Demystifying annuities: Fixed, variable and beyond

I'm Benny and today I'm going to answer a common question I often get asked as an actuary. What exactly is an annuity and how could it help me in retirement planning? Stick around, because understanding this can make a big difference in your financial future. When I'm asked that question, it's usually by people about to retire who hear about a product that allows you to pay a lump sum and turns into a stream of lifetime income.

So let's start by comparing it to a product you probably are familiar with. Life insurance. Life insurance protects your loved ones in case of an early death. You pay the insurance company regularly, whether that's monthly or annually. And if you pass and when you pass away, your family will get a lump sum payout.

A lifetime income annuity is exactly the opposite. It doesn't protect your family. In case of an early death, it protects you in case of a long life. In this case, you give the insurance company a lump sum and they send you back a regular payment, typically once a month for as long as you live With a fixed annuity, you get the same payment every month for the rest of your life.

The goal of the annuity is to reduce what's called longevity risk, the possibility of outliving your money. Now, why would someone want to give the insurance company a lump sum in exchange for this promise? Here are the three reasons. Number one licensed to spend. This term was created by Professor Michael Finca, and it refers to the fact that income protection of annuities gives retirees the confidence to spend.

Knowing you're going to get a check next month allows you to spend the money this month. It gives you the permission to spend the money without an annuity. Retirees have to withdraw from a shrinking retirement account, something many are hesitant to do. In many cases, it means they spend less than it could have otherwise.

Second, it reduces market risk of fixed annuity, helps reduce the impact of a shrinking stock or bond market. The same check from the insurance company is going to hit your account whether the stock market is up or down. If retirees only rely on withdrawals from a retirement account, and the market has a downturn that might cause them to withdraw less money, putting their crimp on their lifestyle.

And if a bear market happens early in retirement, that could have an impact for many years. Number three maximizing income. We need to compare the annuity to what retirees would do with that one. For many, they rely on the 4% rule, which says you can withdraw 4% of your retirement balance in the year of your retirement.

Meaning, if you have a $100,000 balance, you can pull out $4,000. On the other hand, a $100,000 annuity can produce much more income than $4,000. Feel free to call your retirement provider or do an internet search and see how much more. On the other hand, with that said, there are three important considerations.

Number one, we have to talk about inflation risk, getting the same check every month for the rest of your life. While inflation eats away at the value means you're actually purchasing less goods each month. Number two, once you annuities and start receiving income, you cannot change your mind. There's no boxes.

You no longer control this money. And number three, we have to talk about legacy planning. First. For those of you with a spouse or a partner. Annuities do have options to protect them after your death. But more important, this is only a tool for a portion of your portfolio. No one would say to take all your income and buy life insurance.

You should not be taking your retirement portfolio entirely and buying an annuity even after the purchase of an annuity. You still retain control of some or even most of your assets. To wrap up, an annuity can be a great tool for retirement, offering license to spend, reducing market risk, reducing longevity risk, and potentially providing higher income.

Just remember, it's used for only a part of your overall retirement portfolio. If you want to hear more. Please click like, share and subscribe.

Hello, I'm Benny. In a past video, I described a fixed payout annuity, a product that can turn a lump sum into a check every month for the rest of your life. We noted it provided longevity protection and protection against market risk, but we also said it did not provide protection against inflation risk.

Which brings us to today's video. The variable payout annuity A variable payout annuity allows you to turn accumulation into a monthly check for life. The difference is the word variable. Whereas a fixed annuity has a steady guaranteed payment, a variable annuity payments can go up or down based on returns of the underlying investment.

There are many ways companies determine variable annuity income payments. So let me start by talking about something I call a pure variable annuity. Initial income is set using an assumed investment return, say 4% and some standard mortality table. And at age 67, for every $100,000 you give the insurance company, the insurance company will pay you about $6,600 a year.

This is typically lower than the fixed annuity will pay, but certainly higher than the 4% rule we have mentioned in prior videos. Now, in the future, if the underlying stock based fund earns more than 4%, you will get a raise. For example, if the fund earns 10%, you'll get a 6% raise. If the fund earns 30%.

You'll get about a 26% raise. On the other hand, if the fund goes down, you will get a reduction. In fact, even if it earns 0%, you will get a 4% reduction in your income. A bear market with a 20% loss, you can have a 24% reduction in your income. I should note these numbers are not exact, but let's just go with it.

Payments can also change if mortality is higher or lower than expected. Historically, that has been minimal because the actuaries who price these things are pretty good at predicting death. So that means you're going to be getting a check for life. You just don't know how big it's going to be. So why would someone want to give the insurance company money in exchange for this promise of future payments for life, but of an unknown payment amount.

Well, again, aside from protecting against longevity risk, since you will be getting a check every month for the rest of your life. Historically, this type of product would have protected you against inflation risk. As long as the underlying fund has a high enough return, payments over time will increase.

Over the past several decades, the stock market has averaged 9 or 10% a year, which means the average raise of a product like this has been 5 or 6%, which is a lot higher than inflation. However, we must point out past results are no guarantee of future events, and no one really knows what's going to happen to the stock market over the coming decades.

And even using past returns with their high average returns, there is still a market risk associated with this product or bear market like we saw in 2001, 2002 or the 2008, 2009 or 2022 resulted in reduced payments, sometimes dramatically. This is why this product, much like the fixed annuity product, is only meant for part of your retirement portfolio.

Not all of it. There are other variable annuities out there that can protect against some or all of the downside risk. But in exchange for limiting the upside potential, some variable annuities that offer downside protection start with a lower income, let's say $5,000 per 100,000 instead of the 6600 I mentioned earlier.

Other variable annuities or for lifetime income while still allowing access for cash and yet others offer a death benefit. To summarize, a variable pad annuity offers lifetime income of unknown amounts. A variable annuity comes with the potential for increases, along with the risk of potential income reductions.

Historically, variable payout annuities have produced income streams that increase over time, helping to offset or even beating inflation, and because of the potential for inflation protection. Along with the longevity protection, we believe this product should be a piece of an overall diversified retirement portfolio, along with a fixed annuity and an investment account.

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Hi there. My name is Benny and I've been thinking about the concept of retirement for a long time. First professionally as an employee of Tii and more recently on a more personal level, if you know what I mean. What is retirement? Okay, we all know it means you no longer working or maybe not working the jobs and hours you used to work, but more bluntly, it means you're not getting paid the salary you are earning, which is what makes the decision to retire a bit difficult.

How are you going to pay the bills for the rest of your life? Before we get there, though, you have to know. Do I have enough money to retire? So now let's talk about how we're going to do that. Step one you have to make a budget. How much do you spend every month? How much are you spending now? How much of that spending may go away?

Maybe your mortgage will be paid off. Maybe your last kid will be out of the house and off payroll. How much spending will increase? Maybe. Every day is now Saturday and Sunday, and you'll be spending more than you ever did before. Now, there are simple rules of thumb people could use, for example, 80% of your income today.

That's a good rule for people who are younger. But as you get closer to retirement, you really should be making a budget. Now that we've covered the spending side of your lifetime balance sheet, let's talk about step two. The income side of your balance sheet. How much income can you receive once you stop getting a paycheck?

If you haven't already done so, go online and create a log on on the Social Security Administration website and ask them for a statement. They have your earnings history and can tell you exactly how much income you're going to get. Whether you retire soon or delay retirement each year, you delay retirement.

You get more income, which might lead you to think you should wait a year or two until you retire. Now we could add in other income. Maybe you have an old defined benefit plan, maybe some real estate investment property or something else that will kick off income. Add that. Move along. Call your retirement vendor and ask them for an illustration of how much retirement income your account can generate and the kind of products they offer.

If you don't want to do that, you could use the other simple rule called the 4% rule. Take your balance. Multiply by 4% and that's the income you can draw from it. For example, if you have $100,000 in the first year of retirement, you could pull out $4,000. If you have a million, you could pull out 40,000. Now, lifetime income products can generate higher levels of income than a 4% rule, which is why I suggest calling your vendor and asking them what they can offer.

Next, you probably want to sit down with a financial planner to run somewhat if scenarios maybe help you with other planning strategies. Maybe there's a state wishes. Maybe there's tax planning strategies you want to deal with. If you're married and you have a partner, how can you best protect them? And last but not least, there's going to be a major change in your mindset.

Your whole life you've been told to save, save, save. But now comes the time in your life where you could spend. Yes, it's okay to spend down your nest egg in retirement. That's what you save for. And that's a change in behavior. That's a very tough nut to crack. Many people can't envision spending down their account and watching it shrink, but that's okay.

So there you have it. Try to create a best estimate budget on your spending. Get a Social Security statement. Call your retirement vendor and ask for an illustration. And speak to a financial planner and hopefully begin enjoying the rest of your life.

If you want to hear more, please click like, share and subscribe. Thank you.