Guaranteed Income Options Worth It IRR?

[DHK]

You assume the investor A sold out after a 50% decline.

You don't have to "sell out" of your position to have had volatility at the end of any given year.

However, anytime withdrawals are in the equation, that's when sequence of returns risk and "reverse dollar cost averaging" risk enters into the equation.

For example:
$100,000 x -50% = $50,000 - $5,000 income = $45,000

What rate of return would be needed for the portfolio to return to $100,000 the next year?

122%

How long would it really take - especially if you still need that same portfolio to generate income for a few years? If you need steady income from that portfolio, you'll never get back to your original values because the % of income withdrawal will be significantly higher.

Let's suppose you got a 50% return from $45,000... that would be $22,500 for a new total of $67,500. Still far off from the $100,000 we originally had.

That same $5,000 now represents a 10% (or higher) withdrawal after a volatile loss... not the 5% it was originally. Even if the reduced portfolio gained 8% per year and never had a loss, you'll be eroding the portfolio over time by withdrawing more than it's earning.

Virtually all of my clients didn't sell to lock in their losses but now even on a 10-year basis are far ahead of what they would have done with an annuity.

I didn't do much with variables but for a few used a VA with a or 7% annual increase in the "pretend value" (the income rider value) This is with a high cost VA vs a mutual fund plus paying for the guaranteed side. In all cases the contract values are higher than the 7%/yr increase in the pretend value of the income rider.

Were any of these contracts also distributing income?

Today there are very few VA's that would work that way. Fortunately the old one I used, we could keep in some equity sub accounts vs newer products that would force a bond allocation so you could not recovery in the equity rebound that always follows declines (most indexes were yet again at all time highs about a week ago). Of course i don't chase index returns but seek managers with long history of positive Alpha (outperformance for risk taken - Beta).

Today only a few VA's have equity sub accounts I would recommend.

On the other hand with clients having had large equity gains (even if went through the 2009-10 decline) will suggest some FIA but without any income rider. Maybe on a $500k portfolio do $100k in FIA. For some am also looking at asset based LTC which can take various forms where LTC protection is a multiple of investment, not just accelerated surrender period.

I would never recommend an index fund or ETF, but the Vanguard S&P500 index fund over 10 years as of Friday including the Great Recession has an average annual return of 7.48%/yr. As expected this would slightly trail the index return of 7.61%/year. These of course are total returns, including dividends vs a FIA that excludes dividends since just call options with a cap.

I believe the outlook for equities is still favorable with about 184 of the S&P500 reporting about 76% are beating estimates again. Excluding the energy sector which is expected to have an earnings loss of about 54% year-over-year we still have solid earnings growth in 9 of 10 sectors.

Large multinationals of course are taking a hit with the continued strong vs Euro and most currencies. However in Western Europe has had some strong gains in some companies funds are in that are overall resulting in better foreign gains than U.S. (overall in general) at this point even with the strong headwinds.

Looking at 2nd quarter results to date U.S. companies that have less than 50% of revenue from foreign operations are doing much better than those with over 50% foreign revenue.

So my clouded crystal ball is still strong on equities for the next few years, not bonds (other than floating rates and short duration high yields) but if I can get a 5% cap with an FIA with no loss on the downside that can fit in a diversified portfolio.

I agree the sequence of returns makes a big difference since if you lose 20% you need a 25% gain to get back to break-even.
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This is a neat little chart regarding the impact of losses and the returns needed to get back. You might like it.

http://www.crestmontresearch.com/docs/Stock-Impact-Losses.pdf

Other than in the 2008-2010 home market crash due to terrible loan underwriting, the last place I want equity is in a home - dead equity assuming no big decline in home values as the 2008-10 crash was unique in history.

If I am paying 5% home mortgage interest (lower now), my after tax cost is maybe 3%. If over 10 years like the last even with the huge market losses in 2009-10 just index investing (without a cap) would have earned 7%+ with most of it tax deferred (even individually owned since most of this would be LTCG on sale not taxed on unrealized gains) the net would be far better with liquidity than dead equity in a home.

However, for many folks they just feel better with a home paid off even if historically it would not make economic sense over almost all time periods. This is due to the lost opportunity cost if the funds were used for other investments.

Yes you have to have enough income coming in to afford payments but being more aggressive myself, I'd rather not have dead equity in a home. This is especially true if you want to continue to own the home a long time, or in retirement.

As real estate values move up, the equity is still "dead" since it would be very expensive to refinance to free it up unless you are going to sell the home.

Completely agree with you. Most people don't really think through the traditional advice we've heard through the years, but you definitely are!

BTW DHK, great comments in LifeHealthPro article

Thank you! It was a great article that I was glad to contribute to!


Anyway, FIA are great when you're getting close to or are in retirement. Unless someone had a zero risk tolerance, I doubt I would be recommending it for someone in their 20's - 40's. They can ride the waves of the market for a while... assuming that the past results will continue.

I'm not much of an economist. I'm not good at reading economic tea leaves and determining the future trends based on different economic events. Never have been. I try to follow Harry Dent regarding demographic-based spending as it seems to make the most sense to me. I also try to factor in different generational attitudes - Generation X, Y, and Millennials, etc. as part of "consumer confidence", but it's all just a 'crapshoot' anyway.

This is my crystal ball:

Get 25 economists in a room and ask them what they think the economy is going to do, and you'll get 25 different opinions with supporting evidence as to why they think that way. If they can't figure it out, I'm not going to try that hard either.

I'm taking the simpler approach now: markets go up and markets go down. The question is... how would you like to experience the markets in your retirement? With principal at risk? Or would you like to limit your upside with no market risk to your principal?

Since qualified plans are designed to have accumulation values and distribution values... why not nearly double your retirement income by guarantying 7% per year for 10 years to distribute that new value over your lifetime - regardless of what the economy does?


All life insurance and annuity sales have one thing in common: peace of mind. They are emotional-based sales, with enough logic to have them make sense for a lot of people.

The real question is really about how your prospect feels about their money and their retirement planning. Even if they want to "play the market", does their retirement plan and savings really warrant it if they want to plan their income to last to age 100?

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Oh, one more note regarding home equity: the more equity you have in a home, and should there be an interruption in your income... the less banks are willing to negotiate and work with you.

Think about it: If you have a home worth $175,000... and a mortgage of $50,000, you have $125,000 of equity.

But you can't tap into that equity unless you have a job.

Here's "Roy's Story" on what happened to him because he followed the traditional advice of prepaying his mortgage:

https://www.youtube.com/watch?v=X3C9CSNo-AM

But, if you had a $175,000 home with $150,000 mortgages... the bank is much more likely to want to work with you because SOME income is better than getting almost nothing if they foreclose on you.