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Show me the Money…

By Stephen Kelley - Author | Sep 11, 2019

So much of the time, we discuss people who are already retired, or those getting ready to retire. After all, that’s what we specialize in.

However, this week I saw a new client who is much younger than is typical; he is 29, and just starting out in a major new position that will increase his income considerably. For convenience, and to protect the guilty, let’s call him Bill.

Bill was referred to me by his father, call him Mark. Mark is a very satisfied non-client of mine. I recognized him immediately, even though he is not a client. When I mentioned I recognized him, he said, “several years ago you gave me the best advice I have ever received from a financial adviser.”

“That’s great,” I said. “So, how come you are not a client?”

“That was the advice,” he said. “You recommended against it.”

“Whoa,” I said. “I really have to work on my messaging.”

“No,” he said. “The advice was spot-on. I came in with a couple of variable annuities for you to evaluate, and after looking at them, you smiled and said, whatever you do, hold onto these. And I predict the insurance company will try to buy you out. Don’t let them. That’s why I brought Bill in to see you. You turned me away and recommended I stay with them, and that insurance company is still trying to buy me out.”

At that point, I remembered the case. The reason I recommended he keep his contracts was it was one of the few variable annuities at the time that actually did what it said. Most variable annuities make it seem like one thing is true, while other things are really true.

Here’s an example. I have another client who brought in a VA that had a “guaranteed lifetime income benefit” that provides a 7% payout, rather than the 5% offered by the aforementioned contract. And while that seems better than the 5% Mark is receiving, it’s important to note, it’s only true as long as the account balance is above zero. As soon as it hits zero, the payout on the income benefit reverts to 3%, rather than the 7% it starts out with. That presents a potential problem for retirement.

The variable annuities Mark asked me to look at are from Mass Mutual, and they have an income rider that grows at 6% per year and offers a guaranteed payout of 5% for the rest of his and his wife’s lives. In other words, it does not go down once the account is out of money. For a VA, that’s critical.

The reason is the cost of the VA and the amount of income that is drawn from it. I have written before in this column about the 4% rule, and how fundamental it is in securing one’s future. The 4% rule is the accepted answer to the question, “How much money can I withdraw from my retirement accounts each year and have at least a 90% chance that I won’t run out of money?” Four percent was the amount determined by San Diego-based financial planner, William Bengin, an early adopter of 401(k)s for his clients in the early 1980s. By 1995, many of his clients were retiring and wondering how they could best use them for retirement income.

Using a model that looked back about 80 years, and assuming the market would continue to grow well into the 2000s, Bengin determined one could start with a withdrawal of 4% and add a 3% cost of living adjustment on it each year thereafter. That doesn’t mean 4%, 7%, 10%…. It means 4%, 4.12%, 4.2436%….

What does that have to do with this case? The typical VA provides for a 7% first year withdrawal. In some cases, that’s on top of fees in the 2.5% to 3.5% range. If I evaluate that with a Monte Carlo plan (the common analysis done for market-based withdrawals, the chance of running out of money skyrockets to around 50%. So, 50% of the time, it will go from about $80,000 per year to around $34,000, without inflation adjustments.

The annuity Mark brought in, however, begins payouts around $70,000, and stays there (with inflation adjustments) for life. No surprises, and nearly guaranteed to provide more income than other methods, for the rest of your life.

Back to the crux of the story. Mark was so happy with me, he wanted me to advise his son, and he was convinced I would pick some kind of annuity.

“Not so fast,” I said. “Annuities are great once you are older, but not so great for someone just starting out.”

“So then, what?” asked Mark. “Leave it in his 401(k)?”

“Sure,” I said. “If you like market volatility, high fees, limited access to your funds, limited investment choices, and maximum taxes in retirement, that’s a great choice.”

“So, if it’s not annuities and not the 401(k), what is it?” Mark asked.

“Permanent life insurance,” I said. “There is absolutely nothing better.”

“Prove it to me,” Mark and Bill said.

“I will,” I said. “Next time.”

Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, he services Greater Boston and the New England areas. He is author of five books, including “Tell Me When You’re Going to Die,” which deals with the problem unknown lifespans create for retirement planning. It and his other books are available on Amazon.com. He can be heard every weekend on the “Free to Retire” radio show on WCAP and WFEA, and he conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. Steve can be reached at 603-881-8811, or at www.FreeToRetireRadio.com.


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