Guaranteed Income Planning For Small Business Owners
“Fixed indexed annuities” (FIAs) and their ability to provide a guaranteed life income in retirement without market risk are to the private sector what “defined benefit pension plans” are to government employees in the public sector—but on steroids. Granted, there are still some larger companies that offer full “pensions,” but this is becoming more and more rare. Ironically, in my nearly 30 years of experience as an insurance and financial advisor, I find most people truly don’t understand what annuities are or how they work—or see the similarity to pensions. Instead, they erroneously believe the only way to get a “pension” is to retire from a city, county, state or federal government job or a large company still offering full pensions.
Everyone remembers 2008 when the S&P 500 lost 38.49 percent and 2009 when the Dow lost 52 percent. Ironically many people in the private sector, such as self-employed business owners, invest in traditional and Roth 401Ks and IRAs, stocks, bonds and mutual funds, falsely believing there is no “pension style” guaranteed life income in retirement available to them, and simply resign themselves to the reality that their retirement plans can implode and this is just a part of life. Something to be accepted.
Some may think real estate is the answer, either flipping properties on pure speculation or trying to create positive cash flow through nightly or long-term rentals. But there’s no guarantees in real estate either; values do go up and down and people do lose money. On top of that, tenants don’t always pay on time or quit paying altogether and can be a complete headache to evict and deal with. Landlord-tenant laws often seem to unfairly favor the tenant rather than the landlord. In addition landlords are responsible for all property taxes, insurance and maintenance, which can really add up. Real estate isn’t instantly liquid which can be a problem if you are trying to sell. You must find a buyer who is willing to pay what you want and sometimes must qualify for a loan. Stocks, bonds and mutual funds may be “liquid,” but you may have to realize a terrible loss to access them if the market is down at the time of liquidation.
FIAs, on the other hand, provide guaranteed protection and safety to both your principal and gains earned by “locking them in” each year so you don’t ever have to worry about the market being “down” when you access them. And unlike pensions, some annuities can be accessed for additional funds—even while taking a guaranteed income for life. This is a huge advantage and distinction. In the early years of annuity contracts, there may be “surrender charges” that apply if you take a withdrawal from an annuity or surrender it outright. But there are also exceptions to surrender charges where they don’t apply. Each contract is different, so you’ll want to know the details.
As the saying goes, “There are no guarantees in life,” but I beg to differ. There are guarantees in life—but you must pay for them in advance with insurance and annuity premiums. Additionally, with life insurance you must also go through underwriting and medically qualify. Provided you do, with the stroke of a pen, or these days with “e-apply” and a click of a button, you can guarantee that when you die your loved ones will be able to wipe out all your debt including the mortgage and be provided with a comfortable income to keep them in the world they are accustomed to. Similarly, with annuities the cousin to life insurance, you can guarantee your clients will never lose another cent in the market and you can guarantee they will never have to worry about ever running out of money. This peace-of-mind is priceless, and you are bringing a ton of value to the table by sharing with people the unique advantages of annuities and what only they can do. Without guarantees, retirees are doomed with the constant worrying if they are losing money in the market, running out, and losing more and more of their spending power due to inflation. The guarantees offered by life insurance and annuities are opposite. Where life insurance provides guaranteed death benefit protection from the risk of dying too soon, annuities provide guaranteed income protection from the risk of living too long.
When it comes to guarantees people justifiably want to know how something is guaranteed and where it comes from. Where pensions are typically partially guaranteed by the federal Pension Benefit Guaranty Corporation (PBGC), conversely, annuities are protected and backed by the strength, security, assets and reserves of life insurance and annuity companies. For this reason top “A” ratings for financial strength and claims-paying-ability from the main rating companies, A.M. Best, Standard & Poors, Moody’s and Fitch do matter, and it’s important to go with a company with a proven track record. Because ratings and what they mean differ with each agency and they can be hard to interpret, it can be helpful to look at a company’s overall Comdex rating, which is an average score of all the ratings like a report card or GPA. In addition, each insurance company wanting to offer life insurance and annuities must, at minimum, be first approved by each state’s insurance commissioner to do business. Sometimes even if a company is highly rated, people still often seem absolutely baffled and in total disbelief about how life insurance and annuity companies can possibly provide such powerful guarantees. Once clients fully understand the power of annuities and their contractual guarantees, I often hear, “Wow! This is amazing! How do they do that? Why would anyone not want to do this?”
One very helpful analogy I often use to help my clients to understand this is using life insurance as an example. On average, a 25-year-old female athlete in perfect health can buy about $1 million in 10-year term life insurance for only $25 per month. But keep in mind, on average, someone buys a life insurance policy every 17 minutes and won’t survive to make the second premium payment! So, if this person buys a million-dollar policy for only $25 and dies instantly in a car accident one week later, the life insurance company must pay $1 million dollars. Because of the risk that companies take, they must set aside adequate reserves in very conservative portfolios to uphold their promises. The same goes for making good on promising to pay a lifetime income with annuities.
Similar to cars and phones that keep adding more bells and whistles, FIAs have also added many value-added features over the years such as liquidity, even while taking a guaranteed income—something pension plans clearly do not have. In addition, annuities can provide enhanced death benefits to beneficiaries but with the advantage of no medical underwriting. This can be helpful for those with health issues who might otherwise not qualify for life insurance.
One of the downsides to government pensions is they often pay a fixed income and do not keep pace with inflation. Some pensions do have COLA options that increase monthly benefits over time, however this feature is generally very expensive forcing people to take a real haircut, a very reduced monthly benefit. So most people opt not to do it and thus have a level fixed income that later can be a problem when things get more expensive. Conversely, FIAs can provide an increasing income that can be very substantial, even outpacing inflation. Some companies pay generous “interest bonuses” which cause your monthly income to go up. For example, let’s say a stock index such as the S&P 500 over the course of a year goes up by eight percent. Some annuities will give you a 50 percent interest bonus, which is four percent more, so this means the next year you will get a 12 percent raise in income that gets locked-in! If the market goes down, your guaranteed income remains the same. Put another way:
“Having an annuity with guaranteed income in retirement is like having a job you love where you can never be fired, and each year you’re eligible for a pay raise that gets locked-in.”
The money to fund an annuity can come from a variety of sources. It might be from the sale of a business or the liquidating of savings, real estate, investments, or other assets. It can also come from transferring an IRA or rolling a 401k into an IRA with an FIA as the funding vehicle instead of stocks and mutual funds. It can come from an accident, an inheritance or legal settlement. It can also come from converting the cash value of a permanent life insurance policy such as whole life or universal life into an annuity using something called a “1035 Exchange.” With FIAs guaranteed life income can be started right away upon inception of the contract, or they can be allowed to “cook” growing over time in the accumulation phase (either tax-deferred or tax-free if in a Roth IRA) until you are ready to retire—which is called the payout phase—when lifetime income payments begin. Typically, the longer you wait, the higher your life income will be.
An additional advantage for business owners using annuities and cash value life insurance is their freedom and ability to pick and choose who they have a plan on, such as only themselves or only their very best key people, vs a 401k where everyone must be included regardless of merit.
The bottom line: If you are working with self-employed small business owners in the private sector, help them to explore fixed indexed annuities. Not all annuities are created equal of course and they can be complicated with many moving parts to understand, so meeting with an expert to help them can be invaluable.
