Guaranteed Returns, Lifetime Income

Most of those approaching retirement or in its early years share several goals. They want to avoid the volatility and periodic steep losses of the stock indexes. They want higher yields than can be earned in the safest investments, but they don’t want their principal to decline if interest rates rise. Down the road they’d also like guaranteed lifetime income.

An impossible combination? No, it’s not. If those are your goals, considering allocating part of your nest egg to a fixed index annuity.

A fixed index annuity is a deferred annuity. You contribute money to the annuity, usually in a lump sum, and don’t plan to withdraw money for a while, usually at least five years. During the accumulation phase, the annuity earns a return. In a traditional fixed deferred annuity, the annual earnings rate is fixed by the insurer and usually is close to the intermediate bond yield. But in a fixed index annuity the account’s yield is determined by the returns of one or more investment indexes that the insurer offers within the annuity.   

These annuities usually have a guaranteed minimum annual return or at least a guarantee that they won’t lose money.  Furthermore, any previous gains can’t be reduced due to a subsequent market downturn.

Let’s take a look at a specific fixed index annuity that has a twist and is very attractive today.

Security Benefit’s Total Value Annuity has high guarantees and a high income payout rate, and also has two valuable options from which you may choose (since these options are mutually exclusive, you may select only one). First, there’s a guaranteed lifetime withdrawal benefit rider, that guarantees a lifetime stream of income (the income rider), and second, there’s a guaranteed minimum death benefit rider, which you would choose when your goal is to leave the funds to loved ones. I’m going to focus on the income rider, because it’s an excellent vehicle for someone who wants to earn safe income for over five or more years and then plans to take a lifetime stream of income.

When you make a deposit to the annuity and select the income rider (which incurs an annual charge of 0.95% of the benefit base), you receive several benefits. You receive an immediate bonus on the account value (5% to 10% depending on your state of residence) and a bonus of up to 10% on the income rider amount. 

In addition, you choose how the annual return on your account is calculated from four index options offered by the insurer. The first option is the traditional annual interest rate, which is determined by the insurer but with a minimum rate of 1% to 3% for the life of the annuity, depending on the state you live in.

A second option is based on the S&P 500, but really isn’t an attractive option because of the way returns are computed and the 3.25% annual maximum earnings cap on the returns.

The two other options offer much more upside potential and are more attractive.

There’s the Transparent Value Blended Index. This index is balanced between stocks and bonds, with the allocation changing with the markets. As one of the components becomes more volatile, it is reduced and the allocation to the other is reduced. The stock index used is the Transparent Value Large-Cap Defensive Index, and the bond index is the S&P 2-Year U.S. Treasury Note Futures Total Return Index.

The other index is the Annuity Linked Trader Vic Index (ALTVI). This is the only commodities-based index offered in these types of annuities, providing true guarantees, upside growth potential and inflation protection not available elsewhere. The index is based on 24 futures contracts spread among physical commodities, global currencies, and U.S. interest rates. This index also tends not to be correlated with stock and bond indexes.

You can choose how the annuity is allocated among the four different options. When you select one or more of the index options, your account increases in value when the index increases, but you are guaranteed there won’t be a decline in your account if an index declines. Both your deposits and previously credited interest to your account won’t be reduced if there’s a subsequent decline in one or more of your selections. But for the Transparent Value Blended Index and Annuity Linked Total Value  Index the no-loss guarantee applies only over a five-year period, and your returns are credited and fully vested only after five years.

The annuity has two separate values for you to track. The first is the account value, sometimes called “walk away money.” This is the sum of your deposits in the annuity, plus the upfront bonus and interest earned from the performance your chosen Index. You’re also guaranteed there won’t be a loss at any time.

The higher value is the benefit base, and this is what’s important when you select the income rider and plan to receive lifetime income from the annuity. This value is based on the interest from the investment options you selected plus an extra 4% per year that is stacked on top.  The benefit base value assumes you’ll take annual or monthly payouts from the annuity for life.

Let’s look at how the numbers work out in an example. Suppose Max and Rosie Profits both are age 60 and deposit $100,000 in the annuity. They split the account evenly between the three index options and let the returns compound for 10 years. Then, they start to receive regular income. Todd Phillips of Phillips Financial Services ran this example through 200 hypothetical historical scenarios and produced these results for me.

Looking back historically over the past 30 years, the best-performing of the 200 iterations of 10-year periods, would have grown the Profit’s $100,000 to an income base worth $303,164, giving them a joint lifetime income of $16,729. Their account value “walk away money” would have grown to $200,581.

The median case would have grown their benefit base to $286,626, for a joint lifetime income of $15,764. The account value grew to $189,542. 

And over the worst-performing period their benefit base grew to $239,302 with a joint lifetime income of $13,162, and walk away money worth $158,877.

If we assume the Profits earned only the contractual minimum guarantee of zero for the 10 years, their income benefit base would have grown to $162,827, with a joint lifetime annual income of $8,955. Their account value, or walk away money grew to $110,000 because of the 10% signing bonus.

Security Benefit is a 120 year old company rated B++ by A.M. Best and B by Weiss Ratings. It is a subsidiary of Guggenheim Partners.

You are allowed to include this annuity in your an traditional IRA. 

If you fund the annuity with after-tax money, withdrawals are treated as though you are withdrawing all earnings first, so they are fully included in taxable income. After all earnings are withdrawn, you are withdrawing principal tax free.

There are other advantages to this annuity.  One of my favorites is the long-term care feature. If you selected the income rider and become unable to perform at least two of the six activities of daily living, you can double the income withdrawal rate for up to five years. After the five years have passed, the annual income withdrawal returns to the original rate. The income doubling kicks in two years after you purchase the annuity, and you must be able to perform all the ADL’s when you acquire the annuity in order to have this option. Only one spouse can use this option. The income withdrawals won’t qualify for tax-free treatment, even when used to pay for long-term care.

Another benefit is that after the first year, the annuity allows you to withdraw up to 10% of the account value each year without a penalty. But withdrawals above that amount might be subject to surrender charges and the loss or reduction of bonus interest. There also might be a market value adjustment to your account value. You are guaranteed to receive at least 87.5% of your purchase payments in a full withdrawal. Of course, withdrawals will reduce the amount of earnings on the remaining value and the eventual income you can receive.

In my opinion the most attractive feature of the Security Benefit Total Value Annuity is the lifetime income guarantee benefit. It has the highest income payout rate around and also a higher upside than other annuities with high payout rates. Even the worst-case scenario, in which you earn only the minimum guarantees, the return is solid.

If you have money you want to earn a solid decent return for the next five years or more, and with a guaranteed minimums return, and then convert it to a lifetime stream of income, you should seriously consider this annuity.

Fixed index annuities can be complicated products as you can see, and they’re not for everyone. But they are valuable when a person is matched to the right annuity. To help guide you and to learn more about this annuity, including where to find several helpful video links, I recommend you contact Todd Phillips at Phillips Financial Services by calling 888-892-1102.

RW November 2013.