RPF0316-Friday_QA
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00:00:30.000 | Q&A show today on Radical Personal Finance.
00:00:32.000 | We talk about two questions.
00:00:34.000 | Should I stay at my job in order to take advantage of the public loan forgiveness program?
00:00:38.500 | Or should I leave and go work knowing that I'm going to have to pay a bunch of money back because of it?
00:00:44.100 | Also, is there an age or a time at which it's better to buy a single premium immediate annuity?
00:00:51.300 | [Music]
00:01:09.800 | Welcome to the Radical Personal Finance podcast.
00:01:12.000 | My name is Joshua Sheets and I'm your host.
00:01:13.700 | Thank you for being with me today.
00:01:15.200 | Fridays we do Q&A.
00:01:17.600 | Q&A is a good way if you want to ask me a Q, I can try to give you an A.
00:01:23.800 | Try to give you some ideas to guide you toward a rich life now and financial freedom in 10 years or less.
00:01:30.500 | That's the theme of this show and today we continue that theme.
00:01:34.100 | [Music]
00:01:41.900 | These Friday Q&A shows are a live call in on the conference line
00:01:45.700 | and they're a live show that you can call into if you're a patron.
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00:01:58.100 | RadicalPersonalFinance.com/patron.
00:02:00.100 | This is one of the benefits of supporting the show directly.
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00:02:08.600 | RadicalPersonalFinance.com/patron.
00:02:10.600 | And let's get right into the questions today.
00:02:12.600 | Joe, welcome to the Q&A call.
00:02:14.200 | How can I serve you today?
00:02:16.200 | Thank you.
00:02:17.200 | I've been a long-time listener and just love the ideas from the show.
00:02:20.200 | Basically, my question kind of encompasses lifestyle design, financial freedom, all the ideas we've been talking about.
00:02:27.200 | So here's the scenario.
00:02:29.200 | I went to about 10 years of school, so I have my – I'm a psychologist in Upper Midwest State,
00:02:35.200 | but I have about $200,000 in student loan debt.
00:02:38.200 | So scenario one is I stay at my current nonprofit for about another seven to eight years and get the public loan forgiveness.
00:02:46.200 | So drop that down to zero, but make quite a bit less per hour than I could maybe in private practice or with a private group practice or something else.
00:02:59.200 | Or scenario two is that under the new Obama student loan repayment plan where it takes 20 years and you pay 10% of your income per month,
00:03:09.200 | and then after 20 years it's forgiven.
00:03:12.200 | But under that scenario, all of the accrued interest is taxable.
00:03:16.200 | So my $200,000 will grow to about $500,000.
00:03:21.200 | So basically, here's the scenario.
00:03:23.200 | I could quit tomorrow and get paid the same amount and work in about two days a week, have more time with my kids, garden,
00:03:31.200 | do all the things we've been talking about on the show, which would be a big risk because I would in 20 years be facing quite a big tax bill.
00:03:41.200 | So that's kind of the gist of my question, if that makes sense.
00:03:46.200 | Wow. So how much are you making now working for a nonprofit?
00:03:51.200 | It comes out to be about $35 an hour, and I could be pulling in – my private practice would be anywhere between $70 to $120 an hour depending.
00:04:02.200 | If you went into private practice – and I don't know much about psychology – if you went into private practice,
00:04:08.200 | would you be working easily in a situation where you're with a group and you just simply show up to the office and sit and talk with people?
00:04:19.200 | Or would you be responsible for everything else associated with running the business – finding clients, renting the office,
00:04:26.200 | just all the other stuff associated with the business?
00:04:29.200 | So that's a good point. I have a different opportunity that's in the middle.
00:04:33.200 | So I have my current one at about $35 an hour.
00:04:36.200 | I have a group opportunity that I kind of drive about an hour away, and I'd have all the clients there at about $50 an hour.
00:04:43.200 | And then I'd have private practice, which is – I would do everything myself, but get paid a lot more.
00:04:49.200 | And I have an above-average interest, obviously, in financial matters and running businesses than other potential people in my class and things.
00:04:58.200 | So it wouldn't be that much to learn, I guess.
00:05:02.200 | There's certainly not that – running a business is not all that difficult. Learning how to figure out which tax form to file is not that tough.
00:05:12.200 | Signing a lease is not that tough. The challenge is just simply having the marketing operation set up to where you're going to have a steady flow of clients.
00:05:20.200 | So that's the major challenge with every business is what's going to bring the revenue in the door.
00:05:27.200 | So at the moment, you're currently – how much are you currently paying on the student loans?
00:05:33.200 | Are you on a percentage level, or what's the payment plan that you're making on them right now?
00:05:39.200 | Well, thanks to you and the show, I've kind of figured out my taxes where I can pay close to zero because they do that on adjusted gross income.
00:05:48.200 | And because I'm contributing to 401(k) and doing other things to lower my taxes.
00:05:53.200 | So basically, I could pay zero for the next 20 years, but then I'd be faced with a $500,000 tax bill if I don't stay at a nonprofit.
00:06:03.200 | But you said if you stay where you are, you just have about another seven or eight years, and then you could have them all forgiven, right?
00:06:09.200 | Yep.
00:06:11.200 | Do you like the nonprofit?
00:06:14.200 | It's good enough, but it's a nonprofit with a lot of incompetent management, and I'm sorry I left my name off.
00:06:27.200 | Man, is the nonprofit – is it really draining as far as the number of hours required of you to do a good job?
00:06:33.200 | Is it a 60-hour a week thing, or can you just show up, do a good solid 40 hours, and be done?
00:06:38.200 | Well, that's the thing I'm thinking about because in order to get the public loan forgiveness, you have to work a minimum 32 hours a week, and right now I'm doing 40.
00:06:48.200 | So I thought about at least scaling back to 32 and maybe just picking up some private practice to supplement.
00:06:56.200 | Yeah. So I don't know how to tell you what to do.
00:07:02.200 | What's the most specific question that you have?
00:07:06.200 | Is it between these two? Should I leave and go and start a business? Is that the major question that you're asking?
00:07:10.200 | Well, I think it's the risk of the taxes, and I guess if you were faced with – if you know for certain or pretty much for certain that you'd have a $500,000 tax liability in 20 years,
00:07:25.200 | but looking at my investment projections, it'd be like my portfolio should hit about a million by then given if I stay the course.
00:07:35.200 | So, yeah, so the $500,000, I'd actually owe about $120,000 to the IRS if I jump ship now and don't do the public loan forgiveness.
00:07:46.200 | Well, I guess here's how we could put it into financial terms.
00:07:49.200 | So under the scenario that you just said, they're going to forgive about $500,000 of loans, and then that's going to be imputed to you as income.
00:07:58.200 | It's phantom income. It's imputed income where they're going to tax you on it.
00:08:02.200 | Let's just say – well, let's just go with your $120,000 number. At your tax rate, et cetera, they're going to charge you $120,000, and that's going to be in 20 years.
00:08:11.200 | What we could do is we could figure out what the present value of that is to figure out how big of a question that is in today's dollars.
00:08:18.200 | So $120,000 in future value, discount that for 20 years, no payments, and I'm not sure what discount rate we should use here.
00:08:29.200 | Let's use 5 percent. So discounted 20 years to today's dollars, that $120,000 would be worth about $45,000 in today's dollars.
00:08:38.200 | So essentially that should put it into perspective to try to figure out how big of a gain or how big of a loss this is to you from the perspective of that forgiveness.
00:08:51.200 | We're talking about a $45,000 bill. So you've got to add that and weigh that somehow in your decision criteria.
00:09:00.200 | Do I stay for another seven or eight years paying essentially nothing, recognizing that this full balance is going to be forgiven so that I don't have to pay this – what's equivalent to a $45,000 bill in the future?
00:09:14.200 | Remember I used a 5 percent discount rate. If we used a 3 percent discount rate, it would be bigger.
00:09:18.200 | If we used more – that's about the numbers that you are – that you're thinking of.
00:09:23.200 | And frankly, man, I don't have a good framework for how to tell you what to do.
00:09:28.200 | I guess what I would look for is I would look for a couple of things before I just jump.
00:09:34.200 | Given that you're only seven or eight years away from that public loan forgiveness and given that you do have such a substantial amount of student loan debt – I mean that's $200,000 of student loan debt.
00:09:43.200 | So that is pretty substantial, and the risk about going into the – into private practice is based upon that income repayment plan.
00:09:56.200 | You're constricting yourself from being able to make a lot of money if you want to stay into that – under that low-income repayment plan.
00:10:03.200 | So your way of talking about it was, well, I could go from working five days a week to working two days a week, which is valid.
00:10:09.200 | But you might not want to do that, and so if you continue to increase your income, then those payments are going to go up under that – under the terms of that payment plan.
00:10:18.200 | If I were in your shoes, I think what I would first look at would be, number one, can I pull back a little bit on the work that I'm doing at my job and arrange a deal that's going to free up some time while I'm still making enough money at the current situation?
00:10:37.200 | You owe your employer a solid week's work, but if they only require you to work 32 hours, can you work a very productive 32 hours instead of 40 hours in order to keep yourself in this loan forgiveness situation?
00:10:50.200 | I would also look at it and say, is there another organization that I could transfer to that would be very in line with my mission or my calling or my purpose in my work that might be a better work environment?
00:11:04.200 | So instead of just simply – because you don't want to – I mean it's a really tough call to say, "Oh, I'm going to go for seven or eight years to a job that I'm not all that interested in doing something I don't really care about with an organization that's dysfunctional."
00:11:18.200 | It's hard to do that just for the sake of student loan forgiveness.
00:11:22.200 | You could do it, but you could also go and find another organization that would fit in under these criteria and perhaps would do some work that's really meaningful to you.
00:11:32.200 | So is there another not-for-profit organization that exposes you to the marketplace, that exposes you to the ideas that are important to you, that gives you time to spend time not only working with patients but also doing research perhaps that could be important to you and can use a transition there to solve the financial problem and to solve the creative problem of wanting – doing work that matters?
00:12:00.200 | Another thought is can you invest the next seven or eight years in some way that's going to really make a major difference once you've finished out that term?
00:12:12.200 | So that's where my mind went for you as a psychologist.
00:12:15.200 | My mind went to some sort of research project.
00:12:18.200 | Can you view this period of time as – I don't know if you have a – what degrees you have, but can you view this period of time as a PhD research project?
00:12:28.200 | Is there some significant area of research or focus that you'd love to dig into?
00:12:33.200 | And for the next seven or eight years, you are intensively investing in making a contribution to this area of research.
00:12:40.200 | You're establishing your platform and your brand.
00:12:43.200 | You are writing in whatever way is appropriate to your industry, so you're establishing yourself.
00:12:48.200 | Then at that point in time, in seven or eight years when you leave the umbrella organization and go into private practice, instead of being able to bill $50 or $70 an hour, is there some way that you can dramatically transition that to a much higher hourly rate through the investment of time over the next seven or eight years?
00:13:04.200 | This is essentially what you see many people in government do where people will go and work in the government for a period of time, and they use that to establish their credentials and their connections and usually to build their political power.
00:13:17.200 | And then they go and they get a job for a lobbying organization and they go and get a job or for a major bank or something like that.
00:13:25.200 | And yes, they put many years working in that government organization at a relatively low pay, but on the flip side, they get paid $750,000 a year to work as a lobbyist because of all the connections they've built.
00:13:36.200 | So you can take that strategy and apply it in hopefully a less evil way just by using the seven or eight years to advance the cause of your organization and build the connections, build the network, so that on the back side you can step into something much more lucrative if that's what you want or much more financial.
00:13:55.200 | So that's the best idea I've got.
00:13:57.200 | Does that resonate with you?
00:13:59.200 | Yeah, no, that's helpful, and it's just nice to run it by someone.
00:14:03.200 | So thank you.
00:14:04.200 | I mean in summary, discount the numbers, but these are not small numbers, and if you can keep it where you're not – but they're not massive.
00:14:13.200 | But if you can keep it to where you don't have to pay that $200,000 student loan and you're going to get it forgiven and you can basically make zero payments and you can work in a less than stressful job over the coming years.
00:14:25.200 | And if this stage in your life is appropriate, then I would encourage you to consider and look for that.
00:14:31.200 | So cool. Let's go on.
00:14:33.200 | All right. Thank you.
00:14:34.200 | Frank, next question.
00:14:37.200 | Sure. Can you hear me? I'm on the speakerphone.
00:14:39.200 | Sounds great.
00:14:40.200 | Do you need me to pick up?
00:14:41.200 | Go ahead and pick up. It'll make better audio, but I can't hear you.
00:14:45.200 | Got it?
00:14:46.200 | Yes, much better. Thank you.
00:14:47.200 | Hello?
00:14:48.200 | Yep, go ahead.
00:14:49.200 | All right, great. Okay, my question is kind of the reverse of what you were just talking about.
00:14:53.200 | I'm interested in single premium media annuities, and I've been fascinated by these things because they basically pay you to stay alive.
00:15:02.200 | But looking at how these things pay – I'm not thinking about buying one now.
00:15:08.200 | I'm thinking about when I get to be old, like sometime in my 70s or some – this is at least one scenario.
00:15:17.200 | It seems to me, and I've looked at essentially what's called – what is it?
00:15:23.200 | Gompertz mortality curve.
00:15:25.200 | It shows that as people get older, the percentage of them dies more quickly every year.
00:15:33.200 | And so it looks like for a product like that, you really get the bang for your buck, if you will,
00:15:41.200 | if you are healthy and getting up there like 70-something.
00:15:48.200 | But I'm wondering, is that just my observation?
00:15:53.200 | Because what I'm thinking of is when I get to be of a certain age, I don't really want to be fooling around with investments too much anymore.
00:16:02.200 | I just want to have some income knowing that I'm going to have it until I'm dead, and my wife's going to have it until she's dead.
00:16:10.200 | So my question is, is that the right way to look at it, to wait until you get up to one of those ages?
00:16:17.200 | Or is there some other commonly used strategy where you would say, for instance – and I'm just making one up –
00:16:24.200 | buy a little bit of one for like the next 20 or 30 years, building up essentially the payment stream that you would get out of one of these things?
00:16:35.200 | Got it.
00:16:36.200 | So a couple of questions embedded in that, and I'm going to pull them apart to answer them.
00:16:41.200 | So first, the first question that you're articulating is, is there an ideal time for me to start a stream of income from an annuity?
00:16:54.200 | So is it superior for me to start that at the age of 70, or is it superior for me to start it at the age of 65,
00:17:01.200 | or is it superior for me to start it at the age of 60, et cetera?
00:17:04.200 | That's the first question.
00:17:06.200 | My answer is no.
00:17:08.200 | The life insurance company is not going to be fooled by your starting at a different time.
00:17:14.200 | The mortality tables are calculated carefully based upon the life expectancy.
00:17:20.200 | And so you're going to share in a mathematically consistent way in the appropriate percentage of your returns,
00:17:28.200 | whether you start the stream of income at 55 or at 70.
00:17:32.200 | So when you're looking at the difference in payouts, there's no way that I'm aware of to somehow choose a magic age of payout.
00:17:40.200 | This is the same complaint that I have when people talk about – my pet peeve is when people talk about buying long-term care insurance at a certain age.
00:17:48.200 | There have been many financial pundits who at many times have said you should wait until 65 to buy long-term care insurance.
00:17:54.200 | Well, as a former insurance agent, I never understood that because at 65, it was just a little bit more expensive to buy than it was at 64,
00:18:02.200 | and it was a little bit less expensive to buy than it was at 66.
00:18:05.200 | And you're not going to fool the insurance company.
00:18:08.200 | They're working with the tables.
00:18:10.200 | So my answer was always you should buy it when it's appropriate to you, and that's my same answer to you with regard to the annuity.
00:18:16.200 | You should purchase the annuity at the time that it's appropriate to you.
00:18:20.200 | You could make an argument that it's best to start a stream of income even earlier if you're expecting a long lifespan and if you have some of the little sweeteners in your annuity.
00:18:34.200 | So for example, if you have – if you've purchased an annuity product with a certain level of increase, with a certain inflation increase, et cetera, there are all kinds of riders and benefits.
00:18:44.200 | Well, it's to your advantage to have those things working for as long a period of time.
00:18:49.200 | But I do not see any reason why from the perspective of trying to get the best deal off the insurance company, you should wait for a certain age.
00:19:00.200 | If you're going to live to be 100 years old, you're going to get a great deal if you start your annuity stream at 50.
00:19:05.200 | You're going to get a great deal at 60 and a great deal at 70.
00:19:08.200 | You're just going to get a great deal no matter what.
00:19:10.200 | And your payments will be proportional to when you started it.
00:19:16.200 | This is different than when we're doing something like social security analysis.
00:19:21.200 | Social security analysis is going to be affected by your age because we're factoring in not only the normal amortization schedule – that's the wrong word – not only the normal mortality table of if you start at this age, then you get extra money.
00:19:36.200 | But we're factoring in the guaranteed growth of the payment when we're stretching social security out.
00:19:41.200 | We're also factoring in the – not only the guaranteed growth of the payment, but we're also factoring in the tax savings of whether you're earning and working or not.
00:19:52.200 | So when you're just buying a straight annuity from an insurance company, you're not getting a savings based upon your age.
00:19:59.200 | You're getting the appropriate mathematical stream of income for your age.
00:20:04.200 | So that's question number one.
00:20:05.200 | Now, question number two is kind of a subset.
00:20:08.200 | Is there a good time for me to start the annuity?
00:20:13.200 | And the answer to that is it's a good time to start it when you need it in your income plan.
00:20:19.200 | So if you, for example, were working and you were planning to retire at the age of 70 and up until then you had a consistent salaried income, then there's no reason for you to start receiving income payments before you retire.
00:20:36.200 | You would start it after you retire because that's when you actually – that's when you actually are going to need the money.
00:20:45.200 | You don't need the money before you retire, so you start it when you retire.
00:20:48.200 | It's not due to anything about the age of 70.
00:20:50.200 | It has to do with when you're going to stop working.
00:20:53.200 | And then – and so you plan it – you plan to buy the annuity when you need the stream of income as it relates to all of the other factors in your financial plan.
00:21:04.200 | And then I guess point number three is the question of should I buy an immediate annuity or not?
00:21:12.200 | So this is one of the distinctions you made is when should – and it's another question of when should I buy an annuity.
00:21:18.200 | If you're going to buy an immediate annuity – and so for those who are not aware of what this means, a single premium immediate annuity means that you take a large lump sum of cash.
00:21:28.200 | You give it to an insurance company and you immediately annuitize the money.
00:21:33.200 | You've given them a single premium, a large basket of cash, and you immediate annuity. You immediately annuitize the money.
00:21:41.200 | So you receive a payment the very next month.
00:21:43.200 | The idea behind this type of product – and this is heavily – and rightly so is heavily promoted and I'm glad that it is in the financial press – is because you are only getting the pure benefit of the insurance.
00:21:59.200 | You're not particularly buying it as an investment product 20 years earlier.
00:22:03.200 | You're not particularly trying to use it as a tax shelter.
00:22:07.200 | You're just buying an annuity.
00:22:08.200 | This is the simplest type of annuity, which is why people often recommend it.
00:22:12.200 | You're going to buy it when you have the money and when you want to receive it – receive the income immediately.
00:22:18.200 | There can be times that you want to buy an annuity before you need the payments.
00:22:25.200 | And so that's almost the subset. It's not related to – because you identified a SPIA, a single premium immediate annuity.
00:22:32.200 | But there could be times where you would wish to purchase a certain type of annuity product, perhaps at 50 or 55 or 60, that has certain built-in features to the contract that are valuable to you.
00:22:43.200 | And you'll buy it at 60, but you'll defer the income until a certain future date at which you need it.
00:22:50.200 | So you do have to make that decision separately.
00:22:52.200 | It's not applicable with a single premium immediate annuity, but it certainly is applicable with other financial planning factors.
00:23:03.200 | Is there – I mean, is there – I mean looking at a deferred option – between a deferred option and an immediate option.
00:23:14.200 | What would worry me is that I'm going to die in the – if I were to buy it at 60 to go into effect when I'm 75 or 80 or something, my worry would be I'd die before I get there.
00:23:28.200 | And then I might have a better idea of what my health is going to be like if I just wait until I get there.
00:23:37.200 | But obviously you're going to pay less when you're 60 than you would when you're 75 or 80 up front for the same stream of income.
00:23:48.200 | Is it just – math, is it about the same or is there something to be said for one over the other?
00:23:56.200 | Well, there's two – so here's the reason not to buy an annuity early.
00:24:00.200 | So do I still own an annuity?
00:24:02.200 | I think I own – yes, I have – I own a deferred annuity.
00:24:06.200 | I have a deferred annuity in one of my Roth IRAs, and so I own an annuity.
00:24:14.200 | Now, I don't necessarily recommend that.
00:24:15.200 | I did that because one of the things that I wanted to do when I was an insurance agent, I wanted to, if possible and if reasonable – I didn't own all of them.
00:24:22.200 | But I wanted to own all of the products that I sold so I could understand what they were like and how they work from the inside.
00:24:27.200 | I could see the statements and all of that.
00:24:29.200 | So I don't – it's not generally a great plan, but it's an OK plan.
00:24:36.200 | The reason – so here's the reason why you don't buy an annuity very early on.
00:24:41.200 | It's the cost.
00:24:43.200 | An annuity contract will have two sets of expenses.
00:24:47.200 | It will have the investment expenses from the underlying mutual funds of the company.
00:24:56.200 | And here I'm specifically referring – we need to break out the difference between a variable annuity and a fixed annuity.
00:25:03.200 | So I'm going to assume a variable annuity for the sake of this example.
00:25:06.200 | So when you buy a variable annuity, that means within the annuity contract you own mutual funds.
00:25:12.200 | These are technically using insurance language.
00:25:15.200 | These are called subaccounts.
00:25:17.200 | They're not called mutual funds, but they are the equivalent of mutual funds.
00:25:21.200 | They just have a different name.
00:25:22.200 | So you own within the annuity.
00:25:23.200 | You own these mutual funds, and those mutual funds have all of the normal expenses associated with them of any other mutual fund out there.
00:25:31.200 | They have the investment expenses.
00:25:33.200 | They have all the expenses.
00:25:35.200 | In addition to the cost of the expenses of the mutual funds, you also have the cost of insurance.
00:25:41.200 | So the cost of that insurance will vary depending on the annuity contract.
00:25:44.200 | It will vary and it will be partly – it will be partly the mortality expense.
00:25:52.200 | It will be partly any kind of additional insurance expense that the insurance company is charging for an extra investment benefit.
00:25:59.200 | For example, does this have a guaranteed minimum income benefit or a guaranteed minimum withdrawal benefit or some of these other things that the insurance companies have come up with that are charged?
00:26:09.200 | So you have generally higher expenses than you do with just straight mutual funds.
00:26:14.200 | That's the reason why you wouldn't buy an annuity at an early date because if you're going to own it for 20 years
00:26:21.200 | and you're going to accumulate the money over time, you're going to have higher expenses.
00:26:28.200 | The annuity – one of the variable annuities that I own in one of my Roth IRAs right now is just sitting in cash.
00:26:36.200 | I don't have it invested any longer, but I intend to take it out and move it into something else.
00:26:41.200 | But if I were to compare that side by side to the lowest cost Vanguard mutual fund, my annuity would come out behind because of the higher expenses.
00:26:49.200 | Now, the reason why you would buy an annuity at an earlier date is because you're going to get a benefit from it during that period of deferral.
00:27:00.200 | So if you – let's say you sell a house.
00:27:03.200 | Grandma dies, leaves you a house.
00:27:05.200 | You turn around and sell it and you've got this $400,000 that you didn't particularly plan on.
00:27:10.200 | You could take that $400,000 and you could take it and contribute it into a deferred annuity.
00:27:16.200 | And so you just take the insurance company, a lump sum of $400,000.
00:27:20.200 | What would be the benefits to you from that?
00:27:23.200 | Well, the first one that you would get with the annuity is you would get tax deferral.
00:27:27.200 | So annuities are – the tax in an annuity is deferred until the time of distribution.
00:27:34.200 | So if you were going to compare that to another type of investment where you were going to be paying, say, short-term capital gains or ordinary income taxes year by year, then you could get some tax deferral with the annuity.
00:27:45.200 | This is an important one, but it also can be oversold simply because there are many ways to accomplish tax deferral.
00:27:54.200 | You could take that same $400,000, buy another rental house, and you're not going to be taxed on the growth of that rental house until you sell it.
00:28:02.200 | So you're getting tax deferral in two places.
00:28:04.200 | But that is one compelling feature of an annuity is you get tax deferral on the growth of the money.
00:28:09.200 | So if your plan – if your A/B option was I want to invest this in mutual funds, but your only choice was to put the $400,000 into a taxable mutual fund account, which is going to be generating some dividends and some taxes year by year, or you could buy that same portfolio within the annuity, you may be better off simply based upon the tax deferral to put it into the annuity.
00:28:34.200 | So that's one option, especially as you climb into a higher tax bracket. It should be considered and the numbers should be calculated.
00:28:41.200 | Another benefit of the annuity will be – could be that it could give you some creditor protection.
00:28:47.200 | So you could take $400,000.
00:28:49.200 | By going ahead and putting it into the annuity, depending on the state creditor protection laws, you could gain some creditor protection that you wouldn't have when it's just simply sitting in a taxable brokerage account.
00:29:02.200 | It's a benefit of the –
00:29:04.200 | That's the OJ plan.
00:29:06.200 | Exactly. That's the OJ plan.
00:29:08.200 | And that does need to be considered.
00:29:10.200 | Again, all of these things can be oversold by aggressive insurance agents, but just because they're oversold doesn't mean they don't need to be considered.
00:29:17.200 | Another benefit would be if you were going to purchase an annuity that had an investment feature that was valuable.
00:29:25.200 | Now, you need to be careful here because these have also been very oversold and a lot of people, rightly so, hate the annuity marketplace because of the level of complication that can be associated with the contracts.
00:29:38.200 | So in general, these have not been good for most consumers.
00:29:42.200 | But insurance companies from time to time have offered products that have truly incredible benefits when you actually factor them into your plan.
00:29:51.200 | So let's say you took this $400,000 and you were looking at an annuity contract and you found one that, with careful, rigorous analysis, demonstrated that it had a benefit.
00:30:01.200 | Say it's a guaranteed minimum income benefit that could be very helpful for you in your financial plan for retirement.
00:30:09.200 | You might go ahead and choose to just buy that thing and have that be there as a component of your income plan for when you're going to retire at the age of 70.
00:30:16.200 | There's no disadvantage to buying a deferred annuity at an early date.
00:30:21.200 | And in fact, your question about I'm concerned about dying, that's where an annuity could really shine beyond even investing the money into, say, a brokerage – some mutual funds in a brokerage account.
00:30:33.200 | Most annuities will come with a standard death benefit.
00:30:37.200 | And these death benefits, you can usually choose a couple of them depending on how much you want to pay.
00:30:41.200 | But you can come with a standard death benefit that will guarantee the greater of either the initial contribution to the account or the value of the account at death.
00:30:55.200 | So let's say an example.
00:30:57.200 | Pretend I'm 50 years old. Grandma died. I sold her house and I have $400,000.
00:31:01.200 | I could take that money and I could put it into a very simple variable annuity where I go ahead and purchase it as a deferred annuity.
00:31:09.200 | I purchase one mutual fund within it, invest in one subaccount, which is the equivalent of an S&P 500 index fund.
00:31:16.200 | Now, three years later, the stock market turns down, and we wind up with a situation where my $400,000 account has declined in value to $250,000.
00:31:29.200 | And I die that year.
00:31:32.200 | My wife or my heir, my beneficiary would not receive $250,000.
00:31:38.200 | My beneficiary would receive the total original contribution of $400,000 to the account.
00:31:44.200 | And so that can be a compelling benefit.
00:31:46.200 | Just the death benefit itself can be a compelling benefit in some financial planning situations.
00:31:52.200 | It can go the other way as well.
00:31:54.200 | If the S&P 500 has increased in value from $400,000 to $600,000 and now my annuity is worth $600,000 and I die, well, then my beneficiary would receive the higher amount, the $600,000.
00:32:08.200 | You can also – in many annuities, you can purchase a ratcheting feature.
00:32:12.200 | And so this costs a little bit extra as far as to purchase the insurance.
00:32:17.200 | But the ratcheting feature will allow that the value of the portfolio on the – it's called the contract date, the anniversary of the contract date ratchets up as far as the death benefit.
00:32:32.200 | So let's assume that you bought this annuity at the age of 50.
00:32:35.200 | You intend to take the money out at 70, but you want to be careful about the death benefit for your beneficiaries.
00:32:41.200 | So you invest $400,000 into the contract.
00:32:44.200 | The next year, the contract is worth $450,000 and pretend after 10 years, the contract each year has – it's gone up and down and up and down and up and down.
00:32:52.200 | But at the age of 50 – what number did I say?
00:32:56.200 | You invested at 50.
00:32:57.200 | So 10 years later, at the age of 60, the contract has increased in value from $400,000 to $700,000.
00:33:03.200 | Well, if you've purchased this ratcheting feature, then let's say the market slides down for the next six years and you're now at 66 years old and the account value has declined from $700,000 back down to $300,000 for whatever reason.
00:33:25.200 | Well, if you die at 66 years old and if you purchase this ratcheting feature in the account, your beneficiary would get $700,000, whatever the account ratcheted up to at the anniversary date of the policy, whatever that highest amount was.
00:33:40.200 | That's what your beneficiary would receive.
00:33:42.200 | So you could see some scenarios where in a financial planning context, that could be extremely valuable.
00:33:49.200 | And it could be extremely valuable especially for that death benefit.
00:33:53.200 | I'm trying to think of a case.
00:33:56.200 | I feel like I worked on one of these where I proposed it because of this, but I don't think – so I can't grasp the details.
00:34:04.200 | So I'm kind of making this up because it's fuzzy.
00:34:07.200 | But if I were working with somebody who had a – let's say they were late savers.
00:34:14.200 | They were 50 years old, something like that.
00:34:17.200 | They had just started.
00:34:18.200 | They had made some mistakes, lost some money, closed a business, whatever.
00:34:21.200 | Now they have some money, but they need to invest aggressively for retirement because they're short on time and they want to invest aggressively.
00:34:30.200 | They continue – let's say it's a single-income household.
00:34:33.200 | Husband is earning wages.
00:34:35.200 | Wife is at home and they want to invest aggressively into a stock-heavy portfolio.
00:34:41.200 | They intend to keep working and doing a lot, but they're concerned about making sure their spouse is OK.
00:34:49.200 | And let me sweeten my scenario and just say that they're uninsurable.
00:34:53.200 | They've got some medical condition where they're uninsurable.
00:34:56.200 | Well, I could use an annuity contract as a form of death benefit, and I could use a simple, inexpensive annuity contract, put the majority of the money into that annuity contract.
00:35:08.200 | Whether it comes from a 401(k) or it's taxable money, it doesn't matter.
00:35:11.200 | You don't get any additional tax deferral from an annuity on top of a 401(k) money.
00:35:17.200 | But I could move a 401(k) into that, and I could purchase that ratcheting feature within the contract, invest the money aggressively, hoping for substantial gain, and have it effectively served to protect the interests of the wife by making sure the death benefit is there.
00:35:33.200 | So a lot of people don't – they don't see – they make this blanket statement about annuities saying, "Oh, annuities are bad."
00:35:40.200 | No, they're not.
00:35:41.200 | They just have features, and yes, they're oversold.
00:35:43.200 | I agree.
00:35:44.200 | They've been oversold and I think abused, but these features for a good financial planner can be very valuable.
00:35:51.200 | And the only downside to owning a deferred annuity at an early date is the annual cost, is am I paying a higher level of expense for the funds and for the cost of insurance within the contract on an ongoing basis?
00:36:06.200 | You could own that contract, buy it at the age of 50.
00:36:08.200 | You could own it until 65 and you could decide that you want to cancel the contract, never having annuitized the money.
00:36:14.200 | You could cancel the contract and take the money and go buy your kids a house for cash if you wanted to.
00:36:20.200 | So there's no downside to the annuity generally as long as you are following things like surrender charges.
00:36:28.200 | You need to be careful with surrender charges when you're buying an annuity.
00:36:30.200 | There are going to be commissions paid.
00:36:32.200 | You need to calculate those costs.
00:36:33.200 | But there's no downside to owning an annuity even if you don't ever turn it – annuitize it, turning it into a stream of income payments.
00:36:41.200 | Okay, okay. Yeah, I think at least for me, my interest in it – I see my parents who are 83 and 87 right now, and they can't manage their money anymore.
00:36:56.200 | They need help.
00:36:57.200 | And I know when I get to be that age, I could be in the same situation.
00:37:04.200 | I mean, they're fine, but they can't manage money anymore.
00:37:07.200 | And so for me, I think that's the attraction of having some of my assets put into something like this.
00:37:15.200 | I'm just going to get money every month, and if I screw up with it, it's not going to be a big deal.
00:37:21.200 | So it sounds like I'm going to be better off just waiting until such time where it seems to make sense with the rest of what I've got going on.
00:37:35.200 | Yeah, depending on the pot of money, you may be better off just waiting.
00:37:39.200 | If you're happy with the investments, they're protected.
00:37:41.200 | You don't need any of the benefits of the annuity.
00:37:43.200 | You can just wait.
00:37:44.200 | You'll probably incur a lower cost, and you'll be able to have it for the future.
00:37:49.200 | The only reason you wouldn't wait is if you see a product which is being offered at an extremely compelling interest rate.
00:37:57.200 | So for example, the fixed annuity market has fallen apart over the last eight to ten years.
00:38:02.200 | But imagine if you had purchased a fixed annuity at a much higher interest rate, how happy you would be.
00:38:08.200 | So in this case –
00:38:09.200 | In 1981 or something.
00:38:11.200 | Exactly, exactly.
00:38:12.200 | And so you've got to kind of compare it in some ways to purchasing a long-term bond.
00:38:16.200 | But there used to be – you could get some excellent rates on a fixed annuity product where you were essentially purchasing a CD, a long-term bond, that type of fixed income equivalent.
00:38:27.200 | But to response to your parents and their income, I don't know what the financial – I don't – number one, I hope to never stop earning income.
00:38:40.200 | I don't ever want to retire in that sense.
00:38:42.200 | But if I ever – if I do, that will be something to cross that time, and I don't know what financial products will look like in 40 years.
00:38:48.200 | But if I were retiring today, ceasing having earned income, I would have a portion, perhaps even a significant portion of my income invested in a variable income annuity – a variable annuity.
00:39:05.200 | And I would take what's called a variable income plan.
00:39:07.200 | Let me explain why I think this is so powerful.
00:39:11.200 | You've got to have some fixed base.
00:39:14.200 | But what a variable income plan does, when you annuitize a variable annuity – so to define our terms again, a variable annuity has – it's an investment product that has contained within the annuity contract variable subaccounts, mutual funds.
00:39:28.200 | There are two stages to the ownership of this type of variable annuity.
00:39:33.200 | In the beginning stages, you purchase what are called using insurance lingo accumulation units.
00:39:39.200 | So each time you're not purchasing shares of a mutual fund.
00:39:42.200 | You're purchasing accumulation units, which are equivalent to shares of a mutual fund, but they are the insurance course – they're the insurance component of that.
00:39:52.200 | Then you annuitize it, and at that point in time, what you do is you swap out your account value for – of accumulation units for what are called annuitization units.
00:40:02.200 | And you purchase this certain set number of annuity units.
00:40:06.200 | So for the sake of simple math, let's assume that you've purchased 100 annuitization units.
00:40:11.200 | From that point in time, you receive an income, and you receive a check every single month going forward, and that check can be guaranteed for your entire lifetime.
00:40:22.200 | It can also be just like with any annuity option.
00:40:25.200 | It can be guaranteed for your lifetime.
00:40:27.200 | It can be guaranteed for your lifetime and your spouse's lifetime.
00:40:31.200 | It can be adjusted with any option, so I could have it for 100 percent of my lifetime.
00:40:37.200 | But if I die, my wife gets two-thirds of the income or 50 percent of the income or 75 percent or 100 percent of the income for the rest of her life.
00:40:44.200 | We can adjust it where there is a period certain component of it where if we both die in a car accident today and I just started taking my first month's income, my beneficiaries will get 10 years or 20 years of income, whichever one of these options I choose.
00:40:59.200 | So we can guarantee that the money is going to come out.
00:41:02.200 | But the way the money comes out is it comes out based upon the current value of those annuity units that I own.
00:41:11.200 | And so when I've run back-tested scenarios when I was with an insurance company and I had access to the software, I could put together a nice, balanced portfolio, and I could run a scenario.
00:41:22.200 | Because it's an investment product, I couldn't do a forward-looking projection, but I could go back and say, "What if you've done this 20 years ago or 30 years ago?"
00:41:30.200 | And what you see is you get all of that compounding effect in your income stream that you get from stocks, but it's just pure income and it continues to grow.
00:41:40.200 | And so I've ran scenarios where somebody started with $600 a month, but then it grew and it was $600 and it was $800, then it was $900.
00:41:49.200 | Then there was a down market and it dropped from $900 to $750 for a few months and then it went up and it was $1,000.
00:41:54.200 | You could see where it was $3,000 a month today.
00:41:57.200 | And so for somebody who's going to endure this long-term retirement, I love this option for a component of the income because you get to experience all of the benefits of compounding growth in the stock market.
00:42:11.200 | But you don't have the fear of running out of money.
00:42:14.200 | And because it's compounding over time, once you are advanced into the period, you may have started with that $500 a month payment, but then 25 years later, you're up to $3,000 a month and then you have a market correction.
00:42:27.200 | Well, you don't go back to that $500 a month.
00:42:30.200 | You go from $3,000 a month down to, say, $2,400 a month.
00:42:34.200 | And the retiree can adjust their lifestyle to handle that decreasing reduction.
00:42:42.200 | So when you look at it in the aggregate, I feel that variable annuities and annuitized on a variable income plan solve an important component of that fear that retirees have of running out of money by guaranteeing the income that is not going to go away.
00:43:02.200 | You can never outlive your money with an annuity contract.
00:43:06.200 | The financial planning purists will make the case, and I can't refute it, that you can come out better with a simple distribution model from a portfolio, whether it's a percentage distribution model, etc.
00:43:22.200 | And there's good data to support that argument.
00:43:25.200 | So I can't necessarily refute that argument.
00:43:27.200 | But in practical terms, I feel like for normal people who are fearful of running out of money, normal people who are fearful of the stock market going to zero, it's irrational, yes, but normal people are fearful of that.
00:43:41.200 | I feel like for a component of income, the variable income plan is a useful tool because you can help people get a much higher growth rate in their retirement income by taking advantage of a more aggressive portfolio because you solve the fear of running out of money.
00:43:57.200 | So I think it's a valuable tool for retirees.
00:44:00.200 | Yeah, I mean I think you're probably better off doing some of both.
00:44:05.200 | You have one component that's guaranteed or it's coming to you and you can still have investable assets and some other pool or pot or whatever.
00:44:18.200 | At least that's the way I always look at these things.
00:44:21.200 | It's a form of diversification, I think.
00:44:24.200 | You're right, and that's where you need to right-size it to somebody's income.
00:44:29.200 | So if you have a retiree who has a base – let's say a paid-for house.
00:44:33.200 | They have a base level of expenses of property taxes and car insurance, etc. of $2,000 a month.
00:44:40.200 | They have social security of a couple thousand dollars a month.
00:44:43.200 | They have a normal level of expenses of a couple thousand dollars a month of just normal lifestyle expenses.
00:45:02.200 | And then on top of that, if they want to still maintain a portfolio, mathematically, you should be able to get the highest returns from the portfolio.
00:45:10.200 | And so as long as you've got those base lifestyle expenses covered to some degree, then you can go ahead and enjoy the benefits of the portfolio.
00:45:18.200 | Take a lump sum distribution when the markets are up.
00:45:20.200 | Go ahead and use the portfolio to plan the $25,000 cruise for taking your kids and grandkids on a cruise.
00:45:27.200 | Use it to buy kids' college tuition for kids and grandkids, those types of things.
00:45:33.200 | And those things work really well to be able to be pulled off of a portfolio.
00:45:37.200 | So as with anything, it's just a tool that needs to be applied in the right context.
00:45:41.200 | If somebody needed a – I got to have $10,000 a month and I don't have much money.
00:45:46.200 | Well, we're going to have to figure something else out.
00:45:48.200 | But as a component of the plan, it's powerful.
00:45:51.200 | [Laughter]
00:45:53.200 | >> They better keep working.
00:45:54.200 | [Laughter]
00:45:55.200 | >> For most people, yes.
00:45:56.200 | They better keep working.
00:45:57.200 | [Laughter]
00:46:01.200 | >> Oh, gosh.
00:46:02.200 | Well, yeah, I think that answers it pretty comprehensively.
00:46:05.200 | Thanks.
00:46:06.200 | >> Great.
00:46:07.200 | Absolutely.
00:46:08.200 | Any other questions you'd like to ask while we're on the phone here?
00:46:10.200 | >> Personal ones.
00:46:13.200 | >> Sure.
00:46:14.200 | Go ahead.
00:46:15.200 | [Laughter]
00:46:16.200 | >> So when are you going to shave that beard?
00:46:17.200 | [Laughter]
00:46:18.200 | >> You know, I haven't shaved this beard in, what is it, three or four months, something like that.
00:46:25.200 | And I always thought it would be fun to have a big beard.
00:46:28.200 | And the biggest one, I always thought it would be cool to have a really sweet mustache.
00:46:33.200 | But it might be coming soon.
00:46:36.200 | We'll see.
00:46:37.200 | I don't get quite so many kisses as I used to from my wife during the presence of a large mustache.
00:46:42.200 | And I like kissing her, so we've got to adjust for that.
00:46:46.200 | >> Well, my wife likes whiskers, but not that many whiskers.
00:46:50.200 | [Laughter]
00:46:51.200 | >> Indeed.
00:46:52.200 | Indeed.
00:46:53.200 | So we'll see.
00:46:54.200 | Well, cool.
00:46:55.200 | Thanks for calling in, Frank.