Do you want a wealthy retirement without worrying about money? Welcome to “Retire in Texas”, where you will discover how to enjoy your faith, your family, and your freedom in the State of Texas—and, now, here's your host, financial advisor, author, and all-around good Texan, Darryl Lyons.
Darryl: Hey, this is Darryl Lyons, CEO and co-founder of PAX Financial Group. I hope you're doing well today. You're listening to Retire in Texas, and I'm excited about this show, but before we could get you started on this show, I need to remind you that this information is general in nature only. It's not intended to provide specific tax, legal, or investment advice. Visit PAXFinancialGroup.com.
Then I also want to remind you to text the word “TEXAS” to the number 74868. That's the word “TEXAS” to the number 74868, and you'll have a financial adviser speak to you with the heart of a teacher. It's a 15-minute consult, it's free, and that way you can just figure out if we're a good fit. [01:07.8]
Okay, so I want to talk annuities here, because I’ve been getting a lot of calls for annuities. In fact, we're doing some workshops on annuities. If you're on our website, you should have gotten an invitation, if you're not on our website. You need to get on our email-distribution system because we do a lot of events, and if you're not, if you don't know about those events, then you're not going to be able to go. We're going to do more, we're going to do a ton more.
I think our biggest attending event is annuities, and because there's a bunch of people on AM radio that sell the heck out of them, it's that nice lady. “Hi, my name is Jane Smith, and I think the world is going to fall apart and I really think you should own it. Fixed equity-indexed annuity. Well, what do you say, Bill?” I mean, it drives me crazy, honestly. But they're out there and they're always selling these annuities. I can't say that I haven't sold the news. I've sold the news.
In fact, when I first started the business, a very hungry person, I sold an annuity. They actually sold a lot. But this was a situation where I earned a commission on it and I earned a $1,000 commission and it was, man, I needed it. But the way I had to do it is I'd fly to Colorado to get the paperwork. This was dinosaur age, right? This was like 2000. It was a $1,000 commission. [02:15.2]
I was like, Man, okay, so what's the plane ride? What's the hotel? It was like, I don't know, I'm making this up, maybe $500, probably $500 for the plane ride. I was like, Okay, I’ll make 500 bucks, cool. Mind you, I didn't have any clients, so I flew up to Colorado. I was like, Okay, $500, I’ll make $500. So, go up there, meet the people, sign paperwork, come back, and now we process the transfer form, so I'm waiting for the checks so then I can finally get paid.
So, the client’s money comes into the account and then I get my commission check, and my commission check was $500. I go, “Man, I was waiting for 1,000.” They decided to take out half of the money and spend it on a new car. They didn't tell me that. So, I was obviously discouraged, but that was one of my first experiences with an annuity. [02:57.4]
Now, annuities pay commissions. They pay a good commission, if you're an insurance salesman. I mean, you can earn 10%. If somebody invests $100,000, that salesperson can get 10 grand just like that. Because that's a concern of mine as running an advisory firm, we just did the compensation model whenever we use annuities to not provide any commission to our advisors. We adjusted.
We can finagle compensation, and so we adjusted the compensation so that it would behave in the same way as all of our other investment products so there wasn't a conflict of interest. If one of the PAX’s advisors is recommending an annuity, I want you to know that they're not getting paid anything differently than if they were to recommend a municipal bond portfolio or a stock portfolio, not any different. We have accounted for that and we feel very good about that.
But that's not the case in the marketplace. Most people in the marketplace, they get 10%, so that's a lot of money, so there's a lot of people out there pitching them, especially when the market is kind of scary, which is 90% of the time. I've got to work through that and I’ve got to educate people. [03:58.6]
There's three types of annuities. There's the variable annuity. There's the equity-indexed annuity, and there's the fixed annuity. Let me explain all three of those real quick, and then you can be educated and go that way, if you think you want one.
A variable annuity, really, it's a bunch of mutual funds, but, legally, they call them sub accounts. Just, it’s vernacular, but they're a bunch of mutual funds. You can have Vanguard and Fidelity, and you can select 20 or 30 of them. But they put a wrapper around those mutual funds and that wrapper, legal wrappers, the annuity, and that annuity allows those mutual funds to grow tax-deferred, so you don't pay any taxes on the growth of that annuity, which is cool.
Then, a lot of times, they'll put what they call riders, so a little additional cost to the annuity for some guarantees. Those guarantees are called living benefits, so those are key features of the annuities, and many times people don't even find the annuity to be attractive unless the living benefits are attached. [05:00.9]
Now, here's where it becomes a little problematic. It’s that when you add up some of the annuity costs, because to put that wrapper on, it can cause one and a half percent. Then if you look at the sub accounts, those mutual funds, those can cost 1%, and then you have a rider, so you're probably up to 2.5% or 3% for a variable annuity. It can get very expensive.
But what they'll do is that they'll have a living benefit on it, and so they'll say, “Okay, what we're going to do is we're going to give you the greater of the stock market performance,” or I'm going to make up a number, this is not . . . I don't want you to hold me to it because this is just an example. We'll give you the greater of the stock market rate of return, or 5%, whatever is greater, and you're like, That's awesome, I love it, until you say, “Okay, I want that 5%,” and they're like, Ah, about that 5% that we promised you, you have to do something to get it.
“What do I have to do?”
“You have to take that annuity out in a monthly check for the rest of your life,” and you're like, What? I thought I got the greater 5% of the market? Yeah, you get the greater 5%, but you can't just take it out. You've got to take it out in the form of income over the rest of your life and you're like, If I would have known that, I would have done it. [06:09.0]
That happens a lot, by the way, and so that's a problem with variable annuities because not only is there a lot of costs, nearly 3%, but also the confusion that comes with these guarantees. Now, in a polyphonic world, if somebody fully understood the risk, they fully understand the cost, and they fully understand how they operate, and then they make a business decision, then, okay, I can accept that. But most of the time, some of those elements are missing, because the salesperson kind of rushes through to get the transaction across the finish line, so I find that most of the people don't know what the variable annuities are.
But then that goes to the equity-indexed. That leads us to the equity-indexed annuity. The equity-indexed annuity is kind of different because there's typically—typically, not always—hardly any fees to it, so you're like, That's better. Kind of. The fees are embedded. They're just in a weird formula. Instead of giving you mutual funds, they give you formulas. The formulas look like the stock market, but they're not the stock market. [07:03.1]
Let me give you an example. A formula might be you're going to get stock-market-like returns, which would be the S&P 500, the 500 largest stocks, but you won't lose money, and so you're like, Oh, that's great. Cool. That's good. That sounds easier than the variable annuity. I get the stock market returns, but I don't lose money. Okay, I’ll take that. That's an equity-indexed annuity.
Whoa, whoa, whoa, okay, there are some rules to this, and so when you peel back the onion, here are the rules. First of all, they have caps and participation rates on these equity-indexed annuities, meaning, the cap that most that you can get on the stock market at any given year, this does change, let's say in this example, is 5%. You're like, That's still not bad.
Then they might have a participation rate. Then you can only participate in 80% of the stock market, and oftentimes, they give you options to choose from. But it really comes down to, it's still not that transparent, because the S&P 500, in their modeling, it does not include dividends and dividends account for 40% of the S&P 500 returns, historically. [08:02.5]
When I look at the equity-indexed annuities, I find that a lot of people on the radio that are talking about them don't even understand how they work, and I don't mind them, I think they certainly have a place. In fact, I’ll tell you what, I think they're pretty good products. I'm going to be honest with you, I bashed him over the years, but after understanding how they work clearly, and it's taken me a long time to understand, and then also to understand where they fit for some people, I don't mind them at all. But I really want the client to understand how they work, what they're getting, what they can expect.
So, I'm a fan of them, but you just know, do not expect stock market rates of return and don't expect a free lunch. There's always fees on this stuff and they are either transparent or they're embedded. They'll get their money either way. These annuity companies are very smart. I've been up and I’ve been in their home office in their high tower buildings, they've got three floors of actuaries. They're not doing this for free. They're going to get paid and they're going to get paid well. As an advocate and advisor, I have to find where they're getting paid and just understand it, and once I understand the game, I'm cool. [09:01.7]
Equity-indexed annuities, I don't mind them, honestly, but you just want to know how they work and, again, know that if you're buying from somebody on a radio show on Sunday morning, they're getting a fat fee and they probably don't understand a lot of it.
Now let's go to the last one, which is fixed annuities. Fixed annuities are really clean, but they haven't been relevant for 10 or 15 years because they pay a fixed interest rate. Interest rates have been really low, right? And so, when interest rates start to come up, which they're getting there, we're going to start seeing fixed annuities start to become attractive.
They're kind of like a CD on steroids to certain degree, because what they'll do, and I’ll make this up again, let's say you get 4% from a fixed indexed annuity and it's very clean, you're going to get 4% and this as an example, and you might get that every single year and they'll just kind of guarantee it almost like a CD.
So, that's really clean, fixed indexed annuities, but haven't been important for years because rates have been so low, but they may come back again and we'll keep an eye on those fixed indexed annuities—I'm sorry, “fixed annuities.” I just confused you. So, indexed annuities and fixed annuities. Sometimes people call them fixed indexed annuities. Just know, indexed annuities and fixed annuities are different. You’ve got variable annuities. You’ve got indexed annuities. You’ve got fixed annuities. [10:12.8]
When do you even need to entertain this? I think you should probably entertain it five years from retirement. If you're within five years from retirement, you probably want to know how an annuity works, because you can kind of toned down your stock market risk a little bit and then by getting in the annuity before you need it, because the annuity’s ultimate purpose is to give you income that you cannot outlive.
That's the ultimate purpose of an annuity. They're going to give you a paycheck that's going to hit your bank account, just like you were working on, the third of the month, the check is going to hit. And it doesn't matter if you live to 105, they're going to give you a check forever. That's how annuities work. When you want to turn on your annuity and get paychecks from it, you want to do that within about five years of retirement because there's some benefit of letting it cook before you turn it on. [10:57.5]
Regardless of what type of annuity you get, if you decide to look at them, look at them five years before you retire because you might want them to cook a little bit before you turn them on. All of them have some benefits, some bells and whistles that encourage you to let them cook. So, I have found that if somebody is pivoting into retirement, if they look at any type of annuities, my preference is the equity-indexed annuities today, but if they look at it within five years of retirement.
Then the key element is don't put all your money in there, because you might find yourself down the road saying, “I don't like it, because I was I didn't understand it because they can have a lot of features,” and there's liquidity. A lot of them have surrender charges on them so you can't get out.
How much can you put in there? I mean, I don't know, it just depends. It'd be a stretch to put in 50%, more than 50% of your money in one. I've seen it. I don't know if I like it. But I’ve seen situations where, okay, I get it. You have some creditor protection with these things, too, which is very attractive, but keep in mind your IRAs already have creditor protection. But for the most part, make sure you don't put all your money in it, and you can add. A lot of times, you can add later, but try to have a reasonable amount. Just don't put [all]. Don't say, “This is so great, I'm going to put it all in there.” [12:12.1]
Then be careful with these people on the radio that are just so sweet that “You can get all stock market returns with no risk. Why don't you? Jim, what do you think about that?” Yeah, you might just want to stay away from that. My personality type doesn't like half-truths. It makes me cringe. Even if a pastor is giving half-truths, nighttime television half-truths, it makes me cringe. There's a lot of half-truths.
I hope this was helpful to get you to understand variable equity and fixed, and then make a business decision. Check with your advisor. I assure you, the PAX advisors are not going to have a conflict when they make these recommendations. Then once you have one of these and it's in place, what's nice, what I like about them is you really don't have to worry much. You just get a check every single month and you can't outlive it, so it's kind of cool. And there are some inflation features that you can put on these things that are helpful, too. So, other little tiny details that are beyond the scope of this podcast, but annuities are worth considering, I'll say that. But, still, you’ve got to do your due diligence. [13:13.5]
Thanks for letting me hang out with you. Thanks for letting me chat about annuities. And I hope you have a great day, and remember, I want to remind you that you think differently, you think long term. Have a great day.
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