Podcast Episode - Suze School: Annuities, Annuities, Annuities

Investing, Retirement

June 20, 2021

Listen to Podcast Episode:

On this Father’s Day, 2021, we go to Suze School as Suze breaks down the different types of annuities and which one might be right for you.

Podcast Transcript:

June 20th 2021. It's Father's Day. It is Father's Day. It's also my friend Annie's birthday. It's a month from your brother's birth and it's a month and one day from your birthday coming up and it was Juneteenth yesterday. Such a great, can you believe they made an official holiday? I'm so excited about that time. It's about, time is putting it right because. Wait before we begin because I know this is a lesson. Sunday. You do not get to stay here for very long. I don't get to participate but I can stay here and listen and learn but I don't get, I don't get to participate. But I have a question for you since it's Daddy's Day. We have so many great dads we know sadly we don't have ours around anymore. But what's the first you know how you do your first money memory? What's your first dad memory? Your daddy memory? Dancing on his toes? No, actually my very first daddy memory is my daddy had kind of this big belly and he would always lie in his bed and watch football or hockey or something. We only had one tv in the whole house and it was this little tv in their bedroom and I would climb up on his belly with a little car and I would make it go up and down and up and down and I would I would ride that little card with my hands all over his belly. That's cute. That's my very first memory. What's yours? Mine is when I was really, really little, maybe, maybe two years old and I'm a twin for those of you that don't know, I have an identical twin sister. And my dad had really wide shoulders and really big strong arms and he used to take my sister and I, and we were maybe two years old, in each arm and hold us and bring us into the ocean and jump the waves. And because we grew up on the beach, we were very privileged to grow up. My parents were city kids and when they had children, they wanted to move to a place that was more child-friendly. So we grew up on the Jersey Shore. Six wait six kids, two parents and a tiny one bathroom house. That's besides the point. That was in the beginning days. Yeah, we never had much, but we had so much fun. He used to hold us both and jump. We would squeal and scream and laugh. So that was my first dad memory. All right now, KT, we can't go on and on. Happy Father's Day! Only because school I'm going to do Suze school on annuities and there's and that's a long Suze school. I don't even know if I'm going to get through it and if not I'll continue it next Sunday. But I think it's an important Suze school. What are you going to go do now? I'm gonna do my favorite thing to do on a Sunday swim. No I'm gonna garden, today's gardening day. Oh is that what you're gonna do with landscaping and gardening? Are you growing anything particular? I'm trying to revive tomato plants. Oh yes because it's so hot. I mean in the summer and the island is when it's difficult to grow things so I'm going to kind of take a look at the garden and do my pruning. Get dirty and have a little fun out there this morning. All right girlfriend you go do that and Happy Father's Day dad. Yeah we love you and need you so much. All right now that Ms. Travis has left we're going to go down the Suze School tunnel and try to learn what we need to know about annuities. Now annuities there's a lot to know about annuities so we'll see how far we get today in our 30 minute time limit and if I don't finish it today I'll finish it next week. So the first thing you have to understand is what is an annuity. And in the most simplistic terms an annuity is a contract with an insurance company. And for that contract they maybe will invest your money in the stock market. They might guarantee you an interest rate for a specific period of time. They might guarantee you income for life. There's all different kinds of annuities. But all annuities have the following thing in common. All annuities have an owner, have what's called an annuitant and have a beneficiary. The owner could be you, let's say you want to purchase an annuity and you put in $25,000, okay, or whatever amount of money. But they're also because this is a contract with an insurance company, there has to be somebody who is insured and usually the owner is the annuitant, the person that's insured. And then there's the beneficiary, the person who gets the money or the people who get the money when the annuitant dies. Why is there an annuitant? Because the one supposed benefit of an annuity is while the money is in there, you do not pay taxes on it. It is tax-deferred and when it finally is withdrawn, its taxed to you as ordinary income. A few rules with the annuity, you have to be 59 and a half years of age to withdraw any of the gains from the annuity without a 10% penalty. And all annuities, or most annuities I should say, come with a surrender charge. So you have to keep your money in that annuity for a specific amount of time, usually 5 years, 7 years, even 10 years. And if you take it out before them you will also pay a penalty. So that's a very simple view of what an annuity is. Now, annuities come in different forms. There's a fixed annuity, and indexed annuity, and income annuity, and a variable annuity. And some of these annuities I don't have a problem with, although they still may not be my favorite way for you to invest your money. But some of them I absolutely do not like on any level. So maybe we should start with the ones that I do not like. The one annuity, an most cases that I really don't like is a variable annuity and a variable annuity is simply, rather than you taking your money and buy mutual funds or exchange traded funds directly from Charles Schwab or Fidelity or wherever you invest your money, you would buy a variable annuity where you would be the owner, you might be the annuitant as well. And there's a beneficiary and within the contract they buy mutual funds for you within this annuity. And the reason that most people like a variable annuity is that they have been told that they can never lose the amount of money that they put in. So think about it, fs somebody said to you, hey, want to invest in the stock market, but you can never ever lose what you put in. So upon your death, if let's say you invested $50,000 and the markets went down and there was really only $25,000 in there because the markets went down, your beneficiaries would get $50,000. If that $50,000 all of a sudden went up and it was not worth $150,000 upon your death, the beneficiaries would get $150,000. But a variable annuity is sold under the pretense that you will never ever get back less than you originally put in. And this money is invested in the stock market. It's also sold to you that while the money is in there, you don't pay any income taxes on it. So if you want to sell or you want to change investments or something like that, no tax consequences and you just go, oh this is fabulous, I can never lose more money than I put in and I can buy and sell and do these things and not have to pay any taxes on it. So if that's the case, why does Suze Orman not like a variable annuity? Because there are charges in there. Do you think that they're just going to give you back what you put in simply because they like you? No, it's also how they make money annuities will charge you what's called a mortality charge. And that mortality charge over the years because they kind of know when you're projected to die, that mortality charge makes up for the fact that they would have to give you back the money when you die. And that charge is 1.3% a year. Now that is a lot. And that's usually not all, but usually what annuities, variable annuities will charge you. The other reason I don't like it is you have to die to get your money back. So you put $50,000 in, now it goes down to $25,000 and now you need it. You don't get back your $50,000 you get back, what's in there? The $25,000. And so you have to really be careful here and then you might also be within the surrender period. When if you take this money out, they're going to charge you a surrender charge. And now what have you done to yourselves? Also, if you've lost money, it goes from $50,000 to $25,000 and now you need to take it out. Well chances are you might not be able to take that off your taxes, everybody. So you really have to think about it if a variable annuity makes sense to you. The other reason I really don't like variable annuities is that when you go to take the money out, you pay ordinary income tax on it. Really everyone, if you put money into a mutual fund or an exchange traded fund and it's in there for a year or longer, when you take it out, you only pay capital gains tax on it. That's it. Oh, let's say you don't need to take it out. Okay. And the variable annuity went from $50,000 up to $150,000. Okay. And now you die, your beneficiaries get it, they pay ordinary income tax on it. The difference between the $50,000 and $150,000, the beneficiaries are going to pay ordinary income tax on $100,000. If you had $50,000 in mutual funds and they went to $150,000 and now you die, and it goes to your beneficiaries, they currently get a step up in cost basis, which means their cost would be $150,000 for tax purposes. So if they turn around and sell it right then and there, they don't pay any income tax whatsoever. So are there really advantages to a variable annuity? In my opinion, there is not and there's definitely not an advantage to owning a variable annuity within a retirement account. That makes absolutely no sense whatsoever. Because you have a tax-deferred investment, which is what an annuity is. It differs the taxes till you take the money out. Held within a tax deferred vehicle, which is a retirement account. You don't pay taxes on that until you take the money out. And especially if it's a Roth IRA, when you go to take the money out, you don't pay any taxes whatsoever. And if you think that that 1.3% mortality charge doesn't add up, you're wrong. So if you were to compare the returns of the exact same mutual funds in a variable annuity versus outside of a variable annuity. Your money will grow 1.3% faster because there's no mortality charge outside of a variable annuity. I just don't like them. If you want to invest in the stock market, if you want to invest in mutual funds, if you want to invest in exchange traded funds, just invest that way and take advantage of capital gains tax. Take advantage of a step up in basis for your beneficiaries. I just don't think a variable annuity is worth it period. So that's a variable annuity. The next annuity that many of you are sold is what's called an indexed annuity. A little bit similar to a variable annuity. But in an indexed annuity they guarantee you that you will also never get back less than you originally put in. Okay. It has a floor to it. It cannot go below that floor. But most indexed annuities, the reason they call them indexed annuities is that your money is indexed or tied to like the Standard and Poor's 500 index. So if the Standard and Poor's 500 index goes up, your money goes up as well. If the Standard and Poor's 500 index goes down, you're guaranteed a floor, usually of about 2% that you at all times will make at least 2% on your money. And people love that. They oh my God, I have total downside protection. The minimum I'm going to make 2% or 3% on my money per year. And if the market goes up then my annuity will go up as well. And every year in many of the annuities, the indexed annuities, your balance is reset. So if you go from $50,000 the markets go up and now let's just say you have $55,000 in there, then that's now set the second year, $55,000 is locked in. You can't get back less than that. However, if it goes from $50,000 to $45,000 you they make 2% on your $50,000. So people seem to love indexed annuities. However, what you have to know about an indexed annuity is that they do set a limit on your potential gains because every indexed annuity has what's called a participation rate. Listen closely now, and that is the rate that you get to earn in comparison to what the Standard and Poor's 500 index did or whatever index your annuity is tied to. So let me give you an example, let's just say your participation rate is 80%, and most indexed annuities the participation rate is 80% to 90%, they can go from 25% to 100%. But on average there 80% to 90%. Listen closely now. So the participation rate is how much you get to participate from what the index did. Let's say the Standard and Poor's 500 index that you're tied to went up 15% for the year and your participation rate is 80%. That means all you are going to get is 80% of the 15% or 12%. So while you could have made 15% if you invested directly in the Standard and Poor's 500 index that year, you're only going to get 12%. That's how an indexed annuity works. And because it works that way, that's why they're able to pay you in down years a minimum 2% or 3% or whatever your minimum rate happens to be. But besides the participation rate, many annuities also have what's called a rate cap, write it down because if anybody ever approaches you wanting to sell you an indexed annuity you need to know the participation rate, you need to know what index you are tied to, and you need to know the rate cap. What is the rate cap? So besides the participation rate, some come with a rate cap of anywhere from 4% to 15%. So 4% to 15% which would mean the most you can make per year, no matter what the index does, is 4% or up to 15%. It depends what your annuity sets it at. The average is about 7%. So let's say you have an indexed annuity that has an 80% participation rate. You all know what that means now. You get to participate in 80% of what the index does. But your rate that you can get is capped at 7%. So the index goes up 15% in that year, you only are able to participate in 80% of that gain. So you get 12%. No, you actually don't get 12% because the rate cap is 7%. So all you get is 7%. Are you understanding how the indexed annuities that are sold to you, how they make money? Now, what you also have to understand is that these rate caps and everything, the annuity company has the ability to change at any time they want. That I think is a big deal. Here's what I bet. 100% of you do not know about indexed annuities, even if you own them. Okay, indexed annuities exclude dividends. So if they invest in an index and the indexes sometimes pay dividends like there's a time, remember I've been telling you all to buy the total stock market index fund, it pays you 2% or whatever it may be. So, indexes also pay dividends. So all indexed annuities exclude dividends and dividends on average, you know, account for a big, big return of what you would make. Now let me just give you an example of that. Let's just take, oh, let's say October 2010 to October 2020. Just let's take that 10 year period of time, the S&P 500 index with dividends returned 13.01%. Right. That's how much you would have made period. You probably only would have made 11% or 10% without dividends. But that's not what we're talking about here. In the indexed annuity, over those 10 years you would have made, because of no dividends and certain other things, you would have made about 3.48%, or you would have lost 9% on your money simply because you went for the safety of an indexed annuity. You have to look at the question, can you lose money? And you know, typically you cannot lose money in an indexed annuity, but you can if the index has gone down and the surrender period is still in effect and you need to withdraw money. So these are the things that you have to understand before you just buy an annuity because again, in both cases the variable annuity as well as the indexed annuity, a salesperson sits down in front of you and says, you can invest in the stock market, you can make money but you can never lose money, it's tax-deferred so you don't have to worry about it. And you go okay and you just sign on the bottom line and that's all you do. But do you understand how there are downsides in both of these? Again, an indexed annuity, you go to take the money out, you pay ordinary income tax on it, your beneficiaries get the money and let's say it has grown, they pay ordinary income tax. And so is it worth it? I don't know. I don't mind an indexed annuity as much as a variable annuity. But I think there's things that you really need to understand about them and I'm not sure that I would do either anymore to tell you the truth. The next is a fixed annuity, and a fixed annuity is where your interest rate that you are quoted is fixed. Now there are two types of fixed annuities and these are annuities, I just want you to know that I actually like, I do not have a problem with them whatsoever. Sometimes an annuity will pay more interest to you than a certificate of deposit or a money market account or something like that. And also what is good about it? Is that the interest is tax-deferred so that your interest now is staying in there and compounding for you and growing faster for you than if it were outside of a fixed annuity. What you have to be careful with when it comes to a fixed annuity is that sometimes truthfully they sucker you in with a very high interest rate the first year. They'll pay you 4% the first year, and then you're so happy because all you think about is the 4%. It might come with a 7 year surrender period, which means your money has to stay in there for 7 years. And if you come out before then, then you're going to pay a surrender charge and they can be 10%, 7%. They can be high. All right. And again, you then pay ordinary income tax at that time as well. That they kind of sucker you in with uh 4% surrender charge, maybe a 4% bonus just to transfer your money into that annuity. That the second year, the third year, the fourth year, the fifth year, the sixth year, the seventh year, all the way through, maybe they're only going to pay you 0.10%. You have to look at what is the minimum guaranteed interest rate that you are guaranteed to get when you buy a fixed annuity. And if all their guaranteeing you is a high interest rate that has absolutely attracted you to want to put money in there. You have to ask the question: how long is the surrender period? And during that surrender period, what is the minimum interest rate that you are going to pay me? And then you will make up your mind of a fixed annuity is what you want. Another kind of fixed annuity is known as a CD Annuity or certificate of deposit annuity which I like a lot. And I like it a lot because you put in a single premium, or an amount of money once in one lump sum, and in a CD Annuity they guarantee you the interest rate for the entire length of the surrender period. So if it has a five year surrender period, then the interest rate that they're going to pay you is going to be fixed for all five years. So you don't have to worry about what are you going to make year two, what are you gonna make year three? You don't have to worry about that. Again. The reason that I like a CD Annuity over a CD nis that with a regular certificate of deposit you pay income tax on your interest every single year. And chances are you don't even use it or want it. With a fixed CD Annuity, you do not pay taxes on that money every year. The interest that you've made. So in the long run you'll probably come out better and further ahead with a CD Fixed annuity than a certificate of deposit. So now you know everything about a fixed annuity. Now we have one annuity left and that's called an income annuity. And I kind of like income annuities at this point in time, even though their interest rates are very low, because some people just want to know that they are guaranteed a monthly income no matter how long they are going to live. So an income annuity is very simple. You put a specific sum of money, up to you, into this annuity and based on your age and everything, they will tell you that they will pay you a monthly income every single month for as long as you live if it's a life-only annuity, meaning it's only a based on your life. And that's just that simple. So a lot of people like, like I said, income annuities because they want to know they're guaranteed income. Interest rates are very low on them at this point in time. But for some people, it just gives them peace of mind because an income annuity just doesn't give you the interest in terms of a monthly payment. They give you a portion of the principle that you also put in back as well. And because of all of that, a lot of it, or the majority of it, really is tax free to you for a specific period of time. So once you start to annuitize an income annuity. And again, annuitize means you have started to receive monthly income from it, it cannot stop. And that's that. And depending on how you've structured the annuity and you die before your life expectancy, then the insurance company can keep all that money, or you can get less and have what's called a 10 years certain immediate annuity, which is,= they will pay you at least for 10 years or as long as you live. So if you happen to get an immediate annuity with a 10 year certain period, and you die in two years, then your beneficiaries will get your income for the next eight years. So there's all different kinds of ways that you can structure it. But that's essentially an income annuity. Now, what all of you need to know about annuities in general is that they are not guaranteed by FDIC like banks are or NCUA like credit unions are. So they are not protected by any national insurance program. They are guaranteed by what's called the State Guarantee Association, which really differs um state by state. So you never want to buy an annuity with an insurance company that isn't really highly rated, the highest rating from all the rating companies. It's really important that you check that out. When an insurance company happens to fail, the State guarantee association usually tries to sell off the assets and everything to other insurance companies so that the policyholders can be made whole. But you know, you don't want to play with these kinds of things. You want to know that your insurance company is really safe and strong. And I personally would not put a lot of money. More than $200,000 or $300,000 the max in one insurance company. I just would not do it. All right. I can't quite believe it. I think we went to Suze School on annuities, which is fabulous. Now one other thing that I do want to tell you, on June 23rd at 1:30 p.m. East Coast time, I am going to be giving a webinar on a company that I co-founded. And I'm going to be telling everybody about it along with the CEO of that company, Devin Miller. And if you are an employer and you have employees, you really should go to securesave.com and register for this webinar so you can hear about what I personally think is the most extraordinary employee benefit that you can offer, that's really never been offered to employees before. So check it out. Go to securesave.com. That's June 23rd 1:30 p.m. But you register at securesave.com. Happy Father's Day, everybody. And I hope you enjoyed this Suze school. But until Thursday you stay safe, you stay strong, and you stay secure. Bye bye now.

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