EPS 8 - Annuities, Demystified: How They Work, When They Fit, What to Watch

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everybody, this is Jerry and welcome to the Pink Money Podcast where we talk about all about things from a gay perspective as it pertains to money. And today what I'm going to talk to you about is annuities because they're kind of a strange vehicle and I think sometimes they sound so weird. A lot of people just have misconceptions about them and quite frankly they probably don't even know really what an annuity is. are how they work. So I've had a lot of questions about them. And I know that it's not as straightforward, I think, as some other things are. But when you really look at an annuity, really, what it is, is a vehicle that is tax deferred, meaning you put your money in and essentially it locks it away, locks it away until you're 59 and a half. So it acts very similar to an IRA in that sense. And if you pull it out early before you're 59 and a half, then you get a penalty as well. So the benefit that you have is that your money grows in this tax deferred environment, just like an IRA. So no matter the gains or losses, et cetera, all the interest you receive, none of that is going to be taxable until the money comes out. And that depends on when you want it to come out, because some annuities have an automatic annuitization feature, typically around the age of 90. Just really depends on the contractor the company, etc. But usually they're not going to let you keep it forever in perpetuity. They're going to make you annuitize your contract. So in and of itself, annuities have two phases, accumulation and distribution. Accumulation, of course, you're putting money in and distribution money is coming out. And that process of turning money from an annuity into a series of payment is your annuitization. So do you have to annuit? No, because there's so many different kinds of annuities and it really just depends on what you want to do. So let's just take, for example, like there are fixed annuities. Um, and that's just saying you put a lump sum of money in for a certain period of time, you get a certain interest. Okay. Um, there's also ones that allow you to contribute money on an ongoing basis and that interest rate can fluctuate. Um, there's variable annuities, equity index annuities, all different kinds. But again, they all have that same common feature of accumulation and distribution. But I think what gives annuities sort of a bad name or bad rap is the fees that go along with it. And people don't really understand them because again, they're not as transparent as a lot of people hope it is. Because when you're dealing with a financial product, it's not like they have a price tag on it that is very observable and you know exactly what you're paying, right? Because it just it really depends. And in this sense, an annuity, you have to really look at the bells and whistles to determine exactly what it's going to cost you. And a financial professional is usually your best bet in terms of helping you decipher how much are you ultimately going to be paying. And again, it depends on the type of annuity that you're buying. A very basic annuity would be a fixed annuity. Again, you put lump sum of money in for a certain period of time you get a certain interest rate at the end of that contract even let's say that you're under 59 and a half let's say it was a five-year annuity and you put it in when you're 30 and now you're 35 and the contract is up so what happens to your money so you're no longer getting that interest that you were receiving during that time frame that's over so now you have to elect to re-up meaning choose another annuity contract or you have to move it from one tax deferred vehicle to another. So can you go from annuity to annuity? Yes. You have to make sure, of course, that you're not going to be getting out of this and it's going to cost you a lot of money. So you have to make sure if you're doing it, let's say within a life insurance company or a brokerage firm or what have you, that you remain in the same type of vehicle and get the same type of annuity let's say from the same company that usually will allow you to move from type to type kind to kind so you don't want to go from one annuity contract to another that's vastly different and especially you don't want to do it when you're talking about before your contract is over because there are very steep surrender charges taking your money out and those surrender charges can be upwards of like 10 percent and it really depends sometimes they go down like it's 10% during the first three years, then it goes down to 8% for the next couple years. And then, you know, five, three, two, one, it just depends. Because they're all written a little bit different. But the surrender charges are to prevent you from taking your money out prior to the end of the contract. Because what the investment company does is they take all the money that's in that annuity, they go out and they buy financial products that make that money grow. So of course, they have to pay you x interest, but they are to pay that and then of course they're going to make money off of whatever they've invested in there are other contracts like variable annuity now those are tied to the market so let's say you were thinking about an annuity and you knew that you had again a long term time frame and you're willing to take some risk so What is suitable amount of risk for you? Again, that depends on you. And you can look at how conservative you want to be, how aggressive you want to be, and maybe you've got a certain pot of money that's very aggressive, and maybe you want this to be a very conservative part. So it kind of balances out your portfolio, or just the reverse. You're willing to take more risk on this money because maybe it's the smallest portion or smaller portion of your overall portfolio. That all depends on you. So nevertheless, let's just say that you're at least moderate in terms of your willingness to take risks. So moderate could be, again, a balanced portfolio, something that stocks and bonds, or it could be just maybe something that's just in equities, and it's very diversified. All again, really depends on what is suitable in regard to the amount of risk you're willing to take. And again, you can decipher that for yourself, work with your financial professional to kind of come up with the right mix. So a variable annuity is something that is tied again to the market. So meaning the underlying investments in the accounts are all tied to the market they get invested and in stocks and bonds and whatnot those financial products that go up and down as the market goes up and down sometimes that has a positive effect sometimes it's negative overall you're hoping that now versus later on that your contract has grown and that your money has grown and that you've made money in this this overall purchase that you've made for this financial product so again you know future pro performance is not an indicator of excuse me past performance is no indicator of future performance and you just really want to look at the history and is this a strong company and what are the ratings because you don't want to go by with some fly-by-night company and again you want to know that the fees are reasonable they're not going to you know eat you alive and are the surrender charges again customary reasonable and will you need this money and the answer to that should be no i don't need this money i'm willing to put it away for x number of time or years so that would be money of course you don't need today for whatever reasons now if there is a situation that comes along that's unforeseen and you need some money usually after the first year that they will typically allow you to take out 10% and that 10% you can move it if you wanted let's say you want to you made some money in the contract and maybe you want to take that gain and you want to move it into something else that's a possibility right so you're not in necessarily going to take it out of the annuity and you are going to suffer an early withdrawal charge from the irs that says hey are you under 59 and a half yes if i am well now you have to pay taxes on that money so you want to keep it um in the same vein meaning you want to go from ira to ira or from annuity to annuity you have to go from like to like so that you don't incur any early withdrawal penalties. But if you want to move that money, that 10% from like to lack, you can usually do that. And the finance, the investment company can typically can typically help you do that you just submit the transfer paperwork and do a 1035 exchange and move it from like to like. So again, that really just depends, but that can typically be done. Now, let's say that you're unsure of, you are meaning what are you actually investing in again you want to work with your financial professional you want to get a copy of the prospectus and you want to look through it and is this again a reputable company that i'm going to be doing with doing business with today because are they going to be there in 10 years and 20 years or whatever your contract is so because you can go contract to contract to contract until you reach that age where you decided to annuitize your contract because usually what happens with an annuity is at some point in your life let's say when you reach retirement and you've started to maybe draw your social security and you've started to withdraw from some of your IRAs now this annuity can either be just again a regular straight up annuity where you again cannot pull the money out before you're 59 and a half and has that tax deferred advantage or it can be an annuity inside of an IRA so you would go sometimes why would I do that why would I put a tax-deferred vehicle inside of another tax-deferred vehicle? Well, the reason is because usually if, let's say, it's a 10-year annuity and that 10-year runs out, maybe this company doesn't offer 10-year annuities any longer. Who knows, right? So let's say you had $100,000 in that annuity and it comes due in that 10 years. Well, that contract is over. It's still inside of the IRA. But that actual contract that you have is gone. So that money has to be moved into something else. So you could do a 1035 exchange and go from annuity to annuity or you don't maybe you don't want another annuity, right? You're like, done had my fill of it. Let's do something else. As long as long as it's in an IRA, then you can transfer it from one IRA to another and you could go into let's say mutual funds. Or maybe you want to go into a short term bond fund because you're going to be using that money in a relatively short period of time or what have you it all depends because maybe you don't want to annuitize your contract but if it does come to the point that let's say you're 70 and you decide to annuitize that contract because you want to supplement your income then you just pull the trigger and you can choose to annuitize your contract based on your life expectancy it could be a single life expectancy just yours. It could be a joint life expectancy, you and your spouse. That really depends. So the payouts are going to be higher based on the annuitization option you choose. So meaning if it's just based on my life, the day that I die, then boom, the contract is over. Where's that money go? Usually goes back to the insurance company unless you've chosen a beneficiary or that is an option. Because some immediate annuities, when you annuitize the contract, the high payout is single life just as long as I'm alive the day that I die boom it's over the insurance company gets the remainder of the money so a lot of people don't like that but many people do because they're like I want as much money as I can get because I don't plan on anybody else getting this money I don't care if they get it or not I'm the only one who needs it hey that's strictly up to you nobody's going to tell you what to do I've seen many many many many people do that especially let's say if the spouse has died and the surviving spouse gets this, then they want to annuitize it and they don't really care. But a lot of people have a lot of money that, you know what, at the end of 10 years, they are never going to use that money. Then you aren't going to annuitize it and you can just transfer that to the beneficiary. So that is all depends on how you set it up. And you really want to work with your financial professional to construct a portfolio and to review your entire estate plan. And we'll be getting into estate planning and how that works especially as it relates to retirement but back to annuitization again if you're basing basing this annuity annuitization and this contract on two people you and your spouse let's say then it's based on both your lives you die it'll continue on to your spouse and when that your spouse dies again same thing does the contract end all together boom it's over and done with or do does somebody get the remainder and that just really depends the lowest payouts are going to be based on that kind of payout structure where the beneficiary gets some so the higher payouts are going to be where the beneficiaries get none so if you are really concerned about you and your spouse and that is maybe your kids are fine they don't really need your help they don't really need this money then maybe that is the right thing to do especially as it goes in regard to let's say if you're doing some long term care planning and you're looking at hey how do I structure this so I can use this money when I need it to take care of myself when I can no longer do that. So that is certainly an option and what a lot of people look for. Because when you go into a long term care facility, it's usually based on a daily rating, you want to be able to know that you can afford that without having to deplete all of your assets. Let's say if you're trying to go on something like Medicaid and get them to pay for your long term care, because you have to be essentially destitute for any government assistance in that regard. because they're going to make you go through your assets. They're not going to make you essentially use them, but they're going to say, well, why is this money sitting over here and you're asking for government help? Well, I want that to go to my beneficiaries. Well, no, you really need to use that for yourself because why in the world would we pay for that for you when you've got the money, right? So use it. That's what it's there for. All of those things want to be taken into consideration and you really want to work yourself through it. But I do remember one gentleman one time that he reached the age of 90 and he had a whole series of contracts and he did not want to take the money he wanted to continue to invest and the insurance company said no sorry contract is over year 90 you know basically you're near death and you're going to die anytime so we're not going to allow you to go into another contract we're going to say you need to take your money and do something with it so in the contract that he had chosen unfortunately the only distribution option that he that this contract allowed him was annuitization that was it he had to annuitize the money there was no your contracts over it stays in a lump sum and you can move it that wasn't an option it was you have to annuitize it now he did not like that at all and he went you know through all the chains of command trying to get somebody to agree to let him do this nobody would do it and that was it and even though he had a lot a lot of money he had to take this money in in the series of payments now you could always do as you know whatever is suitable for you but the insurance company can always help you do that speaking of that annuities are usually offered by insurance companies so like you know the new york life etc those are usually the companies you're going to be dealing with when you're talking about annuity now it's not always 100 that way there's a lot of investment companies that offer them as well but usually they'll be using a life insurance company and offering those financial products via that insurance company and that that's here and are there it just means that if you want to dig around and you want to look at this insurance company then you want to go to the insurance commissioner and you can investigate the company and see if there have been any complaints and see if you know they're continuing to get the blessing from you know the the insurance commission but you know nevertheless that's just kind of how that works so accumulation and distribution and distribution to It depends on what you sign up for and how you decide to take it. And then if that timeframe comes, you either won't need or don't need the money, then you can annuitize your contract or typically not. So, and then move it into something else, wherever you want to invest in. Now, a lot of times in a 403B teachers, that's a tax deferred vehicle for them, similar to a 401k for non people who don't work in the public sector private sector sector private sector people get 401ks for the most part so anyway in a 403b then teachers are typically able to invest only in an in an annuity that may be their only option so they put money weekly monthly what have you into this tax deferred vehicle for their retirement they also might be able to invest in mutual funds via 403 And that depends because not all school districts have to offer both. They may only offer one. I think it's more common now for them to offer both. But I know plenty of school districts that, again, only allow their teachers to invest strictly in an annuity. And there's lots of different kind of annuities. They don't make them usually choose one specific one. But sometimes the 403Bs are tied to an entity like an investment company. And then they have to use the products from that company. All depends. There's a lot of different mechanics that go along with that. And sometimes teachers, it depends on their circumstances. You know, let's say their spouse is doing very well and they're just working, you know, to keep themselves busy and they don't really need the money that they're earning. Then that money can just be simply socked away and go into the retirement vehicles and max out their 403B. And they can also max out if they have the option for like a 457 plan. All depends. Really depends on your unique circumstances and what you're able to do and you want to again work with your financial professional to construct a strategy that works for you so all that being said annuities they sound kind of strange and they don't really have I think the best reputation I know there's some financial professionals out there that really bash them and they have like all financial products been misused at times sold to the wrong people for the wrong reasons like would I say sell an annuity to somebody who's 24 years old Not likely, right? The reason why is, again, because that money is locked away essentially forever until you're 59 and a half. If you're 24 and you're putting money into an annuity, are you going to be needing that money for a certain reason at a certain period of time? Like, are you using that money that's in an annuity to, let's say you're hoping to use it for a down payment on a house. If you're going to, let's say, save for 10 years, you don't want that money stuck in an annuity. that would not be suitable for you and certainly wouldn't be appropriate. And why is that person selling you an annuity when you don't really need one? So you want to look at and really try to understand why am I buying what I'm buying and is it suitable for me? If you're getting into a contract that doesn't meet your needs, you can always typically get out of it if it's completely unsuitable for you. And you can always make a complaint, et cetera, and get out of it if it depends on how long you've been in the contract. But usually there's a seven day period where you can simply get out. But once you sign that contract and you've let this thing run, then it's going to continue to run. And if you need your money, you know, usually you're only going to be able to get that 10% out or you're going to break the contract and suffer the surrender charge again, which can be very high. And then you're just losing money all the way around. Not a good thing. And again, if you're in an investment vehicle, that's maybe too risky for you. You want to continue to monitor that on a regular basis. is so that this level of risk is appropriate for you you might have been very bullish initially and you're like this market is doing terrific and I want to continue to just throw all my money on it I'm willing to take as much risk as possible and boom you know you're doing fantastic and then several years the bottom falls out of the market and you're like oh my god I've lost so much money in this I need to get out of this I don't know what I was thinking well that may or may not be the an option for you really depends on how you set it up so you want to be careful conscientious and do a very thorough suitability review and a risk tolerance profile with your financial professional so you get in the right thing at the at the beginning and then you monitor this contract as time marches on so again you aren't faced with an ugly surprise that's really a pretty much it again fees and surrender charges those are all a part of the contract and you want to look at how all this ties in most financial professionals do get paid via commission when they sell you an annuity not 100% and again hey this person has to eat too but they should be able to sell you something that's 100% suitable for you and that way you feel comfortable paying this person whatever they earn on this commission you can just again you should simply ask them up front and they should be able to tell you or show you and so that hey everything's transparent and you know exactly what you're doing and all the features of this annuity need to be explained to you 100% so you know exactly what you're buying. So are annuities a bad thing? No. Are they a good thing? Yes. Are they for everybody? No. So you need to just determine, is it the right thing for me at the right time? It doesn't mean you can never get into one. It just maybe means if I'm under 30, I really want to think about it. Unless you're a teacher again and that's the only option for you, then hey, you got to do what you got to do because you want to put money aside for your retirement and you probably aren't going to need it anyway until you're 59 And you need to start investing early or saving money as soon as you can. So if you're in your 20s, the only thing you have available is a 403B. And the only option is an annuity. Do it. You have no choice. Do it. As long as, again, this is money that you're not going to need. Now, if you're just unsure, put your money into an IRA, like a Roth IRA. You still get that tax-deferred vehicle working for you, right? And you still can put money into your 59 and a half. And that money, though, in a Roth IRA, at least, is money that you can get into and withdraw it if there's a circumstance or situation where you absolutely have to get into that. We'll go in to another whole podcast about IRAs and how they work and the different kinds, et cetera. But we'll leave that there for right now. But there's different strategies again, and you just want to make sure, going back to the whole thing about suitability and risk, those two components work hand in hand. And you really want to get that right from the get-go, monitor that on an ongoing basis. Hopefully that helps everybody. And if you have questions about annuities or anything else, you can reach me, jerry, at pinkmoneyonline.com. There's lots and lots of resources out there that you can use to your heart's content, do all kinds of research, etc. I think talking with an experienced financial professional is sometimes the best way. And look at these if it's suitable for you and you have some interest and you've got some money and want to put it away. It can be a fantastic vehicle. Again, there's fixed, variable, equity index, etc. All those really go hand in hand. They're not overly too complex just have those two features accumulation distribution and you may or may not just pull the trigger and annuitize your contract depends so anyway thanks for joining me today reach me on Pink Money Jerry at PinkMoneyOnline.com or through Instagram Facebook you'll find me out there as well so anyway you guys have a great day I look forward to talking with you next time

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