Author: Tim U

In over 300 episodes of Your Financial Pharmacist, we haven’t covered much about annuities and today, Tim Baker, CFP®, RICP®, RLP® joins Tim Ulbrich, PharmD to do just that. On this episode, sponsored by First Horizon, you’ll hear all about what annuities are, the main types and how they differ, common misunderstandings, fees associated with annuities, and how they can assist with building a retirement paycheck through the flooring strategy.

Episode Summary

This week on the YFP Podcast, YFP Co-Founder & CEO, Tim Ulbrich, PharmD, is joined by YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP®, RICP®, to discuss annuities.

Tim Baker explains what an annuity is, the main types of annuities, key terms and concepts to understand when evaluating annuity options, fees associated with annuities, and how annuities fit into the broader retirement income planning strategy.

During the second half of the episode, Tim and Tim discuss how annuities may fit into the flooring strategy of retirement income planning.

Key Points From the Episode

• How common annuities are and Tim Baker’s high-level thoughts around them. 
• The importance of viewing annuities from the lens of building a retirement paycheck.
• Tim Baker explains longevity risk and how annuities address it.
• What exactly an annuity is and the two phases of an annuity. 
• Tim Baker delves into the main types of annuities and how they differ in structure and features. 
• How the appeal for annuities has increased due to human psychology. 
• Including annuities as part of retirement income strategy, the four ‘Ls’, and the flooring approach.
• Why the psychological aspect of annuities is underrated. 
• The biggest con of annuities: fees. 
• How the tax treatment of annuities differs depending on the type of annuity and how it’s funded.

Episode Highlights

“We kind of shy away from [annuities] as a tool to be used in retirement.” — @TimBakerCFP [0:05:34]

“An annuity refers to an insurance contract where you give the insurance company money, typically in the form of a premium, and they invest the funds – with the idea of paying you back an income stream in the future.” — @TimBakerCFP [0:09:16]

“I’m less worried about legacy and I’m more worried about can my money sustain me?” — @TimBakerCFP [0:29:19]

Links Mentioned in Today’s Episode

• First Horizon’s Pharmacist Home Loan  
• LIMRA: 2022 US Retail Annuity Sales Shatter Annual Sales Records Set in 2008
• YFP Episode 275: How to Build a Retirement Paycheck
• YFP Episode 242: Social Security 101: History, How it Works, and Why it Matters
• YFP 294: 10 Common Social Security Mistakes to Avoid
• Immediate Annuities Website
• YFP Planning: Fee-Only Financial Planning for Pharmacists
• YFP Disclaimer
• Tim Baker on LinkedIn
• Tim Baker on Twitter
• Tim Ulbrich on LinkedIn

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey, everybody. Tim Ulbrich here. And thank you for listening to the YFP podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom. 

This week, YFP co-founder and Director of Financial Planning, Tim Baker, joins me to talk about annuities. During the show, we discuss what an annuity is. The main types of products available. Key terms and concepts to understand when evaluating annuity options. How the fees are associated with these products? And how annuities may fit into the broader retirement income strategy? 

Before we jump into today’s topic of annuities, I recognize that many listeners may not be aware of what our team of certified financial planners do working one-on-one with more than 280 households in 40+ plus states. 

Our team offers fee-only high-touch financial planning that is customized to the pharmacy professional. Whether you’re a new practitioner, in the middle of your career, or nearing retirement, we have you covered. To learn more about how our financial planning services can help you live a rich life today while planning for the future, book a free discovery call at yfpplanning.com. 

Whether or not YFP planning, financial planning services, are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom. 

[00:01:18] TU: Does saving 20% for a down payment on a home feel like an uphill battle? It’s no secret that pharmacists have a lot of competing financial priorities, including high-student loan debt. Meaning that saving 20% for a down payment on a home may take years. 

We’ve been on a hunt for a solution for pharmacists that are ready to purchase a home loan with a lower down payment and are happy to have found that option with First Horizon. 

First Horizon offers a professional home loan option, AKA doctor or pharmacist home loan, that requires a 3% down payment for a single-family home or townhome for first-time home buyers. Has no PMI and offers a 30-year fixed-rate mortgage on home loans up to $726,200. 

The pharmacist home loan is available in all states except Alaska and Hawaii and can be used to purchase condos as well. However, rates may be higher. And a condo review has to be completed. 

To check out the requirements for First Horizon’s pharmacist home loan and to start the pre-approved process, visit yourfinancialpharmacist.com/home-loan. Again, that’s yourfinancialpharmacist.com/home-loan. 

[EPISODE]

[00:02:30] TU: Tim Baker, welcome back. What’s the good news? 

[00:02:33] TB: Not much, Tim. Just kind of hopefully whining tax season down here shortly. The team is frantically at work crunching through tax returns. That’s really the theme of the next few weeks here. Excited for the deadline to be here and gone.

[00:02:49] TU: Yeah, shout out to the tax team. As you mentioned, Tim, hard at work. This season is intense. And we’re really looking forward to doing more year-round tax planning with these individuals. And if they’re listening, which I suspect the tax team is not, since they’re in the weeds right now, but grateful for all their contributions and the value they’re providing to clients and others in the YFP community. So, huge shout out to them. 

Tim, annuities. It’s hard to believe in 300+ episodes now the podcasts that we’ve done that we’ve really covered very little around annuities. I think we had an Ask a YFP CPF a while back that we touched on it briefly. 

And I’ll be honest, Tim, this is an area of the plan that I underestimated just how big it can be both in the volume of people that are purchasing annuities, the questions that are around the annuities, and how they can build under the retirement plan. 

One report from LIMRA was at over $310 billion dollars’ worth of annuities that were sold in 2022. And that was a 22% increase from 2021. Just a big area of the plan. I’m curious to hear at a high level your thoughts around annuities and how common they are as you hear those statistics. And maybe just as surprised as I am that we haven’t dabbled into this more yet. 

[00:04:07] TB: I think it depends who you talk to. I talk to some advisors that use them as part of their practice. I talk to a lot of advisors that I trust and that have looked on them that don’t necessarily use it as part of their practice. I think it’s going to be dependent on kind of the market and where we’re at. 

Annuities, kind of like long-term care insurance, Tim, kind of get a little bit of a bad rap. And rightfully so, in some instances. And we’ll kind of talk through that. But I think a lot of people, at the end of the day, it’s an insurance product at heart. But you can intertwine in investment products. That’s typically what a variable annuity is or like an index annuity is with this. 

But just like insurance, any other type of insurance, we don’t really like to give up our money in the form of a premium for coverage that we may or may not need. I think annuity is a little bit of a different breed. But there seems to be, again, some negative connotations around annuities mainly because like I got to give up my money for something that’s kind of nebulous in exchange. 

And I think for those reasons, it’s kind of more psychological that people are like, “Hmm, I’m going to stick to I have a million. It’s a 4% withdrawal rate. It’s $40,000 a year. Couple that with social security. I’m good.” 

And for a lot of reasons, maybe not so much. That 4% rule, I think a lot of people are looking at that and saying, “Hmm, going forward, I don’t know. That’s not necessarily the best rule of thumb to be using.” 

I think for all of those reasons and probably others that I didn’t mention, that we kind of shy away from this as a tool to be used in retirement. And again, I think that – I think everything should be on the table more or less. And biases aside to see, okay, what are the goals of the client? What’s the balance sheet look like? And then move from there. 

[00:05:51] TU: Yeah. And Tim, before we even jump into what is an annuity at a high level, what are the types of products that are out there? Advantages? Disadvantages. We’re going to get into that in more detail. But I think it’s important to take a step back and view this from the lens of building a retirement paycheque, right? 

We talked about that previously on the podcast. We’ll link to that episode in the show notes. But here, what we’re talking about is a sliver, apart, perhaps an important part, annuities, that are a broader part of how we’re going to build a retirement income stream. How we’re going to replace what was our paycheque and build that retirement income? I think it’s important that we lay that framework as we get into the weeds on the annuities. 

[00:06:34] TB: Yeah. I mean, I think, at the end of the day, when we are thinking about a financial plan, a lot of roads point to, “Can I accumulate enough assets to then not have to rely on a pay cheque and can kind of live my life?” And this topic is – a lot of us, we focus more so just on the accumulation phase and like save and invest, save and invest. But then when we get to the end of it, it’s like, “All right, how do we actually turn this into a sustainable paycheque for the rest of our lives with that timeline being unknown?” And that’s one of the things that annuities address. Because it’s unknown, the payment for a lot of these annuities can go out to the rest of your life. It addresses some longevity risk. 

It’s a crucial part of this discussion. And that’s why we’ve been big proponents of Social Security claiming strategy. It’s one of the most important decisions that you make in retirement. And this type of discussion around annuities and longevity risk is right there. 

I think it’s something that we should definitely bring to the top of the fold and make sure that we are situating this in a way that it goes back to kind of that retirement paycheck. And how does this all fit together? 

[00:07:49] TB: Yeah. And speaking of longevity risk, I pitched a question out there on LinkedIn to say, “Hey, Tim and I are going to be talking about annuities on the podcast. What questions do you have? Would love to hear from the community.” And one of the things that Bryce on LinkedIn said, to your point about longevity risk, is frame it as like the opposite of life insurance. You’re ensuring the risk of living longer than expected instead of shorter than expected. Tim, what are your thoughts on that viewpoint? And I guess, as a part of that, just what is an annuity and how does it work? 

[00:08:17] TU: I think it’s dead on. I think what Bryce said is when you think about longevity risk, that’s the risk that people are living longer than they expect, right? I can go on to socialsecurity.gov, put in my gender and my birthday, and says, “Okay, based on all of the data that they’ve collected since the beginning of time or for as long social security has been around, you’re going to live to 88.6-years-old.” 

But, Tim, I’m not going out like that. I’m going to be here until 95, 105. I’m going to be here for a while. That means that I potentially have 10, 15, maybe 20 years that, according to my plan – again, we as planners, we go out a little bit further to kind of model that. But think about having a decade worth of expenses. Probably a lot of medical expenses that aren’t accounted for. That’s what longevity risk is. That, to me, is one of the things that an annuity addresses. 

An annuity refers to an insurance contract where you give the insurance company money, typically in the form of a premium, and they invest the funds either very, very conservatively or could be more aggressively with the idea of paying you back an income stream in the future. That could be a fixed income stream. That could be a variable income stream. There’re so many different flavors of ice cream when it comes to annuities, Tim. That’s the basic concept. 

Typically, you really have two phases in annuity. You have what’s called the accumulation phase, where this is the annuities being funded. And it’s before the payouts begin. Any money in the annuity kind of grows on a tax-deferred basis during this stage. And then the second phase is the annuitization phase, where you say, “Hey, either I have the option or per the contract that I set up five years ago. It was a deferred annuity for five years.” Now these payments start and they are X based on the underlying performance of the investments or just what you agreed to five years ago. Again, there’re lots of different types of variation here. But essentially, that’s it. 

It’s kind of like Social Security, but not Social Security. The big difference is that Social Security, even with all the negative headlines, it’s still backed by the US government. There’re lots of fears there that benefits will be changed in the future. I think they will be to kind of keep it solvent. It’ll still be there. This is kind of like private Social Security in a sense where you say, “Hey, not US government.” But, “Hey, insurance company, here’s money either all at once or over whatever premium schedule that you set up. And then give me that money back in the form of an income stream.” 

What you’re doing is you’re increasing guaranteed income. Really, the only guaranteed income that most people will have, because pensions have really kind of gone away, is social security. What you’re trying to do is increase guaranteed income. And again, one of the things you have to look at is how is the insurance company rated? Are they rated well or not? Because there is risk of failure there and we’ve seen some bank failures that have, I think, shocked some people. That’s one of the things that you have to make sure that you are in tune with. But that’s essentially the broad strokes of an annuity. 

[00:11:36] TU: And, Tim, great point about the comparison to Social Security. It obviously operates very different. But we’ll come back here in a little bit about the concept of a flooring strategy. But essentially, if we think about, again, replacing our paycheck with a retirement income stream. For most folks, even with the negative press around on Social Security, it may be that, hey, from Social Security, and then plus or minus an annuity, we’re going to have some type of – let’s call it base income, right? Oversimplifying a little bit because of how those can fluctuate and be variable in the different products. But drawing on some type of base. And then we can talk about how to make up the rest of the paycheck from there. 

Types of annuities. Tim, I know this is a lot to cover in a short episode where we’re really focusing on some of the basics and we’re going to come back to this topic more in the future. But what are the main types of annuities. And how do they differ in terms of the structure and features? 

[00:12:28] TB: I’m going to rattle off a bunch of different types of annuities. You have the immediate annuities, immediate fixed annuities, immediate variable annuities, deferred annuities, deferred income annuities, fixed deferred annuities, indexed annuities, variable deferred annuities. There’s – 

[00:12:41] TU: Really easy to shop for, right? Is what you’re saying? 

[00:12:44] TB: Yeah. Yeah. Super straightforward. We’ll put these in two kind of macro categories. You have kind of immediate versus is deferred. An immediate annuity is just that let’s say you’re retiring and you have a $2 portfolio. And you say, “Hey, I want to take some money off the table in terms of like my traditional portfolio. The market is blah-blah-blah. The volatility. I’m going to put a quarter million dollars into an immediate annuity.” 

That means that I give the insurance company $250,000. And then within, I think, 13 months is what is considered an immediate annuity, you start receiving payments. A deferred annuity, the only difference is, is that you give that money today. And then 13-plus months later you get – there’s some growth there. Straight up, like if you do an immediate annuity today and you get that payment next month, the payment might be a little bit less. Versus if you wait 14 months, it might be a little bit more. That’s really the big difference. 

One of the big products that’s out there that’s an immediate annuity is called a single premium immediate income annuity, a SPIA. These are contracts. Generally, start in providing income before 13 months after the date of deposit. They’re typically bought as a period certain. 

One of the strategies that you could use – we just talked about social security and how powerful that could be. You could say, “Hey, I’m retiring at 65. I want to defer and get as many deferral credits for social security as possible. I’m going to buy a period certain of five years to get me to 70 so I can then claim Social Security.” That might be a way to kind of bridge the gap between that. 

And I think that’s a viable strategy, Tim, which people don’t think of. They might say, ” I’m just going to draw down my traditional portfolio.” You can buy it for a single life. So, just me. Or you and a spouse. A joint life. 

Obviously, the more people – typically, if it’s single life, and you are a guy, you are going to get paid higher. Versus a single life and you are female. Because females typically live longer. Single life versus joint life, if there’s two people, typically that payout is going to be less than a single life. Because there’s two basically occurrences for that annuity to kind of go away. 

The SPIAs are typically lifetime income vehicles. You must be paid at least 12 months substantially in equal payments. But it can be not just monthly. It can be quarterly, semi-annual, or even annual payments. 

Many SPIAs can accommodate a death benefit, which means that after you die, a lot of people – this is one of the misconceptions. A lot of people say, “All right if I give quarter million dollars to your insurance contract and I get one payment and then I keel over and die, I lose all that money.” And there are lots of ways to structure that to protect. It could be return of premium. It could be to pay it out for five or ten years. These are all kind of riders that you put on the annuity. 

And then you have a deferred annuity, which is basically the same thing again. But it’s like 13-plus months later. The other macro category, Tim, that I would talk to is the fixed versus variable annuity. Fixed annuities provide regular periodic payments to the annuity. They’re fixed. They’re the same. Just like a mortgage. You pay the same, I guess if your taxes go up a little bit. But you pay the same thing month after month. 

The variable annuity is based on the underlining performance of the funds that you kind of select. This is where the investment part comes in. You typically get a higher payment if the market does well and a lower payment if they don’t. 

The big problem that I have with variable annuities is the commissions and fees associated with it. I’d almost – just like we talk about, buy term life insurance, invest the difference. Anytime you mix these products and there’s complexity upon complexity, typically means that the fees are going to go up. 

But I would say the main types, immediate versus deferred, which is more about time-in. Fixed versus variable, which is more about the amount of payment that you’re going to receive connect it to whatever underlying investment that’s there. 

Now if you do a fixed, the insurance company is going to invest it. They’re just going to invest it very safely and typically not necessarily tied to market. Maybe treasuries or bonds, things like that. 

[00:17:04] TU: Tim, perhaps an oversimplification, but I would assume. I’m just thinking about this from why do these products exist. Obviously, they have to have viability from the person selling the policy, right? Just like a life insurance policy. And it feels like, while different based on variable or fix, that obviously they may be taking a larger lump sum of money investing and growing that at a greater return. Depending on the type of product and what you’re putting that money into. And then whatever they’re paying you out, in theory, their goal is to pay you out less so that they can make some money on the upside of that. 

And that’s not a bad thing, right? I mean, in terms of if we want some stability – and we’ll talk about the flooring here in a moment. That’s what we’re willing to potentially give up is some of that higher upside. And obviously, we’re putting floor on some of the downside as well depending on the type of product. But is that generally how these products work from the institution standpoint of how they’re making money off of them? 

[00:17:58] TB: Yeah. You know, no free lunch, right? In exchange for guaranteed income, I’m going to pull my money with other annuitants. And essentially, they’re playing the game of what do the morbidity table say? And can we still turn a profit? 

But I think of it as I put in a quarter million, Tim. You put in a quarter million. Joe Schmo puts in a quarter million. And we’re all drawing on those funds. But Joe Schmo might die at age 75. You might live to age 105 and I might be somewhere in the middle. 

But at the end of the day, you take a lot of maybe stress or some other things that are more soft, like more the human element, off the table. Because those checks are rolling in. I don’t have to worry about the markets as much. I mean, you still do. Because unless – we’ll talk about the flooring strategy. 

But like one of the things that I think can stretch out retirees, especially in markets like this where it’s really volatile, they’re up and down, they’ll be kind of trending down over the last couple years, is that, “Hey, I started with a million bucks. I’m four years into retirement and I have $750,000. Or I have –” That’s because of what I’ve taken out. Because of losses. The annuity kind of addresses some of those things where it’s like, yeah, you might take a haircut at the start. But for that haircut, you’re getting $1,000, $1,500 on top of that Social Security that you have kind of rolling in. 

[00:19:24] TU: And the emotional side. 

[00:19:25] TB: Yeah. 

[00:19:26] TU: Yeah. I mean, we haven’t talked a lot about that. Obviously, there’s a risk tolerance question here. But there’s also a peace of mind aspect to this as well in terms of building some of that base. 

And I think Tim, what you just shared there in terms of the market changes are probably why we have seen such a strong uptick in the purchase. I shared those stats early on in the episode, right? 

I mean, prior to that, we really were on this – what, 12, 14-year run of markets constantly going up. And obviously, we’ve had more volatility. And it would feel, like in a greater volatility or down market, the interests and annuities goes up. I mean, I think that would be human psychology, right?

[00:20:02] TB: You’re looking for more safety. And I would say that annuities typically are going to be – I think of myself as having more of an appetite for risk. But when I think about myself when I’m making these decisions in retirement, I feel like there’s a lot of appeal for this. 

It’s like, “Okay, can I peel off a percentage of my traditional portfolio to turn that into an income stream that’s matched with my social security?” That like, at the end of the day, like everything could fall apart. But I still have enough to pay for my living expenses. Like all that kind of stuff. And I think that’s a big deal.

[00:20:41] TU: Tim, I have this visual of like you and I in our 80s like sitting on our rockers, like drawing on the annuities. And like I’m still waiting for the Bills to win a Super Bowl. You’re still waiting for the Sixers process to work out that’s taken forever. 

[00:20:54] TB: Yeah. Yeah. 

[00:20:55] TU: We’ll see where that goes. 

[00:20:55] TB: Yeah, it’s going to happen. I think that the Sixers are good for a run. 

[00:20:58] TU: This is the year. This is the year. 

[00:21:00] TB: This is the year. 

[00:21:01] TU: We’ll see yeah so let’s talk about how annuities fit into the broader income strategy. We’ve danced around this a couple times now with the flooring strategy. We’ve talked about that previously on an episode that we covered Social Security. We’ll link to that in the show notes. But talk to us about annuities as part of the retirement income strategy and creating that floor. 

[00:21:19] TB: Yes. Again, I think when we’re looking at this, essentially, we’re trying to address kind of the four ‘Ls’ of retirement. It would be longevity. Do we have enough money to sustain us throughout lifestyle? Are we living the lifestyle that we want to live? Or do we have to adapt that because we didn’t plan enough, or we didn’t save enough, or whatever that looks like? Legacy. What do we leave behind to heirs? Or what are the things that are important to us that we want to make sure that we’re focusing on? And finally, liquidity. Do we have enough money that we can you know pull for those discretionary things? 

To me, we’re kind of looking at – with an annuity, we’re trying to address I would say like three major – actually, probably four major risks in retirement. One is the longevity risk, which we’ve talked about. One is excess withdrawal risk, which means that if we’re trying to build a paycheck, there is a risk that we’re going to be pulling too much, especially in the early years. Maybe we’re pulling 5%, 6%, 7% early on. And then later on, we have to pull a lot less because we just pulled too much early on. Or the market is wonky, which is probably the third risk, which is market risk. We want to, with annuity, try to eliminate the volatility. 

And probably the other one that’s maybe not necessarily talked about is like early loss of spouse. If you have social security, you and a spouse potentially could be pulling in two checks. But then when that spouse dies, now you have one. Annuity can help that as well, where you still have the dollars coming in. 

When we look at it from a flooring approach, the flooring approach is probably the most conservative approach to building a retirement paycheck. The flooring approach calls for special products to be used, a la annuities, to set the floor. What we essentially are trying to do is establish what are the essential spending amounts that we need? And then what are the discretionary amounts that we need? The basic needs would be food, shelter, clothing, transportation, insurance premiums, and health expenses. 

The main tools to kind of basically set that floor is going to be social security. Pensions, if you got them. Could be things like a bond ladder or TIPS and I bonds. And probably the last one is the annuity with fixed terms that have fixed terms or fixed payments. Or typically lifetime income streams. 

To kind of walk through an example here, is that I might sit down with a client and say, “All right. We have between house and food, gas, utilities, maybe some debt still, medical insurance, that’s going to be $5,400 a month.” And then if we add up all the discretionary between travel, gifts, dining out, entertainment, hobbies, maybe that’s another 2,000. I’m really going to look at that as two separate buckets. We’ll say 5,400 for essential and 2000 for discretionary. 

When I try to line up those income streams of like how are we going to cover the essential expenses? I know that this particular client, their benefit from Social Security is going to be $3,000 per month. I know that I have about a 2,400 gap. We’ll round it up to 2,500. About a 2,500 gap for those essential expenses. 

What most people do is that that’s when they typically say, “Hey, 4% rule. Draw down the portfolio.” What the flooring strategy says is, “Okay, we have 3,000. We want to get to, say, 5,500 for the essentials. Let’s go out and peel off part of the traditional portfolio and have an annuity fill in that 2,400, 2,500 per month gap.” 

So now, we go out, we say, “Okay, we’re going to take X from the traditional portfolio and we’re going to have a $3,000 check coming in for Social Security and then a $2,500 check coming in for the annuity.” That $5,500 meets the floor of those basic essential expenses. And then the remainder of the traditional portfolio, the 401K, the IRA, the simple IRA, the TSP, for those $2,000 for discretionary, we’re going to pull from the retirement portfolio. It could also be for part-time work, consultant work, or whatever. 

But that’s the idea, is that create the floor with – if the wheels come off, we have to pay these no matter what. And then the rest, kind of the fund money, comes from the traditional portfolio. 

For a lot of people, it’s just too conservative because they’re like, “I don’t want to give up X amount of my traditional portfolio for that $2,500 payment.” I was messing around with the immediate annuities.com. And you can put in a lot of different information to get a quote. 

Just give you an example, Tim. I put in my information as if I was 65 and Shea was 60. And I said, “All right, I’m going to put in $250,000.” Let’s pretend I have a $2 million portfolio. I’m going to basically spend that down essentially to 1.75. That $250,000, if I were to basically buy an immediate life annuity, this would cover my life and her life. Would basically pay me out $1,308 for the rest of my life.” 

[00:26:38] TU: Per month. 

[00:26:38] TB: Per month. 

[00:26:39] TU: Yeah. 

[00:26:40] TB: If you do life plus 10 years certain. This would be – if I buy this annuity at 65, and then I die at 67 and she dies at – she’s five years younger, 65 herself. It would pay out to the beneficiaries 10 years. There’s also one. That would go down a little bit. That’s 1,299. 

[00:27:00] TU: Which makes sense, because you’re getting that additional benefit. Yeah. 

[00:27:04] TB: If it’s life with a cash refund – this is like the whole, “Hey if I give the insurance money and I get two payments, do I not get my money back?” Life with a cash refund. Basically, what’s left there, that payment goes down to 1,267. 

And then it shows like five-year period certain. This was that whole idea of like, “Hey, if I want to extend Social Security or wait to do that,” if I do $250,000 for five years, you get 4,584 for those five years. 10-year period certain, 2,528. There are so many different variations of this in terms of how you purchase. 

[00:27:39] TU: I’m curious. Like 250k, let’s just look at that more simple kind of straight option. 250k that you’re giving up of a nest egg of whatever, $2 million, $3 million, that you’re going to get about $1,300 per month and that was going to cover you and Shea. What are your thoughts on that, right? Because I hear that, I kind of feel the emotional tug in my brain, right? There’s the safety security side that’s like, “Oh, man. I know a check’s coming in every month for 1,300 a month.” 

Assuming that I’ve saved enough for that 250k, isn’t going to be a massive percentage of the nest egg? I like that security. And then the other side, I’m like, “Geez! That’s only – what? 13,000, 14,000 a year. 

When you look at kind of floor income, I too think of myself as being a little bit more aggressive. And what could that 250 be worth if it grows? You start to get into risk tolerance and some of the analytical side. What’s your gut reaction when you hear 250k to 1,300?

[00:28:35] TB: I don’t know. I mean, again, I think about in the context of like $2 million portfolio, peel off a quarter million. Basically, a quarter million turns into 1,300. For whatever reason, I don’t hate that. I think that like, again, our strategy probably is going to be for us to defer Social Security and wait as long as possible. That payment is going to be pretty substantial. 

And then if you pepper in what you can get to at least reach that floor, I think that like just like any time you get like an insurance policy or your estate plan is set, I think there’s a could be like a feeling of like maybe you give up some upside. But like – I don’t know. I mean, I think like if I look at the worries that I would have in retirement, I’m less worried about legacy and I’m more worried about can my money sustain me? 

[00:29:24] TU: Which is interesting part of the plan, right? And that to me speaks to the value of, like we say all the time, not looking at this in a silo. Even what you just raise, where does someone sit in terms of their feelings around legacy and maybe leaving money to family or leaving big philanthropic gifts? Or is there risk or concern on the longevity side? Those bigger questions have to be discussed and answered before we can determine what’s the pathway that we’re going to take in purchasing annuity. 

[00:29:55] TB: If you look at it from the insurance perspective. If I’m 65 and I live to 95, that’s 30 years of $1,300 payments per month. When you multiply that out, that’s like $471,000. That I’m giving 250, I’m getting 2 – is there a risk that I die before that? Yeah. But you can also put those writers in that say, “Okay, you can get your premium back or a period certain.” 

What would that 250 do outside of it? To me, it’s like when you get – I think my approach to this is like I want to be as aggressive and pedal to the metal. But then when I get to like decision time right as I’m setting up my paycheck, I want – and that’s why we talk about like Social Security. I want as much guaranteed income as I can get with reason, right? 

I don’t know. Is it a quarter million? Is that half a million? Is it a hundred thousand? And again, like a quarter million out of a $1 million portfolio is a lot different animal. I want to make sure that I don’t have a $2 million portfolio. I have a $4 million, $5 million, $6 million portfolio that I can then look at this. 

It’s an exercise in kind of a little bit of the what-ifs. But like what do you value? For me, again, if we put ourselves back on the beach and I’m complaining about the six years and you’re complaining about the bills, the checks are rolling in. Social Security, the annuity check. I guess what I would argue is I’m less concerned about the markets, which my dad, every time I talk to him, maybe because I’m a financial planner. He’s like, “Oh, the market. Blah-blah-blah. My socks.” And I’m like, “Cool.”

[00:31:29] TU: What? 

[00:31:30] TB: Yeah. Like, how are those word searches going? But like I think the other argument that you can make is that you can afford more risk in a portfolio. Now the regulars might disagree with this. But this is something that the RICP was saying, is like, “If you can show in the grand scheme of things that you have two clients. One client that is straight, systemic withdrawal, 4% rule, blah-blah-blah.” Like, as you go through the eye of the storm, which is plus or minus five or ten years before and after retirement, you have to be super conservative. But if I can make the case that this client has what they need, then I don’t necessarily have to be as conservative. And I can still let the market do what it does over long periods of time, which is return 10%, 7% as we adjust down for inflation. 

[00:32:17] TU: That was my thought. As a piece of this we haven’t talked about, what you’re alluding to right now, is for those folks that have a sizable nest egg. Let’s say that the math shows they need three, but they’ve saved five or six. That’s a very different conversation than someone that maybe, “Hey, I needed two and I’m at 1.2.” 

Because it opens up. Again, depending on someone’s goal of risk tolerance, all the factors we need to discuss. If someone has a nest egg of five and the math says they needed three, if there’re other things they want to take more risk with, whether it’s in a traditional portfolio, whether, “Hey, I want to start a business. I want to start a foundation. I want to do X, Y, or Z.” This, to me, is very intriguing that you can write a check for an annuity that doesn’t have as big of an impact on percentage of the overall nest egg. And gives you some of that freedom and capacity not only mathematically, but mentally, to take some of that other risk. 

[00:33:11] TB: Yeah. And I think that’s one of the things I think is underrated and all this. It’s just the mental, the psychological aspect of it. Because, again, many retirees, they have social security. But a lot of their paycheck is based on their portfolio. You’re spending that down. Whereas I would make the argument, you have a big chunk that comes out with like the flooring strategy. But then you’re spending that down a lot less comparison. 

It’s a little bit of – for me personally if you check most of the boxes, I’m like risky, risky, risky. But then like I’m thinking about this in the context of like, me personally, I’m like, “I don’t know. That sounds pretty good.” If I can convert some chunk of my traditional portfolio to a lifetime income payment and not have to worry as much about a lot of these external factors that we have no control over. 

[00:33:58] TU: Which, let me get on the soapbox here for a minute, Tim. This, to me, is such a great example of why having a partner, a planner, a coach in your corner is so valuable. We talk about this at length on the show. But especially in products like this. The same can be said for a long-term disability policy. The same could be said for purchasing a home. Because of how these are marketed, it takes us down a pathway of making a decision on a singular part of the plan, right? 

And this is such a great example where we’re really talking about much broader issues, which is, “Hey, an annuity is one part of the retirement income strategy,” which we got to know what else is going on in the rest of the financial plan to be able to know where are we at in terms of building that retirement paycheck, which that information is needed to then determine what we may or may not need in an annuity. And then, obviously, the nuances within the annuity options. 

But behind all of that is what’s the point? What’s the purpose? What do I want to accomplish? What’s the risk? What’s the goals? And this is the behavioral part of the plan that I know, Tim, I fall victim to. Like I’m punching numbers in the calculator. And I’m on the website you’re on and I’m like, “Ah. I love it. I don’t love it.” And I quickly lose sight of, “All right. Step back. What’s the purpose? What’s the plan? What are we trying to accomplish? What are we trying to achieve?” And where does this one important but very small part fit within the context of everything else we’re trying to do? 

[00:35:24] TB: A lot of these things all fit together. Another thing that we’ve never talked about, which I think has a pretty nasty reputation, is even like things like reverse mortgages. And like how does that fit with this? Yeah, it’s multi-factor – like there’re just so many things to consider. 

And I think a lot of people, one, they want to know, are they okay? Are they crazy? And I think pharmacists in particular, they want to know that like the math kind of supports that. 

The cool thing about like what we can do is we can model all of these things out and say like, “Okay, this is how it affects you.” You know, the bottom line at the end of the day. And I think that this is another vote in the annuity corner, is I feel like sometimes, in retirement, people, they get so preoccupied with their money and with what the market is doing. 

And part of it is like you’re not – your day-to-day, especially early in retirement, there’s this kind of like, “All right, I reached the finish line. My identity has been I’m a pharmacist.” Like a lot of that’s tied up. And like, you know you try to fill. And a lot of it goes to things like finances and the markets and things like that. 

But when you look at your goals, like it’s typically not what you really want to do or enjoy doing. Some people do. But I think if you can take some of that stress out and really focus on what matters most, which might be volunteering, or traveling and things like that, and not have to worry about that. I mean, I think that’s a huge benefit. 

One of the things we haven’t talked about, there are lots of cons to annuities as well. There’re pros. But there’re cons as well that you have to be kind of aware of and before you make that decision. Because it’s a decision that you can’t really reverse. 

[00:37:05] TU: Let’s jump into one of those cons, Tim, which I often hear about. And before I started to dive more into this topic, I certainly had that talking point, which was fees, fees, fees, right? Annuities equals fees. And we probably underestimate the impact of those fees on the overall value of the product. Talk to us more objectively about the fees. How they work on these products? And what we should be considering? 

[00:37:27] TB: Yeah. When you think about the costs, the fees, related fees, obviously, you have the premiums. That’s what you give the insurance company for that income stream. But I remember when I got into financial planning, Tim, when I worked in the broker-dealer world, one of the things that I heard was like sell variable annuities. And I’m like, “Why?” And like because they pay 6% to 8% commission. And it was like just talked about like that. 

[00:37:53] TU: Do the math on that, right? A couple hundred thousand dollars.

[00:37:56] TB: Yeah. And I’m like, “Okay, the ones that have the higher commissions are – they have the longer surrender period.” Their surrender period, or their surrender charge, is where annuitants cannot make withdrawals during like a period of time or they get penalized. They pay a surrender charge or a fee. And these typically can last five, six, seven eight years. That’s involved. 

There are annuities that will work with like the fee-only community like us, where they’re commission-free. But they still have to make money somewhere. It could be where they have admin fees. I wouldn’t make money as an advisor because I get paid differently. But there are still admin fees. Could be a mortality expense. This is the compensation that the insurance company basically earns for taking a risk of like you outliving that amount of money that you give them. 

It could be if it is investment, like a variable annuity or an index annuity that there’s the expense ratio that you pay for those investments. And then all those riders. You know, you can have a rider for long-term care insurance that you can access your policy for long-term care. I should say, it could be a rider for return a premium. Or there’s lots of different writers that you can kind of tack on. 

That’s one of the things that, regardless of the annuity that you elect to purchase, you’ll likely have to pay at least administrative and mortality expenses. Again, some will not have surrender. Some will not have commissions. And the ones that I typically like, which are typically like the SPIA. Keep it simple stupid. Those are going to be the cheapest for that. 

But again, if I pay 1% or 2% to get a lifetime income, I’m willing to have that conversation. Versus I don’t know if I’m going to have that conversation at 6%, 7%, 8%. 

[00:39:47] TU: Yeah. Tim, I’m not ashamed about the bias I’m going to have here and saying what I say because we’re proud of the value of fee-only fiduciary advice. This is an example where separating the advice from the purchasing of the policy is really valuable, right? 

[00:40:02] TB: Totally. 

[00:40:02] TU: If I’m totally in an annuity and I’m trying to understand the nuances. What do I need? What do I not need? Not only does a good-fee only planner able to see the rest of the plan and help us advise it. But when we’re in that purchase decision, which is true with any other insurance policy as well. And that insurance policy is tied to a commission, separating the advice from the commission of the policy can be really valuable. 

We’re looking at two, three, four options. Understanding what we do or don’t need. Doesn’t mean people that are selling annuities are bad. But just understanding where the conflicts may arise. And then how do we mitigate those so we can ensure we get what we do need and don’t get what we don’t want? 

[00:40:40] TB: Yeah. Tim, variable annuities, and non-traded REITs. Back in the day, those were like sell those. And it was because of those commissions were just ridiculously high. And again, I think most people are inherently good and they want to do right by the client. 

But also, if you’re in that system, like you don’t really bat an eye at that. Where I’m like, “Geez.” I was new. I was like that doesn’t seem like something that we should just – I don’t want to say flaunt. But it didn’t sit well with me.

[00:41:11] TU: Tim, last question I want to ask you before we wrap up here. Refers to the pre-tax, after-tax component. My understanding is that annuities can be purchased with both pre-tax and after-tax dollars. And so, how does the tax treatment of annuities differ depending on the type of annuity and how it’s funded?

[00:41:27] TB: Yeah. I think the tax treatment, I think the best way to understand it is that think of it as very similar to a pre-tax and an after-tax IRA. If you purchase – say, we use that example. Let’s say I have my $2 million portfolio but a million of that is from a traditional – a pre-tax IRA. And I’m going to peal the $250,000 for my SPIA out of my pre-tax IRA. 

Essentially, the funding source is pre-tax. That annuity will be qualified. It’ll be funded with pre-tax money. Essentially, that means that when those payments start to come out, they are taxed as ordinary income just like it would be if I just withdrew it from the IRA. 

[00:42:15] TU: To move down to Florida? 

[00:42:17] TB: Yeah, exactly. Right. Exactly. I can void state Yeah. If I say, “Hey, on second thought, I want to fund my annuity with after-tax dollars.” Let’s say I use a Roth or it could be even let’s say a brokerage account. Those are post-tax dollars. You only pay taxes on the earnings or interest portion of the distribution but not the principal. 

They look at the bulk of that payment come back as like a return in principle. think of it very similarly to how you would just distribute a traditional 401k or a Roth 401k. One of the things to call out is that annuities still have that 10%. If you do this before 59 and a half, you still have a 10 penalty on those qualified annuities. 

I think there is – and don’t quote me on this. But I think if you say I’m 57, so I’m before 59 and a half, and I buy a SPIA and I knew – that means I basically annuitized that within 13 months. I think that circumvents that role because you’re basically drawing it out immediately. I think there are a little bit of like variations to the tax and the penalties. But pretty much I would say think of it as how you would distribute a pre-tax or an after-tax account. 

[00:43:32] TU: Tim, great stuff. We’ve covered a lot. But we’re just dabbling into the topic of annuities. One that we’re going to be talking more about along with other topics, especially to those pharmacists that are in that mid-career, pre-retiree, retiree. Things that we know are top of mind as they evaluate that transition maybe soon or a little bit later into retirement. 

And I really want to call out, as we wrap up here, our financial planning services offered by our five certified financial planners at YFP Planning. We work with pharmacists at all stages of their career. Whether you’re nearing retirement and you’re thinking about this decision on annuity. Whether you’re in the middle of your career. Or whether you’re a new practitioner, we have one-on-one comprehensive financial planning that is ready to meet your needs based on your goals and your stage of career. 

For those that are new practitioners, we’ve got a foundational financial planning offering. For those that are more in the middle to later in their careers, we have a wealth management service. And I will link to in the show notes a link where you can book a free discovery call with Justin, pharmacist from our team, to learn more about those services and whether or not they’re a good fit for what you’re looking for. 

Tim, thanks so much, as always. And looking forward to get back to it in the future.

[00:44:41] TB: You got it. 

[OUTRO]

[00:44:43] TU: Before we wrap up today’s show, I want to again thank this week’s sponsor of the Your Financial Pharmacist podcast, First Horizon. We’re glad to have found a solution for pharmacists that are unable to save 20% for a down payment on a home. 

A lot of pharmacists and the YFP community have taken advantage of First Horizon’s pharmacist home loan, which requires a 3% down payment for a single-family home or townhome for first-time home buyers and has no PMI on a 30-year fixed-rate mortgage. 

To learn more about the requirements for First Horizon’s pharmacist home loan and to get started with the pre-approval process, you can visit yourfinancialpharmacist.com/home-loan. Again, that’s yourfinancialpharmacist.com/home-loan. 

As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment. 

Furthermore, the information contained in our archived newsletters, blog posts, and podcasts is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analyses expressed herein are solely those of your financial pharmacists unless otherwise noted, and constitute judgments as of the date published. Such information may contain forward-looking statements are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacists.com/disclaimer. 

Thank you again for your support of the Your Financial Pharmacists podcast. Have a great rest of your week.

[END]

 

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