Tag: indexed annuity

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Annuities Celebration Income Tax Planning IRA Retirement Income Planning Roth IRA Social Security

Retirement Income Visions™ Celebrates 2-Year Anniversary!

Retirement Income Center

Thanks to all of my subscribers and other readers, Retirement Income Visions™ is celebrating its two-year anniversary. Since its debut on August 16, 2009, Retirement Income Visions™ has published a weekly post each Monday morning, the theme of which is Innovative Strategies for Creating and Optimizing Retirement Income™.

As stated in the initial post two years ago, Retirement Income Visions™ Makes Its Debut, the importance of retirement income planning as a separate and distinct discipline from traditional retirement planning was magnified during the October, 2007 – March, 2009 stock market decline. Although the stock market experienced three positive and encouraging days this past week, the market volatility the last three weeks has only served to emphasize the need for a comprehensive retirement income plan.

Add to the mix the increasing instability of the Social Security and Medicare programs and the rapid decline of traditional pensions as a source of retirement income. Not to mention increasing life expectancies, soaring health care costs, and an economic situation ripe for inflation. Retirement income planning is no longer an option – it has quickly become a downright necessity.

Since inception, Retirement Income Visions™ has used a themed approach, with several weeks of posts focusing on a relevant retirement income planning strategy. This past year was no exception. The weekly posts, together with the customized Glossary of Terms, which currently includes definitions of 99 terms to assist in the understanding of technical subject matter, has contributed to a growing body of knowledge in the relatively new retirement income planning profession.

Going back a year, the six August 16 through September 20, 2010 posts completed a 36-part series on Roth IRA conversions. This was a very timely topic with the January 1, 2010 availability of this strategy to all taxpayers regardless of income level, combined with the ability to defer 50% of the reporting of income from a 2010 Roth IRA conversion to 2011 and the other 50% to 2012.

The September 27, 2010 post, Plan for the Frays in Your Social Security Blanket, began a 25-part educational series about Social Security. The first two parts discussed some of the historical events in connection with changes to the Social Security system affecting benefit amounts and delay in the commencement of receipt of benefits. The October 11, 2010 post, Do Your Homework Before Flipping the Social Security Switch, began a five-part series regarding various considerations in connection with electing to begin receiving Social Security benefits before full retirement age (“FRA”).

The November 15, 2010 post, Wait Until 70 to Collect Social Security? examined the opposite end of the spectrum, i.e., delaying the start date of receipt of Social Security benefits. The follow-up three-part series, Pay-to-Play Social Security, presented the “do-over” strategy, a little-publicized strategy for increasing monthly benefits in exchange for repayment of cumulative retirement benefits received.

The “file and suspend” and “double dipping” strategies for potential maximization of Social Security benefits were addressed in the next two two-part posts from December 13, 2010 through January 3, 2011, Breadwinner Approaching Social Security Retirement Age? – File and Suspend and Working? Remember Your Social Security Spousal Benefit When Your Spouse Retires.

Income taxation and associated planning strategies was the subject of the subsequent respective two- and four-part January 10 through February 14, 2011 series, Say Goodbye to Up to 30% of Your Social Security Benefits and Increase Your After-Tax Social Security Benefits. The February 21, 2011 post, Remember Your Future Widow(er) in Your Social Security Plan made the point that the decision regarding the start date of Social Security Benefits, in addition to fixing the amount of your retirement benefit, may also establish the amount of your spouse’s monthly benefit.

Retirement Income Visions™ Social Security series culminated with the three-part February 28 through March 24, 2011 series, Your Social Security Retirement Asset. These three posts discussed the importance of Social Security as an asset, perhaps one’s most important asset, in addition to its inherent role as a monthly retirement income stream.

With the media’s emphasis in 2010 on the two-year deferral of inclusion of income from a 2010 Roth IRA conversion as the motivating factor for pursuing this planning technique, I felt that there wasn’t enough attention given to the potential long-term economic benefits available through use of this investment strategy. Roth IRA Conversions – Don’t Let the Tax Tail Wag the Dog began a six-part series on this important topic on March 21, 2011 that ran through April 25, 2011. The May 2 and May 9, 2011 Roth IRA Conversion Insights two-part series followed up the Roth IRA conversion economic benefit discussion.

The importance of nonretirement assets in connection with retirement income planning was discussed in the May 9, 2011 Roth IRA Conversions Insights post as well as the May 23 and May 30, 2011 respective posts, Nonretirement Investments – The Key to a Successful Retirement Income Plan and Nonretirement vs. Retirement Plan Investments – What is the Right Mix? This was followed up with two posts on June 6 and 13, 2011 regarding traditional retirement funding strategies, Sizeable Capital Loss Carryover? Rethink Your Retirement Plan Contributions and To IRA or Not to IRA?

The June 20 and June 27, 2011 posts, Do You Have a Retirement Income Portfolio? and Is Your Retirement Income Portfolio Tax-Efficient? addressed the need for every retirement income plan to include a plan for transitioning a portion, or in some cases, all, of one’s traditional investment portfolio into a tax-efficient retirement income portfolio. This was followed by the July 5, 2011 timely Yet Another “Don’t Try to Time the Market” Lesson post.

The July 11, 2011 Shelter a Portion of Your Portfolio From the Next Stock Market Freefall began a new timely and relevant ongoing series about indexed annuities. This post was published just ten days before the July 21st Dow Jones Industrial Average peak of 12,724.41 that was followed by the beginning of a steady stock market decline coinciding with the final days of U.S. debt limit negotiations and Standard & Poor’s unprecedented U.S. credit rating downgrade, culminating with a closing low of 10,719.94 this past Wednesday. As implied in the titles of the July 18 and July 25, 2011 posts, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities and Limit Your Losses to Zero, this relatively new investment strategy has the potential to be a key defensive component of a successful retirement income plan.

As I did a year ago, I would like to conclude this post by thanking all of my readers for taking the time to read Retirement Income Visions™. Once again, a special thanks to my clients and non-clients, alike, who continue to give me tremendous and much-appreciated feedback regarding various blog posts. Last, but not least, thank you to my incredible wife, Nira. In addition to continuing to support my weekly blog-writing activities, she also endured my year-long family tree project that I recently completed. Well, sort of. Is a family tree ever completed?

Categories
Annuities Fixed Index Annuities

Do You Want to Limit Your Potential Gains?

Retirement Income Center

With Tuesday’s debt-limit deadline just three days away as I write this post following six straight sessions of declines in the Dow Jones Industrial Average, with a total loss of 581.17 points, or 4.6%, from its close of 12,724.41 on July 21st to 12,143.24 on Friday, the American public is understandably on edge. An investment in U.S. government bonds, a traditional safe haven, is no longer the gold standard in the face of a potential unprecedented imminent rating downgrade.

So the proverbial question, “Where do I invest my money?,” is often heard during these uncertain times. Last week’s post, Limit Your Losses to Zero, continued the discussion of indexed annuities, a defensive investment strategy that protects against, and eliminates, market losses. Unlike the value of a direct investment in a market index which fluctuates up and down in response to the performance of the particular index, an investor’s return in an indexed annuity is controlled. Losses are never realized, with minimum rates of return credited during market declines. Per the example in last week’s post, whereas an investment of $100,000 in the Dow Jones Industrial Average on October 9, 2007 declined in value to approximately $78,000 three years later, the same investment in an indexed annuity grew to approximately $113,000, or $35,000, or 45% more.

With an indexed annuity, there’s a tradeoff for having the ability to limit losses to zero. In addition to losses being controlled, gains are limited. If the return of the index to which the annuity is tied is positive, only a portion of the return, often times subject to a cap, is credited to your account. Let’s suppose for purposes of this week’s illustration that our investors, Dow Jones and Ann Uity invested the same $100,000 on December 31, 1996 instead of on October 9, 2007. Once again, Dow invests his $100,000 in a Dow Jones Industrial Average index fund and Ann invests her $100,000 in an indexed annuity tied to the S&P 500 stock market index. Ann’s indexed annuity has a minimum rate of return of 2% that she will realize when the index’s return is negative. Ann’s investment also has a cap of 5%. Gains are credited to Ann’s account, however, any increases in the S&P 500 stock market index in excess of 5% are forfeited.

How would Dow and Ann have done during the first three years since they each invested $100,000 on December 31, 1996? Per Exhibit 1, Dow’s initial investment of $100,000 would have increased to $122,641 on December 31, 1997, increased to $142,386 on December 31, 1998, and increased to $178,298 on December 31, 1999. Ann’s initial investment of $100,000 would have increased to $105,000 ($100,000 x 1.05%) on December 31, 1997, increased to $110,250 ($105,000 x 1.05%) on December 31, 1998, and increased to $115,763 ($110,250 x 1.05%) on December 31, 1999.

While Dow participated in 100% of the annual gains of the S&P 500 stock market index that ranged from a low of 16.1% to a high of 25.2% during each of the three years of the bull market, Ann’s gains were limited to 5% per year. Whereas Dow’s investment of $100,000 increased by approximately 78%, or an average of 26% per year, to $178,000, Ann’s investment increased by only 16%, or an average of 5.25% per year, to $116,000. Dow’s investment value of approximately $178,000 on December 31, 1999 was $62,000, or 54%, greater than Ann’s investment value of approximately $116,000 on the same date.

As we have seen, although the use of an indexed annuity limits your losses to zero, it also limits your participation in gains. Given this reality, should you invest in indexed annuities? As stated at the conclusion of last week’s post, if the pain of losing is greater than the pleasure of winning, it’s probably worthwhile to analyze how indexed annuities may work for you. As always, investment diversification should be the overriding consideration when designing any investment plan, especially a retirement income plan.

Categories
Annuities Fixed Index Annuities

Limit Your Losses to Zero

Retirement Income Center

When the Dow Jones Industrial Average declined by 7,617.48 points, or 53.8%, going from an all-time high of 14,164.53 on October 9, 2007 to a low of 6,547.05 on March 9, 2009 in just seventeen months, what did you do and how did you feel? Assuming you were in the stock market, did you remain fully invested or did you liquidate a portion, or maybe even all, of your holdings?

If you chose the latter approach, perhaps the pain of losing was simply greater than the pleasure of winning for you. If this was the case, indexed annuities may be a good solution for you. With an indexed annuity, your return can vary due to the fact that it is tied to a stock market index, however, it will always be positive. As stated in last week’s post, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities, there are two possibilities with indexed annuities:

  1. If the index’s return is negative, no loss is posted to your account. You will receive the minimum rate of return stated in your contract.
  2. If the index’s return is positive, only a portion of the return, often times subject to a cap, is credited to your account.

To illustrate the benefit of investing in an indexed annuity at the beginning of a sizeable market downturn, let’s take two investors, Dow Jones and Ann Uity, both of whom have $100,000 to invest on October 9, 2007. Dow invests his $100,000 in a Dow Jones Industrial Average index fund. Ann invests her $100,000 in an indexed annuity tied to the S&P 500 stock market index with a minimum rate of return of 2%. Although, as stated in last week’s post, the minimum rate of return may not be on the full premium paid into the policy, let’s assume that Ann’s minimum rate of return is credited on her full premium of $100,000.

Without getting into all of the various indexing methods available when investing in indexed annuities, let’s assume that Ann’s return is measured once a year on the anniversary date of her investment. Let’s further assume that Ann’s contract states that she will be credited with 100% of the percentage gains in the S&P 500 stock market index with a cap of 5%, i.e., her maximum percentage gain in any year is limited to 5%.

How would Dow and Ann have fared during the first three years since they each invested $100,000 on October 9, 2007? Per Exhibit 1, Dow’s initial investment of $100,000 would have decreased to $61,839 on October 9, 2008, increased to $69,645 on October 9, 2010, and increased to $77,705 on October 9, 2010. Ann’s initial investment of $100,000 would have increased to $102,000 on October 9, 2008 ($100,000 x 1.02%), increased to $107,100 on October 9, 2009 ($102,000 x 1.05%), and increased to $112,455 on October 9, 2010 ($107,100 x 1.05%).

Whereas Dow experienced a 38.2% loss in the value of his portfolio in year 1, Ann’s portfolio increased by 2% – her minimum rate of return. As a result, Ann’s investment was significantly greater than Dow Jones on each of the three anniversary dates, with a difference of approximately $40,000 on October 9, 2008, $37,000 on October 9, 2009, and $35,000 on October 9, 2010. Although Dow was credited with gains of 12.6% and 11.6% in years 2 and 3, respectively, vs. Ann’s gains which were limited to 5% in the same two years, Ann’s investment value of $112,455 was approximately $35,000, or 44.7%, greater than Dow’s value of $77,705 at the end of year 3. Given this differential, unless Dow experiences several more years of double digit returns without any losses, it will be very difficult for him to catch up with Ann.

Although an extreme example was used, with an investment at the peak of the market preceding a tumultuous slide over a relatively short period of time, it nonetheless illustrates the loss protection offered by indexed annuities during a market freefall. If the pain of losing is greater than the pleasure of winning, it’s probably worthwhile to analyze how indexed annuities may work for you.

Categories
Annuities Fixed Index Annuities

Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities

Retirement Income Center

Last week’s blog post introduced a type of investment that may not be familiar to many of you – indexed annuities. For those of you who missed it, an indexed annuity is basically a fixed annuity that offers a guaranteed interest rate for a set period of time. Two features of fixed annuities that have traditionally made them a preferred investment choice when compared to similar-duration CD’s are higher interest rates and tax-deferred growth.

Indexed annuities take it one step further. In addition to having the two aforementioned features, indexed annuities offer upside potential, i.e., a higher potential rate of return than traditional fixed annuities. While the higher rate of return isn’t guaranteed, there’s always a fixed rate of return that provides downside protection.

As such, indexed annuities fall in between fixed annuities and equity investments such as mutual funds and variable annuities on the risk tolerance scale. Unlike variable annuities, other than surrender charges for early termination that apply to all annuities, unless an income rider is added, there are no fees associated with indexed annuities.

How is upside potential provided by indexed annuities? Indexed annuities are a hybrid product, with returns directly tied to the performance of a stated stock index. Stock indexes measure the performance of a specified group of individual stocks. Some popular stock indexes include the S&P 500, Dow Jones Industrial Average, and NASDAQ, to name a few.

If you invest directly in an index, or any investment for that matter, the difference between the value of your investment and your original purchase amount equals your unrealized gain or loss on any given day. Unlike a direct investment in an index where you participate fully in all gains as well as all losses, there are two basic differences when you invest in an indexed annuity:

  1. If the index’s return is negative, no loss is posted to your account.
  2. If the index’s return is positive, only a portion of the return, often times subject to a cap, is credited to your account.

In other words, you won’t participate in losses, however, you also won’t fully participate in gains. In any given year, the floor for your return is a minimum rate of return that can vary between 1% and 3% and the ceiling is a portion of the gain in the index to which your indexed annuity is tied, both of which are defined in your contract. Depending upon the indexed annuity, the minimum rate of return may not be on the full premium paid into the policy.

If you don’t want exposure to losses, however, you’re unsatisfied with taxable CD rates and are instead seeking tax-deferred growth with an opportunity to increase your investment return by a portion of upside market returns, then you may want to consider diversifying into one or more indexed annuities. Stay tuned next week as we continue our series on this investment strategy.