Every year since 2014 when I purchased a fixed index annuity (FIA) with an income rider in my SEP-IRA, I have added $20,000 to it. Furthermore, I plan on continuing to do this until I retire.
Why did I purchase a FIA with an income rider in my SEP-IRA in 2014 and add to it each year? For the same reasons that I am making the recommendation to do so today.
Stock Market Euphoria is Cause for Evaluation
As I write this article, the Dow Jones Industrial Average (DJIA) is hovering at just below 31,000 after reaching an all-time high of 31,653.48 on February 22nd. The DJIA increased 13,440 points, or 74%, since its Covid low of 18,213.65 just 11 months ago on March 23, 2020.
While Covid-19 cases, hospitalizations, and deaths have all recently dropped and more people are getting vaccinated which has contributed to the sizable stock market increase, the party and associated euphoria will not last forever. With the exception of last year’s first quarter drop, the stock market has been on steroids since hitting a low of 6,469.95 on March 6, 2009 after declining 52% in 17 months beginning in October, 2007.
The DJIA has increased 480% in the last 12 years, or 40% per year on average, which is obviously not sustainable. Do the terms “bear market” or “reversion to the mean” ring a bell?
Pivot Into Sustainable Income
I have been extolling the virtues of making sustainable income the cornerstone of a retirement income plan since 2009 when I began specializing in retirement income planning. The 52% stock market decline in 17 months, combined with the elimination of secure lifetime income provided by private pension plans, created a perfect storm for implementing this strategy.
While my clients are happy with the 12-year increase in their portfolio values, I know from many years of experience that this state of exuberance is often short-lived. The reality is that their equity allocation is greater than what is targeted for their portfolio in several cases.
As a retirement income planner, I look for windows of opportunity for my clients to transfer slivers of their investment portfolio from the unpredictable fluctuation of the stock market to fixed income annuities that are designed to provide sustainable income that they can depend on throughout retirement.
There are three types of fixed income annuities that can be employed for this purpose: single premium immediate annuities (SPIAs), deferred income annuities (DIAs), and fixed index annuities (FIAs). Some FIAs have an income payout feature built into them while others require purchase of an income rider.
Add to Older Income FIAs
All payouts from fixed income annuities are calculated using mortality credits, or life expectancy, and current interest rates. If you invest in a SPIA or DIA today, your payout will be relatively low compared to three or more years ago because of declining interest rates. In the case of DIAs, this is true whether it is a new or an existing contract.
Income FIAs that were purchased between 2009 and 2018, including the one that I chose for my SEP-IRA in 2014, provide a unique opportunity for increased sustainable income payouts when new premium dollars are added compared to current SPIA, DIA and income FIA offerings. This is because the income payout for FIAs is calculated using a formula and the variables used to calculate the payout were more favorable and less likely to be tied to performance of the underlying contract accumulation value as is often done today.
The following four variables are responsible for higher income payouts in older income FIAs:
- Higher interest rates in the growth phase
- Wider availability of compound interest crediting in the growth phase
- Ability to extend initial growth phase interest crediting from 10 to up to 20 years
- Premium bonuses offered for longer periods of time, as much as five to seven contract years in some cases
Besides the more favorable variables, there was greater availability of flexible vs. single premium contracts. Funds cannot be added after the first contract year to a single-premium FIA. Flexible premium FIAs, on the other hand, allow for subsequent investments after the initial contract year. Some flexible premium FIAs do, however, place caps on the amounts of annual additions. Finally, qualified, or retirement plan annuities, such as my SEP-IRA, are subject to annual contribution limits.
Exercise Option to Extend Income FIA Growth Phase Interest Crediting
In addition to adding new premium dollars, anyone with an income FIA that was issued between 2009 and 2018 who has not begun taking income distributions should exercise their option to extend the initial growth phase interest crediting if this is available.
With the growing popularity of income FIAs beginning in 2009, a larger number of contracts offering the ability to extend interest crediting beyond 10 years are in play. If you have one of these contracts and have not started your lifetime income, it behooves you to exercise your interest crediting extension option.
This is a no-brainer since the crediting of additional interest, which can be for up to 10 years in some cases, will increase your income payout amount. The increase could be substantial if, for example, your contract provides for 8% compound interest crediting, you extend the growth period from 10 to 20 years, and you defer your lifetime income withdrawal start date.
Opportune Time to Purchase or Add Funds to Fixed Income Annuities
This is a great time to purchase or add funds to fixed income annuities as part of an overall retirement income plan given the continued escalating stock market highs. Shifting a portion of one’s investment portfolio to sustainable lifetime income at opportune moments is a proven long-term strategy, especially if you are within 20 years of, or in, retirement.
Employing this strategy can enable you to accomplish two important goals shared by all individuals doing retirement income planning: portfolio risk reduction and decreased likelihood of running out of money in retirement.
Surveys as well as personal and client experience show that having predictable retirement income results in reduced short- and long-term stress levels, fewer cases of insomnia, and less health issues in general. This unequivocally trumps the often short-lived euphoria associated with increasing portfolio values in a bull market.
