Annuity Speak

Friends, family and acquaintances often ask me what are annuities, why I entered the annuity business and, basically, “Who cares?”

Though annuities have been around for some years, I believe that the current economic crisis, though ostensibly mitigated by today’s “jobless recovery,” has brought increased attention to annuities.  While terrified of market risk only a few short months ago, most investors are still, with very good reason, extremely cautious of risks inherent in today’s financial markets.  So, to answer the question, “Who cares about annuities?”  Anyone who cares about avoiding huge losses of principal via market volatility should care about annuities, if they understand what annuities can do.  That’s why I have this burning passion to clearly communicate what annuities can do, especially to those over fifty (50).

To put it in its simplest form – annuities eliminate market risk while still offering the potential for healthy returns.

 I know doctors, lawyers, dentists, bankers (you name it) who own investment portfolios with, perhaps, seventy percent (70%) of their money in equities.  Much of these investments may be under the “umbrella” of 401ks or IRAs.  While they are delighted at the startling market recovery these past months, they don’t have the time or energy to consider the likelihood of another sharp “pull-back” in the market, what it may do to their investment portfolio and/or retirement planning, much less where might be a better place to stash their money.  Sometimes, an illustration is more enlightening than pages of “annuityspeak.”

John and his wife, Pat, own a $1M investment portfolio managed by a national investment firm.  Seventy percent (70%) of their investment is allocated to stock mutual funds (which they consider conservative) and thirty percent (30%) to high grade bonds.  The following tables illustrate the impact a 40% market contraction might have on their current portfolio, then one in which they have moved $400K from stocks to a fixed index annuity.

You’ll note by moving $400,000 of the Stock Mutual Fund into a fixed indexed annuity (“FIA”), John and Pat reduced their equity market loss (or contrarily, increased their portfolio value) by $160,000.  At the same time, the FIA has the potential to participate in market growth (via links to the S&P 500 index and/or other indices) up to a certain cap – typically in the 6 to 8% range, depending upon the carrier and the annuity product.  So, when the market bounces back up, the FIA, having lost ZERO value in the downturn, can pick up a good portion of the next upward bounce.  (By the way, with the 40% market drop, John and Pat need a 67% market gain to get back to square one regarding their stocks. More below.)

Regarding loss of principal, it’s important to understand the basic math fact that any percentage loss requires a greater percentage gain to breakeven.  Thus, a 50% principal loss requires a 100% principal gain to return to square one.  Just read the below illustration to really drive this home.

A stock at $10/share drops to $5/share (a 50% loss).  That $5/share must increase by $5 (a 100% gain) to get back to $10/share or break-even.  Principal losses destroy our financial future!

So, who cares about annuities?  Well, I suppose I can’t really answer who cares, but I can answer who should care about annuities.

Who Should Care About Annuities?

1.Those who have significant liquid assets (especially those over fifty years old).

2.Those who own an IRA or 401k which holds investments in the markets.

3.Those who are relying on welfare for retirement (it’s $7 Trillion in the hole!)

4.Those who would be broke if they had to stop working.

5. Those who dislike the stress of market spikes and dips and would sleep better if they could ignore them.

Basically, I have found two categories of people which, legitimately, don’t need to concern themselves with annuities:  (1) those who are so wealthy that, should the stock market turn deeply south, they would be alright.  They have such deep and diversified financial pockets that a big market loss wouldn’t change their lifestyle much, or at all; and, (2) those who have so little in the way of liquid assets (e.g. under $20,000) that they can’t take advantage of the risk-mitigating (and/or guaranteed lifetime income) features of annuities.

So, ask yourself where you fall in the above categories.  Should you care about annuities?