How a Trigger Rate Works Within Fixed-Indexed Annuities

“Hey Mike, I was pitched an annuity with something called a trigger rate. What is that, and is it worth it?” Discover the nuance found within fixed-indexed annuities and their cash value growth potential. Remember, there’s no such thing as a perfect investment, product, or strategy. 

Text your questions to 913-363-1234.

Request Your Wealth Analysis by going to www.yourwealthanalysis.com.

What is How to Retire on Time?

Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.

Mike: 00:05

Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, health care, and more. This show is an extension of the book, How to retire on time, which you can grab today on Amazon or by going to www.how to retire on time.com. My name is Mike Decker. I'm the author of the book, how to retire on time, but I'm also a licensed financial adviser, insurance agent, and tax professional, which means when it comes to financial topics, we can pretty much talk about it all. Now that said, please remember this is just a show.

Mike: 00:38

Everything you hear should be considered informational as in not financial advice. If you want personalized financial advice, then request your wealth analysis from my team today by going to www.yourwealthanalysis.com. With me in the studio today is my esteemed colleague, co host, friend, and mister David Frandsen. David, thank you for joining me today.

David: 00:59

Hello. Hello.

Mike: 01:01

Alright. David's gonna be reading your questions, and I'm gonna do my best to answer them. You can send your questions in right now to 913-363-1234. Again, that's 913-363-1234, or email them in at hey mike at how to retire on time.com. Let's begin.

David: 01:21

Hey, Mike. I was pitched an annuity with something called a trigger rate. What is that, and is it worth it?

Mike: 01:28

Alright. Well, there everything has a trade. Right? No such thing as a perfect investment product or strategy. And when we're talking about annuities, they're very complicated products.

Mike: 01:37

1st thing to understand high level, there are variable annuities. K? There are fixed indexed annuities, and there are fixed annuities. Let's quickly define those. First off, you've got fixed annuities.

Mike: 01:49

It's like a a CD from an insurance company. K? You just get it at a certain rate until a certain period of time. K? Check that off the list.

Mike: 01:56

Then you've got variable annuities, which variable annuities typically have higher fees. They invest in the market, so they're completely at risk. And the only reason why I see people using them, I've never actually sold one, but I've seen it used very few times, is you just have a lot of nonqualified assets that you're trying to shelter from a tax standpoint, and you want guarantee for life income. You might put some of those non qualified assets into a variable annuity with the intention of turning on income and to shelter the tax consequences of it instead of actively trading. I would argue, though, why wouldn't you just, I don't know, use long term capital gains strategies or other there's other ways to do it.

Mike: 02:33

But everyone's different. Right? I've never actually sold a variable annuity, but that's that's the one that you'll get these companies say, I hate annuities and you should too. They usually are referring mostly to variable annuities, the high fees, the risk, all the complications that are there. And then you have fixed indexed annuities, which have certainly become more popular.

Mike: 02:52

The idea of a fixed indexed annuity is that you put money into a policy for a certain period of time. And then every year or so, if the markets go up, if the index it's associated with increases in value, then you would receive credit into the policy. So they basically increase your cash value a certain amount. How does the crediting get structured? How do these fixed index annuities make money?

Mike: 03:17

Well, there's 3 ways. Typically, there's caps, spreads, and participation rates. A cap means you get everything up to a certain point. So let's say you have a 5% cap on the s and p.

David: 03:28

The cap, but you can't go beyond the cap. Right?

Mike: 03:30

Yeah. So if the s and p goes up 10%, 15%, 5%, doesn't matter. You were capped at 5%. So you just get that amount. K?

Mike: 03:39

There's a spread, which means the insurance company, in simple terms, gets the first part of it. So let's say there's a 3% cap on the S & P. They get the first 3% and you get everything after that. Spreads aren't as common anymore, based on what I've seen, but they exist. And then you have participation rates.

Mike: 03:58

So let's say you had a 40 or 50 percent participation rate of the S and P. If the S and P were to go up 10%, you'd get 5%. If it went up 20%, you'd get 10%. Right? Annuities are really not a vehicle for significant growth.

Mike: 04:13

The market will probably outperform fixed indexed annuities pretty much every year. So when you consider the product as a whole, why are you considering a fixed indexed annuity? Which is what this question I think is really about. It's to not go backwards. It's to transition to preservation of cash and use an annuity as a bond alternative.

Mike: 04:38

Because most people aren't as concerned about this trigger rate when they're using it for income. And annuities are typically structured to either be a bond alternative for cash growth. So better cash growth with less income. The income's not as competitive. Or maybe better income, but less cash growth potential.

Mike: 04:56

It's kind of 1 or the other. That's my opinion. I have to say that's my opinion. Right? Because there's always exceptions and nuance with this.

Mike: 05:03

Yeah. Broad statements are are difficult from a a suitability standpoint. The devil's in the details. But as a general rule, that's kind of how it works. Now you also have a crediting time frame.

Mike: 05:15

So every year, you might lock in the cash value, the growth, and then it resets a new floor. You can't go backwards every year. It resets that new floor. K. So s and p goes up 10%.

Mike: 05:27

Let's say you got 5% of that. Right? So you got 5% credited the policy. Then the next year, the S and P goes down. But you had a 1 year reset, so it can't go backwards after that 1st year.

Mike: 05:37

So instead of losing money, you just locked in there.

David: 05:40

Okay.

Mike: 05:41

But greed can settle in. So some annuities will have 2 year point to point crediting strategies. So if the 1st year is great, the 2nd year is terrible, but 2 years average 0, then you would get 0. Because it doesn't lock in until 2 years or 3 years or 5 years or 10 years. And so you gotta be very careful about well, there's more growth potential.

Mike: 06:03

Yes. But if you're trying to grow your assets, why are you really using an annuity? The market's really there for long term growth. The annuity, if used as a bond alternative, would be more appropriate, in my opinion, for preservation with hopefully better growth than a CD or Treasury. That's how I view it.

Mike: 06:21

And so insurance companies get very technical about these ideas of what could be. So this trigger, I believe I actually know the company that they just had a lot of marketing around this trigger concept. So I probably could guess which company, which product that they're talking about here. I I looked at it. I'm not recommending that to clients personally.

Mike: 06:41

But if it's the one I'm thinking of, it's around a 7% or so trigger rate. Here's what they mean. If the index let's say the S and P, that's the most common one. If the S and P were to be positive, regardless of if that was 1% or 10% or 20%, it would trigger a 7% crediting strategy. And if the market were negative, you would just get 0.

Mike: 07:07

And so it's simplified how you make money really down to if the markets up, you get, let's say, 7%. If the market's down, you get nothing. And the market typically makes money. Most years, I think it makes double digit returns. Like, 60 plus, 60s to 65% of the time somewhere around there, it's made like double digit returns.

Mike: 07:29

But the s & p also can crash every 7 or 8 years or so.

David: 07:33

Mhmm.

Mike: 07:33

And so there's this trade and the simplicity creates comfort. Comfort has a cost. Simplicity has a cost. And so what are you trying to solve for? Don't go product first.

Mike: 07:46

Put the plan together first. Look at the strategies, and then maybe this could make sense to you based on your economic and emotional limits. You have to work within your comfort level. I get that. This is a it's a simple concept that's that's been rolled out by some companies, and it's kinda nice.

Mike: 08:06

Yeah. If the market is up in in any way, you know what you're gonna get. And 7% is a little better than a CD would offer right now. Right? And if the markets were to crash, you don't go backwards.

Mike: 08:18

But notice the emotional comfort here. When the s and p, majority of the time, has had actually pretty good returns, double digit returns, You're giving up more growth potential than maybe is necessary. And the growth annuities, the growth cash value annuities that I have seen, I believe they should be earning based on today's products, and these will change 7, 8, 9% cash growth is what I think they should be doing. If you do your due diligence right. Most annuities stink when it comes to cash growth because they're their income products and they can't be everything to everyone.

Mike: 08:58

But that's I think it's a little bit low personally, if it's the product I'm I'm thinking of. I think there are better ways to utilize these within a portfolio, and I think there could be better products out there. But that depends on what the Fed does. That depends on what insurance carriers offer. There's a lot of nuance in there.

Mike: 09:15

So you've got to shop. You gotta do your research. You gotta vet these things. But that yeah. That's my opinion.

Mike: 09:21

The trigger, it's simple. People get it, but there may be a cost because it's so simple.

David: 09:26

To me, this sounds like if you have the mindset going into an annuity that, hey. This isn't a big, like, income maker for me. This is to keep my cash. And if I get a little bit extra, that's some icing on the cake. But if I go into it knowing that this is more of a preservation that I can fall back on rather than, oh, I'm gonna get rich off this.

Mike: 09:44

Annuities don't make you rich.

David: 09:45

Yeah.

Mike: 09:46

They don't. It's preservation. That's the correct mindset. A fixed index new to use as a bond alternative. The objective really is, can I get more cash growth from this vehicle than a CD or treasury, which also offers protection?

Mike: 10:02

That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility.

Mike: 10:28

This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date. Go to www.yourwealthanalysis.com today to learn more and get started.