MONEY Master the Game: 7 Simple Steps to Financial Freedom (64 page)

How could Babbel commit what his Wall Street buddies call “annuicide”?
Annuicide
being the term that brokers first coined for a client who withdraws money from the stock market and uses age-old insurance companies to guarantee a lifetime income. Brokers see it as an irreversible decision that no longer allows them to generate revenues from your investment. The death of
their
profits.

Come to think of it,
when was the last time your broker talked to you about creating a lifetime income plan?
Probably never. Wall Street typically has no interest in promoting concepts related to withdrawal. To them,
withdrawal
is a four-letter word. Here is the irony: you represent a lifetime of income for the broker so long as you never leave.

Americans should convert at least half of their retirement savings into an annuity.

—US TREASURY DEPARTMENT

Dr. Jeffrey Brown knows a thing or two when it comes to creating a lifetime income plan. He is an advisor to the US Treasury and the World Bank, and is one of the people called on by China to help evaluate its future Social Security strategy. He was also one of only seven individuals appointed by the president of the United States to the Social Security Advisory Board.

Jeff has spent most of his professional career studying how to provide people an income for life.
What did he resolve? That annuities are one of the most important investment vehicles we have.

Jeff and I had a fascinating three-hour interview around income planning and how baffling it is to him that income is omitted from most financial
planning conversations. How is it possible that income insurance is barely discussed in the offices of most financial planners, nor is it included as an option inside 401(k) plans, the primary retirement vehicle for Americans?

I asked him, “How do people find a way to protect themselves so they really have an income for life when they are living longer than ever before? They’re retiring at sixty-five, and today they’ve got twenty or thirty years of retirement income needs ahead of them, but their financial plan won’t last that long. What’s the solution?”

“The good news, Tony, is we actually do know how to address this problem,” he said. “We’ve just got to get people to change the way they are thinking about funding their retirement. There are products out there in ‘economist land’ that we call annuities, which basically allow you to go to an insurance company and say, ‘You know what? I am going to take my money and put it with you, you’re going to manage it, grow it, and you’re going to pay me back income every month for as long as I live.’
The easiest way to understand this is, it’s exactly what Social Security does. With Social Security, you know, you’re paying in over your lifetime while you’re working, and then when you retire, you get paid back income every month for as long as you live.
You don’t have to be limited by Social Security; you can expand your lifetime income by doing this on your own as well.”

Jeff and his team performed a study where they compared how annuities were described, or “framed,” and how the shaping of that conversation completely changed people’s perceptions of their need or desire for an annuity.

First, they portrayed them the way stockbrokers do: as a “savings” account or investment with relatively low levels of return. Not surprisingly, only 20% of people found them attractive. Sound familiar? You can hear the broker saying, “Annuities are a bad investment!”

But when they changed just a handful of words and described the
actual
and
real
benefits of an annuity, the tide changed.
By describing the annuity as a tool that gives you a guaranteed income for the rest of your life, more than 70% found them attractive! Who doesn’t want income insurance that kicks in if you have burned through your savings? Maybe your cost of living was greater than you expected. Maybe you had an unexpected medical emergency. Or maybe the market didn’t cooperate with its timing of returns.
What a gift to know that your future income checks are just a phone call away.

And today a revolutionized financial industry has created a whole new set of annuity opportunities. Many of these pay you returns that mimic the performance of the stock market but carry none of its downside losses. Annuities aren’t just for your grandpa anymore.
Turn the page, and let me show you the five types of annuities that could change your life.

16
. Insurance guaranty associations provide protection to insurance policy holders and beneficiaries of policies issued by an insurance company that has become insolvent and is no longer able to meet its obligations.
All states, the District of Columbia, and Puerto Rico have insurance guaranty associations.
Insurance companies are required by law to be members of the guaranty association in states in which they are licensed to do business. Each state has its own maximum amount that you are covered up to, and in most states, that varies per person up to $300,000 to $500,000.

17
. Dr. Anthony Atala, director of the Wake Forest Institute for Regenerative Medicine, has been creating and implanting organs like this for more than a decade.

CHAPTER 5.4

TIME TO WIN: YOUR INCOME IS THE OUTCOME

The question isn’t at what age I want to retire, it’s at what income.

—GEORGE FOREMAN

Annuities have long been the whipping boy of the financial industry. When I first heard the concept of using an annuity a few years ago, I scoffed. I had been conditioned to believe that annuities are bad news. But when challenged, I didn’t really have a solid reason why I thought they were bad. I was simply picking up my torch and pitchfork like the rest of the mob.

But the conversation has been shifting. Imagine my surprise when I was handed a 2011 issue of
Barron’s
with this cover line:

“Best Annuities—Special Report—Retirement: With Their Steady Income Payments, Annuities Are Suddenly Hot.”

Barron’s
? The classic investment magazine, with an annuity cover story! Is the sky falling? I flipped open the pages, and there it was in black and white:

“Now, as baby boomers approach retirement with fresh memories of big market losses, many sharp financial advisors are recommending an annuity as an important part of an income plan.”

Wow. Annuities have been given quite the promotion lately. From your grandpa’s annuity stuffed away in a dusty drawer to the hottest product recommended by sharp financial advisors. But guess what?
Annuities are not just for retirees any longer. More often, younger individuals are starting to use annuities, specifically those where the growth is tied to a market index (such as the S&P 500), as a “safe-money” alternative.

To be clear, they are
not
an alternative to investing in the stock market, or a way to try to beat the market. We already made it quite clear that nobody beats the market over time, and as Jack Bogle and so many others have echoed, using a low-cost index fund is the best approach to investing in the
markets. But certain annuities, specifically those “linked” to market returns, can replace other safe-money alternatives such as CDs, bonds, Treasuries, and so on—and
offer superior returns.

But I am getting ahead of myself! Let’s take a moment to do a quick overview as to what’s available today and what’s coming soon.

First, let’s be clear: there are really only two general categories of annuities:
immediate annuities
and
deferred annuities.

IMMEDIATE ANNUITIES

Immediate annuities are best used for those at retirement age or beyond. If you aren’t there yet, you can skip over this page and go right to deferred annuities, or you can keep reading because this might be applicable for some special people in your life, such as your parents or grandparents.

Simply put,
immediate annuities beat every other potential vehicle for providing a guaranteed lifetime income
for one reason: a concept called
mortality credits.
I know it sounds gruesome, but it’s really not. Remember how annuities got their start 2000 years ago in the time of Caesar? For hundreds of years, insurance companies have successfully guaranteed lifetime incomes for millions of people because when a bunch of people buy an immediate annuity, some people will die early, while others will live a long time. By “pooling” the risk,
the annuity buyer who lives a long time gets the benefit,
while those who die early leave some money on the table. But before we shun the potential of leaving some money on the table, let’s look at the power of annuities when wielded appropriately.

2,750% MORE INCOME

My son Josh has been in the financial services industry his entire adult life. He was telling me a story about a client of his who came to him ready to retire. He had just turned 65, and over his lifetime he had managed to sock away about $500,000. He needed a secure income stream, and he felt taking risks in the market was not an option. Sadly, his former broker had him allocated to a very aggressive portfolio, which resulted in a near 50% drawdown
in the 2008 crash. It wiped out hundreds of thousands of dollars that had taken him a full decade of hard work to sock away. And like so many other people, he’d barely gotten back to even, and now he was more afraid than ever of running out of money.

He wanted his income checks to start immediately. So Josh began to walk him through his limited options.

• He could go to a bank, and a CD would pay him 0.23% (or 23 basis points) per year. This arrangement would give him $95.80 per month in fully taxable income for a $500,000 deposit. That’s a whopping
$1,149 a year
—before taxes. Don’t spend it all in one place!

• Bonds would pay him closer to 3% per year, or about
$15,000 a year
before taxes, but the risk that option would entail would be if interest rates rise. This would cause the value of his bonds (his principal) to shrink.

• Josh showed him that a $500,000 deposit into an immediate lifetime income annuity, as of today would pay him $2,725 per month or
$32,700 per year,
guaranteed for life!
¹⁸
That’s a 2,750% increase over CDs and an 118% increase over bonds, without their risk.

At today’s life expectancies, this man has at least 14 more years to live, and if Ray Kurzweil is right, he could live well beyond that! When he added this guaranteed income to his Social Security payments, he had more than enough to maintain his standard of living and could spend his time focused on what mattered most to him: his grandchildren and fishing.

Do you see the power here? When compared with any other type of “sure thing” investment, he will certainly run out of money. But with an immediate annuity, which is really a form of income insurance, he has protection for life.

Critics will say, “Yes, but if you die early, they keep your money! You will have left that money on the table.” When I asked David Babbel about this concern, his response was swift and blunt:
“If you are dead, who cares?! What’s painful is if you live too long with no income—that’s when you’ll really suffer.”
And if you are really worried about premature death, you can select an option where the insurance company will refund your heirs the same amount you put in. (This arrangement, however, will decrease the size of your income payments, so there is a trade-off.) Or as David recommends, use an inexpensive term life insurance policy. So if you live a long fruitful life, you win because you have income insurance. Or God forbid, if you pass early, with a life insurance policy, your heirs win as well.

CONTROL IS AN ILLUSION

We all love control. But control is often an illusion. We think we have control over our health, our finances, our kids—okay, maybe not our kids. But we all know that things can change in the blink of an eye. A storm can cause your house to flood (as it did to my brand-new home in Florida after a torrential rain had my wife and I wading through 12 inches of water at three in the morning). Or you could get a callback from the doctor after a supposedly routine checkup. The point is, control is often more of an illusion than a reality.

Stockbrokers will tell you that by handing your money to an insurance company in exchange for a lifetime income, you are “losing control” of your principal. Let’s look at this a little more thoughtfully. Say you are 60 years old and have accumulated a $1 million nest egg. Your broker advises the traditional approach of stocks and bonds, and you apply the 4% rule for your income (which means you’ll be able to take out $40,000 per year). The reality is you will need every bit of that $40,000 to pay your bills. You know your money needs to be invested, so you really can’t afford to touch your principal.
And what happens if the market drops?
You don’t want to sell at the bottom, but at the same time, you may also feel that you can’t afford more losses at this stage of life. You are between a rock and a hard place.
This so-called control is an illusion. Floating with the whims of the market waves and hoping the tide turns in your favor can be a recipe for disaster.

Remember, our focus is not just on asset growth. Our theme is:
guaranteed income for life!

It is better to have a permanent income than to be fascinating.

—OSCAR WILDE

DEFERRED ANNUITIES

Okay, so we said there are two general types of annuities. You now know what an immediate annuity is: you give your money to an insurance company, and it immediately starts to provide you with an income for life.