Income Annuities | Vero Beach-FL

How Do Income Annuities Work

Today we dive into Income Annuities (SPIA) and Fixed Annuities.

by Danny Howes, EA, RFC

by Danny Howes, EA, RFC

Transcription: Financial Pulse | Income Annuities

(This is an automated transcription please ignore grammatical errors)

00:01 Danny Howes: Good Morning Vero Beach. Welcome to the Financial Pulse radio show. I’m your host, Danny Howes, CEO of East Coast Tax and Financial Planning. We are continuing our annuity series this week. We have been doing an annuity series, breaking down each type of annuity to help you understand how they work, the ins, the outs, the good, the bad, the ugly of all of them. And the first week we talked about variable annuities, last week we talked about fixed index annuities, and this week we’re going to be talking about good, old-fashioned fixed annuities and single premium immediate annuities *Income Annuities*. A lot of times they’re called income annuities. And if you remember, variable annuities are insurance contracts wrapped around a group of mutual funds, and th performance of that annuity, the growth or the loss thereof comes from the performance of the underlying investments. The account can go up and down in value. There are different income benefits that are available with variable annuities. And we talked about a lot of the pitfalls and a lot of the benefits in that first week and we have more information on our website, with the whiteboard videos and some write-ups on different things to look out for to empower you so that you can make good choices if that’s something you are considering.

01:13 DH: Last week we talked about fixed index annuities, which they have more opportunity for growth than, say, a traditional fixed annuity in that they link the interest to a common index like the S&P 500 or the Dow Jones industrial average, and now they’ve got more and more index strategies that are out there that are even proprietary indices that allow you to make a little bit more. But it’s a moderate rate of return type of product, and it can’t go down in value. It locks in each year, so even if the market is down, it can’t lose, but, of course, you’re limited on the upside. And there are income benefits to fixed index annuities and different bells and whistles just like with variable annuities.

01:58 DH: This week we’re going to talk about really where it all started, and that is the fixed annuity. Fixed annuities are, a lot of times, considered almost like a CD alternatives. You can’t compare them as apples and apples because CDs are FDIC insured, they are issued by banks. Whereas fixed annuities, they earn a guaranteed fixed rate of return and sometimes they can be more attractive. Right now, they’re very competitive with CDs. CDs are really hard to get up over 1%. Whereas fixed annuities, it’s very easy to find them over 3% now, and so that could be attractive to people that are savers, and they’re tired of not making money with their money that they have in CDs or sitting on the sidelines. And that’s what they are.

02:47 DH: They’re fixed for a particular period of time. They have one-year, two-year, three, you name it, all the way up to 10 even 15-year fixed annuities, and the longer the term, obviously, the higher the interest they’re willing to give you. But to compare that with a CD, CDs don’t have any surrender charges. There’s no surrender period, so with traditional fixed annuities, there is a little bit of ill-liquidity there in that you can’t just cash it in without maybe getting imposed a surrender charge before the term is up or surrendering interest that you’ve earned or both, that sort of thing.

03:29 DH: These contracts are much simpler in design than variable annuities and fixed index annuities because they have a lot less moving parts. However, they still manage….these insurance companies still manage to play around with them enough to where there can be caveats. And some of the caveats you see in the paper, they advertise these high annuity rates and so forth for fixed annuities, but then you find out that there’s all kinds of little rules in order to get that rate. And sometimes it’s a juicer, what I call a juicer, where they’ll give you a real big fat rate in the first year, but then in the trailing years, it’s up to whatever the insurance company decides to declare with a minimum interest rate. So you may get maybe 4% or 5% that first year, but in the remaining years, they may be able to have the opportunity to drop it down to 1% or even 0.5% for those remaining years.

04:21 DH: So you’ve got to be really careful and read the fine print and understand exactly how much you’re going to earn over that long period of time because you don’t want to get stuck in something that just ends up only earning 0.5% or 1% when all of a sudden interest rates rise or there’s other things out there that are better. So you’ve got to be really careful with that. You’ve got to read your contracts, and you’ve got to make sure whoever is explaining this stuff to you is explaining more than “hey, this is just a rate.” No, this is exactly how it works. These are what the surrender charges are. If you were to get out early, this is what the impact would be, and here’s the benefits that would go along with it. So that’s something you want to definitely be careful of.

05:00 DH: And you also, with fixed annuities just like with all annuities, you really want to pay attention to the carrier that you are dealing with. Just like with banks and any other kind of investment companies, there’s great companies out there that are solid, great foundation, some of these companies are 100’s of years old, believe it or not, but then there’s other companies that aren’t necessarily ‘A’ rated. They may be really low on the totem pole. They may have a low Comdex score which is another way to rate and measure the stability, liquidity, and performance of a company.

05:35 DH: Comdex score can go all the way up to a 100, of course, 100 being the best. There are annuity companies out there in between 60 and 70. So obviously there’s something there if these rating agencies are rating them with a much lower rating. That doesn’t necessarily mean that it’s not worth a go. It just means you have to understand what the underlying message is that the rating companies are sending out. Could it be maybe a newer company? Could it be a spin-off? Could it be just a one-time thing that’s really just happened to them but they’re fine, and their balance sheets are sured up? I’m of the mindset that there’s so many different companies out there, and a lot of times when you get to the highest rates, there’s very little difference between them. So why not go with the strongest carrier with the best rate and stick with those A-rated carriers, maybe triple-B plus, but really make sure that you understand the carriers that you’re selecting because the guarantees of that annuity are based on that insurance company’s ability to return your principal plus interest. It’s not based off of FDIC. There are different insurance elements that insurance companies pay into, different state reserves, but that doesn’t necessarily guarantee that your insurance company has that same robust insurance like a traditional FDIC insurance would be. So it’s very different in the insurance world compared to the banking world.

07:02 DH: But that’s not to scare you because fixed annuities can be a great alternative to people that just have mattress money, I call it. Or it’s just sitting in a money market or sitting in CD’s. You don’t think you’re going to spend it any time soon. And you might even be thinking, “I’m just going to leave it to my kids, but I don’t wanna mess around with anything fancy. I’ve got everything I need. I’ve got plenty of income, but I just wanna make more money with my money instead of just earning 1% or a 0.5%.” They can be a really great alternative for that.

07:31 DH: It’s just like what I always talk about. You have to first reverse engineer before you even get into even something as simple as a traditional fixed annuity, because you gotta figure out where you want to go, where that end point is, whether it’s leaving a legacy to your children or your Alma Mater or your charities or church, whatever the case may be. Or maybe it’s just, “No, I wanna make sure that we’re both protected,” if you’re married, “that we’re not gonna outlive our money” and that if something happens health-wise, that something pops up that’s unexpected, the what-ifs in life, I call them, long-term care issues, all those type of things, that you want to make sure that you begin with the end in mind when you’re looking at these products so that you’ve already got a plan in place, you know where you wanna go, and you know what the potential holes are, and you know what that magic number is that you want. Then you can kind of reverse engineer and plug in these different investments and tools.

08:24 DH: Annuities can be great tools, but they’re not the end all and fix all. And although they have a lot of great slogans and a lot of great bells and whistles that can make them very attractive, there are so many other things out there that are too. They’re just one arrow in the quiver of a financial plan that could be very effective that can really serve a great purpose. And sometimes some people’s lives, that’s really all they need is some cash, a little bit of investments, and an annuity. It can be as simple as that. But a lot of times what I see people doing is they get attracted to the nuances of a product, the interest rates or the bells and whistles, like with the other annuities we talked about, variable annuities and fixed index annuities, the income writers, they get fixated on that, and they want that because we want to earn more money, and we’re attracted to that, but then we find out later that really that doesn’t even fit with my objective. And now you’re kinda stuck, or it’s just gonna take time in order to get things turned around so that everything is lined up with your objective.

09:25 DH: When we get back we’re gonna talk about single premium immediate annuities. We’re gonna go back to talking about the three-legged stool of retirement income right after the break. Remember, it’s tax time. If you need your taxes prepared, East Coast Tax Financial Planning, we do taxes. So, give us a call 772-774-7970. And if you want more information on any of this stuff, these variable annuities, fixed annuities, fixed index annuities, go on our website. There’s tons of bonus material. Go to and click on the financial pulse, and we’ll continue to empower you with education to make smart decisions. We’ll be right back in just a bit.


00:00 Danny Howes: Welcome back Vero Beach to the Financial Pulse radio show. I’m your host Danny Howes, CEO of East Coast Tax and Financial Planning. We are talking about traditional fixed annuities and single premium immediate annuities today. If you’re just joining us, we’ve been doing an annuity series and we started off a couple weeks ago talking about variable annuities; the good, the bad, the ugly, and the great things about ’em, and some of the dangers of things you have to look out for. Last week we talked about fixed index annuities and the good, bad, and the ugly, and the things to look out for. And we’ve added bonus material to our website, because we just don’t have enough time on the radio show to go as deep as we want to and a lot of people have lots more questions. So you can always go to our website,, click on the Financial Pulse and you can see all the different bonus material, videos, blogs, and write ups, and things, so that you can make good notes and know what to look out for when you’re making financial decisions.

00:56 DH: Last segment we talked about fixed annuities, traditional fixed annuities, and how they are fixed for a particular period of time. Much like CDs are, you can go out and get a one year CD, even a six month CD, all the way up to five years and even longer. And the fixed annuity works the same way in that sense, in that they give you a guaranteed rate of return for a particular period of time. Sometimes they have bonus rates in the first year and then it drops significantly in the subsequent years, so you gotta be really careful with that when you’re looking at those things. And you also got to think about the fact that the annuities have surrender charges. There’s typically more consequences to cashing in a fixed annuity before its term is up, maybe it’s three, or five, or even 10 years, seven years, than with say a CD.

01:46 DH: A CD is always gonna be more liquid most of the time, so that’s something you definitely want to think about when you’re considering those fixed annuities. If you ever want to listen to our shows… If you joined us in the second segment, you’re like, “Man, I missed the first one.” Like I said, “Our website has all our shows on there,” so you can go on there, and listen to them at your leisure and really pay attention, if you’re driving in a car and you can’t take notes.

02:09 DH: Now, we’re going to talk about single premium immediate annuities or income annuities. These are pretty simple. They’re called SPIAs and the way that they work is you put a lump sum amount of money into this account, and it immediately turns on an income stream to you for life or a certain period of time. It’s not always life. It could be just a certain specified period of time. So a lot of these are used in lawsuit settlements, they’re structured that way, especially if they are lawsuits regarding injuries to children where they want to set something up, where the children can have income later on in life. Maybe you could defer the income, so that maybe the income doesn’t start ’til they’re 18 or they’re 21, and they come in systematic payments and so on and so forth. But otherse, retirees, and people do this too, because they want income. And it’s really a reverse amortization if you want to think of it that way. When you pay on your mortgage, you’ve got a 30-year mortgage and every month you pay a little bit of interest, and you pay a little bit of principal, right? And so you just plug away, you chug away. And by the time you get to the end of that 30 years, your house is paid off. You paid interest all that time and principal.

03:27 DH: Well, it’s almost like the reverse of that for you as an investor. If you put money in a single premium immediate annuity and you decide to take that income, and you say, “Well, I want it over five years, or 10 years, or I want it over what my life expectancy is. I want it for the rest of my life.” The insurance company is then going to basically pay you payments plus interest for the rest of your life and the payments are static. They’re exactly the same and they’re based off of whatever the mortality… If it’s for life, it’s mortality tables that they utilize, and so they’ll say, “You’re 60 years old. Your payout’s gonna be higher if you do a lifetime payout than somebody that’s 30 years old, because a 30-year-old has a much longer time span, obviously. So at near the end of life, some people will utilize a health rated SPIA, where you actually have the insurance company underwrite your health, and in this situation worse health is actually better for the income. If they have your life expectancy pegged much shorter and you do a lifetime payout, and you live longer than what they expected, they still have to pay you that income and they call that a health rated SPIA. And it’s basically a gamble, you’re gambling you’re gonna live longer and the insurance company is gambling you’re gonna live shorter. But it’s a way to maybe enhance estate last minute.

04:51 DH: There’s lots of different reasons why people would do it. It could be a long-term care issue, a final days issue, that kind of thing, and there’s other really neat strategies that you can play around with as well. If you can find an insurance company that says, “I think you’re really unhealthy, and so I’ll give you a SPIA with a high payout for rest of your life, and you find another insurance company that says, “Well, I think you’re pretty healthy, so we’re willing to give you a life insurance policy.” And so you take that health rated SPIA, those large checks that come in, and you feed that life insurance policy. I know this sounds pretty complicated. I’m going down a rabbit trail, but at the end of the day, it’s really simple. As a single premium immediate annuity, I deposit my money in and I get my principal plus interest back over either a certain period of time, sometimes they’ll do five years period certain, and what that means is they’re gonna return all your money to you with interest and over a five-year time period, but if you die before that five-year time period is up, the rest of your payments will go to your heirs.

05:57 DH: But if you don’t have a period certain on there, your payments will be higher, but there won’t be that extra protection if you actually predecease the five years, the annuity company keeps the rest. They don’t continue to pay it out. If you look back in the ’70s and ’80s, that was very common, they didn’t have a lot of period certain annuities. People would actually put their money in annuities and they thought they were gettin’ this great income. Grandma put money in, and three years later she’s gone, and the insurance company kept all the money, when they were supposed to pay her out over a 10-year time period. So that’s one thing you wanna be very careful of, is that if this money is really important to more than just you, it’s also important to your kids, or important to your spouse, making sure that they’re taken care of. If you’re gonna do one of these type of SPIAs, you want to keep that in mind. That might be a good option. Yeah, the payment might be a little bit lower, because the interest will be lower, because they’re guaranteeing that time period regardless of whether you lived throughout that whole time period, but it still could be a good practice in your particular situation. So that’s single premium immediate annuities, and that’s how they work.

07:04 DH: And I wanted to circle the wagons back around and talk about the three legged stool of retirement income, because that’s what annuities are there for, for the most part. Yeah, they’re great for growth. If you are looking at a variable annuity or fixed index annuity, you want to get more interest than maybe CDs are paying. And yeah, they can offer some protection elements, especially with fixed index annuities and fixed annuities, and there’s a place for that as part of your asset allocation. But really at the very beginning of annuities and what they’re really meant to do, is they’re meant to provide income at their core. Now, they’ve morphed and they serve multiple other purposes now that are great, but at its core, it’s income. And we’ve been talking about income riders over the last couple of weeks and how to get income, more income than you can in just the traditional market, or bonds with the low interest rates the way they are. And the three legged stool of retirement is this: The first leg is Social Security. Two thirds of Americans depend on Social Security to have their dignified lifestyle in retirement. The second leg is a pension, and we talked about how the pension has gone the way of the dinosaur, they’re dying. Not a lot of companies are offering ’em anymore, unless you’re lucky enough to work for the government, or municipalities are still offering ’em, teachers, government workers, and so forth.

08:26 DH: But those are getting less and less rich of a benefit. Then you have investment income, and investment income is the idea that you’re gonna invest your money and you’re gonna live off the interest. And so that three legged stool has been around for decades in this country, but it’s starting to wobble in a big way right at the worst time it could with 10,000 baby-boomers a day retiring. And with people not having a pension anymore or not as big of a pension, and with Social Security, cost of living, going up so minuscule every single year, it’s barely noticeable. And with the fact that interest rates are so low for our investment income, that it’s hard to squeeze safe income. It’s becoming very difficult. And that’s what annuities are all about. They’re there to help solve that problem. They’re not always the end all and the silver bullet, but I hope that this series has really helped you, the listener, really understand them and equip you to maybe make smart choices and investment decisions. You can always go to our website to learn more:

09:26 DH: If you have questions about this stuff and you wanna come in my office, and you’ve been thinking about things and pondering what might be right for you, best for you, and you’re actually thinking about making a big investment, give my office a call: 772-774-7970. Come on in and I’ll have a conversation with you. We’ll check out your situation and I’d be happy to guide you. But make sure you get educated and you know the source of your advice and the people that you’re working with. Every single Thursday, 10:30 AM, right here on WAXE radio. Make sure you protect that money, folks, but most importantly, make sure you know who and what you’re protecting it from. I’m Danny Howes for the Financial Pulse.