Annuity Illustrations
Annuity Marketing, Sales Ideas, Suitability, and Issues by Michael J. Prestwich

I will let you decide which is the best income plan for a hypothetical sixty year-old man in a 25% tax bracket who wants the highest lifetime income from $100,000 starting in five years:

Plan A: Certificates of Deposit

$100,000 at 4% interest, less 25% taxes, grows to $115,927 in 5 years. He lives off the interest, $4,637, pays $1,159 taxes, and enjoys a non-guaranteed lifetime after-tax income of $3,478.

Plan B: Indexed Annuity With Income Rider

The $100,000 grows free of taxes for five years then provides $7,040 guaranteed lifetime income at age 65. He pays $1,760 each year in income taxes and enjoys a $5,280 guaranteed lifetime income. (See slide 23 in the PowerPoint training seminar designed by the insurance company for licensed agents.)

Plan C: “Laddered” or “Split” Annuity

$100,000 is divided into three annuities that grow free of taxes for five years:

1.    $24,862 - Five Year Guaranteed Rate Annuity at 4.90%

2.    $23,587 - Ten Year Guaranteed Rate Annuity at 5.00%

3.    $51,550 - The same Indexed Annuity as Plan B above

This plan qualifies for the exclusion ratio so most of the income is tax-free. At age 65, this plan guarantees $7,020 annually, $6,508 after-tax, for five years; at age 70, it guarantees $8,541 annually, $7,584 after-tax, for five years, and finally, at age 75, it generates a $10,793 guaranteed lifetime income ($2,698 taxes, $8,095 after-tax).

So which plan is better after 15 years?

Plan A: $34,780 “maybe” after-tax income; $100,000 likely remaining in account

Plan B: $52,800 guaranteed after-tax income; $61,869 guaranteed amount in indexed account (guaranteed values calculation detail)

Plan C:  $70,460 guaranteed after-tax income; $70,676 guaranteed amount in indexed account (see last page of split annuity illustration for details)

Plan C has double the income of the CD and also outshines Plan B. Plan C, the three product plan, gives the client more flexibility, more access to his money, higher guaranteed income, and better tax advantages.

The agent also benefits; a higher, guaranteed, after-tax income is easier to sell. Shorter surrender charges make this concept easier to defend as a suitable sale. The commission is less in the first year, but since there is a built-in new commission every five years, the 15 year total commission is actually higher.

After 30 years, when the client is age 90:

Plan A: $86,950 “maybe” after-tax income; $100,000 likely remaining in account

Plan B: $132,000 guaranteed after-tax income; $0 guaranteed amount in indexed account (guaranteed values calculation detail)

Plan C:  $191,885 guaranteed after-tax income; $0 guaranteed amount in indexed account (see how income riders work)

It is important to mention that the indexed annuity may perform above its guaranteed interest rate and that the client may have a positive balance in his indexed account at age 90.

Seniors have heard the “high rate of return” story for fifty or more years. Most of them have been burned by this tale at one time or another and they are tired of hearing about it. Today most seniors are interested in four things:

1)    Safety

2)    Guarantees

3)    Tax Advantages

4)    Income

Why would they be interested in hearing about growth when millions of people just lost their shirt to this story?

It took 18 years for the market to recover from the 1929 crash – how many seniors can wait that long?

Obama promised to raise taxes on those who earn $50,000 or more – why not use this as a door-opener?

Forget accumulation values – focus on Income, Guarantees, Tax Advantages and Safety!

Closely examine a sample Flexible Income Stream illustration from ImagiSOFT.

Did you know that in most states that agents can lose their insurance license if they sell using illustrations that do not give the guaranteed values the same emphasis as the illustrated or hypothetical values? This illustration does just that – and I recommend that you spend the majority of your time talking about the guaranteed values and mention the illustrated values in passing, rather than the other way around.

If I were presenting to the 65 year-old John J. Smith, I would ask him this question, “Which would you rather have, an annual $9,000 after-tax income per year, guaranteed for only 5 years (his current certificates of deposit)    - or -    $11,700 after-tax income guaranteed for the next five years, guaranteed to increase to $14,200 for the next five years, guaranteed to increase in year 10 to $17,200? (See the second to the last page of the previously mentioned illustration.)  In short, which would you rather have, $135,000 of “maybe income” or $216,000 of guaranteed income over the next 15 years?

The last page shows the “Grow Back Account,” a fixed indexed annuity, illustrated at 5% interest, which may bring the account back to $303,000 after 15 years. Again, I recommend that you emphasize the guaranteed value of $189,500.  If the Guaranteed Lifetime Income Rider is elected, starting at age 80, this account will generate $33,765 each year for the rest of John J. Smith’s life.

In summary, why is this income strategy a suitable, high-quality sale?

·         John J. Smith is currently using $300,000 CDs for income to generate an income of $12,000 per year

·         This income is fully taxable. In his current 25% tax bracket, he must pay $3,000 per year

·         His primary goal is safe, dependable income

·         The interest rate is guaranteed at 4.00% for five years, and thereafter, renewal rates are uncertain

·         He is in good health with a family history of long life

·         Annuities lock-in a safe, dependable, predictable, guaranteed, income for 15 years

·         Annuities provide this income 90% tax-free

·         This annuity strategy guarantees an income increase every 5 years

·         After 15 years, the last component of this strategy guarantees $33,765 annual lifetime income. This is nearly three times the current income generated by the certificates of deposit – with an extremely high degree of safety

·         If John’s future goals change, this strategy offers three different surrender charge schedules – one as short as five years long

Focus on Income, Guarantees, Tax Advantages and Safety, and I guarantee you and our annuity customers will have a prosperous 2009!

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Several companies advertize their Guaranteed Lifetime Income Riders as costing “only .40% interest” per year.  How much does this really cost your customer, and is it worth the price? To answer this question I created an Excel spreadsheet that you can modify to help your customer answer the “is it worth the price” question.

The spreadsheet uncovers an interesting fact. The worse an indexed annuity performs — the better the income rider is for the customer.  The spreadsheet reveals the cost for an income rider for a hypothetical fixed indexed annuity product after 10 years:

·         Guaranteed Minimum Value:                                $4,513

·         Hypothetical Assuming a Constant 5% Interest Rate:  $6,710

·         Hypothetical Assuming a Constant 6% Interest Rate:  $7,309

The cost is calculated by doing two calculations; one that includes the Guaranteed Lifetime Income Rider and assumes a .40% lower interest rate and another that assumes interest rate without the .40% annual reduction. The “cost” is the difference between the two numbers.

The annual Guaranteed Lifetime Income Benefit at the end of 10 years for this hypothetical example is $16,624. Let us assume the annuitant is a male, age 70 and will live to age 87, which is four years beyond the average life expectancy. Based on the calculations from the spreadsheet, withdrawing $16,624 each year from the indexed value of the annuity would give the following results:

If the policy earns only the guaranteed minimum values, it would run out of money at age 86 if the rider was not elected. Clearly the $4,513 cost for the rider is a bargain based on the guaranteed minimum values and assuming a slightly longer than average life expectancy.

Examine the values for the 5% hypothetical interest rate assumption and you will see that the policy would run out of money at age 89 without the income rider. Since this is six years beyond the normal life expectancy, and two years beyond the assumed age at death, some of your clients may decide that spending $6,710 for “insurance” is not worth the cost.  

On the other hand, many of your clients may live long into their nineties; people such as my father-in law who will turn age 88 next year. His brother just turned age 91. Both are still in excellent health. My father-in-law still drives, shops, reads, writes, and plays with his great-grandchildren. Why should a person like that have worry about his retirement fund running out of money?

A Guaranteed Lifetime Income Rider is not for everyone. However, for those who enjoy excellent health, who have family members who lived to a ripe old age, and are concerned about the risk of running out of money before they die, adding a Guaranteed Lifetime Income Rider may be the perfect solution for those who want a guaranteed, worry-free income that will last as long as they do.

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Today one of our support staff received a call from an agent who was upset because he wanted to illustrate an 8% return using our Stretch IRA software and it allows him to show a maximum of only 6%. He told us that “the policy guarantees an 8% lifetime interest rate” and he wanted to illustrate 8% to his customer.  Unfortunately, this is a common question from agents who misunderstand how indexed annuities with guaranteed income riders work.

First of all, selecting an income rider is not a suitable option for someone who wants a Stretch IRA because the income produced by the rider will very likely deplete most of their indexed account if they live until age 90 or more. Also, a person elects a Stretch IRA because they want to leave as much money to their heirs as possible. The income rider defeats this purpose because over 10 years, the difference in indexed accumulation value between electing the guaranteed income rider is substantial; at age 70, it can be as much as $8,000 per $100,000 premium.

Many agents do not understand that the indexed account and the guaranteed lifetime income account are different accounts, with different purposes. The indexed account is an accumulation account; it is money the customer can touch. The income account is just that – an account from which the guaranteed lifetime income is formulated. The account holder cannot touch this money; it does not exist in any tangible form.

Here’s the math. After 10 years, the income account growing at the 8% guaranteed interest rate accumulates to $215,892 which will produce a $17,271 guaranteed lifetime income. The $17,271 annual income is impressive, but what is the $215,892? Can the account holder withdraw this money? No. It is simply a number used to calculate the $17,271 annual lifetime income. What happens if the account holder decides not to exercise the lifetime income option? It all vanishes. The $8,000 cost for this rider [calculated by doing a illustration with and without the rider and comparing the difference] is completely wasted. In my view, agents shouldn’t even talk about this phantom guaranteed 8% interest rate or the income account. Throw around this “8% guaranteed interest rate” and this will be all customers will remember. It leads to false customer expectations, unhappy clients, and opens the doors for lawyers.

To illustrate my point, let’s look at two hypothetical scenarios on a $100,000 deposit into a Fixed Indexed Annuity for a 70 year-old man held for 10 years, after which the guaranteed lifetime income option is exercised:

Scenario One: The index does poorly and account earns only the guaranteed minimum surrender value of $128,208. In this case, the guaranteed lifetime income is a blessing because the account holder will be able to withdraw $17,271 each year for the rest of his life. Let us assume that he lives until age 92, about six years beyond normal life expectancy. The $17,271 annual withdrawal will deplete the policy by about age 88, so there will be no remaining cash value at death. The average rate of return for this scenario is 4.90%. If the policy holder dies at age 86, which is his normal life expectancy, his rate of return will be only 1.64% This isn’t too bad for a worse-case scenario.

Many agents don’t seem to understand that once the guaranteed income begins, this income is withdrawn from the indexed account, not from the “guaranteed income account,” which no longer exists.

Scenario Two: A hypothetical historical point-to-point, 10% cap, 0% spread, 100% participation rate product issued on January 1, 1990 grows to $190,152 after 10 years, an impressive 6.64% return. Based on the income available under the guaranteed income option, the customer begins to withdraw $17,271 each year. The hypothetical historical return in 2000, 2001, and 2002 for this product was 0%. Withdrawing $17,271 per year reduces the indexed value to $138,338 after three year of these guaranteed withdrawals. Even if the indexed annuity receives 10% per year every year thereafter, the indexed value will decrease quickly because the withdrawal is higher than the interest rate. In the unlikely event that the policy earns 10% every year for the next 8 consecutive years, and death occurs at age 92, the indexed account will have been reduced to $68,212, providing an average rate of return of 6.04%. If the policy holder dies at age 86, which is closer to his his normal life expectancy, his rate of return would be about 5.29%.

What happened to the “8% guaranteed interest rate?”  It never existed. I cannot find a hypothetical historical scenario where it is possible for a policy holder to achieve anything close to an 8% of return from a fixed indexed annuity contract from a guaranteed income rider on a hypothetical basis, let alone on a guaranteed basis.

Am I saying that guaranteed lifetime income riders are bad? No. In fact, I believe the opposite. Go back to the fundamental reasons annuities exist:

·         To provide safety

·         To provide predictable, steady, guaranteed, lifetime income

A fixed indexed annuity with an income rider is an ideal vehicle to plug a specific income gap in a prospective client’s retirement income stream. As shown above, however, the agent should not promise both income and a sizable cash inheritance after death.  Generally, income riders provide either high guaranteed income or safe cash accumulation; they rarely provide both.

Annuities are ideal financial tools when they are used in ways that meet the customer’s needs. This happens only when agents understand what annuities can do – and what they cannot do.