like a swiss army knife. They can meet a lot of financial goals, but they can typically only do one thing well at a time. When I see clients disappointed with the results of their annuity, it’s typically because they were told it would do too many things. It would give them market upside with no risk and a high amount of income. The reality is that an annuity can be designed to give you strong returns or a high amount of income. It can’t do both. For me, it was all about the income. Any upside was just a bonus.
I deposited $550,000 into this annuity one year ago when I was 64. The plan is to start taking the income at age 68. Since my time frame is relatively short, I chose the Eagle Life option that adds 14% simple interest to my income value each year. Therefore, while my account value only increased to $568,197, my income calculation value increased to 627,000. Side note here – for those of that can’t help but notice grammar and style errors and therefore made note of the fact that there is no “$” sign in front of the income calculation value, it was omitted on purpose. This value is not money. It’s just a number that is used to calculate the amount of income I can receive, much like credit card points. I think the industry does itself a disservice by putting a “$” sign in front of this number on client statements. Now that I got that off my chest, let’s continue with the example.
Now that I’m 65, I can take 6.2% of the 627,000, or $38,874 per year for as long as either my wife or I live. That number is 6.84% of my account value. In essence, Eagle Life is guaranteeing a 6.84% systematic withdrawal rate. But since I don’t plan to start taking income for 3 more years, let’s take a look at how these numbers will look then. Since the 14% simple interest rate is guaranteed for 5 years, I know that on my 4th policy anniversary the income calculation value will be 858,000. At age 68, I can take 6.5% of that value rather than 6.2%. That comes to $55,750. Since both the 14% simple interest growth rate and the withdrawal rate are known, the $55,750 is not a projection. It is the amount I will be able to receive no matter how much or how little my policy value grows.
Now let’s assume that I had chosen to follow the Fisher Investments advice and believed that with a properly structured, diversified portfolio, I could confidently withdraw 4% per year without fear of running out of money. In fact, because Fisher Investments are such good money managers, let’s move that withdrawal rate to 4.5%. How much would I have to earn on my $550,000 investment over the next 4 years to provide the same $55,750 in income?
This is really just a simple math question. If I plan to withdraw 4.5% of my portfolio, I will need $1,238,888 in order to generate $55,750. On an initial investment of $550,000, I would need to achieve a 22.44% average annuity return to grow that value to $1,238,888. Now who wants to bet on that scenario? I’m quite sure that if me becoming a client at Fisher Investments – or any other firm for that matter – was contingent upon them increasing my $550,000 at 22.44% on average per year over four years, they would all laugh me out of their office.
For you annuity nerds out there, I did not really buy an FIA. I bought a deferred income annuity (DIA) with an accessible account value with some annual growth. Certainly, I could have bought a FIA with a cap of 10% or more and therefore seen significantly more growth in my policy. But that was not the goal of this particular annuity. The goal was to maximize my income in just 4 years. And that is why I’m happy with earning just 3.3%.
Related: Choosing Between Participation, Cap, and Trigger Rate Strategies in Fixed Indexed Annuities