Perhaps you’ve heard the phrase, “Don’t buy an annuity” or “Beware of annuities.” These are common marketing messages for today’s retirees. If you haven’t heard this phrase, that’s a good thing because annuities, basic annuities, have been around for a really long time as a building block for retirement income.

Annuity Confusion

Admittedly though, the landscape for good advice and the landscape of annuity products in today’s marketplace have both become confusing. Who do I trust? Are they telling me the right thing? Are they acting in my best interest? What is an annuity? Does this annuity do the same thing as that annuity? Are these the products that I should be looking out for? Today’s retirees are confused. What we’re going to do in this video is hopefully break through some of that confusion.

Behind the Scenes with Annuities

We’re going to look at basic annuities and income-focused annuities as they’re often used in the 4Buckets strategy, and we’ll actually get into the details. What sort of income do they provide today’s retirees? How much do they cost to the consumer? How much does the advisor get paid when an annuity is in the picture? So we’ve got a lot here. Stay tuned, I’m going to be sharing my screen and we’re going to be looking through these details together.

Okay, so here we are, we’re going to look at an annuity, an income-focused annuity as it’s often used in the 4 Buckets Retirement Income Strategy.

To lay out our scenario, we’re going to look at a 65-year-old male who is nearing retirement. If that sounds a bit old school, well, when it comes to annuities, they are age-based and gender-based.

The 4% Rule

Our retiree is set to retire, and he is weighing the options available to him. He’s considering the conventional wisdom of the 4% rule. If you don’t know what that is, I’ll briefly explain. The 4% rule is an investments-only income strategy where a retiree will use an investment strategy across their retirement savings and liquidate 4% of their accounts each year to use for retirement income. Why 4%? Well, there’s research that shows this amount of income can often be sustained over the course of retirement enabling a retiree to receive income and still have money left over.

Annuities in Focus

On the other side of the spectrum the retiree is considering an annuity. Why would he do that? Perhaps he wants to comfortably enjoy more than 4% from his retirement savings? Perhaps he doesn’t want market exposure on his retirement income – the same sort of stability he had when earning a paycheck during his working career. Outside of Social Security and pensions, the only other source of guaranteed income comes from annuities. This guarantee is based on the claims-paying ability of the insurance carrier. Many insurance carriers have paid lifetime income to retirees for decades, others may be newer on the scene.

Now we can’t do a direct comparison between income strategies built on investments or insurance. That opens up a regulatory can of worms that would require me spending the rest of the time reading disclosures. What we will do is focus on the annuity income tool for the remainder of our time. We’ll look at actual numbers, pros and cons and we’ll even pull the curtain back and ask, “what does the advisor get paid when implementing annuities?” How does their compensation work? Are there conflicts of interest here? Are there things that I need to be aware of when having these conversations? So we’re going to look at all of that together right here.

How an Advisor is Paid with Annuities

Advisor compensation can get a little confusing so let’s simplify it. An advisor basically kids paid in three ways – investment advisory fees, consulting fees and commissions. Probably the most prevalent is where an advisor gets paid an assets under management percentage. Meaning, the amount that the advisor has under their management, they receive a percentage of that. The industry average is roughly 1% of assets that are under an advisor’s control. Finally, the last way that an advisor can get paid is through commissions. These could be commissions on insurance products like life insurance, or in this instance we’re looking at annuity products. Insurance companies have historically built their distribution and their marketing costs into their products in the form of commissions. Depending on the type of advisor you’re working with could mean they’re receiving different types of compensation. A fee-only advisor would only accept advisory and consulting fees while a fee-based would accept all types.

Now, there’s actually a newer landscape where commission-free annuities have come into the fold and that’s what we’re going to look at here on our chart as well – commission-free annuities. They’re not without cost, they just simply don’t have a commission going to the advisor. We’re going to look at the cost of those and again compare them to commissionable annuities.

Income-Focused Annuities

For this scenario we’re going to look at income-focused annuities, we’re not going to get into specific titles of annuity products because, to be honest, an annuity is a chassis, and you can build all sorts of modifications and riders to that chassis to create different types of annuities. We’re just going to use a broad brush and say we want to use an income-focused annuity that provides guaranteed lifetime income based on the claims-paying ability of the insurance company or companies that we’re considering and doesn’t have any investment component to it.

Commission-Free Annuities

Let’s start with the commission-free annuity. We’re going to look at how this annuity works from all angles. In this scenario, the advisor recommending this annuity may be “fee-only” meaning they don’t accept commissions. Let’s assume they charge advisory fees as a percentage of the assets they manage for the client. Now, understand that there’s not a whole lot of strategy or asset allocation having to take place with a commission-free income annuity. That being the case, let’s say the advisor in this situation is going to charge less to manage that annuity, and decides to do so for 0.50% annually.

Now, the annuity, both commission-based and commission-free, works the same way for the retiree. It’s going to pay lifetime income for as long as the retiree lives, whether retirement is a 20, 30 or even 40-year long life chapter.

So here we’re looking at the top three income-focused, non-investment annuities and the data that we’re receiving here is from DPL Financial Partners. It’s a public site – you can create your own login for free and you can get the same data that I’m looking at here. Furthermore, we’re using the top three payouts of insurance carriers that have a minimum of an A+ financial rating.

Our scenario again involves a 65 year old soon-to-be retiree. Let’s say he’s considering using $300,000 of his retirement savings towards an annuity for retirement income. That is going to provide us roughly $23,000 or $22,780 annually for this retiree.

Now, this commission-free annuity has a balance that’s being spent down, but don’t worry, once it gets depleted it will continue to pay our retiree that same annual income for the rest of their life. But for the advisor, their fee is getting charged based on that balance so we have to understand that in order to know what the advisor is making in this situation. They’re charging 0.50% of assets under management on this decreasing balance and their total fees are going to be $10,635 in placing this commission free annuity. The total income for this retiree in this 14-year span of time is $318,000. Compared this to $168,000 total income for the 60/40 portfolio – that’s a big difference. That’s a lot of income to be enjoyed and used in retirement.

The net income, the total economic benefit to the retiree is $308,000 after we take out that advisory fee that the advisor received. And again, the total compensation for the advisor in this situation is $10,635.

Commission-Based Annuity

Next, we’ll look at a commission-based annuity. An advisor operating as a fiduciary who receives commissions would be called a “fee-based” advisor. They are going to receive this commission from the insurance company. The client doesn’t pay this directly to the advisor like they would an advisory fee. Let’s see how this shakes out.

For this situation, we’re using the top three income-focused, non-investment annuities. We’re receiving this from a private data provider called Cannex and we are again using the criteria that these companies have an A+ financial rating or higher.

The retiree is looking to use $300,000 in an income-focused annuity and using a commission-based annuity this retiree will receive more income annually for the rest of their life rather than the commission-free annuity. So that’s interesting, they’ll receive a little bit more here – $22,940 a year. The total income received was $321,000. As we jump down here, you’ll see that this total economic benefit does not change because again, the cost (there is an indirect cost here) when using a commission-based annuity rather than a commission-free annuity, the retiree gets to see all of that economic benefit of $321,000. Now, with commissions, there’s always this sort of murkiness of like, “What’s the advisor’s incentive? How do they get paid?” Well, we need to look at that. That’s what we’ll do.

On these income-focused annuities that we’re looking at here, they pay an upfront commission of 3.5% to the advisor. Okay, 3.5% against our starting balance is $10,500 being received by the adviser in this situation, which is actually lower than the compensation received from the commission-free annuity. The key difference being that the advisor is getting this all upfront rather than spread out over time.

The Findings

So, we see that the commission-based annuity is going to pay the most in lifetime income. Now, what we must understand is that the principal sum of money in this exchange is being given to the insurance company when we’re using an annuity. That’s uniquely different from other retirement income tools. There’s not an investment balance to follow or an account statement to receive. The retiree is giving up liquidity to receive stable, uninterrupted lifetime income. Is that liquidity a big loss? It’s typically not of the income strategy is built the right way. A retiree will usually have other savings to maintain liquidity for emergencies and enjoyments and other assets invested for long term growth. That’s the beauty of the 4Buckets strategy. Retirement savings are given a specific purpose within the overall retirement income plan that can provide greater investment confidence and income peace of mind.

Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Variable annuities are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information, can be obtained from a financial professional. Be sure to read the prospectus carefully before deciding whether to invest.