Welcome to How to Retire On Time, a show that answers your retirement questions. We're here to move past that oversimplified advice that you've heard hundreds of times. Instead, we're gonna get into the nitty gritty. As always, text your questions to (913) 363-1234. And remember, this is just a show, not investment advice.

Do your research. David, what do we got today?

Hey, Mike. How can some insurance companies offer a better version of a buffered ETF if they work in

the same market? Yeah. This is a great question in that someone's obviously done their homework, and they're trying to make sense of something. They probably hate insurance companies and are trying to figure out how to get around them. What's sad is how horrible insurance companies have to deal with their PR.

Mhmm. So I'm not gonna defend insurance companies by any means, but let's make sure we've divided up three different categories. Okay? Okay. First off, you've got health insurance.

That's the one people love to hate. Yeah. That's different. You've got home and auto insurance. Mhmm.

That's another one people love to hate. That's a different category. You've got annuities. People love to hate them, but not for the same reasons. Well, it's not a good investment.

Well, it's not an investment. The expectations are misaligned. Let's first just define what is going on here, then let's define the insurance component of an annuity, and then let's define why they're different.

Okay.

Okay. So first off, what's going on here? What people are looking for typically is they want growth potential with no downside risk.

Yeah. Sounds good.

The easiest and most common two options for this, you'd have a buffered ETF or a fixed indexed annuity. Why is that? Well, a buffered ETF, these are roundabout numbers. Okay? But let's say you can get up to 7% growth on the S and P and 60% of downside protection.

So if the markets go down 50%, you don't lose anything. If the markets were to go down 65%, you might lose 5%.

Okay.

And then there's fees to account for whatever the expense ratio is. But it does expense ratios and everything, so it's not a weird thing. So when I explain what a buffered ETF, they say, oh, well, that's what the fixed index annuity is. Well, kind of. A buffered ETF is an annual contract.

Okay.

Not even a contract to you per se because it's technically liquid. You could sell out of it whenever you want at whatever the fair market value is. But what they're doing is they're buying option contracts and derivatives. Basically, a fancy way of saying, hey. We're gonna gather some money, and all the growth above 7%, we're gonna sell to some other person, and they're gonna pay money for the contract or the right to buy those shares at the seven percent threshold and above.

So they're buying the growth potential after that threshold. Are you with me?

Yes. But when I hear that, I think, who's coming up with this stuff? How does someone figure that out? Oh, I'm gonna buy the growth above 7%.

Yeah. The financial markets are incredibly more complicated than most people realize. Mhmm. I mean, the intricacies would melt your brain. It's it's deep.

Yeah. And the hard part is people have no idea. They think it's just kind of magic behind the scenes. Now there's a lot going on here. But, yeah, these are very sophisticated contracts on an institutional level that move millions, if not billions of dollars every day.

Yes. Okay. That aside. Yeah.

What a buffered ETF does, they take then the proceeds, and this is oversimplified explanation of a very complicated situation. Okay. But they take the proceeds from the sale of that option contract, and they then go around and buy basically protection or a buffer. So someone else, if the markets were to go down, they're gonna take the hit. That's the idea behind it.

Okay? And so the price is predicated on that. There's some flexibility with it. I don't even wanna go into that because it gets even more complicated. Let's just start from a high level standpoint here.

Okay?

Mhmm.

That's a buffer ETF one year up to 7%. And then people say, well, you know, a fixed index annuity could offer nine percent or or something like that. I'm not quoting the price here. The rates are gonna change all the time. Okay?

I'm not highlighting a particular product. I'm just trying to explain something. Sure. So if a fixed index annuity can offer you 9%, well, how come they're better? There's two main reasons for this.

One is your assets are illiquid for a longer term period of time.

In the annuity.

The annuity, it's gonna be three, five, seven, ten years, whatever it is. Your assets are there, and if you pull them out, you're going to pay a surrender penalty. So they can do more with the money because if you pull it out, you're gonna get hit. You're less likely to pull it out. That's why insurance companies are less likely to have a run on an insurance company as opposed to a bank where people would have a run on the bank.

Uh-huh. Assets are liquid at the bank for the most part. Assets are not liquid with an insurance company. Where are you gonna go? If you have a disaster, you're gonna go to the bank first.

You don't wanna pay the $8.09, 10 percent penalty or whatever it is. 5%, 3%, they're all different, and they're different in different years.

Yeah. I wanna try and avoid that loss.

Yeah. So they have a higher probability of the money being in there, so they can do different things with it. For example, let's say instead of doing the option contract derivative component that I just explained Mhmm. They go in and they take maybe, I don't know, 95% of your assets and put it with a note for one year at five point something percent. And I'm oversimplifying a very simple I'm just I'm trying to explain the concept here.

So they can put it in there, 5.6%, whatever it is, it's a note, millions of dollars, a bank or institution might lend it to the company, to insurance company. So it's a different grade, a different amount. I mean, private credits pay 9% for goodness sake. So you could probably get 7%, something like that. So then after one year period of time, that money fully recovers.

So 95% of a portfolio at a 5.2% loan rate or note becomes a 100% after one year because of the compounding effect. That means they can take 5% and buy upside contracts and derivatives and all these other things, so then they've got more room to either incorporate the note for some guaranteed returns, but also they've got more flexibility to buy options in a different way. So because of the illiquidity, because it's an insurance company, they're not actually investing your money in the market. They're investing it around the market with very sophisticated instruments. They can offer you a possibly better return.

Possible is the keyword there because some of them will do teaser rates, and contractually, they can lower the rates. Uh-huh. So there are some companies that have a reputation where they're gonna offer you a great rate. Oh, man. This is a deal.

But then in year two or three, they might drop it, and now you're making, like, up to 4%. Well, the buffered ETF would have been better in that situation. So understanding which companies offer what, what's the renewal rate, what's the liquidity schedule, you need to do this kind of due diligence. But, yes, in essence, they're kind of doing the same thing, but because assets in an insurance company are less liquid, they have more flexibility to be more creative on how they structure the product. And most people do not dive into those kinds of details.

Oh, well, here's the rate. It should be good. And if it's not, we'll just switch it. That's garbage planning. I mean, it's like saying, oh, well, here's a car.

It goes. Well, how long does it go? How does it do at 50,000 miles? How about a 100,000 miles? Yeah.

Is it one of those cars that can go three, four hundred thousand miles if you take care of it, or is it gonna fall apart? That's important research. Yeah. The same as with these financial products. It doesn't make the category good or bad.

It says that the due diligence is that much more important.

And can a DIY person sort of learn and understand all this and do this on their own? Should they have an adviser?

Anyone can learn it. We have to know the right questions to ask, and you also have to get people willing to talk to you. A DIY person's probably not gonna get a VP of an insurance company with the person that created the index that's the underlying mechanism that supports the entire product. Uh-huh. They're not gonna talk to you.

Yeah. Right.

But they'll talk to me. Yeah. Because they want my business, and so I will ask a ton of questions. I've annoyed a lot of higher ups by asking a lot of questions, and I don't care. And you can't buy an annuity anyway unless you go through a licensed insurance agent.

Yes. And a lot of the times, they'll sell off of the illustration. Well, I'll tell you what. The illustration the only thing true about an illustration are the page numbers. Everything else is a sales pitch.

Yeah. So if you're leaning on illustrations, if you walk into an agent's office and they've got all these brochures from that company, they're just selling you the product and some story. Unless you can have a detailed intelligent discussion about the underlining index and how it's going to be able to hedge against a rising or decreasing interest rate environment, how the Fed could affect the rates, how the markets could shift over time, how is the price point sustainable, the underlying contracts are sustainable within the product. If you can't talk about stuff like that, if you can't have that conversation, I'd question, you know, are you selling a car and you have no idea how the engine works? I'd rather buy cars through mechanics than salespeople.

That's not a criticism of salespeople. I just would rather get into the nitty gritty with a mechanic. Yeah. So there are different fixed index annuities that are honestly built for cash growth that are more sustainable, in my opinion at least, but their income offer is garbage. There are other fixed index annuities that have a very competitive income offer, but the cash growth is garbage.

There are some that have all sorts of bells and whistles to make it look like long term care insurance. It's not long term care insurance. So you can't have your cake and eat it too. What are you really trying to shop for? What's your single objective for a singular product as a part of your overall portfolio?

That's the question to ask. And then you might be better suited to do more appropriate shopping to find the right product. When people are disappointed, it's often because they either didn't do enough research, or the person they were working with didn't ask enough questions, or either party just didn't understand how the product actually worked. And that goes without actually calling out some of the products that have really been set up to fail in my opinion, but we won't disparage. So in conclusion, if I may.

Sure.

Buffered ETFs are great for shorter term liquidity and more flexibility, but you could get a better I believe if it's done right, you can get better cash growth through a fixed index annuity and have a little bit more flexibility of, like, 10% withdrawals or five year period certain payouts, and other things like that. Just understand, though they may rhyme, they're two different tools in a toolbox. Just like there's different hammers for different purposes, there are different saws for different types of situations. I I was looking at leaf blowers the other day. Mhmm.

There are leaf blowers that are great for the yard. There are blowers for like sawdust. Can you imagine trying to use a a blower that blows sawdust off your table and try to blow the leaves in your yard, that'd be a horrible situation. Yeah. Just because they have similar functionality doesn't mean they do the same thing, and you might want both.

You might want neither. You might want one or the other. That just depends on your specific situation. 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 podcasts.

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. 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.