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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.
Do you see the difference here?
David:The risk is lower because you have time to recover.
Mike:Yeah. But but people think I don't wanna take risk because what if I need my money?
David:Hey, Mike. When should someone use buffered ETFs versus index annuities in their plan?
Mike:Let's start with the conflict of interest of the inherent part of this question.
David:Okay. Yeah. Tell us what that is.
Mike:Buffered ETFs don't really give you a commission.
David:The adviser a commission?
Mike:Yeah. Yeah. Okay. It's like if I were to say, hey, buy this stock. Uh-huh.
Mike:I'm not gonna get a commission from it.
David:Oh, okay.
Mike:If I were to sell you a fixed indexed annuity. So indexed annuity fixed indexed annuities, it's the same thing or FIA. The the agent is going to receive around a five to 7% commission on average, sometimes more, sometimes less. So there's inherent conflict of interest of which one's right for you. I'm going to try and get rid of that conflict of interest for a moment and just explain them objectively as is.
Mike:Okay? Yeah. Because there's several layers of complexity to it. Basically, when you look at these investments or products, they're inherently supposed to be kind of the same ish in this sense. Now let's define what that means.
Mike:In this sense, we're not using annuities for lifetime income. We're using them as a bond fund alternative. What does that mean? Bond funds are supposed to be the less risky part of a portfolio. Buffered ETFs and fixed index annuities help hedge against the downside, the losses, while also give new market participation on the upside.
Mike:However, they're not gonna make you rich. On the good years, your equities, your stocks are probably gonna outperform your buffered ETFs or your fixed index annuities. Don't assume that you're gonna get rich off of annuities or buffered ETFs. Not gonna happen.
David:This is just like
Mike:this term.
David:A step above shoving the cash under your mattress. This is
Mike:Yeah. Put in some protection. Yeah. That's all it really is. K?
Mike:One's offered from a financial institution like First Trust, for example, or is it Kalamaz is the other one? There's a couple out there that do these really, really well.
David:That's the buffered ETF.
Mike:Yeah. Those are buffered ETFs. And then you've got insurance companies that offer annuities.
David:Okay.
Mike:Okay. So we're defining those two who where the custodian is, where the money actually is. Okay. Now let's let's first define buffered ETFs. Okay?
Mike:A buffered ETF basically, it's you're not actually buying the index. What you're doing is you're buying a position where you've got a complicated structure of options, option contracts for the right to buy and and so on. Here's the simplest way I could explain that. Okay?
David:Okay.
Mike:You get up to, let's say, 7% of the S and P's growth for over a one year period of time. But if the S and P goes down, you don't get anything and it resets every year.
David:That's where the buffer comes in. It buffers you from
Mike:a loss. Yeah. Now the more complicated side of it is basically they're selling away the profits above 7% to then go and buy protection for if it goes down. And that's even an oversimplified explanation of how it really works. But bear with me.
Mike:We're trying to make this simple.
David:Okay.
Mike:Okay. So you can't just buy something and get all the upside and all the downside. It doesn't work that way. There's always mechanics associated and those mechanics have limitations. Okay.
Mike:So that's that's one idea with it. Now buffered ETFs based on what I see today, you have some options. Some of them are like, you can have up to 7% of like the S and P and no or little downside. When I say little downside, I've seen some buffers where like the market would have to lose more than 66% for you to start losing money.
David:Okay.
Mike:Not likely gonna happen in a twelve month period of time. I've seen other ones that have a 100% buffer. They're all structured a little bit different, but they're very similar. I've seen other ones where it's like you get 12% of the upside, but the first 5% on the downside you might lose. So if the market go down 5%, you lose 5%.
Mike:If the market goes down 10%, you lose 5%. If the market goes down 20%, you lose 5%.
David:Okay.
Mike:But then there's even a threshold where that that buffer goes away. So the point of a buffered ETF is to it's an alternative way to buy growth within something like the S and P 500. You get upside potential, more upside potential than you would with a CD or treasury, but you've got some downside protection. It's meant to buffer out the volatility.
David:Sure.
Mike:Are you with me so far?
David:Yes. Yes. It sounds like you instead of just having a savings account with very small, you know, interest rate, right? This this gives you some some protection, some stability, but it's not It's more narrowly focused. Narrowly focused, and you can keep up with inflation or something.
Mike:Yeah. Alright. Okay. Yep. And remember inflation typically happens when the markets grow exponentially.
Mike:So if inflation is out of control and you're in a buffered ETF, you're getting hopefully the maximum amount that you're allowed in that buffered ETF. So it should hedge against inflation better than a treasury or a I mean, I guess you got some treasuries that are hedged against inflation, but you get my point. CDs, bonds, or whatever. Okay. So how does the taxation work?
Mike:This is very important.
David:Yes.
Mike:So if you buy a buffered ETF, as long as it's it's not one of these trigger or like weird ones, like it's the ones that we're talking about, what happens is if you don't sell the position, just resets so the new value and then it grows again and then it resets and it conceals. It's kind of like under the umbrella of a long term capital gain situation. What does that mean? Means when you sell it, you're gonna pay zero to 15 to 20% depending on how much you sell in your tax situation of taxes on the gains. That's important because on the fixed indexed annuities, if you're putting it in a brokerage of a non qualified after, you know, the cash you're funding with cash.
Mike:Yeah. It's taxes income, not capital gains. That's a very important distinction. Yes. So if you're funding IRAs, this doesn't matter.
Mike:But when you're not funding with IRAs, when you're funding with after tax funds, that difference could be the deal breaker.
David:Right.
Mike:Okay. Now let's let's talk about fixed indexed annuities. Okay.
David:Okay.
Mike:In my opinion, that's my this is this is not absolute. This is my opinion. What I've noticed, my anecdotal research.
David:Okay.
Mike:I believe that some annuities, fixed index annuities are better for cash growth, but aren't good for income. They don't have a lot of bells and whistles. There's not these extra insurance components with it. So they're less expensive to manage. Other annuities have a lot of bells and whistles and perks and benefits and those are expensive to manage.
Mike:And a lot of people I don't think are aware that there's a cost difference. When I say cost, mean opportunity cost, cost. Okay. Because I could probably today, and I'm not quoting any product specifically here. This is radio.
Mike:This is podcast. This is YouTube. Things are gonna change. Yeah. But I could find a fixed index duty today for probably around a 10% cap.
Mike:So up to 10% of the upside of the S and P. I could also find one that's gonna give you up to 6%. Why would anyone want the up to 6% when you can get up to 10%? Because there there's other benefits they might want. This is insurance.
Mike:It's very convoluted, very tricky. You've got to understand how to navigate this because it's one insurance company doesn't have some proprietary access to the S and P or the markets. They're all trading in the same market. It's how do they structure their product and what's the cost or the burden to support the promises within that product. People miss this.
Mike:So they go, well, that's a reputable company. I'm just going to go with that. Well, they have different products. They've got these bonuses and all sorts of things that really it's like a labyrinth. So let's let's now scale all that back and really simplify this.
Mike:Let's only talk about for a moment the fixed indexed annuities with no intention of income. So you don't care about the income benefits. You don't care about any sort of health contingency or any of the other stuff.
David:Okay.
Mike:You're just looking to grow your assets with protection. Okay. Because a fixed indexed annuities duration, it's illiquid typically for five, seven, ten years or so. They're able because they know the money's gonna stay in there unless you're willing to pay a penalty. They know it's gonna stay in there.
Mike:They're able to negotiate different contracts, different option contracts. And so as long as you shop this right, you should be able to get slightly more upside. Does that make sense?
David:Interesting. Yeah. More upside.
Mike:So buffered ETF, it's one year. It goes over and over again. Yeah. They don't know when you're going take your money out. Right.
Mike:Fixed index annuity, it's in there for five years. So they have less liquidity or more control or they know they can do more with the cash.
David:So that's one of the major differences then if we're contrasting them is the liquidity differences, right?
Mike:Yeah. Okay. Illiquidity, people hate. The reality is illiquidity can be your friend.
David:Uh-huh. In certain situations.
Mike:In certain situations you want let's like in REITs, real estate investment trusts. Publicly traded REITs have to have a lot of cash on hand in case people want their money back. Privately traded REITs can have more cash or more investment in the actual portfolio in the investments and less cash on hand because there's illiquidity. Because if everyone wants to sell or get their money back, they can limit the redemptions that allows them to have more money actually working for it. But you got to figure out which REIT is the right REIT.
Mike:Is it a good, is it well run one? Is it not? Is the in a high risk real estate portfolio? Is it low risk? Things matter.
Mike:Same things with with fixed index annuities. So the reason why I bring this up is generally speaking, in my opinion. I think it's typically more appropriate if you're looking for upside potential with a hedge or a buffer against downside risk that buffered ETFs might be a more appropriate choice from a tax standpoint. And you can blend things together. So you've got some with a 100% buffer or a very large buffer, max kind of buffer, some with maybe less of a buffer, but you've got long term duration.
Mike:So maybe don't need it for five years. But you can structure that and then take income out off of long term capital gains, which you can't do with the fixed indexed annuity. Maybe you've got assets in your IRA. Okay. And and you're not concerned about the tax side because regardless of when you take the distribution, you're paying income tax, maybe then a fixed index annuity because you don't need the funds for five years or seven years.
Mike:Maybe that's more appropriate because you could get slightly more upside potential. So it all it all depends on your plan. When do you need the money? And then what's the growth potential? In my mind, if I don't need the $100,000 of my portfolio, it's in an IRA fund.
Mike:I'm going to prefer a fixed indexed annuity that has a higher cap or a larger participation rate or more upside potential than I would have buffered ETF because there's more growth opportunity and I don't need it for five years anyway, or ten years or whatever it is. Sure. Do you see the difference here? Yeah. They both play their own part, but the problem is buffered ETFs don't pay people.
Mike:And so I have found that they're often not discussed because well, you know, hey, just buy this fixed index annuity. Will you have all this? It's like, how do you have? Well, okay, let me be kind kind to those who don't know. There are many financial professionals who don't even know what a buffered ETF is.
Mike:They've never looked into it. I talked with a thirty year veteran. I say, how are you guys including buffered ETFs in your your portfolio? I know they use fixed index annuities. They said, no, we never really looked into it.
Mike:I said, why not? Says, well, we understand how annuities works. We just kind of keep recommending that. Do you want to learn that? No, we're good.
Mike:So it might not be dishonesty. It might just be, they don't know. I mean, can a doctor recommend a medication that they'd never heard about or never researched? No, they can't.
David:Right.
Mike:It would be, I don't know. It'd be really difficult to do that. Right? So it's it's tricky because you shouldn't be angry at your adviser if they've never talked to you about buffered ETFs. You shouldn't be angry at your adviser if they didn't talk to you about structured notes, which we didn't even talk about today.
Mike:That's another version of all these things in this category. But you have to also accept the fact that maybe you're not getting a more comprehensive conversation. Because when you consider the taxes, when you consider your risk, when you consider risk as in how we've talked about risk, when do you need the money? What's the purpose of the money? What's their objective?
Mike:There is a fair argument for both in different situations.
David:Have you ever had a client where you might think, hey, why don't we put some of this in a fixed index annuity and some of this in a buffer to do that? Is there ever a time where you might want a little of both?
Mike:Almost always. There's a little bit of both. Oh, Okay. It's extremely common to have a little bit of both.
David:Okay. Diversifying by objective.
Mike:Mhmm. And it's buffered ETF. So if you need your money, like, for example, next year. Okay. Put them on money market or, know, a six month CD or something like that.
Mike:Like that's short term duration. There. Anything could happen. But if you've got two, three, four years, you might do us a buffered ETF for your fund money. So, you know, it's always there.
Mike:You can pull it out whenever you want things like that. Right. It's there. It's growing. It's it's fun.
Mike:Maybe you have travel expenses and you could, you could go down that route, but you might also do a fixed index annuity. Maybe you want a five year payout. Maybe you want just a one year payout. Like all of these things matter and it shapes which investment should go where and how it shall be, structured. There's so much nuance to it, but it's how do I say this?
Mike:Can you imagine trying to cook and you never knew about butter? You only knew olive oil, which is a great fat. Yeah. Easy to cook with. It's fun.
Mike:Right. But it's like, how do you really experience finance if you don't know all the ingredients, the tools available? Mean, you build a house without a saw? I mean, maybe? No.
Mike:That'd be that, you you have to cut the wood.
David:Yeah.
Mike:I asked you could build a house with just a hammer and nails, but no screws. But screws are nice to have. So and I mean, analogy you wanna use. Sure. You want to have a more comprehensive toolbox of different tools so that you can put the right tools in the right places.
Mike:You know, have the right people on the right on the bus and put them in the right seats at the bus. Whatever analogy you want to use. This is so essential and I find that it's not done because I personally believe there is a commission bias towards fixed index annuities, which are close enough to a buffered ETF that they don't need to explore it. It's close enough. They get paid whatever.
Mike:Sure. I it's disheartening. That doesn't make fixed and next to is bad. It means that there's more nuance to it. We use them all the time just like we use buffered ETFs all the time.
Mike:We have no problem with structured notes. We have no problem with stocks or ETFs or mutual funds. I mean, heck, we're a flat fee financial planning company. So we we try to stay as objective as possible. The point being is there each one of them has its own place.
Mike:It should be done appropriately based on your plan. What are your plan needs? What's your lifestyle and legacy goals? What's the objective of your money? Diversify by those objectives.
Mike:And that should allow you to have a a more holistic conversation and, you know, get the right place right things in the right places. Recording. That's all the time we've got for today's show. If you enjoyed the show, consider telling a friend, leaving a rating, and most importantly, that you are subscribed to it so that you don't miss a thing. For more resources, including a copy of my book, on demand courses, and so much more, just go to www.retireontime.com.
Mike:If you want help putting your retirement plan together, go to retireontime.com and click the button that says get started. Seriously, from all of us here at Kedrick Wealth, we wanna thank you for spending your time, your most precious asset with us today. We'll see you in the next episode.