Too Young for an Annuity? Think Again!

03/27/2012 11:45 am EST

Focus: ANNUITIES

Stan The Annuity Man

Annuity Expert, Stan The Annuity Man

Through the magic of compounding, certain annuity strategies can build a lifetime income stream with a relatively small upfront investment for younger investors, writes Stan Haithcock of Stantheannuityman.com.

Senior citizens are usually the target demographic for most annuity products, as well as most other financial products, because seniors control the majority of the investible money.

Most of these retirees are good candidates for the “transfer of risk” annuity strategies I outline in my PILL acronym for how an annuity should properly fit into your portfolio (P = Principal Protection, I = Income for Life, L = Legacy, L = Long Term Care).

But how about 40- and 50-year-olds? Should they even look at annuities? Do annuity strategies make sense for them? For that age range, the annuity strategy that works best is what I call “Target Date” income planning.

People ask me all of the time, “Does Stan The Annuity Man personally buy annuities?” The answer is yes! I really do drink the Kool-Aid. I use the “Target Date” income strategy for my wife and me as a future lifetime income payment that neither of us can outlive.

Most people in this country who work in the private sector are not going to receive a pension when they retire. Even government workers are going to find their future pensions reduced, or at a minimum not as generous as they are currently.

“Target Date” income planning using fixed deferred annuities is a way to protect your principal while receiving a guaranteed annual growth percentage during the deferral years that you can use for a lifetime income stream.

Here’s how it works: Take myself (age 47) and my lovely wife, Christine. We purchase a Fixed Deferred Annuity with an Income Rider that grows at 7.2% annually during the deferral years. (Income Rider growth can only be used for income, so this application is perfect for that additional benefit.)

We put in $250,000 and do not touch it for 20 years, until I am age 67. That amount growing and compounding tax deferred by 7.2% for 20 years will double twice and contractually become $1 million. That is a worst case, no market growth, scenario number.

When I am 67, the actuarial payout will be around 5% to 6% for joint life, depending on the specific company and product. Let’s use the 5% actuarial payout number for this specific example. 5% of $1 million is $50,000 per year. So when I turn 67, Christine and I will receive $50,000 annually for the rest of our lives, regardless of how long we live.

Some of the newer Income Riders offer an annual increase in your income stream as well. With this feature, every year your income can increase and lock-in with any CPI-U increase or index increase. I love that these riders help combat future inflation, the “gorilla in the room.”

Here’s how these riders work to combat inflation. Let’s continue with the example above where $250,000 contractually grows at 7.2% for 20 years and turns into $1 million for lifetime income, adding an Income Rider that increases with CPI-U.

If the government announces that the CPI-U increase for the current year is 3%, then the $50,000 lifetime income stream would increase by 3%. That means the $50,000 would become $51,500 and lock-in at that amount for that year. If the next year the government announces a CPI-U increase of 2.5%, then the $51,500 would increase by the 2.5%, increasing the $51,500 payout to $52,787.50 for that year.

If CPI-U does not increase, then your income would not increase. However, we all know that CPI-U is a “political football” and is attached to Social Security payment increases. Because of this, and the fact that Social Security payment recipients equal voters, I am confident in this strategy for increasing income.

The same type of lock-in increase in your income stream happens with fixed index annuities (also known as equity indexed annuities) that attach future increases to annual index growth. There are only a handful of annuities that have riders that do this, but the numbers work the same. If you have your index annuity attached to the S&P 500 index, then your income stream will increase by whatever the upside return of that specific option is for the year.

In addition to “target date” income planning, I personally use these annuities for long term care/confinement type coverage. Some of these riders also have LTC type coverage built in.

I like this feature, because if I need the LTC/Confinement Care, the benefit is there. But if I never need it, then I fully control the money. I call this strategy “Full Control Long Term Care,” because you always retain full control of the principal.

So the next time you think that annuities are just for “old people,” think again! Prepare for your future retirement by using “target date” income plans using fixed deferred annuities.

A news reporter recently called me the National “Annuity Consumer Advocate” in the same vein as Ralph Nader and Clark Howard are for other products and services. My goal is to continually educate the public on the complex and sometimes ugly world of annuities so that people can make an informed decision.