A new twist
There must be a million ways to arrange annuities (fixed and investment). I was visiting with Andy Nerney, CRPC, regional vice president for Pacific Life the other day, and he discussed using separate investment annuities from two different companies (as you might expect, one of the companies was Pacific Life).
Andy talked about using one annuity (Annuity A) to pay out immediate income of 7% for no less than 14.2 years, and to use the other (Annuity B) to treble its living benefit so to provide income later.
It is unlikely that Annuity A would actually only last for 14.2 years — 14.2 years would be the worst case, and in that worst case, 7% yearly is guaranteed. Whenever Annuity A stopped payments — whether at 14.2 years or after — Annuity B would begin paying lifetime income.
Andy’s idea was a good one. There’s nothing wrong (and lots right) about using two vehicles to get to a destination — when one wears out, begin driving the second one. Ways to “split” income with annuities — usually through income from one and the other with its use deferred — have been around for years, and the technique often works quite nicely.
That got me to thinking. Suppose we tried this: Buy a fixed annuity with a monthly guaranteed income stream for 10 years, and then find an annuity that will double its income (living) benefit in 10 years?
Prudential, for example, doubles its Spousal HD Lifetime 6 Plus benefit in 10 years. It also looks back at the highest daily value for the previous year and accumulates that benefit at a 6% compound rate to determine the income benefit — the husband and wife get the greater of the compounded daily amount or the doubling at year 10, or a quadruple benefit in 20 years. So, the doubling is the worst case, but you have to keep the annuity going for 10 years in order to get the multiplied benefit. (The 6% is used to accumulate income benefits in case income is needed before the 10-year marker is reached — if the husband and wife annuitants needed lifetime income beginning in year three, the worst case would be the deposit compounded yearly at 6%, and the best case would be that the actual value outperformed the 6% compounding.)
Okay, so we make the single premium annuity with the 10-year benefit Annuity A and the Prudential investment annuity will be Annuity B. A $500,000 deposit goes into Annuity A and a like amount into Annuity B.
The beauty of Annuity A is that it pays about $4,645 for 120 months and it’s 89% non-taxed. Once those 120 months are over, Annuity A is dead, gone, finito.
Since A is dead, we move to Annuity B, which offers at least two choices:
1. Choice 1 is selectable if the Annuity B has itself done better than its income (living) benefit. For example, if Annuity B has averaged a few basis points above 10% average growth, the value would be $1.3 million at the end of the 10th year.
a. At 5%, $1.3 million would generate about $65,000 a year, or $5,416 a month, which assumes the income (living) benefit is used from Annuity B. If not,
b. The $1.3 million could be rolled from B to new Annuity C, which could be structured as a single-premium immediate annuity with a refund feature, which could generate, at today’s rates, $8,811 monthly for two lifetimes (and, by the tables, 77% tax-free; however, before getting too excited, keep reading). There would be additional tax on the exchange from B to C, since the $800,000 gain would have so far escaped tax. When B rolls to C, Company B will report the gain of $800,000 and C will calculate and adjust the exclusion ratio to reflect the gain. So what might have been a 77% exclusion ratio will be less, but still it will reflect that each monthly payment is a combination of growth and principal.
2. If Annuity B does not perform — in other words, if the actual cash value is less than $1 million — then the income benefit must be used, and it will generate no less than $50,000 a year. Of course, if the actual value is close to $1 million, it may be advantageous, for tax reasons, to switch to Annuity C anyway, but that is a decision and process that does not need to occur until 10 years down the road, or a month or so before the 10th anniversary of Annuity A.
Andy’s Way
This is all academic if the husband and wife investors like investing (have a tolerance or appetite for risk), and lifetime income is very much a secondary consideration. In that event, Andy Nerney’s idea is just the ticket. Why? Because the investor could wind up with lots more at the end of 10 years, despite the 7% income that is guaranteed to last for 14.2 years.
Suppose that annuity does perform at 10% or 12% — if so, we are talking about serious money. I calculate that Andy’s Annuity A would last for just over 20 years if it earned a constant 12% (constant works like Bernie Madoff customer investment reports). But, since Madoff math really does not work because returns and losses look more like yo-yo patterns, we could say that Annuity A could last in from roughly 17 to 23 years at an average growth of 12% after constant 7% withdrawals. Even so, we would only be approximately accurate.
To give Andy and investors with a taste for some risk their due, the combo of using two investment annuities could win big and offers a lot of possibilities (stopping the income from A, which could have $177,000 left after 10 years and switching to B for income would allow the $177,000 remainder in A to grow for X years, and then one could add from A to C, and so forth, on ad infinitum).
If income and death benefits are a concern, interesting pairings may be designed using annuities like ING or Genworth that offer interesting compounding death benefits that may be independent of underperforming market results along with annuities that offer solid income benefits (Prudential, Transamerica, Jackson, SunAmerica, Ohio National, AXA, MetLife, Sun, Lincoln Financial, ING, and so forth).
All of this simply points out that investment annuities and their fixed brethren are wonderful tools with which to plan for and provide assured income for life for one person or for a married couple. Being able to know that income has a worst-case scenario (and it’s not at all a bad picture, either), gives planners a great deal of power to help customers arrange retirement years. If you have ideas that are different, or which spring forward after reading this, send them along by e-mail. If the idea or ideas reflect something that looks as if it would be of interest and value to readers, I promise to share it and to give you credit.
Broker's Bookcase
The Professional’s Guide to Financial Services Marketing — Bite-Sized Insights for Creating Effective Approaches, by Jay Nagdeman (Wiley, 2009). I’ve long held that there are two kinds of people in our business — those who love investing and those who love marketing. It’s a good idea for those two populations to merge and we even have at least one example in Tulsa — a financial planning firm that separates the marketing and portfolio functions.
Regardless of which side of the equation you reside, this book is a helpful guide that will help get you in front of potential customers. Databases, in the “Putting Technology to Work” part of the “Slice and Dice” chapter, can help meet marketing challenges.
Jay Nagdeman writes: “Eighty percent of your business comes from 20 percent of your customers.” He argues that if the database reveals that this is true — and it probably is for most of us — wouldn’t it be a good idea to find prospective customers with similar characteristics to the 20% segment; not the 80% segment?
The author again: “Database analysis enables a company to identify the most receptive market segments for a given product or service. The firm can then create a marketing campaign focused on the needs, wants and preferences of those individuals.”
In “The Secret of Successful Advertising” chapter, I particularly liked this: “All ads are image ads. The objective of every ad is to enhance the company’s marketplace recognition and credibility through the consistent use of visual and verbal brand elements such as logo, tagline, color, graphics and key marketing messages.” I would hammer that one home — every message you send, ad you produce or presentation you create is about image.
This is a terrific book — I really like the way the author breaks things down into (as the title says) bite-sized pieces of information. This is a work that one can and should keep as a reference. Not only that, you may take your own self-paced marketing course with this book, maybe digesting one or two chapters along with lunch each day.
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All-Star Selling, by Stan Fidel (Xlibris, 2009). While we are on the subject of marketing (see Broker’s Bookcase — Part 1 on page 60), how about its companion — selling? If marketing is the strategy that gets you in a position to sell, selling is when the supermarket shelf item meets the consumer.
This well-organized, small volume gets an amazing amount of info into your hands, and shows how to communicate with prospects, manage presentations and understand processes.
In your practice, have you met The Seer, The Hearer, The Feeler and The Hybrid? No, the hybrid is not a Toyota — it’s a person. In fact, all the titles refer to types of people and expert coach Fidel tells us how to meet the needs of each. Did you note that I said “meet the needs?” My impression is that All-Star Selling’s author is not trying to have us manipulate, he is trying to help us understand.
You’ll like All-Star Selling, and the odds are that it will help your practice. I particularly like: “That’s fine; no problem.” You’ll see what I mean when you read the book.
This information is intended for financial professionals only, not the general public. This is not a solicitation to buy or sell any specific security. Mr. Hoe may have positions in the securities or other investments discussed.
Richard Hoe, ChFC, CLU, AEP, has been an investment professional for 40 years, and is a registered representative and investment advisor representative. He is a member of the adjunct faculty at the California Institute of Finance, a graduate school at California Lutheran University. Readers may e-mail Richard Hoe at richardhoe@richardhoe.com.