Jack in CA asks; If the dollar goes into a nose-dive, how safe will it be to own an immediate, fixed or hybrid annuity?
In figuring out how to best answer Jack, we have to speculate on the level or severity of the collapse – if we have total anarchy or a Zimbabwean type of inflation, the paper dollar would be worthless and so would most investments. Do we feel that is likely to happen in the near future? No. Now, that being said, common sense says that if you spend more than you make, eventually you will go broke and our government has to figure out a way to meet its obligations and payoff its debt.
Annuities; just like equities, bonds, and commodities; to name a few, can have a place in a well structured portfolio. Dick and Eric examine the potential effects that the collapse of the dollar would have on the annuity industry and address annuity strategies that are best suited for this particular situation.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Considering an inflation adjusted annuity? Check out this recent USA Today article from John Waggoner
Should you get an inflation-adjusted annuity?
An inflation-adjusted annuity aims to solve the problem by giving you an automatic cost-of-living increase every year. But the cost is steep.
Most people still have nightmares about math word problems: “If Nate has 37 red gumdrops and Hope has 43 blue feathers, what time will their train reach Altoona?”
If you have a 401(k) plan, you’re being asked to solve a similarly impossible problem: “Assume that R is the amount of money you’ll need to retire, X is the number of years you’ll live, Y is your rate of return, and Z is the rate of inflation. You have no idea what X,Y, or Z is. Solve for R.”
One solution is an inflation-adjusted annuity, which promises to pay you a sum that will rise with the cost of living every year until you die, much as Social Security does. Should you try one? Only if you expect to live long — and even then, you’d be better off waiting until interest rates rise.
The rule of thumb with 401(k) withdrawals is to start by taking out 4% of your portfolio the first year, and adjusting that amount upward for inflation each year. Most times, it’s too conservative: You’d need a $1.25 million portfolio to get an initial $50,000 annual withdrawal. But when the first few years are down years in the stock market, your withdrawals can simply aggravate your losses and increase the chance you’ll run out of money.
Because the stock market is unpredictable, to say the least, some people use an immediate annuity to smooth out some of the bumps in a portfolio. An immediate annuity is a contract between you and an insurance company. You pay the company a lump sum, and they agree to pay you a set amount per month for the rest of your life. If you live to 120, you win. If you join the Choir Invisible the year after signing the contract, you lose, and the annuity company pockets your investment.
The payout is based primarily on an interest rate — what the company expects to earn on your lump sum. As a simple example, suppose you want to invest $100,000. According to Immediateannuity.com, a 65-year-old man could get $548 a month for life — a 6.58% payout rate.
The 30-year Treasury bond yields about 3%, and insurance companies are not magic yield-making wizards. Some of the extra yield comes from the money left on the table by annuitants who have gone to the great field office in the sky.
The rest comes from the insurance company’s own investments, which is why it’s good to choose a financially strong annuity company. You want a company that can still pay, even during economically stressful times. States do have **guaranty associations backing annuity policies, typically to at least $100,000, but it’s best to avoid shaky companies entirely.
While the annuity’s payout is decent, it’s fixed. Let’s assume that inflation averages 3% — the average inflation rate since 1926, according to Morningstar. The effects of inflation are cumulative: After 30 years of 3% inflation, your $548 will have the buying power of $220. Unless you plan to live on toasted plaster, you’ll have to find a way to offset inflation, and a fixed annuity won’t provide that. [Read More…]
Annuity Guys® Video Transcript:
Dick: Today, we want to give a shout out to Jack in California.
Eric: You don’t know Jack.
Dick: I do know Jack. In fact, this is for and Jack and Sharon. Jack, hey, we appreciate the question. The concern today is what happens if the dollar collapses, what does that do to annuities?
Eric: Right. What’s it going to do to fixed index annuities and hybrid annuities? Excellent question. Now, we first have to define the collapse of the dollar I guess. If we look at it in a Zimbabwean sense . . .
Dick: Or Germany.
Eric: . . . where they’ve had, basically, a decimation of their currency . . .
Dick: Anarchy in the street.
Eric: . . . then the honest answer is nothing can save it.
Dick: Nothing’s going to save it.
Eric: In all honesty, it wouldn’t save the country. Social Security would be messed up. Your pension would be gone.
Dick: Right. Even having gold, you’d need to hire the A-Team to protect your gold.
Eric: Your interests.
Dick: I think that we’re all looking for that answer that is somewhere in the middle. We’re facing a lot of headwinds in our economy. Our government does not look very reliable, at this point, to make the right decisions.
Eric: Right. Peter Schiff is one of those guys that’s been calling for the collapse of the economy because of, basically, the overspending. I don’t think anybody would deny that, as a country, we’ve maxed out the credit cards. Until we start paying them down, we’re kicking the can down the road. We haven’t had a budget in, what, three years on a federal level.
Dick: The debt just keeps rising and rising, and it’s going to have to be paid back. The alternatives aren’t very good. You can raise taxes, which is political suicide, or you can devalue the dollar, which looks like everybody just raising their price. But really the value of the dollar is dropping.
Eric: Right. So your buying power is going kaput. Now, if I own an annuity, am I better off than if I don’t own an annuity?
Dick: Well, I’m going to answer that, but before I do, let me just say this, folks, the topic that we’re on today is complex. It is a very big concern that we talk about regularly with our clients. It’s very important that you do work with a good local advisor, somebody that actually gets it, works from a point of safety and diversification. That’s what we’re really going to talk about today. Your question, Eric, in terms of, if I have an annuity and the dollar starts to devalue, my question would be, same as yours: How far is the dollar devaluing, and did I set my annuity up to offset inflation?
Eric: Right. There are annuities that exist right now, hybrid style annuities, where the income rider is tied to something called the CPI or the Consumer Price Index.
Dick: Right. And immediates will . . .
Eric: They have the ability to, basically, be indexed to that. So those products exist right now if that’s one of the things you’re concerned with. You can set it up. Now, you’re going to start a little bit lower, typically, than you would if you took a level payout.
Dick: When you turn your income on, it’s going to start at a lower level. Yes.
Eric: Right. Now, depending on inflation or that index, you’ll get bumps in your income as those things increase. There are ways to dial in from that, but you’re making a choice to trade, perhaps a higher level now for future safety and security if those things do happen.
Dick: The other aspect of that for those of you that have means, that have the assets to work with, annuities may be one small portion or one moderate portion of your portfolio. It is not the end all and the be all.
Eric: No. We you always talk about asset allocation or diversification. You don’t want to put all your eggs in one basket. It’s really that simple. So having some hard currency. We’ve talked about if you’re worried about the economy as a whole and our domestic crisis, and you think companies here are going to be impacted, you may make the decision to make some investments in companies that are either multinational or overseas.
Eric: There are lots of options in securities, bonds, hard currency, gold, silver, platinum.
Dick: Take care of all of it. I don’t want to say in summation, but should we avoid buying annuities with the current economic situation and if the dollar is going to start to see this impact?
Dick: Well, Eric, I think that as we look at this whole situation, I think we want to always be cognizant of how long annuities have actually been around. Annuities go way back to the Roman Empire. That’s where the word comes from, “annua,’ annuity.
Eric: I “annua” that.
Dick: You “annua” that. Then, as we move forward into our modern times, we have annuity companies that have existed for 300 years. Do you think they have seen some devaluing of currencies?
Eric: Oh, yes.
Dick: Do you think they have seen some revolutions? The answer to that is yes, and even those that are quite plentiful in the United States, that are in excess of 100 years old. Insurance companies have a proven record of being able to withstand deflation, inflation, world wars. Not that in a total collapse, an anarchy type collapse that they’re going to be unharmed, but are they worth a diversification in your portfolio to have an allocation towards annuities? I think that any reasonable prudence would say yes.
Eric: Yes. It’s worth considering for a portion of your portfolio.
Dick: Yes. Hey, Jack, thank you for the question. The rest of you out there that maybe now have more questions, send them in, and we’ll get to them as soon as possible.