This week’s episode covers the most exciting topic since our Utilities Sector episode… Annuities! Join Josh and Austin as they discuss different types of annuities, how they are used, and the pros and cons that come along with them. Tune in now!
Main Talking Points
[1:30] – What is an Annuity?
[5:06] – Fixed Annuities
[6:38] – Deferred Annuities
[7:36] – Indexed Annuities
[10:34] – Variable Annuities
[12:33] – Why Would You Wait?
[16:01] – Pensions
[16:47] – Cost of Living Adjustments
[17:36] – Dad Joke of the Week
[18:11] – How are Annuities Used?
[19:23] – Pros of Annuities
[20:43] – Cons of Annuities
[24:35] – Should You “Invest” in Annuities?
Links & Resources
Invest With Us – The Invested Dads
Free Guide: 8 Timeless Principles of Investing
Social Media
Full Transcript
Intro:
Welcome to The Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments, here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right. Hey, hey, hey. Welcome back to The Invested Dads Podcast, a podcast where we take you on a journey to better your financial future. Today! Bom, bom, bom, bom! We are going to be talking about the most exciting thing since our utilities sector episode.
Josh Robb:
Oh, boy. Here we go.
Austin Wilson:
That we’ve ever talked about. And that is going to be annuities.
Josh Robb:
Yes. So get your pillow, get your blanket out. We’re going to be putting you to sleep.
Austin Wilson:
Yeah. So if you’re driving while you’re listening to this?
Josh Robb:
Yes.
Austin Wilson:
You might want to either pull over or listen to it later.
Josh Robb:
Or if you’re in a Tesla, let it do its thing.
Austin Wilson:
Yeah, that’s right. So, yes.
Josh Robb:
I guess you’re not supposed to fall asleep while you’re in your Tesla.
Austin Wilson:
Do you still have to, yeah. Touch the wheel or…
Josh Robb:
Spoiler. Spoiler.
Austin Wilson:
You should touch the wheel. That’s how people die.
Josh Robb:
Yes.
Austin Wilson:
So, anyway. Yeah. I hope you really don’t feel that way. This is going to be an interesting discussion. But Josh, this is really all your show. So I’m going to be facilitating a discussion around your thoughts and a couple of my own about annuities in general.
Josh Robb:
Yes. And I actually do have a lot of opinions when it comes to this. But when you talk about insurance products, because that’s what an annuity is. We’re going to get into that. But insurance products tend to be a little boring anyways.
Austin Wilson:
Speak for yourself.
Josh Robb:
But I’ll try to be as neutral as possible, keep my opinions until the end.
Austin Wilson:
That’s right.
[1:30] – What is an Annuity?
Josh Robb:
We’ll just talk about, what are annuities and how do they work?
Austin Wilson:
True. So let’s start 50,000 foot.
Josh Robb:
Yep.
Austin Wilson:
That’s kind of what we always do.
Josh Robb:
Always up there.
Austin Wilson:
So the official definition, according to annuity.org. So that sounds reputable, right?
Josh Robb:
They got a .org.
Austin Wilson:
I know.
Josh Robb:
So it’s a nonprofit organization.
Austin Wilson:
It’s nonprofit. They’re not profiting on this definition. So the definition is, “Annuities are insurance contracts that provide a fixed income stream for a person’s lifetime or a specified period of time. An annuity can be purchased with a lump sum or a series of payments and begin paying out almost immediately or at some point in the future. Annuities are often used as a way to fund retirement.” So alternatively…
Josh Robb:
It’s a lot of words.
Austin Wilson:
It’s a lot of words. To put it a little bit different.
Josh Robb:
Yes.
Austin Wilson:
A different definition says, “An annuity is a contract between you and an insurance company to cover specific goals, such as principle protection, lifetime income, legacy planning, or long-term care costs.” And that’s from a U.S. News article. And we’ll link that in the show notes below.
Josh Robb:
Yeah. Principal protection. That’s the guy in charge of your school. You don’t want him to get hurt. You need that principal protection.
Austin Wilson:
It’s good insurance policy on your principal.
Josh Robb:
That’s right. It’s very important to do that. Yeah. According to that same article though, by the way, annuities, or the concept of what an annuity is, has been around for a long time. In fact, in Ancient Rome, people would make a single payment in turn for a lifetime of income.
Austin Wilson:
Wow.
Josh Robb:
So way back in Rome, Ancient Rome, were they doing this type of insurance planning. So the concept is; and if you think about it, if someone’s worried about running out of money, if someone says, “Hey! If you give me some money now and I’ll make sure you never run out of money,” that’s a pretty cool deal.
Austin Wilson:
Yeah.
Josh Robb:
So that’s kind of what this is. All right?
Austin Wilson:
For sure.
Josh Robb:
So let’s break it down though. Those definitions you gave. Good.
Austin Wilson:
Yes.
Josh Robb:
But there’s a lot of words in there. And there’s a lot of, “for a lifetime” or a specific amount of time.
Austin Wilson:
There are options.
Josh Robb:
For a lump sum or a series of payments.
Austin Wilson:
Mm-hmm (affirmative).
Josh Robb:
You can start immediately or in the future. So let’s talk about that. So like I said, an annuity is an insurance product. It’s sold by an insurance company, right?
Austin Wilson:
Right. It’s not necessarily an investment.
Josh Robb:
No.
Austin Wilson:
You’re not owning something.
Josh Robb:
Yeah. While some invest within the product.
Austin Wilson:
Correct.
Josh Robb:
The annuity itself is an insurance product.
Austin Wilson:
Yes.
Josh Robb:
You actually have to be licensed by the insurance… It’s a Series 7? I don’t know what it is. It’s a special license you need for insurance selling, the insurance license. Annuities are designed to provide a steady income stream. That’s their primary selling point. We’ll talk about a couple that don’t have that selling point. But in general, when people think of annuities, they think of an income stream. And that can, like I said, either be for your life, the life of you and your spouse, or just a set period of time, depending on how you set up your annuity. You can buy one by throwing down a big chunk of money or set it up where you pay monthly for a while and then you stop paying and start receiving the income.
Austin Wilson:
Right.
Josh Robb:
So there is a lot of flexibility. And then, annuity can start at any point, either immediately or in the future.
Austin Wilson:
So let’s break down some different types of annuities.
Josh Robb:
Yeah.
Austin Wilson:
And there’s going to be a lot of subcategories.
Josh Robb:
Yes.
Austin Wilson:
That we’re not even going to go into the details of.
Josh Robb:
Right.
Austin Wilson:
But this is like the major types of annuities here. So Josh, fixed annuity sounds like something that would be fixed, right?
Josh Robb:
Yeah. They have fixed.
Austin Wilson:
So explain a fixed annuity. It’s not broken.
Josh Robb:
It’s not broken.
Austin Wilson:
If it ain’t fixed, don’t break it.
Josh Robb:
Yes. And so, a fixed annuity.
Austin Wilson:
Wait. Did I say that wrong? If it ain’t fixed, don’t break it?
Josh Robb:
If it isn’t broke, don’t fix it. No. If it’s not fixed, don’t break it. I don’t know. You don’t want either.
Austin Wilson:
I don’t remember. Okay. Anyway.
Josh Robb:
If it’s not a fixed annuity, don’t buy it.
[5:06] – Fixed Annuities
Austin Wilson:
Josh, what’s a fixed annuity?
Josh Robb:
So a fixed annuity is fixed in the sense that there’s a set interest rate.
Austin Wilson:
Fixed. Yeah.
Josh Robb:
That they will provide. Fixed. Set.
Austin Wilson:
Yep.
Josh Robb:
It’s guaranteed.
Austin Wilson:
It’s like your mortgage.
Josh Robb:
Yep. And I use the word guaranteed a lot because you’ll hear that with annuities. Guaranteed income stream, guaranteed returns, guaranteed protection. The guarantee is only as good as the insurance company backing those. And so, keep that in mind. But they’ll push a fixed annuity and say that there’s a guaranteed interest rate, which is true. They’ll say, “Okay. You give me $100,000 and I will guarantee that, from now until you start taking the money out, in 30 years or whatever you set it up for, you will get a 3% return on that. It’s guaranteed.” And so, that’s what they do. They’ll take your money. They’ll invest it in a way where they can earn more than 3%.
Austin Wilson:
Oh, yeah.
Josh Robb:
They’ll grow your 3%. And then, they’ll pocket the rest.
Austin Wilson:
That’s how they make money.
Josh Robb:
That’s how they make money.
Austin Wilson:
Right.
Josh Robb:
Exactly. That’s what the setup is. All right? So that’s a fixed annuity. The other side of it too is, because they know how much they’re going to pay you in a fixed amount, they also have a guaranteed income payout for that as well. They’ll say, “Okay. Based on when you want to start this annuity, here is your guaranteed amount of income.”
Austin Wilson:
Right.
Josh Robb:
And then, you say, “Okay. I want it for my lifetime.” They use an actuarial table and say, “Here’s what we’ll give you, based on how long we think you’ll live.” If you say, “I want it for…” So we’ll get to this. Because every one of these that we’re talking about can either be an immediate annuity, which means it starts right away, or a deferred annuity, which means it starts in the future. So if I’m 20, I probably don’t want an immediate annuity. I don’t want my income stream to start at 20 because that’d be in little payments.
Austin Wilson:
Right.
Josh Robb:
Because my life expectancy is pretty long by the actuarial tables.
Austin Wilson:
Yes.
[6:38] – Deferred Annuities
Josh Robb:
So I might get a deferred annuity. Say, “Okay. At 20, I’m going to start paying into it, but I don’t want my income stream until I’m 60.” All right? So that’s deferred. If you have fixed annuity, that deferred point, the future when it’ll start, they’ll start your actuarial from there till life expectancy or however long you want it to go. So that’s how they calculate your fixed payment amount.
Austin Wilson:
So contract-
Josh Robb:
So everything’s guaranteed.
Austin Wilson:
Oh, yeah.
Josh Robb:
Or set at the beginning point. There’s no surprises.
Austin Wilson:
When you sign the contract. Yeah.
Josh Robb:
You know how much you’re going to get, how much it’s going to grow, and how much income you’ll get once it starts paying out.
Austin Wilson:
Absolutely. So there’s not, yeah. There’s not a lot of variables.
Josh Robb:
No. It’s pretty simple. When it comes to annuities, from understanding, that one’s pretty straightforward. Which also means the simpler it is, the less costs there are associated with it.
Austin Wilson:
Yes.
Josh Robb:
Pretty straightforward. Insurance knows how much they’re going to get. Because they really invest in pretty high, stable bonds for their own protection as well. So they just give you a little bit less than they’re going to get and everybody’s happy from that standpoint.
Austin Wilson:
Yeah. So let’s get a little bit more complicated then.
Josh Robb:
Yes.
[7:36] – Indexed Annuities
Austin Wilson:
So a little bit more complicated would be maybe what’s called an indexed annuity. So break down an indexed annuity.
Josh Robb:
Yeah. So an indexed annuity, it’s tied to some sort of index.
Austin Wilson:
Ooh! Like an S&P 500?
Josh Robb:
Like an S&P 500, the Russell 2000. You pick an index, they’ll probably have an annuity that’s tied to it.
Austin Wilson:
That’s right.
Josh Robb:
And so, what they do there is… I mean, these used to have different names to it. Equity, indexed annuity, equity annuity, equity variable annuity, all these different words. But an indexed annuity of some sort is designed to give you more growth potential than a fixed annuity. But they still keep in it some guarantees of downside protection. And so, again, with annuities, there’s a lot of flexibility. These insurance companies can really build these however they want. So I’m going to use some examples but it doesn’t mean they have to be this way.
So for instance, you could say, “Okay. I’m going to buy this indexed annuity.” It’s indexed to the S&P 500, meaning it tracks its returns off of the S&P 500. And they may say, “Okay. If you give us $100,000, we will give you a guarantee from loss of 80% of that.” So $80,000 is guaranteed. You’ll always have that, no matter what. That’s the minimum. If tomorrow, the market drops in half, you still have $80K, even though the stock market would’ve gone down to $50K.
Austin Wilson:
Right.
Josh Robb:
All right? So they give you a downside guarantee. And then, with this indexed piece, instead of getting a flat 2%, 3% return, whatever they were going to give you in the fixed annuity, you get to participate in that index’s growth. And the way they make money on this type of product is to offer that guaranteed downside protection. They also cap it on the upside or they have some sort of way of capturing some performance. And so, and again, going back to the example, they may say it is a 8% cap. So if the S&P goes, in a year, up 6%, you get the whole 6%. If it goes up 10%, you only get 8% and they get the last 2%.
Austin Wilson:
Right.
Josh Robb:
If it’s up 20%, you get 8% and they get that 12%.
Austin Wilson:
Yeah.
Josh Robb:
And so, they cap the topside and protect the downside so that you narrow your results but give that downside protection.
Austin Wilson:
These structured products are gaining traction in the ETF world, even outside of this.
Josh Robb:
Yes. Yes. Yeah.
Austin Wilson:
Very similar.
Josh Robb:
There are some buffer or strategies where they put that up and downside movement.
Austin Wilson:
Yep. Kind of a similar…
Josh Robb:
It’s volatility reducing is what it’s doing. And again…
Austin Wilson:
You’re paying for it on both sides.
Josh Robb:
It’s an insurance company. So you’re taking… And we talked about this insurance. All insurance companies do is, you’re passing your risk over to that company.
Austin Wilson:
Yep.
Josh Robb:
So in order to pass the risk over, you have to compensate them. And that’s what this structured annuities are is that variable annuity says, or indexed annuity says, “All right. If you don’t want all this ups and downs, we’ll take some of that up-and-down risk, but you’re going to pay us for it.”
Austin Wilson:
Absolutely.
Josh Robb:
So there’s a cost to it.
[10:34] – Variable Annuities
Austin Wilson:
So you mentioned it, but we’re going to hit on it now.
Josh Robb:
Yes.
Austin Wilson:
Variable annuity. So not fixed. It’s not indexed.
Josh Robb:
No.
Austin Wilson:
What is a variable annuity?
Josh Robb:
Yeah. So a variable annuity, the variable piece of that word comes from your returns. Whereas, the fixed annuity, you know exactly what you’re going to get, in the indexed annuity, you know the range of where you’re going to be. A variable annuity is, you invest in a pool of investments. It looks kind of like a group of mutual funds type of thing. And you get the ups and downs of that return on whatever that grouping is. And so, a variable annuity is really just a basket of investments. They don’t have that downside protection necessarily and they don’t have that upside cap. There are some things you can do. And we’ll talk about that a minute. But without riders, which are add-ons, there are no production pieces to that. So why would you not just invest in it? What is the insurance piece of that going to be?
Austin Wilson:
Right.
Josh Robb:
Well, all annuities are tax-deferred.
Austin Wilson:
Okay.
Josh Robb:
So when you have an annuity, whether you put in taxable money or IRA money, it grows without any tax until you take the money out, you pay income tax. So it works like an IRA really, if you think about that standpoint. So if you have a bunch of taxable money, a variable annuity may be, if you’re okay with the cost, may be worth that tax-deferred growth. The other piece of it, too, is there really is very little restrictions on how much you can put into an annuity. So if you think about a 401K, there’s limits.
Austin Wilson:
Mm-hmm (affirmative).
Josh Robb:
There’s an income limit. Roth IRAs, traditional IRAs. There’s limits. How much you could put in it and who can put them in. A variable annuity has the investment growth piece and they really have very small restrictions on those type of things.
Austin Wilson:
Right.
Josh Robb:
There’s some caveats to it. But in general, you can put in about as much as you want into an annuity. So those are some of the benefits for, some people say, “I don’t really have any other choices and I want that tax-deferred growth.” That opens up that option.
[12:33] – Why Would You Wait?
Austin Wilson:
So we talked about it earlier in the definitions.
Josh Robb:
Yes.
Austin Wilson:
But we had talked about, one of the different options you can have when you’re getting into this sort of product is, you can have payouts that start today.
Josh Robb:
Yep.
Austin Wilson:
When you sign the agreement.
Josh Robb:
Mm-hmm (affirmative).
Austin Wilson:
Or you can have a payout. You could sign it all now and say, “I want to start it when I’m 65” or whatever that would be.
Josh Robb:
Yep.
Austin Wilson:
So talk about that a little bit. Maybe why you would-
Josh Robb:
And that works for all three of those, really.
Austin Wilson:
Right. Yeah.
Josh Robb:
And the reason why you would do that is, so let’s say you are a person who’s worked their whole life and you’re heading into retirement. And one of your biggest worries is, “Hey! I’ve got all this money I’ve saved up. I’m afraid, either I won’t manage it well or I’ll overspend it.” I could then get an annuity, one of those three choices; probably not the variable but one of those; where I could then set up something that would guarantee that I wouldn’t run out of money. It would put it in and give me a set of payments for life.
The deferred annuity actually is used a lot of times for people who say, “You know what? One of my biggest fears are, ‘what if I have a lot more health care costs when I’m older?'” So they may be retirement age; 60, 65; and say, “I don’t really need any income right now. But I’m worried that, when I’m 80, I’m going to have some long-term care costs.”
Austin Wilson:
Yep.
Josh Robb:
Some people look at a fixed annuity or an indexed annuity as a way of putting that income piece to say, “You know what? It’s going to cost me about $1,000 a month for long-term care if I have to go in a nursing home” or whatever. “I can put an annuity that, at 80, it’ll start paying me that. And I’m guaranteed for the rest of my life that.” So they may do something like that, push it down the road for an expense they may feel like they need in future years.
Austin Wilson:
Yes.
Josh Robb:
So that’s why you defer.
Austin Wilson:
Essentially saving.
Josh Robb:
Yes.
Austin Wilson:
For something in the future that you think you’re going to have a expense for. So we also mentioned that, another of the variables is that you can set the payout for a set period of time. So if you sign it today, you could say, “30 years, I want payments every month” or whatever. And then, it’ll stop. Or you can have it go throughout the rest of your life.
Josh Robb:
Yep. So an insurance contract, or an annuity piece like that, which is just a set period, is the lottery is a good example. The lottery, if you win, you could choose a lump sum or you could say, “I want you to pay me increments for the next 30 years.”
Austin Wilson:
Right.
Josh Robb:
So that’s one of the choices. That is, the lottery is an annuity option, right there.
Austin Wilson:
Right.
Josh Robb:
And that’s for somebody who says, “A lot at once is not good for me. Spread that out.”
Austin Wilson:
Well, I bet those statistics on how bad people are when they win the lottery.
Josh Robb:
Yeah.
Austin Wilson:
I bet those would go down if they would take…
Josh Robb:
Yeah. If they would take that annuity.
Austin Wilson:
Yeah.
Josh Robb:
Just stop yourself from making a bad choice, yeah.
Austin Wilson:
Because you can always spend a little at a time or whatever.
Josh Robb:
But that’s just an example, though.
Austin Wilson:
Yeah.
Josh Robb:
Of one set period of time. Now, the opposite is, you get it for your life or the life of you and your spouse. Or you can have some of those things set up. There’s a third one in there where it’s a lifetime annuity with a guaranteed timeframe. And so, in a sense, it says, “Well, what if I choose the lifetime but I only live five years and I won’t get my full amount?” So you can have these set periods of time where it says, “Okay. I want it for my life. But if, guaranteed period, maybe let’s say 10 years. So if I die in five, it’ll continue for the next five years, paying out to my beneficiaries, until that full period is met.”
Austin Wilson:
Right.
Josh Robb:
So in a sense, it’s safeguarding the short-term risk of, “What if I pass away early?” But also, gave me that lifetime stream. So there are, again, there’s a lot of flexibility there, depending on what you’re looking at for annuities.
[16:01] – Pensions
Austin Wilson:
One of the big examples that I’m thinking about with annuities is pensions.
Josh Robb:
Yes.
Austin Wilson:
Specifically.
Josh Robb:
Mm-hmm (affirmative).
Austin Wilson:
And that is exactly how that’s set up. So you have the option, just like with the lottery, right?
Josh Robb:
Yep.
Austin Wilson:
When you retire and you have a pension. Now, pensions are phasing out. They’re not so popular anymore.
Josh Robb:
Yeah.
Austin Wilson:
But this was the primary retirement vehicle for decades and decades and decades.
Josh Robb:
Mm-hmm (affirmative).
Austin Wilson:
But anyway, if you retire now, you have a pension, you’re given an option. “Do you want a lump-sum check, Josh?”
Josh Robb:
Mm-hmm (affirmative).
Austin Wilson:
Give you a lump-sum check. And then, you can do with it what you want.
Josh Robb:
Yep.
Austin Wilson:
Invest it or blow it.
Josh Robb:
Yep.
Austin Wilson:
Who knows what you want to do.
Josh Robb:
Whatever you want to do.
Austin Wilson:
Or you can annuitize it.
Josh Robb:
Yep.
Austin Wilson:
And you can take those periodic payments with the same options. “Do you want lifetime? Do you want guaranteed spousal income should you pass? Do you want all of these different variables?” And you can structure it to be an annuity.
[16:47] – Cost of Living Adjustments
Josh Robb:
Yep. And the other piece with all this is, again, with the flexibility of some annuities, cost-of-living adjustments. So inflation, the increase of cost of goods. If I get a set dollar amount, if I get $1,000 a month? Well, in 20 years, $1,000 isn’t going to buy me what it buys now. So some annuities have an inflation or a cost-of-living adjustment built in, which is a good thing. That’s a positive thing is, “If I get $1,000 in 20 years, I want it to be paying me…” I don’t know. $2,000 or whatever it is. “That I’m still able to buy the same amount of stuff I could today.”
And so, that’s something that a lot of pensions don’t have anymore because of how expensive it is. That cost of living adjustment is a big factor. So annuities, a lot of them offer that still, or a rider you can add on to keep up with inflation.
[17:36] – Dad Joke of the Week
Austin Wilson:
Gotcha. All right, Josh. We’re going to take a break.
Josh Robb:
Yes.
Austin Wilson:
I have the, not a. I have the dad joke of the week joke.
Josh Robb:
The dad joke of the week. I’m ready.
Austin Wilson:
Reddit. R/dadjokes.
Josh Robb:
Yes. Hashtag.
Austin Wilson:
Are you ready? Why do teenage girls walk in groups of three, five, and seven?
Josh Robb:
Oh, I don’t know.
Austin Wilson:
Because they literally can’t even.
Josh Robb:
They literally can’t even.
Austin Wilson:
Ha, ha, ha! That’s classic.
Josh Robb:
I love it.
Austin Wilson:
That’s good stuff. So yes, annuities. That’s what we’re talking about. By the way, I’m going to give you props. We’re going to get to it later. But I’m giving current props on remaining quite neutral thus far.
Josh Robb:
I’m trying my best.
Austin Wilson:
You’re getting quite… But we’re going to hear your actual thoughts in a little bit.
Josh Robb:
I will give them to you at the end.
Austin Wilson:
So Josh, before we get there?
Josh Robb:
Yes?
[18:11] – How are Annuities Used?
Austin Wilson:
How are annuities used?
Josh Robb:
Yes. The annuities are designed to offer some insurance against normal market movements.
Austin Wilson:
Because it’s an insurance product.
Josh Robb:
We talked about that. The insurance product. You are paying-
Austin Wilson:
Risk.
Josh Robb:
To remove volatility of some sort.
Austin Wilson:
Yep.
Josh Robb:
And passing that burden over to the insurance company. So they can provide against either market drops, which is that guaranteed piece on the front end, or against that fear of losing out on your money, which is that lifetime income stream. So…
Austin Wilson:
FOLO.
Josh Robb:
Yeah. Fear of losing out.
Austin Wilson:
Ooh, I just made that up.
Josh Robb:
Yes.
Austin Wilson:
It’s never been thought of before.
Josh Robb:
Never, ever. No one’s ever said that. So that’s what an annuity is used for is, someone says, “I’m just not comfortable investing and taking that full risk on my own.”
Austin Wilson:
Right.
Josh Robb:
“I’m willing to pass that on for a price.”
Austin Wilson:
I would say that I think that that probably sounds most attractive to someone who hasn’t spent their entire working career with investments in the stock market to understand the volatility.
Josh Robb:
Correct. Yep.
Austin Wilson:
That’s normal.
Josh Robb:
Yep.
Austin Wilson:
So then, when they think, “Oh, I could lose all my money in a stock market crash,” that seems awful.
Josh Robb:
Yep.
Austin Wilson:
So that’s the way I’m thinking of it. So let’s break down some pros and some cons.
Josh Robb:
Yep.
[19:23] – Pros of Annuities
Austin Wilson:
Before we give our opinions on annuities in general. So Josh, what are good things? What are things that people like to see when it comes to annuities?
Josh Robb:
Yep. So some of the things still hear when someone is talking possibly about an annuity is they offer that security, right? The volatility security and the longevity security. They offer those protections we just talked about. Tax-deferred growth. Like I mentioned, annuities are tax-deferred. Protection for their principle. Most of them do offer some sort of guarantee. Now, the variable annuity is the only one that usually does it or has some limited protection. Probate-free estate distribution, if you have certain riders, it’s looked at, it’s an insurance product. And like a lot of insurance products, that death benefit is usually, bypass probate. And most of the time is not taxed depending on how it’s set up.
Austin Wilson:
Gotcha.
Josh Robb:
Like a life insurance product. A lot of those income streams do have an inflation adjustment for them. So that’s a positive, compared to, like I said, a pension or a lot of those new, those things are just flat, set payments out. And then, death benefit, like I mentioned. And you can name just about anybody for that benefit. So that’s another piece of passing on. If you have charitable causes, things like that, your death benefit’s pretty flexible.
Austin Wilson:
We are taking applications. We would love to be your death benefit.
Josh Robb:
Yes.
Austin Wilson:
No. I’m just kidding. So flip the coin on that, Josh.
Josh Robb:
Yes.
[20:43] – Cons of Annuities
Austin Wilson:
There are some things that may be not so favorable about annuities. And go through those.
Josh Robb:
Yeah. So if someone’s against annuities, here’s some of the arguments they use. Flexibility. So when it comes… I mentioned there’s a lot of flexibility in making annuities.
Austin Wilson:
Yeah. But once you make it?
Josh Robb:
Once you’re in an annuity, there’s less flexibility.
Austin Wilson:
Right.
Josh Robb:
There’s usually a surrender period. Meaning during a period of time, you’re unable to surrender without a penalty. And so, that locks you in. It’s usually, the penalty is enough where it doesn’t make sense to leave. You’ve got to wait out that penalty period. Also, within, once you’re in the product, you can switch from certain annuities to others, but you’re kind of stuck with that insurance product and company that you’re at. There is some ability to move from one to another, but it can get a little tricky.
The other con is it costs. Like we mentioned before, the insurance company, they’re not doing this for fun. They make money on it. There are fees involved for the insurance product. And then, there’s also commissions. And this is a commission product. In most cases. Now, there are some commission-free annuities out there. But in general, most of the time, there’s some sort of sales cost and fees associated. Annual fees, that ongoing.
Austin Wilson:
Right.
Josh Robb:
Complexity? We’re just brushing the surface of this.
Austin Wilson:
Oh, yeah.
Josh Robb:
I mean…
Austin Wilson:
This is really high-level.
Josh Robb:
In my continuing education I have to do? I mean, there’s just hours and hours of education for annuities. So the complexity of these, most people do not fully understand what an annuity is when they’re signing up for it. And that’s…
Austin Wilson:
Not good. Yeah.
Josh Robb:
It’s the scary part for, a lot of times. One protection piece is… Because in our industry, if you are misrepresented and misinformed, there is some protection for you. So one thing you can do is, if someone’s talking to you about annuity, write down exactly how you understand it and have them sign and date it. So if there’s ever an argument in the future, you can say, “This is how it was explained to me. And this was my understanding when I signed up.”
Austin Wilson:
Right.
Josh Robb:
So just something that’s useful is, if they’re telling you all these things like, “Oh, it’s going to do this and it’s guaranteed to do that,” write that all down. Say, “This is my understanding of how you explained it to me. This is what I’m going to pay,” blah, blah, blah. And then, have them sign and date that. And you’re good in the sense of protection standpoint to say, “This…” Because it has to, it really has to do with the consumer’s understanding. Because investing is complex. That’s part of why we’re doing this podcast.
Austin Wilson:
Right.
Josh Robb:
Is we want to help clear things up. So that’s one thing you do to protect yourself. Conservative returns. Because there’s an insurance piece that overlays to help provide that volatility protection, you are going to experience, in the long run, historically speaking, less returns than you can get in the normal market. Because the market’s up more often than it is down, because of those caps, you end up having a lower return, even with that downside protection.
Austin Wilson:
Right.
Josh Robb:
And then, the loss of potential returns from other investments. Again, one being unable to move in and out and having a limited investment choices, you just don’t have flexibility.
Austin Wilson:
Yeah.
Josh Robb:
Nor do you have the ability to fully capture the returns. For instance, I haven’t seen an annuity you can hold individual stocks in.
Austin Wilson:
Yeah.
Josh Robb:
You have to buy within their insurance product.
Austin Wilson:
Well, and the opportunity cost is huge.
Josh Robb:
Yes.
Austin Wilson:
So the money that you are putting into this is money you’re not putting into a traditional investment product that you could earn a higher return on. And I think another, just to build onto the flexibility.
Josh Robb:
Yes.
Austin Wilson:
Liquidity is not…
Josh Robb:
Yeah.
Austin Wilson:
You have no liquidity.
Josh Robb:
Now, like a variable annuity, some of the ones, you have the ability to take out, even before you annuitize. Annuitize means you set up your distributions. You have the ability to withdraw certain amounts. There’s usually, you can take about 10% of your overall value per year, roughly. And so, there is some. But you’re right. You just like…
Austin Wilson:
You give it up. Yeah.
Josh Robb:
If you have an investment account, you could liquidate it all if you’re done with it.
Austin Wilson:
Yeah.
Josh Robb:
So, yeah.
Austin Wilson:
Even if it’s a retirement account, you can liquidate it and take a penalty.
Josh Robb:
Yes.
Austin Wilson:
But you can get to it.
Josh Robb:
Yeah.
Austin Wilson:
But here, your hands are tied.
Josh Robb:
Somewhat, yeah. I mean, there’s that…
Austin Wilson:
More.
Josh Robb:
Penalty involved.
Austin Wilson:
Mm-hmm (affirmative).
Josh Robb:
Yeah. It’s pretty steep sometimes.
[24:35] – Should You “Invest” in Annuities?
Austin Wilson:
So the question is, Should you “invest?” Aah, I’m putting quotations!
Josh Robb:
Aah, yeah.
Austin Wilson:
Is it even investing? Not really. It’s an insurance policy.
Josh Robb:
It’s an insurance product but they have investment pieces.
Austin Wilson:
Yes.
Josh Robb:
Within a variable and indexed annuity.
Austin Wilson:
So should purchase or utilize an annuity for your retirement plan?
Josh Robb:
I’ve done a lot of talking. Why don’t you go for it?
Austin Wilson:
Okay. So I have thoughts on this.
Josh Robb:
I’m sure you do.
Austin Wilson:
And we’ve hit on a lot of my thoughts.
Josh Robb:
Yes.
Austin Wilson:
I really feel that, based on the ultra-conservative returns, and especially if you’re getting involved in periodically purchasing an annuity through your younger years even, you’ve missed out on a lot of returns because you’ve capped. You’re capped on returns. Even if you’re in more indexed.
Josh Robb:
Mm-hmm (affirmative).
Austin Wilson:
Or variable-type returns. They’re lower than they would be, should you even just go out and buy an indexed fund or whatever, in the stock market. Because, like we’ve said, that insurance company, they’re taking on some of that risk and they’re compensating themselves for taking on that risk in the terms of fees and a spread usually. And I think that, over time, that gap gets wider and wider. Because every year, that gets bigger and bigger, bigger what you could get from a traditional investment product.
So I think that that’s something that is something to be cautious about. I understand the fear of volatility. However, I think what we’ve discussed on this podcast a few times is the fear of volatility is really misunderstood. The fear of the stock market going down really isn’t the issue. It’s the fear of outliving your money. And you have a better chance of outliving your money, doing something like this, than you do if were to invest it in stocks. Generally speaking. Every situation’s a little bit different. But generally speaking, you would be better off. That’s my opinion.
Josh Robb:
All right. My opinion.
Austin Wilson:
And?
Josh Robb:
Oh, yeah.
Austin Wilson:
Oh and, like I said, I really feel like a lot of these are aimed at people who don’t have a history of investing in the stock market. And maybe, I’m not going to say that every person who’s selling this is bad or good. But they could aim their targeting at these less educated of stock market-experienced people. And that could be a downside.
Josh Robb:
All right. My thoughts.
Austin Wilson:
You can let it all out here.
Josh Robb:
I’ll let it all out.
Austin Wilson:
You were pretty positive so far.
Josh Robb:
I was pretty neutral. So we are a fee-only advisory firm. And like I mentioned, these are commissioned products, for the most part. Now, they’re coming out with more and more commission-free annuities. And I’ve looked at those. And so, if I just look at, if we take out that conflict of the commission piece that I have with how we run our firm for investing, the annuity products, I can see the benefit and the appeal for certain pieces and certain aspects. So for instance; and I didn’t talk about this yet, for this purpose. I wanted to bring it up here; is almost everybody listening right now will have, in a sense, an annuity when they claim social security.
Austin Wilson:
Oh, yeah.
Josh Robb:
You’ve been paying like you do for a deferred annuity.
Austin Wilson:
Yep.
Josh Robb:
And then, you’re going to get a set income stream for life.
Austin Wilson:
Yep.
Josh Robb:
It’s, for all intents and purposes, the same definition of an annuity, right?
Austin Wilson:
And how’s your return been on that?
Josh Robb:
Right. And so, the concept is, that’s prebuilt in.
Austin Wilson:
Yeah.
Josh Robb:
And with that mindset, if there’s somebody who says, “You know what? I have accumulated more than enough for what I need. And I want to give myself a set bare minimum for the rest of my life,” a fixed annuity or indexed annuity or something like that, where you can just say, “Okay. Between that and social security, my baseline covered, I’m covered. And then, everything else is my, ‘don’t worry, spent,'” I could see that allowing you to be more aggressive in your investment piece because you have your baseline income covered.
So I could see using those pieces. But more often than not, like you said, you could do the same thing with a bucket strategy or an approach where you put a conservative piece in that’s invested in fixed income or something.
Austin Wilson:
Right.
Josh Robb:
That’s your safety net. And then, the rest is there. So there’s other ways around it. But I could see that appeal as if there’s a nice indexed or fixed income annuity that meets those needs and the costs are reasonable for you to justify. I could see you doing that and putting it in place to say, “Okay. My needs are met. Everything else is the fun spending. And that, I can go crazy with.”
Austin Wilson:
Right.
Josh Robb:
“And that, I can invest and grow.” That, in the long run, you may end up with a better return than trying to really limit your volatility because you’re worried about your periodic withdrawals or whatever.
Austin Wilson:
Yep.
Josh Robb:
There’s my thought on that piece. The other side, when you have an insurance piece added on, when it comes to those variable annuities especially, I have a hard time finding a good spot for that. Because once you add in all the additional costs, you’re just never going to be able to keep up with, just straight, an investment account. So I just don’t see that appeal.
The only spot would be, again, if somebody is just really trying to reduce and get that tax-deferred growth and they’ve maxed everything out. But again, at that point, you’re probably in a high tax bracket. So I don’t know really, what…
Austin Wilson:
You’ll probably be all right.
Josh Robb:
Yeah.
Austin Wilson:
Yeah.
Josh Robb:
And so, again, I see a hard time, so. And while I see the concept of a fixed income stream being appealing, but there’s other ways of getting there. But it’s out there. There’s a reason why it’s been around since the Ancient Roman time is there’s a lot of people who will pay for the guarantee.
Austin Wilson:
Mm-hmm (affirmative).
Josh Robb:
And that’s where the trade-off is.
Austin Wilson:
Yep.
Josh Robb:
I can’t tell any one person whether it’s worth it or not for them. And as a fiduciary, it’s always what’s in their best interest. There are clients that it’s in their best interest that they either keep, maintain, or go find those type of products. Because for them, that fear of losing out of money.
Austin Wilson:
Known as?
Josh Robb:
FOLO.
Austin Wilson:
FOLO!
Josh Robb:
FOLO. Not FOMO, fear of missing out. You’re not missing anything.
Austin Wilson:
Nope. You’re losing.
Josh Robb:
You’re losing out.
Austin Wilson:
Yep.
Josh Robb:
So that fear of losing your lifetime income or of running out of money is enough where they’re willing to pay the cost. And that’s the thing.
Austin Wilson:
Yeah.
Josh Robb:
Is that a bad product? No. For them, it’s not. If they’re willing to, if they understand the expense and they’re willing to pay it for that piece of mind.
Austin Wilson:
Yep.
Josh Robb:
Then, the cost is justified.
Austin Wilson:
Yeah. Know what you’re giving up. But if you’re okay with that?
Josh Robb:
Yep. So that’s my thought. It may surprise you that I’m not so hard. I don’t find a lot of annuities I’m excited about. I’m going to be honest with you. Because a lot of those variable annuities are pushed.
Austin Wilson:
Yeah.
Josh Robb:
Because there’s a lot of expenses into those things. I’m not a fan of those.
Austin Wilson:
They can make good money on them.
Josh Robb:
But those indexed annuities? If you look at it, in a sense, indexed annuities have that guaranteed downside and then a cap. If you supplement a fixed income piece with that? I mean…
Austin Wilson:
You pretty much- Yeah.
Josh Robb:
If you net the same, then you net the same, and you just have it in a different structure.
Austin Wilson:
And you pay less fees.
Josh Robb:
And its tax-deferred.
Austin Wilson:
Right.
Josh Robb:
It’s just… Again, I could see it. Do I like it? No. Do I think there’s other ways of doing it? Yeah. But if someone goes that route, that’s fine. If you buy an S&P indexed annuity with a guaranteed 3% return and then a 7% buffer? Well, you’re going to get fixed income between 3% and 7%. I mean, that’s the way of looking at it, right?
Austin Wilson:
Right.
Josh Robb:
So I could see those playing out that if your net is there and you’re saying, “Well, that’s what I was going to be doing over here anyways.” Eh, fine. Whatever.
Austin Wilson:
Right.
Josh Robb:
If you go that route. But then, understand, you’ve got your surrender period and all that stuff that, if your mind changes in seven years, you may still not be able to do anything.
Austin Wilson:
Potential liquidity issues.
Josh Robb:
Yeah.
Austin Wilson:
Yeah.
Josh Robb:
So I see the concepts. Being a fee-only advisory, they’re just limited to what I think makes the most sense.
Austin Wilson:
Yeah.
Josh Robb:
But they’re out there. And there’s a reason why it’s popular.
Austin Wilson:
Yep.
Josh Robb:
Is there’s a lot of people that sell them. A lot of people that I’ve run into that actually like what they’re getting from some of those products.
Austin Wilson:
Yep.
Josh Robb:
They say, “You know what? I know I’m paying 3% a year but I don’t have to worry about it.” Okay. If you understand the trade-off, then for you, all right.”
Austin Wilson:
Right.
Josh Robb:
“Go for it.” So that’s where I’m at.
Austin Wilson:
Well, Josh. This is good stuff.
Josh Robb:
Good stuff. I bet everybody loved annuities.
Austin Wilson:
This is the best episode ever.
Josh Robb:
It’s awesome.
Austin Wilson:
It was a variable-length episode. We’ll see about that. I don’t know when we’re going to cut it. So, anyway. Two things. Number 1, it is not too late to enter our second half stock draft competition.
Josh Robb:
Right.
Austin Wilson:
It is almost halfway through the second half.
Josh Robb:
Second half. So, yeah.
Austin Wilson:
And Josh is still in it.
Josh Robb:
I’m still in almost last place.
Austin Wilson:
But you would start with a fresh $100,000 for the last quarter. And the last quarter is typically pretty good for the market, so.
Josh Robb:
Create a new alias and start over.
Austin Wilson:
Exactly. So, yeah. It’s not too late. Check that out. There’s details on our website or our social media on how to enter there. And Number 2, as always, check out our free gift to you. It’s a brief list of eight principles of timeless investing. These are overarching investment themes meant to keep you on track to meet your long-term goals. Generally speaking, we don’t talk much about annuities because it’s not our preferred often product.
Josh Robb:
Right.
Austin Wilson:
So there we are. Check it out. It’s free on our website. Josh, how can people help us grow this podcast?
Josh Robb:
Yeah. Make sure you subscribe. That way, you get our podcast every Thursday, when it drops.
Austin Wilson:
Even every Thursday.
Josh Robb:
Every Thursday.
Austin Wilson:
Ever. Ever. We haven’t missed one yet.
Josh Robb:
It’s the insurance annuity of the podcast world. Guaranteed.
Austin Wilson:
Keeps coming.
Josh Robb:
It’s always going to be there. As long as we’re still around. All right. That’s the insurance company, right?
Austin Wilson:
Thank you. Yeah, yeah, yeah.
Josh Robb:
As long as you’re still in business.
Austin Wilson:
Actuarial table discussion.
Josh Robb:
That’s right. Subscribe. But leave us a review on Apple Podcasts. If you have any questions about annuities or anything like that, or have a topic you’d love for us to talk about, even if it’s as boring as annuities, we would love to talk about it. Shoot us an email at hello@theinvesteddads.com. And if you liked this? I mean, I know everybody’s going to like this episode.
Austin Wilson:
That’s right.
Josh Robb:
But if you really like this episode, share it with your friends.
Austin Wilson:
Yeah. Wake up and push the share button.
Josh Robb:
Yeah. Yes, that’s right.
Austin Wilson:
All right. Well until next Thursday, have a great week.
Josh Robb:
Talk to you later.
Austin Wilson:
Bye.
Outro:
Thank you for listening to The Invested Dads Podcast. This episode has ended but your journey towards a better financial future doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review, click subscribe, and don’t miss the next episode. Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin, or any podcast guest are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.
