Market volatility combined with limited availability of traditional retirement income sources, such as defined benefit pension plans, has created a greater responsibility on Americans savings for their future. With this greater responsibility comes a need for financial vehicles that can help provide a new level of protection for retirement savings.
In this episode of Money Script Monday, Adam illustrates how fixed indexed annuities can reduce your overall risk and guarantee lifetime income.
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Hello and welcome to another episode of Money Script Monday. My name is Adam Reyna and I'd like to thank you for attending.
Today we're going to talk about how to guarantee a portion of your retirement income using a little bit different strategy than some people might be used to.
Before we get into that, I wanted to say thank you for attending today's episode. As we go through this, there's going to be a lot of numbers, you'll have a lot of questions, so, please always know that you can find a trusted advisor out there to really help you understand these more in depth and go into detail.
Typically, afterwards those questions are going to come up and whether its product related, strategy related, questions about the market, that's where we really want to turn to an expert.
So again, thank you for attending.
Typical Strategy: Retirement Account Only
I wanted to start off by talking about a typical strategy here. This typical strategy, what we're going to talk about is how to use only your retirement account to generate some retirement income.
This strategy is going to be completely invested in the market.
This would be like your IRA, 401k, brokerage account, money market account, something that is actually in a stock, bond or mutual fund.
This hypothetical scenario, we're going to get right into it.
We're going to have a 65-year-old who wants to retire at age 70. So, that's five years. The duration of both of these plans is going to be five years.
We're going to start off with $750,000 of retirement savings. And just so you know, this strategy would be proportionate.
If you don't have that much or if you have more than $750,000, keep in mind that this would still work. We would just use different proportions.
The desired income from this retirement savings of $750,000 for this gentleman is $40,000 a year.
Let's talk quickly about how you access money in this first strategy using your retirement account only.
Again, we've started with $750,000. By the time he turns 70, we're going to need $1 million in this retirement account in order to satisfy that $40,000 a year desired income.
The reason we say $1 million is needed is because a very traditional retirement strategy using a market strategy like this is the 4% rule.
You may have heard of it. It's been around for a very long time.
That's a very good sustainable withdrawal rate that you can take out of your retirement accounts that would sustain for the amount of time that you're in retirement.
Which is now sometimes 25, 30 years.
Let's talk about what needs to happen over these five years in order to get this $750,000 up to the $1 million so you can retire comfortably with that $40,000 a year, again, taking 4% out every single year.
We did the math, and it's actually going to be an average of a 5.92% return from the market over those five years in order to get that million dollars in your account when you turn 70, when you're ready to retire.
The key here is that, again, this is 100% in the market. So, in order to get a 5.92% return, we're going to have to see some pretty good upside.
Hopefully, not see too many corrections or too many downturns with downward volatility.
A lot of people right now I'm sure have been noticing that the headlines, whether it be some financial publications or newspapers, there's a lot of worry about a market correction right now.
If that were to happen, the market took a turn like 2008 anywhere in between that five-year span, it may take us a little bit longer to get there.
Or we're going to need higher returns the following year in order to average, again, 5.92%. So, that's your typical strategy.
Some of the pros in this typical strategy, I know a lot of people really appreciate having control.
Control is always very important, especially when you've spent so much of your life saving for retirement. So, this strategy does have control, you do have flexibility with those assets and they would be typically fairly liquid.
And you have, again, more opportunity for more upside. You have a lot more opportunity to hit those 20%, 30% in a really, really good market.
At the same time, you're also going to have some risk. So, the more upside you have, typically the more risks that comes along with it.
This strategy has no guarantees. So, you're not guaranteed to get the $40,000 every year.
You're not guaranteed to have a 5.92% return. Depending on your risk tolerance as we would call it, this might be a good strategy for you.
Also, you have to consider Social Security and all your other assets that you may have to work with.
Moving on from your typical strategy, again, that's using 100% of your assets in the market.
Recommended Strategy: Combine Retirement Account and Annuity
Let's look at a different strategy which we would call our recommended strategy. We're actually combining your retirement account with an indexed annuity.
If you don't know, annuities are a very safe place for your money.
It's a product that is issued by an insurance company and what we're doing there with an annuity is typically taking away all of your downside, limiting the upside a little bit, but again, it's a very safe place for your money.
A lot of times now, these indexed annuities have what's called an income rider.
That's very important in these products because what that does is it actually supplies you a guaranteed lifetime income.
Even if your retirement account balance were to reach zero, the insurance company would still pay you your income every single year.
So, you have a little bit more peace of mind. And just so you know, right now, the annuity industry has been setting records as far as the amount of volume and the amount of clients that have been agreeing that this is the right thing for them.
A lot of that market volatility that we've been seeing out there in the headlines, it's called a "flight to safety."
Baby boomers, anybody that's within maybe a 5, 10-year horizon of retiring, they're looking for a safer place to put their money and getting out of the market and at least carving off a portion to keep it safe.
Let's get into the strategy here. We are still going to use the market.
We're going to keep 70% of these assets in the market managed by your broker, or wherever that account is, that stays there. We're going to carve off 30% of your total assets.
Remember, it was the $750,000 behind me there. So, we're going to use $225,000 into this indexed annuity, and we're going to leave the rest in the market.
Then, we're going to project this out five years.
An annuity would have a little bit of upside, but for the purpose of this example, we're going to say that this annuity did not grow at all for five years.
Hypothetical scenario here, very conservative scenario, where we're going to say this annuity's not growing one single bit.
You're going to start with $225,000 at age 65, at age 70, you've still got $225,000 in there. But within these indexed annuities I had mentioned, there's an income rider.
So, that income rider, when you turn 70, you're actually going to get a specified withdraw amount from whatever your account balance is, the $225,000 in this scenario.
If you were to take your withdraw percentage at age 70, in this hypothetical example, it would be 7%.
What that means is you'll get $15,750 for the rest of your life from the insurance company. So, even if your $225,000 hits zero, you're still going to get that paycheck of $15,750.
Again, we're guaranteeing a portion of your retirement income strategy.
Let's backtrack and remember, Mr. Client wanted $40,000 a year of income. So, that $15,750, we used 30% of his assets.
That's not enough. That's not the $40,000. We are still going to be reliant on the market to get the rest of that.
In this example, it's the $24,250. So, the $24,000 and change plus the $15,000 and change equals the $40,000 that the client was looking for, that you were looking for.
We have our 4% withdrawal rule. 4% withdraws out of a retirement account, fairly conservative, that's sustainable.
What we need at retirement is $606,250. 4% of the $606,250 is your $24,000 and change. Combined with the annuity income that's guaranteed, we've got that $40,000.
Let's go back here. So, we had $525,000 at age 65. Remember, the $225,000 plus the $525,000 is our $750,000 starting point at age 65.
The whole purpose of this strategy is to take some pressure off of that money that's in the market. We're not going to have to take as much risk.
We're not going to be reliant on the upside.
This all boils down to that you only have to average 2.92% with your money that's in your retirement account that's invested in the market in order to grow your $525,000 to the $606,000.
Because, again, we're using a portion that's guaranteed. 0% return, that's a guaranteed number that you can get a portion of that $40,000 of income that you are looking for.
Some of the pros here, again, it's going to require 51% less of a return than your strategy that's completely in the market, 2.92% versus 5.92%.
That's pretty easy for your money manager to average a 2.92% over five years.
You do have enhanced spending, because again, this is a kind of low-end scenario. You could have much more income to enjoy in retirement.
It's going to reduce your overall risk, and it's going to have some guarantees.
That wraps up our strategy here. This one may be a little bit complicated. So, what I'd recommend that you do is work with a trusted advisor.
Have them explain the differences of being in the market, using an annuity, using a very conservative product.
Or if you're okay with risk and you want to stay in the market and you want to shoot for those home runs, then you'd be more than happy to use this strategy as well.
We're not saying one's better than the other, but it's up to you and what you'd like to do with your retirement.
I hope you found this informative. Thank you for joining us. Have a great day.