The index, there's two categories in my mind, but you need to understand the economics of both. Welcome to the retire on time podcast. I'm Mac Dekker with Kedric Wealth here with David Fransen. We're answering your retirement questions. Text them to (913) 363-1234.

And remember, this is just a show. It's not financial advice. Keep doing your research even though we do like getting into the nitty gritty here. David, what do we got today?

Hey, Mike. Can you explain how indexed annuities work, how to plan with them, and so on?

K. So there are layers to this. First off, what is a fixed index?

Yeah. What that's that's the first layer. Let's peel that off. Index annuity.

This is it's you know how, like, people get triggered? Yeah. And I don't care if you're a millennial, a boomer, or whatever. Everyone gets triggered. You watch enough TikTok or x or whatever, you see people getting triggered.

Enough Karens are out there. Yeah. Enough Chads are out there. Whatever. Okay?

There are certain words that people just hate. And in finance, the four letter word is annuity. Uh-huh. And it's because a lot of companies do a really good job scaring people about these annuity horror stories.

Okay.

K? So let's clearly define the annuity landscape, then let's define and we're just gonna start broad and then go in. Okay? Alright. I define the annuitiescape in four groups.

You've got variable annuities. All at risk, high fees. There's only one situation that it might make sense, might being the keyword there. And in over a decade of working in the retirement planning space, I've never seen that situation ever come up.

Alright.

Okay? They're one of the original annuity products that became popular, but they were very easily criticized because of how many fees are there, and they really don't protect anything. So it's like, why would you put assets into something that has all this risk, that has high fees, and you're gonna turn on the income, like, twenty years later? You might as well just keep in the market and then buy an annuity later

Yeah.

If you really want a lifetime income. So that's when you hear bad stories about annuities, many times it's a variable annuity.

Okay.

Okay? Let's be very clear about that. Then on the other side of things, you have a fixed annuity, like a MIGA, multi year guaranteed annuity. Think of a CD from an insurance company. It is boring beyond belief and as as it should be.

It grows at a fixed rate for a certain period of time, and then either you liquidate it, you could turn on income. I don't know why you'd turn on income at that point. Mhmm. But you could. It's a annuity product.

So by definition, annuities are structured income payouts, whether it's over a certain period of time or lifetime, whatever. So notice the very different range. It's like comparing CDs to the stock market. Variable annuities is the stock market with high fees and an income component. And then you've got your CD annuity version with an income kind of component.

Okay.

When I say income, it's usually not lifetime income. It's like a a multiyear payout, but very, very different.

Mhmm.

Okay? It would be ridiculous to compare the two and say they're basically the same thing and that all annuities are the same. They're just not. No. Then you have this middle group here.

Not to sound like Goldilocks and the three bears.

Oh, yeah. This is the good The

middle group is fixed indexed annuity, which is a stupid name. Because what is a fixed indexed annuity? Why fixed? Why index? It's I from what I understand, trying to make sense of the stupid name Mhmm.

It is that there is a product that has a fixed component like the CD. So usually fixed index annuities, you can allocate things to a fixed rate if you wanted to. Yeah. And then there's also an indexed component where you have participation of a certain index. But if the markets don't go up, you don't lose money, or you might lose, like, 5%.

You know, there are some coming out there where it's like, you might take the first 5% down if the markets go down, but you've got more upside potential. I mean, they'll they'll they'll make Frankenstein into anything. Right? Uh-huh. Annuities can be whatever they want them to be.

Okay.

You just have to you have to create the product, gotta pass it through the state regulators, and then you can make it public. Whatever. Okay? Yeah. So now with that said, you need to understand in the what we're gonna now call indexed annuities, because I'm tired of saying fixed indexed annuities, a mouthful.

It is.

The indexed annuity, there's two categories in my mind. The first one is the lifetime income category, and the second one is the cash growth category.

Okay.

They both have lifetime income components. They both have cash value components, but you need to understand the economics of both. Okay? Alright. So lifetime income component.

You can buy a annuity built for a strong lifetime income. So this is I'm not quoting a product. I I'm doing this just by way of example. Alright. Okay?

Let's say you put in a $100,000 into or let's say a million dollars. You put a million dollars into an annuity. K? You're gonna get, let's say, 7% back for life. So that's pretty good because you would consider the 4% rule.

If you put your money in the stock bond fund, you know, portfolio, you're taking up 4% each year. Well, you can put it in over here, you're guaranteed 7% for life. Now that's flat, doesn't increase with inflation, and so on, but it still sounds like a good deal. Right? It does sound very good.

Okay. So 770%, so a million dollars, $70,000 guaranteed for life. You're getting 70,000 every year in monthly checks. Oh. Okay?

Now the insurance company has to, in in I think every situation, in most situations, let's say, has to pay out the remaining cash balance if you were to pass soon. So if you were to buy a lifetime income stream that's competitive, let's say the $70,000 a year, and you were to die in the second year, there's likely a cash balance. Now be very careful. Read the contracts Mhmm. Before you buy any these, but likely there's a contract cash value balance they have to pay out.

The insurance company doesn't want that cash balance to grow quickly. So but it's an indexed annuity, so it has to paired to an index. So they might give you great lifetime income, but they're gonna put a cap of, like, 3% growth.

Oh. So it's

growing maybe as good as like a money market. Uh-huh. When the the S and P is up like 20%, you got 3%. It's not going down, but then every year, the 70,000, it's eating away at your policy very, very quickly. So within ten years, twelve years, there's a good chance there's no cash value left.

Oh. Now let's walk through the numbers. You're 60 years old. This arbitrary made up hypothetical, like, I'm just trying to illustrate the the concept here. K.

Pays you 70,000. What's your life expectancy? 86 years old. The cash value, let's say, runs out in your early seventies. Do you see how the insurance company's pulling a bunch of people together and the odds work in their favor?

Mhmm.

Because if you die early, they're keeping more of your capital. They're keeping more of your cash. And the few people that live a long time, they're able to pay out. That's how insurance works. Yeah.

You're transferring longevity risk to an insurance company.

Right.

So you're not buying it to get rich. You're buying it to know that this paycheck is going on as long as you're alive. Yeah. And it's not that bad of a deal. If you were to buy it, and then you died in the first year or so, there's probably gonna be some money left over.

Or if you buy it and you live a very long time, it might make financial sense for you.

Mhmm.

Because of the significant increase or the higher withdrawal rate, your other part of your portfolio has less of a burden so that might be able to grow better and offset and equalize things. That's the idea. Okay? It's worse, in my opinion, if you were to die at, like, I don't know, twelve to fifteen years into the policy. You didn't live long enough for it to really make sense.

And so you've just what you've pay you've paid a lot of fees during that time and

Not really fees. Oh. It's just opportunity cost. Which is just a different way of, you know, fees, I guess you could say. No.

Okay. It's built like a insurance policy. The odds are in the insurance company's favor. If you're the exception to the rule, you come out on top. That's the only appropriate way that I believe you can look at a lifetime income stream.

Yeah. K? Now with with this whole thing right here, and just to kind of kick the dead horse here, you don't buy term life insurance with the expectation you're gonna die tomorrow or next year.

No.

You don't buy lifetime income from an annuity with the expectation you're gonna get rich off of it, with the expectations you're do anything other than just payout income, and that if you live longer than expected, you can depend on the income coming in. That's it.

K? That's a job.

Now let's let's compare it to a cash growth indexed annuity.

Okay.

So a cash growth indexed annuity is more along the lines of if you turned on the lifetime income component, which they have to have. They don't have to have it, but they they all have it. You're not you're not gonna get, like, 7% flat payout. You're gonna get, like, a four or 5% payout. Why?

Because the cash value has more growth potential.

Where does this cash value come from? Is it like the initial premium you pay in? Or

Yeah. You put the money in there. Okay. The cash is gonna grow better, so they need to readjust the insurance company's risk with the payout that they're doing, which means if they're gonna give you more cash potential on the growth of the cash value itself, they don't wanna promise you a high payout. Mhmm.

So they're gonna have a lower payout. This is just my observation in over a decade of doing this. I've just noticed these differences. Okay?

Mhmm.

The cash value may last a little bit longer, but you're gonna get slightly less payout for life. So what do which one do you want? Now, with the cash growth one, there are two other ways that you could use them that I've seen.

Okay.

The first one is a fixed indexed annuity or indexed annuity ladder. In that, you could buy one that grows for five years, and in the sixth year, it's a 100% liquid, and you're you're expecting that the indexed annuity grows at a higher rate than a CD or fixed annuity, like a or a bond. So if treasuries are 4%, a CD is 4%, you're hoping this is gonna go up 5% or better

Yeah.

Year over year for five years. And then in the the fifth year, it's liquid. So in the sixth year, you're pulling out income for maybe two years, and then you buy a second annuity or indexed annuity that grows for seven years, and then that's the next source of income. And then you get one for ten years. You can ladder them out from a long long or a a timeline standpoint, and your expectation is the cash value, as long as you don't turn on these income contracts Oh.

They become liquid after the surrender the surrender schedule finishes, and you can then just take it out.

So these are just it's a different policy every time.

It's an index annuity ladder. Just like a CD ladder would work. It just you if you've got more upside potential if the markets are are growing incredibly well. Mhmm. The markets don't grow well, you're not making any money.

But you're also not losing any?

You're not losing money, but you're not making money.

Okay. So that might be kind of the selling point then.

Well, mean, yeah, it's you can't have your cake and eat it too. Right? Yeah. Do you think the markets are gonna go up in the next couple of years? Do you think they're not?

Do think the next crash is gonna be a one year and have a quick recovery? That's a good situation for an annuity, an indexed annuity because you you don't lose money the first year, and then the second year, you have incredible returns. So there's nuance to this part of a a ladder, if you will. Mhmm. But very easy to structure them, very easy to manage them.

It's just you're you're taking on certain risks for certain potential or certain benefits. You need to understand that trade. But I do see a lot of people that will look to those kinds of structures on their income because they want the first ten to fifteen to twenty years of income laddered out from protected sources. They can't go backwards. And because the timeline's long enough, they have more growth potential than a fixed account.

Now, the other one, which I think is interesting because it defies mathematical logic Oh. Is the five year period certain contract.

Alright. And these are available in which type of annuity?

Indexed annuities.

Okay. Alright.

So I'm gonna get a little technical here, but go home and or I guess you're maybe not already home. Yeah. Ask your AI to explain how these things work. Yeah. And ask it question after question after question until you get it.

Okay? So if you say, I don't think the markets are gonna crash next year, but maybe in two or three years.

Mhmm.

I'm concerned about inflation in the short term as well. And so I want something that's got more growth potential than a fixed account, but I know when the markets go down, I don't lose money, and I can turn it on to guaranteed payments for a certain period of time. Well, the shortest that I've seen is called a five year period certain. So let's just use the example. Let's say that there's an index annuity that has a 9% cap on the S and P.

So you get the first 9% growth of SPX or SPY or whatever. Yeah. K? So if the markets grow over 9%, that's a better growth vehicle than the five or 4% or whatever on the fixed account.

Okay.

K? If the markets go down next year, zero is worse because, you know, it's indexed. The index didn't produce anything, so you got a zero when you could get the fixed at five or 4% or whatever. So there's a trade here.

Yeah.

But if if you look at, let's say, a income ladder, and you look at seven years of a fixed ladder, and every year is 5%. This is gonna sound crazy. Okay?

Alright.

Every year, 5%, that's a fixed ladder. K? CDs, treasuries, MYGAs, whatever. And then you look at a indexed annuity where the first two years gets nine percent, and then you do a annuitization, five year period certain. And let's say you get half of the fixed rate.

Let's say you get like 2.5%, something dismal. Okay. You still have more money. You've taken more money. You've got more leftover for income.

You were better off. And the reason is because the sequence of the return, the first couple of years before you turned on income, the account grew fast enough that even though when you turned on the period certain clause, which is likely less of an interest rate than what you would get at a fixed rate

Uh-huh.

It's likely less. You're still getting more money because the first couple of years had more growth potential. You exceeded the growth, had no downside risk, and so the the average annual growth is less than the 5%. But you end up with more cash value because the first couple of years had more growth than the 5%.

Mhmm.

It's like if you're in a race and you you get ahead real quick, you just you get ahead

Yeah.

You can then pace at a lower rate while they're still catching up, trying to catch up to you.

And then you still cross the finish line first.

Yeah. Uh-huh. It defies people's general consensus of how math is supposed to work Yeah. Because you think, well, the average return is what what matters. It's the sequence over the return or the order of the return.

Mhmm. And the reason why I say this is it's the easiest DIY methodology for managing a retirement.

Mhmm.

What do you need protection for? A market crash. Mhmm. When's the market gonna crash? No one knows.

Right.

So what if you had a tool that you knew this is gonna provide five years of income whenever the markets crashed, and you could turn it on whenever you wanted? It's got more growth potential than your CDs or treasuries or fixed annuities. But whenever the markets crash, you could say, okay. Well, this is the year the markets crash. I need income.

You turn it on. Gives you five years for your other accounts to recover. You don't need to be an investment genius. No. You don't need to time the market.

Now you've got a get out of jail free card because you're not gonna accentuate your losses. You're gonna just turn on the income whenever you want. You get five years of payments. Whatever the account value is, you can take it over five years. You could take it over six years.

You just say, I wanna pay out. Five years is typically the least amount. And now you can just manage your assets on your own if you wanted to. You've got the instructions on how to turn on the income, and let's say the market's crashing four years from now.

Okay.

There you go. The first what is that? So four years of growth, five years of payout, the first nine years of retirement, you're fine. Mhmm. Because you took a part of your portfolio and said, I want five years as a get out of jail free card whenever the markets crash.

I wanna take income from a structured product, from a structured income mechanism that allows me to sell through a market crash, which on average it takes about five years to recover, And so I can keep more assets than at risk. More assets in equities. More assets for growth. Yeah. And I'm not scared about the crash because I have my income covered for five years.

And so during those before you turn on income, that's where you're getting you're getting that, like, that cap on the S and P return or the 9% potentially.

Products can't give you unlimited upside with no downside. Yeah. That's not how it works. And what you're looking for, and you can ask AI how this works, but they're basically using options and derivatives to give you upside potential. Now, specifically, the insurance companies can do more than that.

They have they have a contractual promise to give you a to give you growth at least for that year at a certain rate.

Uh-huh.

K? Those can adjust at the detriment. If the 9% could be like a 7%, they can adjust those mid contracts. So be careful about the reputation of the insurance company. Be careful about if it's what we call these bait and switch offers.

Sure. Like, it's not sustainable. They're just doing to get more money in there and the second year they're they know they're gonna drop it. Mhmm. Those things can happen.

So you wanna be very cautious as you do your research, but it's it's it's not talked about. Everyone says, well, just do the lifetime income. Well, lifetime income has inflation risk. This isn't really inflation risk. Your assets are there to grow in the market, but you have your five year bandage.

Not an issue. Yeah. Turn on income. Let everything else recover. Mhmm.

And during the income, that's where the the payback is that's where it's a smaller percent.

Yeah. You're you're not getting like, if you don't wanna overpromise anything. Yeah. You're not gonna get a 5% fixed payout or a six per like, this is not happening.

Right. Right.

Right. What happens is the insurance company then takes over and owns your policy, and you're now an expense to the insurance company. They're gonna give it give you the money back at a fixed rate. Right. And just assume it might be around something like a high yield savings at the time of that period certain annuitization.

I see. Okay.

But it's a strategy that's not talked about a lot because half the industry in financial services want to in a stock bond fund portfolio. Mhmm. Because they'll charge you one to one and a half percent on all of that, and they want you to be in assets they can charge a percentage on.

Right.

You don't charge typically. I know people do it, but like what's there to charge on going for an annuity? There's really not much. Yeah. And then you have the annuity space where they'll get as much money as possible with that and they'll say lifetime income, no more market risk.

Well, lifetime income means they need to take as much money as you can give them

Mhmm.

To maximize your lifetime income. So it's, I think, a conflict of interest.

Sure.

You you're only at market risk when the markets go down. So how do you solve for those specific periods of time? Yeah. So again, you know, how do you use indexed annuities? Yeah.

For it, you can use it for a an indexed annuity ladder if you want.

Okay.

You can use it for lifetime income, but make sure you're picking the right products.

Alright.

And you can use it for a five year period certain, which is basically a bridge to get through a market crash that you could turn on whenever you want, and you're fine. But you need to read the contracts, you need make sure you do your research, make sure that the i's are dotted, the t's are crossed, and you're fully aware of what's going on, and don't get suckered in to these fancy indexes that are basically, in my opinion, built to fail. Some are good. Some are bad. It's easier just to say, here's what the S and P does.

Here's the the rate I expect. That's simple. Yeah. It's okay to get more complicated. Just slow down and and ask a lot of questions.

Yeah. Did I miss anything?

I don't think so. I mean, we talked about how they work and how to plan with them. We we gave some real life examples of how we think we should plan with them.

Yeah. But typically when you're retiring, I I like to recommend that you fund what we call your bear market reserves or your reservoir, basically the protection. The day you retired, we believe, is the day you have the least amount of risk because there's a liquidity issue with indexed annuities. So you wanna make sure you have your first, second, and maybe your third market crash taken care of by just buying them, either laddering out or just having them ready to go Mhmm. So that everything else can be in growth.

Mhmm. It's your bond fund replacement. Mhmm. And whether that's 60% of your portfolio, I've seen people it's 20% of their portfolio, some people it's 30% of the portfolio, everyone's different. So you put your plan together first, then you look at the strategies, specifically tax strategy, you've got healthcare strategies.

You must wanna explore the strategies, and then you can look at the portfolio and find the right dollar amounts for the right objectives. It all works together. Just don't put the cart before the horse.

And is that kind of the is the liquidity issue kind of the biggest detriment to annuities in general? Or

People want liquidity. They don't understand that having everything liquid can actually compromise them. And let me explain it this way.

Okay.

Privately traded REITs are typically better investments than publicly traded REITs, at least in my opinion. And the reason is a publicly traded REIT, you can get your cash back whenever you want. So the REIT itself, the real estate investment trust has to keep a lot more cash on hand Mhmm. In case people want their money back. Yeah.

If you have a lot of cash on hand, that cash is not growing for you. A privately traded REIT can have restrictions on the cash payouts or the redemptions, so to speak. Mhmm. Which means they can have more of your money working for you.

Mhmm.

Buffered ETFs are the securities business option for a indexed annuity.

Okay.

Buffered ETFs are one year timelines. It's really hard to be very, very competitive long term if you know you're only doing a one year contract. Index annuities can ladder things out over five, seven, ten years, and the illiquidity allows them to buy different kinds of contracts No. To structure the growth in different ways, to structure the underlying investments or products in a more comprehensive way, which can give you slightly more upside potential. Mhmm.

People don't realize that that that that the commitment actually helps you. It doesn't hurt you. You just don't wanna put all of your assets into something illiquid. You wanna put the appropriate amount in there whether it's ten, twenty, 40%, whatever it is right for you, and have all of your other assets liquid, growth, flexibility. You're really see really balancing growth protection and liquidity, and any investment in product can offer you two of the

three. Okay.

So you've got your growth with liquidity. Think of like a stock. It doesn't have protection. You've got your growth with protection. You're losing liquidity.

Think of the indexed annuity. And then you've got your liquidity and your protection. Think of like your high yield savings account. Mhmm. You don't really have reasonable growth.

So the ideal portfolio is that you're blending all three groups within the portfolio based on the mini portfolios and the time you need the money. Mhmm. So that's why you put the plan together first, then you explore the strategies, and then you look at the investments and products to to support these strategies when they need to be implemented and the overall plan, which guides you along the way. And if you enjoyed the show, don't forget to like and subscribe for so much more. Also, you can go you can go to retireontime.com to subscribe to the newsletter, to download the book, get the workbook, play with our calculators, and so much more.

You can even work with one of our advisers in helping you prepare to put your retirement plan together. Just click the button that says discover what's possible to get started. A thirty minute call, no cost to you to explore your lifestyle and legacy goals. As always, thank you for spending your time, your most precious asset with us today. From everyone here at the Kedrick Well Studios, we wanna thank you, and we'll see you in the next episode.