This is NOT What Retirement Should Be Like

Imagine for a moment that you’re having a conversation over dinner last Friday night with your brother and his wife.  Answering the common question, “what’s new,” he dives right in and shares what he’s been up to.

In addition to the nice home he owns and lives in with his family, he also owns a two-family home in town which he has been collecting rent on for 15 years.

He explains to you that he called up his real estate broker last week on a Tuesday afternoon and asked the broker what she believed he could sell the rental property for that day.  He didn’t want to know what he could sell it for in a month or two, but right then.

Given the demand for a quick response, her answer was $600,000.

He then called back on Wednesday morning at 9:43 a.m. and asked how much she thought he could receive if he sold it then.

He then called back at 11:57 a.m. and asked the same question.

Finally, he called her back that same afternoon at 3:26 p.m. and asked how much she thought he could sell it for then.

Before you called the local hospital for the men in the white coats to come and take him away in a straight jacket, you asked him if he did this often.

“Oh, I do it all the time,” he said.

Why, you ask, do you waste your time if you’re not selling?

“I like to stay on top of things so I know how I’m doing.”

Brother #2

Imagine for a moment that you’re visiting your brother and his wife at their home in Florida.

In the first morning of your visit, you notice that he’s watching CNBC on television and there are two guys shouting conflicting opinions on the impact of The Fed’s latest announcement on raising interest rates on market prices.

As you’re all waiting on him to head out for lunch, you notice that he has Yahoo Finance pulled up on his iPad checking the prices on the different stock market exchanges.

“The Dow is down 120 points,” he laments as you’re walking out the door to the car.

At the conclusion of lunch at the restaurant, he asks the waiter to switch the channel on the television over to CNBC so he can see what the market is up to.

After some shopping in town, you head home in his car.  On the way, he has business radio tuned in on the radio so he can hear how the market closed at the end of the day.

After a nice meal at his home that night, you all settle in to watch Jim Kramer discuss his take on the market activity that day, and what he recommends everybody do in reaction to the day’s events.

After a futile attempt to get him to change the channel over to a comedy show that you can all watch, you gently ask him if he “paid this much attention to the market every day.”

“Of course,” he said.  “Don’t you?”

After replying that you don’t, you then ask him why he does it.

“I like to stay on top of things so I know how I’m doing.”


  1. Is the behavior by the brother in story #1 any different than the brother in story #2? If so, why?
  2. Is there anyone you know who resembles the brother in story #2?
  3. What is each brother looking for?

These are very important questions I’d like you to ponder for a moment!

What is Your Opinion?

So, what do you think?  Is the behavior exemplified by your brother in story #1 (real estate) any different than your brother in story #2 (stock market)? 

The answer is no.  There is no difference at all!  They’re both equally bizarre and destructive.

The only difference is the investment vehicle they’re using.  

Upon first glance, I suspect the behavior of Brother #1 (real estate) appears more outrageous.  

I also suspect you know someone who mirrors the behavior of Brother #2 (stock market). Perhaps you know someone like this quite well.

We all do and it’s becoming way, way too common.  The media has turned investing into a sport with minute-by-minute reporting of “points” on the Dow.  Why do you think they use that terminology?

The truth is that the behavior of Brother #2 (stock market) is no more bizarre and destructive than the behavior of Brother #1 (real estate). 

Randomly “checking in” via the internet, TV, or your iPhone, etc. multiple times a day to “see how ‘the market’ is doing” is the same as Brother #1 calling his real estate broker on three separate occasions in one day to find out how much she could sell his rental property for at that precise moment. 

Neither accomplishes anything. 

What Are These Two Brothers Looking For?

The bigger question is #3 which is what are they looking for?

What they’re both looking for is a sense of certainty in the short and long run. 

They want to make sure they’re not “falling asleep at the wheel” and missing out.

The reason they have this feeling and desire is their overall “big picture” interpretation, and thus ingrained belief of the world on a day-to-day basis, i.e. that world economies and financial markets are completely fragile, erratic, ungrounded, and out of control. 

And, that the bottom could permanently fall out of their financial lives without any warning whatsoever, and they could be permanently bankrupt because of it.

Please take a moment to go back and read those paragraphs again.  It’s that important.

This is the psychological state of most investors in America today, especially those approaching their retirement transition, and it is my strong opinion that it is not necessarily their fault (in the short run).  

I emphasize “in the short run” because in the long run, everyone has a responsibility to continuously seek the objective truth, and discard everything else which has not objectively been proven to be true.

What the Mainstream Media Feeds Us

What everyone is fed by the mainstream financial media over and over on a day-to-day basis confirms that economies and financial markets are completely fragile, erratic, ungrounded, and out of control.  And, that the bottom could permanently fall out of their financial lives without any warning whatsoever and they could be permanently bankrupt because of it.

If anyone were to take a step back and unemotionally evaluate this assertion, they could and would arrive at the truth which is that it is completely false.  

However, the daunting and fragile picture the financial media paints is not reported because of its level of truth.  It is reported because it keeps millions and millions of viewers tuned in day after day after day.

The Truth About the Financial Media’s Intentions You Must Know

Think about it.  If the financial media can perpetuate this myth, and they can get millions to buy into it, then they condition those millions (like Brother #2) to tune in multiple times each day in order to fulfill their conditioned desire to “stay on top of things.”

If engaging in this activity was of any value to you, I’d strongly endorse it in a heartbeat.  It is not. 

In fact, I recommend doing everything you can to avoid this trap. 

Investing is not a sport, thus scoring it on a minutebyminute basis, as the financial media would like you to do, is not only unhealthy, but it is ineffective as a means of helping you achieve total financial independence.

This does not mean that you should aimlessly bury your head in the sand.  What it does mean is that, in the face of the endless barrage of information coming at you every day, you must exercise extreme levels of awareness of the “intent” of the information, to remember that you are in control, and, above all else, protect your confidence!

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A Critical Retirement Lesson to Implement

Over the last 33 years of coaching individuals and couples to a seamless transition to their retirement years, I’ve witnessed many similarities among those I’ve worked with.

Some of those similarities were positive like the tremendous discipline and dedication employed to save and build up a sizable Retirement Bucket™ of investments which eliminated their dependence on a paycheck from work and provided them with the option to retire or keep working.

On the flip side, however, I’ve also witnessed far too many who have no system in place for their decision-making, and it costs them dearly.

I’ve recently had the pleasure of working with a terrific couple who was referred to us by one of our Relaxing Retirement members.

Their “story” is one I’ve witnessed far too many times, but there’s a great lesson for everyone, so I’d like to share it with you.

In order to protect their privacy, I’m going to refer to this couple as Ron and Rita.

Ron and Rita are both 63 years old and they now find themselves in the same place many of our Relaxing Retirement members found themselves in. 

They’ve hit a threshold!  While they’ve enjoyed working up until now, they’re now emotionally ready to make the transition to Phase II of their financial lives and retire.

Can We Afford to Retire if We Choose to?

What Ron and Rita first wanted to know is if they could afford to stop working if they chose to.

And, if they can, how do they generate lifestyle sustaining cash flow they need because they’ve never done this before.

This is a key commonality that I see so much. They’ve never done this before and they’re just not confident making the transition.

One of the big reasons why they lacked 100% confidence is their investment performance over the last few years.

During Step 2 in our program, their Retirement Confidence Preparation System meeting, in addition to having an extensive conversation about their experiences and their priorities, I also had the opportunity to review their investment holdings going back a few years as Ron was a “spreadsheet guy.”

While reviewing their spreadsheets during our meeting, I noticed that there was a lot of activity (buying and selling) at random times, so I asked what triggered all of that movement.

Ron’s answer was one that I hear far too often: “I evaluate what’s doing well and what’s not and I reallocate.

My response was, “how do you determine what to sell and then what to buy?

Ron’s answer: “I sell what isn’t performing well and buy what is performing better.”

His answer was so matter-of-fact suggesting he thought that’s obviously what everyone should be doing.

Yes, They Can Afford to Retire

Before I comment on Ron’s answer, let me share with you what our analysis showed them.

When we designed their Retirement Blueprint™ and ran their Retirement Resource Forecasters™, taking into account all of their priorities and all their resources, we discovered that they had built up enough in their Retirement Bucket™ of investments to make it all work!

Enough money and income from social security and a small pension to continue living exactly the way they wanted without running out of money over their expected lifetime.

Now, as you can imagine, this was a huge relief for them, and something they did not realize before we met and designed their Retirement Blueprint™.

As you can imagine, they were on a real high at this point.  However, that soon simmered as I alerted them that there was a gigantic “BUT.

But, Not if They Continue on the Same Path

After carefully evaluating Ron’s spreadsheet of their investment activity, the gigantic “BUT” I had to report to them was if they continued doing what they had been doing, there was a high likelihood that they would run out of money within 8 or 9 years!

I know…ouch!

Now, why did I have to tell Ron and Rita this when I just told them that they had enough money built up to support their lifestyle for the duration of their life expectancy?

The reason I had to tell them this was their Retirement Resource Forecasters™ had some assumptions built into them.

First, we have to account for the fact that they’ll need higher and higher income each year just to remain in the same position due to inflation which has now reared its ugly head.

And second, we have to assume that they can earn the investment rate of return they need to earn in order to keep pace with inflation, which, for them, is not a very high return.

However, given Ron and Rita’s “system” of investing, they had little or no chance of accomplishing that.

What they actually employed was not a system, but random selection and timing.

Their allocation actually wasn’t that bad three years ago.  It was fairly well diversified.

However, they continuously killed that diversification by trying to shift out of “what just performed poorly” over to “what had performed better.”

What Ron and Rita Were Missing

Unfortunately, Ron and Rita’s investment “system,” or better stated: “behavior” is not unusual.

Statistics tell us that it’s the norm.

According to Boston-based research firm, DALBAR, here is what their 2020 Quantitative Analysis of Investor Behavior revealed about the 30 year period from January, 1990 through December, 2019:

  • The Average annual return of the S&P 500 Stock Market Index from was 96% (including dividends reinvested)
  • Over the same 30 year period, the average annual return of the “average” equity mutual fund investor (not investment, but an investor, i.e. a person) was 04%

Take a moment to stop and re-read those two numbers for a moment and let them sink in.

What these numbers tell us is that, while the S&P 500 Market Index delivered a strong average annual return over those 30 years of 9.96%, the average stock mutual fund investor (a person, not an investment) only achieved 5.04%!

That means that the average stock mutual fund investor’s return was only half of what the broad stock market index provided each and every year!

How incredible is that!

It’s mind boggling, but it doesn’t surprise me after what I’ve witnessed over the last 32 years coaching couples through this retirement transition.

Just think about Ron and Rita’s story that I just shared with you!

They’re Fighting the Wrong Battle

What you can’t help but take away from those statistics is that, while it makes all the news, markets (or bad investments) are not our biggest problem.

The BIG problem is what the average investor does with markets, i.e. investor behavior, which is driven by their “strategy” or lack thereof.

Forget for a moment about trying to “beat the market” which is what everybody loves to talk about and talk shows are built on.

The average stock mutual fund investor earned 49.4% less each and every year than the broad market S&P 500 index.

Think about that for a moment.  Something that we all can control is what our biggest problem is.

It’s uncomfortable, but it’s the only logical and rational conclusion we can reach given the results of this research report.  What else could possibly explain the massive difference in real life returns that people receive?

The obvious question is why, and what can we do to close this performance gap?

Well, there are several easily correctable “strategic mistakes” that I’ve personally witnessed over the last 33 years that I’d like to share with you.

Stay tuned.  I’m not sure there’s anything more important about investing during your retirement years than what I’m going to reveal to you in the coming episode.

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Avoid This Investing Mistake at All Costs When Transitioning to Retirement

“Why would anyone just sit there through a downturn in market prices and ‘lose’ money?  Wouldn’t it make sense to just sell everything, wait for the dust to settle, and then buy back in after?”

Although nobody with this thought likes it to be labeled as such, this is classic Market Timing: the strategy of attempting to sell in and out of markets on a timely basis in order to avoid short-term losses and capture all upside gains.  This stems from the commonly held belief, which is perpetuated by the financial media, that investment success is achieved by the few who are “in the know” who are able to successfully “navigate” in and out of markets at just the right time.

It’s sounds 100% logical in theory.  Unfortunately, however, it doesn’t work in practice.

History is littered with proof that this belief is false.  Noted Dartmouth Professor Kenneth French’s extensive research concluded that you would have had to be precisely correct on the sell and buy points 74% of the time in order to equal returns earned by continuously holding shares through all market cycles.

And, that a survey of famous market timers revealed that only a handful were correct more than 50% of the time, and the best was still at only 66%!

October 2007 to March 2009

History and distance from traumatic times have a way of providing clarity for future action.  However, at first glance, that’s not always true with investing.

Now that more than a decade has passed, the massive market downturn we experienced over 18 months during “The Great Recession” from October, 2007 to March, 2009 appears to be a period that anyone and everyone should have been able to navigate in and out of successfully.

What we all forget with time, though, is that we didn’t experience that 18-month period of time in one instance.  We experienced it one day, and in some instances, one hour at a time.

From October 10, 2007 to March 9, 2009, broad stock market prices fell almost 57% from peak to trough.

However, it was not a straight line down that was obvious to interpret and act on.

Experiencing Markets on a Daily Basis

Similar to what we’ve experienced over the last two months, during that 18-month timeframe, if you recorded market results on a daily basis, here’s what you would have experienced:

  • Market prices closed up 46% of the days, and
  • Market prices closed down 54% of the days

Isn’t that incredible!  During the 18-month period of time when market prices fell over 50%, market prices closed up about 173 days (46%) and down about 202 days (54%).

I’m sure you expected it to be much worse than that with a much larger percentage of down days.  (For reference, from 1973 through 2015, market prices were up 53% of days, and down 47% of days.) 

So, as we experience markets on a day-to-day basis, that 18-month period wasn’t that different than the average.

What this demonstrates is that, when dealing with markets, our experience is never a straight line up or down.

Instead, it’s more like: up one day, down the next, down the next, up the next, up, up, down, down, down, up, down, up……

That’s how we experience markets, and that’s what makes market timing impossible as a long-term strategy.

Why Market Timing is So Hard

You not only have to make the correct call to sell out, and then to buy in on the correct days, but you have to make those calls at precisely the correct time during each day because prices change all day long.  (And, because all asset classes behave and perform differently, you have to make those split-second decisions on each asset class you own.)

Just think of markets during the early stages of the COVID-19 pandemic where prices moved as much as 12% in one day!

Although it feels as if there was throughout time, there is never a clear and unquestioned signal in the moment when a decision must be made to sell or buy.  Never!

That’s why buying into the belief that you can successfully time when to get out and when to get back in is so destructive to your financial independence.

Put It in a Drawer

After you have set aside five years’ worth of your anticipated withdrawals outside of the short-term volatility of stocks, i.e. in money markets and short-term fixed income holdings, and directed all dividends you earn to flow into your money market fund to support your lifestyle cashflow needs, the long-term solution with the rest of your Retirement Bucket™ is to remain globally diversified and strategically weighted across multiple asset classes during all market cycles with a goal of capturing the long-term higher expected returns each asset class offers.

And, then “put it in a drawer” and go about living your life.

Go ahead and pull it out of the drawer during pre-determined periods of time, i.e. once a quarter, half year, or yearly, and rebalance your holdings back to your originally prescribed mix.

However, as we have just highlighted, do not delude yourself into thinking that looking at it on a daily, weekly, monthly, or even quarterly basis will make you more knowledgeable, provide you with any signals to act on, or produce better results.

What this allows you to do is remain confidently invested for the rest of your life knowing you will not be forced to sell your long-term stock index funds during a temporary market correction in order to provide needed cashflow to support your desired and well-earned lifestyle.

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Beware of Annuities for Your Retirement

I recently had a conversation with the brother of an existing Relaxing Retirement member who is unfortunately, and completely unnecessarily, experiencing some serious pain. 

He and his wife retired last year and now want to split time between a new condo in a suburb West of Boston, and a condo in Florida during the winter.

The reason he called was they were confused and completely frustrated with the answers they were receiving from their advisor, and he wanted a second opinion.

His dilemma, as he explained, was that they both rolled over their 401(k) plans into annuities inside of an IRA because they were told they could earn market returns “without risking their principal.” 

Uh-oh!  Does this sound familiar?

Their dilemma was they wanted to temporarily withdraw a chunk of money from their plan to help finance the purchases and moves.  IRAs allow you to withdraw money and re-deposit funds within a 60-day window without any taxes or penalties.

That was the good news.  Now for the bad news….

What they discovered was that they couldn’t withdraw any more money from their annuities without paying a 12% surrender charge to the insurance company!


On the $450,000 they want to temporarily withdraw and then re-deposit, that’s an annuity surrender charge of $54,000 that can’t be recovered later. 

And, that expense is not tax deductible. 

Can you imagine being in this predicament?  Frustrating and sad at the same time!

After my extended conversation with them, and after thinking about all of the questions I receive about annuities, I thought I’d take the opportunity to discuss the pros and cons so that you can independently understand and personally evaluate annuities for your own unique situation.

Preliminary Comments Regarding Annuities

Before we dig in, just a few preliminary comments…

The first is that an annuity is like any other investment vehicle; they’re a tool to put in your toolbox of potential options. 

They are not a one-size-fits-all solution.  This is one of my biggest pet peeves.  Agents and “advisers” are out there in droves pushing annuities as THE solution to every financial problem.

Like any investment, there must be a very good reason why you would invest in an annuity.  Hopefully, that comes after you’ve carefully and strategically designed a Retirement Blueprint™, and after understanding all the facts and ramifications first.

The second point is that, while there are a handful of annuities that could be a potential option for some to solve a very specific problem, I believe annuities are grossly oversold.  

In my estimation, 99% of the annuities sold are inappropriate. 

Given this, my goal is to help you better understand them so that you can make an educated decision for yourself. 

What’s an Annuity Anyway?

Let’s begin today by first laying out what an annuity is. 

An annuity is simply a savings instrument sponsored by an insurance company. 

There are many different classifications and variations, so let’s tackle those first:

Immediate vs. Deferred Annuity

A deferred annuity has two phases to it:

  • Accumulation: funds you deposit grow inside the annuity on a tax deferred basis until you withdraw funds.
  • Withdrawal or Distribution: you choose how you’d like to withdraw funds from your annuity, either by “annuitizing” the value and receiving a guaranteed monthly payment, or by simply taking withdrawals as you see fit.  (more on this in a moment)

An immediate annuity has no accumulation phase.  You simply place money into the plan and begin receiving monthly income for life.  If you currently receive a monthly pension from your employer, what you’re receiving payments from is typically a form of an immediate annuity that your employer has placed funds in to guarantee your monthly payment.

Accumulation Phase

During the accumulation phase of a deferred annuity, there are two broad options:

Fixed Annuity:  When you invest in a fixed vs. a variable annuity, what they’re referring to is the “investment” element.  In the case of a fixed annuity, your deposit is credited with interest paid by the insurance company.  How much interest you receive is based on the performance of the insurance company who sponsors the annuity, so in that respect, it acts like a CD at the bank.  Typically, they come with a minimum guaranteed interest rate for the life of the annuity contract.

Variable Annuity: In a variable annuity, in addition to having a “fixed rate” option to choose from, you are also provided a list of subaccounts which act like mutual funds from various mutual fund companies.  There are no guarantees.  The performance of your plan will be based on the performance of the underlying subaccounts. 

Withdrawal or Distribution Phase

During the withdrawal or distribution phase, there are also two broad options:

Random Withdrawal:  When you want to begin receiving money from the plan, the first option, within a deferred annuity only, is to simply take random withdrawals subject to the deferred sales charge limitations set forth by your company.  For example, within most companies, you may not withdraw the entire balance of your annuity within the first six to twelve years without paying a hefty surrender charge.  However, prior to the end of that period, many companies allow you to take a partial withdrawal without any charge.

Annuitizing (Guaranteed Monthly Payment): When you “annuitize”, you are choosing to receive a guaranteed monthly payment for a period of time, typically for life.  In this case, it acts like a pension or the social security income you receive. 

  • Single Life:  When you select the single life option, you choose to receive payments for your life only.  When you pass away, even if that’s in three months, the insurance company keeps the money.  However, if you live to be 156 years old, the insurance company must continue to pay you the guaranteed monthly check.
  • Joint and Survivor or Period Certain:  If you have a spouse who you want to protect, or if the prospect of passing away too soon and having the insurance company keep your funds is a problem for you, you may select a joint and survivor or period certain plan.  By doing so, you guarantee payments to your beneficiary either for life or for a certain period of time after your death.  However, in order to compensate the insurance company for this added risk, you receive a smaller monthly payment while you’re living. 

Now that we have the basics down, we’ll continue with a discussion of the pros and cons of using annuities in the next edition so that you can evaluate them for your own use.

Stay tuned.

Four Market Principles All Investors Must Adhere to in Retirement

I have some thoughts to share with you today to help you continue to be a better investor so you can live the life you’ve earned. 

An unfortunate but true outcome during sharp stock market corrections is the transfer of ownership of a finite and fixed number of shares from those who were not prepared, and thus panic-sell out of fear, to those who were prepared and confidently buy shares at a significant discount. 

You may want to pause and read that paragraph again.

Despite what the financial media and large brokerage firms convey, investing is not a reactive “market-oriented” activity, but a strategic and proactive “goal-oriented” process. 

And, that goal-oriented process is based on market principles that we all have to keep at the forefront of our minds in order to avoid the common mistakes that occur during challenging market conditions:

  1. Markets work and they are working.  Although we may not like the direction they take at times, the great news for all of us is that markets work even during crises, and information is incorporated into stock prices.  We always have to remember that for every share of stock that is sold on a given day, there is a willing buyer on the other side making that purchase. 
  2. Stock prices adjust to the point where a buyer believes they can earn a positive expected return from that point forward.  Nobody buys a stock with the expectation of losing money.
    1. Think of it this way as an example.  At $100 per share, a buyer may not be interested because he or she may not believe the expected return from $100 per share going forward justifies paying that price.  However, if the price drops 20% to $80 per share, there is a greater likelihood of the buyer earning the expected return they want to justify the purchase price. 
  3. Stock prices are forward looking, i.e. expectations about the future have already been incorporated into the price.  In today’s day and age, what are the chances that you know something that millions of other market participants don’t know about a company?
  4. Volatility is brought on by uncertainty.  If there was no uncertainty, there would be little or no return, i.e. treasury bills.  Your ability to deal with short-term uncertainty, and thus volatility, is precisely what allows you to earn higher expected long-term returns.

With those principles firmly in our minds, stay tuned for the next edition where we will discuss one of the most common mistakes investors fall prey to during sharp market corrections.

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The Ideal Investment Mix During Retirement

As we’ve discussed many times, investing during Phase II of your financial life, when your paycheck from work is no longer coming in, the stakes go way up, and your entire investing mindset and process has to drastically change.

This is where the next set of strategies in your evidence-based investment system are so critical.

After you’ve set aside what not to invest during your retirement, i.e. five years’ worth of your anticipated withdrawals to support your cash flow needs in money markets and short-term fixed income instruments, and away from the volatility of your broadly diversified stock index funds, implement The 4 Ds:

  1. Determine: What percentage of your Retirement Bucket™ of Investments will you dedicate to the higher expected returns a broadly diversified mix of stock index funds have offered vs. bonds and money markets? Historically, the higher the percentage, the higher the probability of capturing higher expected long-term returns and protecting your purchasing power.
  2. Diversify: It can be tempting to invest in a single company (Amazon) or sector (high tech), but your risk increases dramatically. Instead of searching for a needle in a haystack, buy the haystack.  Your chances of outsmarting millions of other buyers and sellers for very long is close to zero.
  3. Delegate: Avoid expensive actively managed mutual funds and hedge funds. Each has a horrible track record of beating their respective asset class index.

Only 17% of actively managed funds have outperformed their index over the last 20 years, and it’s a different 17% each year.

Instead, use low-cost index funds which are a much more disciplined and cost-effective way to own a broadly diversified mix.

  1. De-Escalate: At pre-determined dates during the year, maintain the discipline and strategically rebalance your holdings back to your target exposure so your risk levels remain in check.

The most common question we all hear asked is what’s THE ideal investment mix during my retirement years?

  1. Is it 100 minus your age?
  2. Is it 60%/40%

The best answer to that question is the mix you can hold through all market conditions so you can capture the higher expected long-term returns markets offer. 

It can be that simple.

All the statistics and sales pitches in the world are of no value to you unless you have the confidence, strategy and system in place to hold your carefully selected Retirement Bucket of Investments through all market conditions, including normal and temporary market downturns like the most recent Covid-19 crash or the 2008-2009 financial crisis.

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Annuities: When to Consider and When to Run for the Hills

As promised in the last edition after the questions I received, I’m now going to give you some examples of situations where I believe you should run away from annuities when they are being proposed to you, and some situations where an annuity might be something for you to consider.

Before addressing situations where I believe annuities are grossly oversold, here are the three situations where annuities might be appropriate for you as long as you do your proper research before signing on the dotted line.

1. Tax Deferral

If you have funds held outside of your IRA, Roth IRA, and/or employer sponsored retirement plans that currently earn interest, dividends, and/or capital gains that you’re not currently spending, an annuity can be used to defer income taxes until you need the money to spend. 

There are three potential benefits of doing this:

  1. Deferring the Tax: You control “when” you pay the tax.  By doing so, you can benefit from compound interest and gains on the balances that would have gone to taxes if held outside of the annuity.
  2. Taxes on Social Security Income: The amount of tax you pay on your social security income is in direct relation to the amount of income you receive in addition to social security.  The lower the amount of your other “provisional” income, the less of your social security income that is subject to tax.

If you currently have interest, dividends, and/or capital gains coming from investments which you’re not spending, using an annuity to defer the taxes on those items not only reduces your taxes on that interest, but it may also reduce the amount of tax you must pay on your social security income.

  • Medicare Part B Premiums: As many of our Relaxing Retirement members have learned, your Medicare Part B premiums you pay are based on the amount of income on your 1040 tax return the prior year. 

Like the example above, if you reduce your taxable income, you may qualify to pay a lower Medicare Part B premium.  One tool to reduce your taxable interest, dividend, and capital gain income is a tax deferred annuity.

There is a downside to this tax deferral strategy, however, which you must know going in.  

All money withdrawn from a tax deferred annuity over your initial investment are considered “ordinary income” and thus taxed at ordinary income tax rates

For example, if you deposit $100,000 into a tax deferred variable annuity and it grows to $150,000, you will pay ordinary income tax rates on the $50,000 of growth when you withdraw the funds.

If you invested in a traditional mutual or exchange traded fund held outside of an annuity or IRA and the value increased from $100,000 to $150,000, you would pay “capital gains tax rates” upon the sale.

This is significant because federal ordinary income tax rates can be as high as 37.0% currently, whereas capital gains tax rates top out at 20%.  

If the investments you will own inside the tax deferred annuity will qualify for capital gains tax treatment, you have to strongly weigh the long-term tax deferral benefits vs. the higher tax rate you and your family will pay upon withdrawal.

2. Tax Free Exchange From Life Insurance

If you currently own whole life insurance (that you’ve determined no longer need) with significant cash value, you may have a tax problem when/if you cash in your policy. 

To the extent that your cash value is greater than the premiums you’ve paid over the years, you will owe ordinary income taxes.

In other words, if you have a policy with a cash value of $100,000 and over the years, you’ve paid a total of $60,000 in premiums, when you surrender your policy, you will owe ordinary income taxes on the difference, i.e. $40,000.

A way of deferring this tax burden is to directly exchange your life insurance policy’s cash value into a tax deferred annuity.

By doing this, there is no tax burden at the time of the exchange and you get to continue tax deferred growth on your funds until you choose to withdraw funds.

3. Annuitizing

Annuitizing simply means turning your savings into monthly income for a stated period of time, typically for life.

  • Covering a Specific Expense:  While this would never be the situation a Relaxing Retirement member would find themselves in, if social security is your only source of guaranteed monthly income, and you have a specific bill that must be paid each and every month, consider funding an immediate annuity.  Structure the amount of the payment to you to cover that expense for the period of time the expense exists, i.e. a mortgage.
  • Medicaid Planning:  It would be impossible to cover all the issues concerning qualifying for Medicaid in this edition.  However, as we reviewed recently, in the big picture, if you have assets above a very minimal level, you will not qualify for Medicaid assistance to pay for your care. 

    One strategy used by many elder law practitioners is to move current assets into an immediate Medicaid approved annuity. 

    In the eyes of the federal government, once the funds are deposited to the immediate annuity, the asset no longer exists.  Only the income from that asset which significantly increases your chances of qualifying for Medicaid assistance.

    However, the same warning that I’ve raised still applies here.  Remember that when you annuitize, you give up access to your money other than receiving your monthly income.  When you and/or your beneficiary pass away, the insurance company keeps the money.
  • Guaranteed Income:  If you want some portion of your monthly income guaranteed, an immediate annuity can accomplish this. 

    Two caveats come with this, however.  The first I just alluded to which is to remember that once you annuitize, your asset is turned over to the insurance company.

    The second is inflation.  With most annuities, the payment is guaranteed for a certain period of time, typically for life.  However, there is no cost of living increase each year to keep pace with inflation.  So, if your monthly payment is $2,000 per month, 10 and 20 years down the road, you’re still going to receive $2,000 per month even if inflation has decreased the value of that $2,000.

Now let’s take a look at situations where I believe annuities are being oversold.

1. Buying a Variable Annuity “Inside” of Your IRA or Roth IRA

As was the case with the story of the brother of an existing Relaxing Retirement member I shared with you recently, a classic example of a situation I see way too often that I don’t recommend is investing in a variable annuity inside your IRA or Roth IRA.

As I outlined above, one of the benefits of an annuity is tax deferred growth of your money.  However, all investments held inside of an IRA or Roth IRA grow tax deferred already.

Given this, why would you need to place a tax deferred vehicle (annuity) inside of a tax deferred vehicle (your IRA)?  An example of this is rolling over balances from your retirement plan at work, i.e. your 401(k), 403(b), or your pension plan into an IRA and investing in an annuity inside your IRA.

Although sellers of annuities tout all the bells and whistles of complicated annuities, there really is no valid reason to invest in one inside of an IRA.

Unfortunately, one of the main reasons why it’s recommended so often is the commission paid on an annuity vs. an alternative.  With the exception of a few no-load annuities (offered through fiduciary advisors who accept no sales commissions), fixed, variable, and equity indexed annuities typically pay much higher commissions, so there’s a significant incentive for a broker to sell an annuity instead of just a mutual fund or an exchange traded fund.

All things being equal, this alone would not be a profound problem.  However, in order to pay those higher commissions, the insurance company sponsoring the variable annuity must charge you higher fees!

For this reason, I do not recommend this practice.

2. Equity Indexed Annuities

During volatile financial markets, products are created and heavily marketed which appear to be “one-size-fits-all” solutions. 

In my opinion, equity indexed annuities fall into this category.  Their promise is to allow you to invest in stocks (using one or more indexes, like the S&P 500), yet not lose any money personally if the market index goes down.

When you first hear the concept, it sounds extremely attractive.  In short, they propose that you will receive the upside benefits of investing in stocks without the downside risk! 

However, as with most financial instruments, you have to read the fine print.  If it sounds too good to be true, it probably is.

Insurance companies do place a floor on your deposit so that when you withdraw funds from the equity indexed annuity, you will receive no less than you deposited.

However, a few key points to note:

  • If you withdraw funds over the first 10 to 25 years, you have to pay a stiff surrender charge for access to your money.  And, I’ve seen that charge be as high as 15%. 
  • Your upside potential is limited.  If the S&P 500, or whatever index your annuity is tied to, earns 10%, you don’t get credited with a 10% gain on your equity indexed annuity. Your gains are capped at a much lower percentage and the insurance company keeps the rest.
  • There is a high price to pay for this “guarantee.”  If you break open these complicated products, you will discover that you are paying significant fees to the insurance company to provide their guarantee, and to pay commissions to the broker who sells the equity indexed annuity.

Without knowing any more, if you objectively stand back and examine this product, you have to ask yourself how the insurance company can take on this exposure and not have a problem down the road. 

During the Covid-19 pandemic, for example, when the S&P 500 Index dropped over 34%, how did their company stand up when they had to guarantee no losses to their equity indexed annuity customers? 

How are they going to keep that promise indefinitely if the stock market doesn’t cooperate and there is a run on annuity deposits from their customers?

For this reason alone, I’m not a fan of equity indexed annuities.

To sum up, I do believe there are very limited situations which warrant using an annuity as long as you do so with your eyes wide open.  I simply believe that those situations are much, much more narrow than those currently being sold today.   

Homework Assignment

Once you’ve digested these last few editions of RETIREMENT GAME PLAN dissecting annuities, and your interest is peaked, here are just a few more recommendations for you before considering using an annuity:

  • Access to Your Money: Be very clear on the language of the insurance company’s surrender charges when you need access to your money.  This is critical.  There are companies who have no surrender charges when accessing your money.
  • Insurance Company Ratings:  With fixed annuities specifically, be careful to examine the independent ratings of any insurance company you’re considering.  Remember, how well you do is directly tied to the performance of that insurance company. 
  • Fees:  Specific to variable annuities, be very clear what their insurance charges are to run the annuity, typically 1.50% or so as a base, and much more in many cases for the “bells and whistles” agents and brokers love to add on.  If a variable annuity is what you’re after, a few companies now have very low cost variable annuities.  Additionally, examine the internal management fees of the mutual fund subaccount options.  Insurance companies tend to offer very expensive, actively managed funds as opposed to low-cost index funds.  These excess fees can have a significant negative impact on your returns. 

I hope this has been helpful for you.  I strongly recommend keeping these editions of RETIREMENT GAME PLAN close by for reference whenever you see an “attractive” ad for annuities, or you receive a “pitch” from a broker. 

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