Annuities have developed a bad reputation over the years. In this episode, Michael, Tommy and John will be discussing annuities and explaining what you can do to help protect yourself and your finances as you begin to consider your options.
Listen in as they describe some annuity products, specifically how complicated these products can be and the importance of finding a financial planner who will set you up with a long-term plan that they will be a part of every step of the way. You will learn the common misconceptions about annuities, the alternatives to annuities, and more.
Listen to the full episode here:
What you will learn:
- Why annuities have a bad reputation. (5:00)
- Why you should be careful about who you hire as your financial planner. (6:45)
- How to find the right financial planner for you. (9:20)
- What an annuity is. (11:30)
- Common annuities.(13:30)
- The difference between a commission and a fee-only financial advisor. (17:00)
- Whether there are alternatives to annuities. (22:30)
Ideas worth sharing:
“You can’t legislate morality, but you also can’t legislate an education level, which is what many 'financial planners' are missing.” - Mason & Associates, LLC
“Annuities are not bad, but they have to be part of a cohesive plan.” - Mason & Associates, LLC
“All annuities aren’t bad.” - Mason & Associates, LLC
Resources from this episode:
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Read the Transcript Below:
Congratulations for taking ownership of your financial plan by tuning into the Federal Employee Financial Planning Podcast, hosted by Mason & Associates, financial advisors with over three decades of experience serving you.
Michael Mason: Welcome to the Federal Employee Financial Planning Podcast, hosted by Michael Mason, Certified Financial Planner; John Mason, Certified Financial Planner; and Tommy Blackburn, Certified Financial Planner and CPA, Certified Public Accountant.
Mason & Associates have over three decades of experience helping federal employees with their financial plans.
This episode, Annuities: The Four Letter Word.
But before we get into that gentleman, hey, thanks for holding the fort down while I spent most of September on travel.
John Mason: Well, it was a lot of fun. Tommy and I enjoyed doing the podcast and the radio show. And each episode has such a unique dynamic to it, depending on the topic, what we're all fired up about. The shows and the episodes are different when there's three of us.
So, I think we had a pretty good time, Tommy, but it's nice to have Mike back picking up some slack for us so we don't have to carry so much of that weight.
Tommy Blackburn: Absolutely. It's been a blast. John and I kind of have our own little antics, we'll get into when it's just the two of us. But you have been missed.
Really happy you had a great September. I think we all took some trips, so it wasn't just you, but you have been missed and really happy to have you back with us tonight.
Michael Mason: Yeah. And speaking of trips, you guys are due to take one here shortly. Are you excited about it?
John Mason: Oh, we're thrilled. By the time this airs, we will have been to Denver presenting at the XY Planning Network, XYPN Live 2022 in Denver.
And for our audience, XYPN is a national organization that supports younger financial planners who typically serve Generation X and Y. We’re a fee-only financial planners, certified financial planners, and oftentimes, also, associated with NAPFA.
So, it's a really cool conference and we're excited to go out there and present how we do our strategic planning meetings with our clients. And after engaging with some other folks at XYPN across the country, we think we have a lot of value we can add, a lot we can share.
And then there's some pretty big names in the industry, Tommy, that are going to be there, like Michael Kitces, Micah Shilanski, Matthew Jarvis, Carl Richards. Some really interesting folks that are like thought leaders in the industry.
Tommy Blackburn: Yeah, we're pumped to get out there. Honored to be a part of it. It's pretty gratifying when you talk about what you're doing in your business and someone asks you to present on it because they think it could be helpful to a large audience of your peers.
We're going to talk about that strategic planning meeting process that we have, talk about what we do to prepare, how we execute it, and just what we do throughout the year with our clients. So, we're pretty excited about it.
And as we prepare for it, there's a ton of content that we can potentially share, but we have to boil it down into less than an hour. So, it's almost a similar task to these podcasts that we do. We can go extremely deep, but we should only cover so much material in one setting. So, similar to what we do already.
John Mason: And for our audience, guys, I think what's so powerful about the conference is one, we get better as we design these presentations. We always learn something about ourselves that we didn't really know before.
And then two, we're going to be around, probably 550 to 600 like-minded, cutting edge, most of them, financial planners and thought leaders in this industry.
Which means we’re going to come back with at least one good idea, Mike. Which we know we’ve heard from other conferences, if you can go back and come back with one good idea, the conference was worth it.
And we know we’re going to come back with something that benefits our clients, whether it’s technology advice, tax planning strategies, or what have you.
Michael Mason: Yeah, the beauty is everybody that’s a financial planner, is a fee-only financial planner is going to be at this. So, I know you're going to get some great ideas and I also know that you're going to come home and make the dinosaurs learn some probably new technology. So, that'll be fun for us, I'm sure.
But we're excited. So, we look forward to discussing the results of the trip when you do get back. But for now, let's talk about annuities and why do we call annuities the four-letter word? Anybody do the math knows it's more than four letters in annuities.
Tommy Blackburn: They have a bad rep. And one of the primary things behind them is it's associated with insurance, which is associated with a salesperson, which brings us down the path of somebody earning a commission.
And that means that they're not a fiduciary, which means they're not held to a standard or they have to put your best interest ahead of their own.
With all that being said, we'll talk about annuities can be a good tool. They can make a lot of sense. Somebody putting it in place could be doing all the right things, but that's at least where our mind goes originally.
And another thought that I have around annuities is, again, many people market them (who maybe aren't doing the best work for clients) as these kind of like simple products.
And when I think about it, it's like, “Wow, we have insurance, we have contract law, we have taxes, we have investments all wrapped up in this one vehicle.” It’s not necessarily a simple vehicle. And I think it is marketed as such when there can be a lot of complexity there.
And that's one of my main moments when I pause with an annuity, is it's you got to really understand the details of this thing.
John Mason: And without going down too far off the rabbit hole and like putting ourselves on too big a pedestal, but we do a lot to stay on the cutting edge of financial planning and doing the best work for our clients, which is continuing education, these conferences.
And one of the issues that we have in this industry, guys, is that anybody who has any sort of license, whether it's insurance or securities, or the licenses and designations we have, can call themselves financial planners.
That's an issue because maybe you're an insurance salesman who is disguising yourself as a financial planner. We don't think that's right. And the government unfortunately, is not legislating that correctly to our thought process.
Why am I saying this? Because people that can market insurance products maybe have the lowest level of competence. They've passed a life insurance exam only, and they help marketing these products that, Tommy, you just said maybe are the most complex financial products in the industry with the lowest level of competence and the lowest barrier to entry to be able to market them. It just doesn't make sense.
Michael Mason: Yeah. What I've seen over the years, and I've been doing this 35 plus years, a pure life insurance license allows you to sell an index annuity.
And you hear statements on the radio all the time, “Get stock market returns without the stock market losses,” which is a complete fabrication. And we don't have a government entity that's stopping that fabrication when you advertise like that on a radio or even a TV ad. So, we have to be careful.
That doesn't mean that all annuities are bad. I mean, you can have an annuity from your TSP, your CSRS, your FERS are annuities.
We've marketed some pretty good annuities in the past, but they were part of an overall financial plan where we could help that client get anything. We could help them get individual stocks, manage money, variable annuities, fixed annuities. We could help them get anything.
Many of these people, all they can do is help you get what they've got. And what I'd like to say at this point, is that doesn't make them bad, it makes them uneducated. And when they get taught at the home office how to sell and overcome objections on why this XYZ annuity is the best, well, they really believe it.
I grew up in a life insurance industry where I really, for the first six months, believed that replacing survivor benefits with life insurance was the good option. And then we taught ourselves more about how federal and military survivor benefits worked.
So, you can't legislate morality, but you also can't legislate an education level, which is what we're missing.
John Mason: Well, and you just made me think about such a great point and XYPN Live and the conference and the network that we're associated with here at Mason & Associates (not affiliated, but associated) — so many of like the qualified firms, we have minimums, we have a number of families we're willing to serve.
And there's a lot of America out there that needs financial planning advice and they don't know where to go. Maybe they're calling and saying, “Hey, can I be a client?” And they just get, “No.” “I found you on the CFP website.” “No, you don't meet our minimum.” “Found you on XY.” “Sorry, you don't meet our minimum.”
Well, then what do they do? Then they go to folks who maybe are less credentialed, less experienced, only have one license, and they get what they get and that's the best they can get.
Maybe a little commercial, Tommy, for XYPN, but if our audience is listening and they don't meet our minimum or minimums of other folks, XYPN is a great location because these folks charge retainer fees.
Tommy Blackburn: They'll do one-time project fees, hourly fees. And there's a variety of models out there to hopefully help you get some help.
And when you're paying somebody who's held to certain standards there, those fiduciary standards, CFP, they're going to hopefully, take care of you, keep you liquid, not locked up into a product that you didn't understand, necessarily. So, could be a lot of good things there.
And it's a pretty big network at this point. So, I mean, you can figure out your specific situation. Are you a federal employee or are you somebody going through a divorce? Are you a widow? And there are people that specialize in these things and you can go talk to them.
Now, some of those folks who specialize, they may charge a fee that you're unwilling to pay. So, you may end up going with somebody else who's maybe more of a generalist, but it's still better than nothing.
John Mason: And just remember … and then we're going to talk more about annuities, but this is good because it's still annuity-related. That advice regarding an annuity sale like … I believe the exact definition is the advice should basically be like only because the advice of the sale. It's not supposed to be like financial planning advice and then, “Oh, there's an annuity sale.”
Mike, what's the word? I'm not saying it as delicately as I want to say, but it's like advice should almost just be like an afterthought. It shouldn't be the primary method when selling a securities product.
Michael Mason: Yeah. And it's not coming to me. I know where you're going, I can't get there. But maybe before the podcast is over, we'll remember that.
Let's talk about what an annuity is. When common folks hear annuity, they think instantly, some type of income stream.
So, an annuity can be immediate, which means you've taken a lumpsum of money, whether it's your IRA money, your TSP money, or even non-IRA money and you've turned it into an income stream.
And that's the one most people think about. And they say, “I don't want to do that. I'm too young to turn it into an income stream, especially one that's not cost of living adjusted.”
But where most of the annuity sales occur is in the deferred annuity space and that's where you're growing your account. So, you've put some money in and at later date, you may turn on an income stream.
And that's where over the last 20 to 25 years, the competition has been, is my deferred annuity better than yours? And if I'm getting ahead of ourselves, you guys will reel me in. But what is that annuity invested in while it's deferred?
It could look like mutual fund sub-accounts, go up and down with the market. It could be a fixed interest rate, which haven't been really attractive over the last 25 years. It could be some type of index annuity.
So, really the annuities that are getting the momentum or have had the momentum, are the ones that are deferred. And then they have some guarantees attached to them. So, I think it might be beneficial to talk about some of the guarantees. And I'll do it, and then you guys cut me off when it's time.
Because in 1990, because it is an insurance product, a common deferred annuity would have one insurance aspect to it, guys. And you won't remember it because you weren't in the business.
Tommy Blackburn: It was a death benefit.
Michael Mason: It was a death benefit.
Tommy Blackburn: I remember.
Michael Mason: And what was the death benefit?
John Mason: What you put in. So, the premium or your initial deposit was the death benefit.
Michael Mason: So, imagine you bought a $100,000 deferred annuity that was invested in the market and they said, “Look, no matter how aggressive you are, if you die, your heirs are going to get at least a hundred grand back.” And you did that in the ‘90s in a market that was booming.
So, now, you wake up five years later and you’re a 100,000 is 300,000 because it's in a booming market. Well, what's your death benefit?
John Mason: It's that original hundred that’s-
Michael Mason: It's the original a hundred. So, then advisors or agents, they, “Hey, if I move Tommy's hundred to another annuity, well, now, he'll get 300,000 death benefit. Maybe he's got a surrender charge to move it, but we lock in 300,000.”
And then the insurance companies caught on and they're like, “We're not going to do this.” So, one insurance company said, “Hey, we'll lock in your highest five-year value.” And then another one said, “Well, we'll lock in your highest year value.”
You got to the point that these companies battled back and forth, not only on a death benefit where it got to your highest daily value, but then you had some guarantees as far as income goes.
And they got out over their skis, guys. In 2008, some of these promises were so beneficial to the client that when the downturn happened and those variable annuities and all that money was reduced, some of these companies almost went out of business.
So, to think that these annuities were not beneficial when placed using the scope of an entire financial plan, would be wrong and it'd be self-inflicting penalty. Because we did many of those and we do believe they make sense and we've kept them in place.
So, the discussion today is, are they still a viable part of a plan?
John Mason: Well, I guess before is it still viable, but it's like … and these are not inherently bad products, they-
Tommy Blackburn: Right. Yeah, you were answering the question, I was thinking; are these bad? And inherently that answer is no, they are a tool.
John Mason: They're a tool in the tool belt or do they cost a lot of money? Yeah, they're probably one of the more expensive investments you can get into. Do they have long surrender charge? Yes, they do.
Do they pay the insurance sales person a decent commission? They do. The person that helped you buy it, do they have any obligation to ever meet with you again? No, they don't.
So, you start thinking about all of these things; are they magic bullets that are going to make your financial plan better? No, they're not. So, you start thinking about some of these things and it's like yes, they can fit. Guaranteed income is awesome.
I had a client back in the earlier part of the 2010s who we knew was terminally ill, Tommy, and we were able to lock in a death benefit to protect that asset for his family.
So, there are use cases for annuities. They're not bad, but like you always say, it has to be part of a cohesive-
Tommy Blackburn: And that's exactly what I'm thinking throughout this. And as Mike was telling the history behind it and how the firm has used it, is it was part of a plan and it was part of a relationship where it wasn't just, “Here's the product and I'm gone,” necessarily. It's, “Let's get keep getting back together, what makes the most sense for you? Let's match this to your circumstance and let's also be able to change with time as we need to.”
And it's interesting, as Mike went down kind of annuities are also like pensions and both of them get caught up when they make bad actuarial assumptions, which is your example, why they almost went out of business.
Because in the ‘90s, the market was only going up at double digit rates, I believe. And they figured well, giving you an 8% increase per year on your income benefit, well, that looked pretty poor compared to what the market was doing. And then we had a reversion to the mean and we know how that story goes.
Michael Mason: And I want to add just a little clarity to the difference between a commission and a fee-only financial planner.
John, you set it up for me terrific. If you have a million dollars and you come to Mason & Associates and you love your spouse and you're easy to work with, you can be a client. And if we get 1% of assets under management, we make 10,000 thousand a year.
But what if all you have is a hundred grand and you go to Mason & Associates? Well, a $1,000 a year is not going to cut it for us. But down the street is a guy that sells a 7% commission annuity and he'll get $7,000 up front.
And the problem with that is not the 7,000 upfront. The problem is he can't do that every year with 50, 60 new clients and service all of them. So, you don't have a financial planner, you have a product, you have a transaction and never works.
John Mason: We're serving annuities that were written or issued anywhere from like 2007 through probably 2018 or ‘19. And what's the common theme? And I know all three of us have seen it and Ken and Ben the same.
We could explain these annuity products to a client until we're blue in the face every year for a decade and the strategic planning meeting comes around and what do we have to do again? Explain it again because they're that complicated.
So, again, they're not bad products but they are super complicated, Tommy, to your point. And if you're not going to have an ongoing relationship with somebody that's going to help you maximize them, it quite possibly is more harm than good.
Tommy Blackburn: Yeah. And sometimes just keeping it simple where everybody can understand and including the client, I think there's something to be said for that depending on the client's ability to keep up with this.
Because sometimes, you do see folks like, “Yeah, I have no idea how this thing works that the guy down the street sold me.” And so then, we have to roll up our sleeves and we figure it out.
I've even got a personal story if you want me to share that one with my own mother. Probably before I had an inkling about financial planning, certainly before I was in college, her company hospital was a nonprofit, got bought by a for-profit, I believe.
So, rollover opportunity, we're getting rid of our old plan, you got to do something with your funds. I think whoever was serving that plan was probably who she went to. It was a commission A, I'm not sure.
But she went to someone selling annuities and she bought it. Because I don't know the full history, I've always questioned like would it have been the best outcome with this annuity? I don't know. Versus if it was invested in a broadly diversified portfolio that was allocated properly.
Anyway, push come to shove, we go through the 2007, 2008, like Mike was referencing. This had a 7 or 8% income guarantee on it. So, this is one of those moments where I'm looking at it with my mother and it's like, “Well, we're keeping this thing because at this point, if you were to say give me my money, it's nowhere near what the income you could draw off of this is.”
So, it was a couple things. Part of that was her having a financial planner to say, “Here's how we're going to use this thing going forward.” But it was also … and my mother's a pharmacist, so she's not an unintelligent person, she's educated. She thought, it definitely had been explained to her that you can take this income amount.
So, when I explained to her, “No, that amount is what an income stream is … they're only going to generate an income stream off that. They're never going to give you that lump sum amount.” Yeah, that was news to her.
So, that's again where it's kind of like how are things marketed to folks? But regardless, real financial planning figures out how do we take this product and how do we take the situation we have and make the most of it. And it's worked well for her plan at this point.
John Mason: That's where we talk about the real money, which is your account value and the fake money, which are these benefit values.
So, guys, we're getting kind of close to the end of the podcast. I know there's a few other topics we want to talk about.
Number one is TSP annuity as compared to a private sector annuity. And then just generally speaking, do federal employees with a 30 or 40-year career need more or should they consider having more guaranteed income?
Michael Mason: Yeah, and I'll take the first stab at that. I would say more guaranteed income is probably not what they need.
Maybe as they're approaching the end of their career, a non-qualified annuity, that's an annuity not in an IRA. Maybe they spent the majority of their career buying life insurance thinking they were going to turn down survivor benefits, and they find out survivor benefits is better.
Well, it's a little known fact. You can exchange the life insurance for an annuity. Maybe the cost basis on that life insurance is 75,000 and the cash value's 50. Well, if you get it into an annuity, you can grow that 50 to the 75,000 tax-free. So, just surrendering it doesn't make sense.
I want to make sure that we identify that all annuities aren't bad. You should seek out that financial planner. And they were originally designed for non-qualified non IRAs.
John Mason: Well, there's a use case like you said, and you just specifically highlighted like nationwide, the old Jefferson National fee-only, fee-based annuity with no surrender charges, no fees. Or low fees, not no fees, low fees, but no riders, no sexy product appeal. Just pure tax deferral, and there's use cases for that.
So, I think we would echo your point that one, not all our annuities are bad. Federal employees probably don't need more.
And then, Tommy, I guess I want to add to Mike and then hear your thoughts on the TSP annuity, is insurance annuity products really did well and offered some good guarantees.
And then as interest rates continued to drop, the guarantees got watered down and the benefits got worse to the point where when we were even able to market these, we didn't because they just weren't competitive.
Is that still the case? Will that always be the case? No. So, are we going to turn a blind eye to annuities? We're not. There are annuities available to fee-only financial planners and if it ever makes sense to use them again, we're not going to just turn a blind eye to products and services and investments that can benefit our clients.
So, I just want to put that out there too.
Tommy Blackburn: Yeah, and I mean we do them. You just even said we use nationwide, where those use cases make sense and it is a landscape that continues to change quite a bit. So, as it continues to change.
And part of it is you're seeing this movement within the financial planning profession to fee-only. So, as that is happening, insurance companies are trying to figure out how do they now reach that market because they can't get in the door under their current structure. So, you are seeing it start to change.
I mean, I’m sure we all read about one of those companies that makes it available to fee-only advisors. Just had a huge funding round. They're seeing a lot of momentum behind being able to make these available. So, it absolutely could change and when it changes, we'll change with it when it makes sense.
Think to your first question though, for most federal employees, I mean the beauty is they have awesome guaranteed income between that first pension or CSRS and if social security, if they have that. So, between those, it's kind of hard to make a case where you need more guaranteed income.
John Mason: But if you want it, we will go out on a limb and say TSP annuity is not the one for you. You can probably find a better annuity through a qualified financial planner. But before you buy it, ask this question: “How does this fit into my overall financial plan? Are you going to design a financial plan for me? And do you have the ability to do anything other than help me buy this annuity?”
So, those are the couple questions you want to ask. You can probably do better in a private sector annuity than you can inside TSP. Guys, let's transition to action points. I'll go first with some immediate action items.
Number one, annuities are not a four-letter word, but make sure you know if you are interested in buying one, who's selling it, who's marketing it, what their credentials are, how it's going to fit into your overall financial plan.
Michael Mason: Yeah, I would say just remember the old adage; if you're a hammer, everything you see is a nail. And when we say that, that's what we mean by if all you can do is X, Y, Z annuity, then it's hard to be a financial planner.
Tommy Blackburn: Yep. And we hit on those federal employees who we designed this podcast for. If you like your pension, annuities aren't so bad because your pension is a form of an annuity.
Michael Mason: Yeah. It's going to get a big cost to living adjustment—
Tommy Blackburn: That’s going out there. Well, that's a great point you make, Mike, about — because what's the risk with some of the non-pension annuities out there that aren't government backed?
Michael Mason: Yeah. You just lost over the last two years because come January is going to be probably an 8% COLA. You've lost 14% of spending power. If you annuitized December of 2021, you've lost 14% of spending power.
Tommy Blackburn: So, many annuities don't have an inflation, they don't go up with inflation. Whereas of course, the federal pension, state pensions, military, they get that. So, that's what makes them really so awesome.
John Mason: Well, thanks guys. Awesome, awesome episode. Thank you to our audience, thank you for listening. Thank you for the ratings.
If you like what you hear, please do subscribe or follow our podcast. We're on most available platforms. Leave us five stars. Shoot us an email at masonfp@masonllc.net if there's any topics you'd like to hear.
We're releasing two episodes a month and that is going to increase, as well as potentially some new videos on our YouTube channel. And if you're interested, we do have a new office tour that's out there as well. So, lots of good stuff here.
Thank you. Thank you again for your service. This has been another episode of the Federal Employee Financial Planning Podcast hosted by Mason & Associates.