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Section 7
Understanding and Annuities
If you’ve read the section of this course on cash value life, you might be of
the opinion that the most protective and tax-favorable/wealth-building tool at your
disposal is a properly designed Indexed Universal Life (IUL) policy.
An IUL policy can be a useful wealth-building/retirement tool for many
people; but there are no “secret” wealth-building tools and no “magic” concepts
out there that are a good fit for everyone. If you are over the age of 65, it is going
to be difficult to make a cash value life insurance policy work as a superior
wealth-building tool.
Regardless of your age, one idea that has really taken hold in our society
after the stock market crash of 2000-2002 (-46%) and again in 2007-2009 (-59%
from the highest point to the lowest) is that of “principal protection.”
Generally speaking, when the American investor thinks of wealth-building
concepts that “preserve principal,” they typically think of low-yielding tools like
certificates of deposits (CDs), money market accounts, or potentially “fixed”
annuities.
All three of the prior listed wealth-building tools guarantee your money
will not go backwards, but the growth or return on each is typically very low (and
CDs and money market accounts create annually taxable income).
What I will cover in the second part of this section of the course is a
hybrid wealth-building tool called a Fixed Indexed Annuity (FIA). FIAs are
unique wealth-building tools that in their “basic” form will be a good fit for many
readers to grow wealth in a conservative manner.
Two of the key features that make FIAs an attractive wealth-building tool
are:
-FIAs guarantee your money will NEVER go backwards due to downturns
in the stock market.
-FIAs lock your gains every year; and once locked in, they can never be
lost due to a downturn in the stock market.
While the above sounds exciting, you’ll read in a bit about how an FIA
can come with a 5-7% guaranteed rate of return* on an accumulation value (not
walk away value) that is used to calculate/provide for you a guaranteed lifetime
income* you can never outlive.
*Any guarantees mentioned are backed by the financial strength and
claims-paying ability of the issuing insurance company and may be subject to
caps, restrictions, fees, and surrender charges as described in the annuity contract.
In order to fully understand FIAs, it’s important to have an education on
annuities in general which is what I will cover in the first part of this material.
You will not be an annuity expert after reading this section, but you will have a
good base of knowledge that will help you whenever you decide to look at
annuities as a wealth-accumulation/retirement tool.

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TAX-DEFERRED ANNUITIES
INTRODUCTION
In the past three decades, tax-deferred annuities have emerged as a
commonly used planning tool by financial advisors and estate planning attorneys
as well as CPAs/accountants. As the financial services industry has undergone
dramatic changes, depository financial institutions, brokerage firms, and
insurance companies have changed their product menus to appeal to a broader
spectrum of the investing public.
As the country’s population has increased in age due to medical
advancements that have increased longevity and the demographic bubble known
as the “baby boomers,” there has been an increased focus on retirement planning
and income planning specifically.
As I stated in the section of the course on Bad Advisors, one of the
problems facing the general public is the fact that most advisors do not have a full
understanding of “all” the annuities available and how to use them to best help
their clients.
Many securities licensed advisors know nothing or very little about FIAs,
how they work, their living benefits, and guaranteed income riders.
WHAT IS AN ANNUITY?
An annuity is a contract between a buyer, or contract owner (typically an
individual), and the issuer (typically an insurance company) whereby the contract
owner agrees to pay the issuer an initial premium, or payment in a lump sum, or
payments over a period of time, during which the issuer guarantees the owner a
stated minimum rate of return or the opportunity to participate in growth based on
an underlying group of assets. As with all contracts, there are numerous terms and
conditions that influence the features and benefits that accrue to the owner.
The annuity contract is generally called a “Policy” because it is issued by
an insurance company, and the owner is generally referred to as the
“Policyholder.” This terminology is used in general even though the annuity is
technically not an “insurance policy” in the traditional sense; however, it may
have some of the attributes of a life insurance policy, e.g., a death benefit. There
are three general classifications of annuities: fixed, variable, and immediate.
These will all be discussed.
There are generally three parties to an annuity: owner, annuitant, and
beneficiary. The owner is the individual or individuals who own the cash benefits
of the annuity.
The annuitant is generally the individual on whose life the death benefit
is contingent. The annuitant may be, and oftentimes is, the same as the owner; but
this is not required.
The beneficiary is the individual or entity who is named to receive the
death benefit of the annuity.

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The period of time that the annuity is growing in value, which may also be
increased by additional premium payments into the annuity, is referred to as the
accumulation period. The accumulation period may be indefinite such as the
case with FIAs; or there may be a set limit, generally determined by the age of the
owner or annuitant or a set period following the initial premium payment.
Once the end of the accumulation period is reached, the payout period of
the annuity begins. During the payout period, the owner will receive a series of
payments, or a lump sum, that is selected from a menu of options. Once the
schedule of payments is completed, or upon the death of the last-named recipient
if a “life-only” payout is selected, the annuity ends and the contract, or policy, is
terminated. A Single Premium Immediate Annuity (“SPIA,” pronounced spee-uh)
does not have an accumulation period and will be discussed later.
WHAT ARE THE COMMON CHARACTERISTICS OF ALL
ANNUITIES?
TAX DEFERRAL AND WITHDRAWAL
All “tax-qualified” annuities, regardless of classification, offer income tax
deferral of earnings until the earnings are withdrawn. If an annuity is funded with
money on which no taxes have been previously paid, then it’s considered a
“qualified” annuity. Typically, these annuities are funded with money from
401(k)s or other tax-deferred retirement accounts, such as IRAs. When you
receive payments from a qualified annuity, those payments are fully taxable as
income.
“Non-qualified” annuities (ones NOT purchased with tax-deferred money)
are treated the same when it comes to the deferral of taxes on growth, but are
taxed differently when you remove money from the annuity.
The initial premium paid for a non-qualified annuity is not taxed.
However, the growth is taxed when withdrawn at your ordinary income tax rate.
When taking money from a non-qualified annuity, there are really two
ways to do it. 1) You can take withdrawals. 2) You can take a systematic income
stream.
If you take a withdrawal (you call the company and ask for a certain dollar
amount), it is assumed that the money coming from the annuity is from the
investment gains and will be fully taxed at your ordinary income tax rate. Once all
gains in the annuity have been withdrawn, the remaining money from the annuity
can come out tax free as essentially a return of your premium.
When taking a systematic income stream, each monthly payment from a
non-qualified annuity is made up of two parts. The tax-free part is considered the
return of your cost for purchasing the annuity (your premium). The rest is the
taxable balanceor the earnings. The percentage of how much is deemed part of the
return of your initial premium and how much is considered taxable income is
somewhat complex. It’s based on your age and expected date of death. For this
course how to calculate it isn’t necessary. That will be done by insurance
company software.

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1035 EXCHANGES
One annuity may be exchanged for another annuity in accordance with the
Internal Revenue Code Section 1035(e). Such 1035 exchanges do not trigger a
taxable event and may be affected at any time regardless of the age of the owner
or annuitant. This happens often when people want to get out of riskier variable
annuities into principally protected FIAs.
INVESTMENT PROTECTION
Because most non-variable annuities guarantee that your money will not
go backwards, annuities provide investment/asset protection from downturns in
the stock market.
Also, all annuities are also protected by the various State Guaranty Funds.
These are reserve funds maintained by states to safeguard the cash value of
policies, up to a certain limit in the event an issuing insurance company is unable
to meet its obligations under the contracts.
PAYMENT OPTIONS
All annuities have options for payment during the payout phase. These
range from a single lump sum payment to a periodic payment over the remaining
life, or joint lives, of the annuitant or annuitants. In between, the owner may
choose a period certain, usually no shorter than two years and no longer than
thirty years. Also, the owner may select a payment for a period certain with a life
option, meaning that, if the annuitant dies prior to the period certain (say 10
years), the payments would continue to the named beneficiary until the end of the
stated period.
FIAs, which are the focus of the latter part of this section, do not have a
set payout schedule. Typically, what happens in retirement with an FIA is that an
annuity owner will decide each year (or month or quarter) how much he/she
would like to withdraw from the annuity (without limitation after the surrender
charge period is over). You might think of the ability to withdraw similar to
taking money out of a savings account when needed.
However, what has become increasingly popular with FIAs is the option to
buy one with a guaranteed income for life rider. With such a rider, with most
products, you will know your guaranteed income payment the day you buy the
annuity (which is both comforting and helps people better map out their
retirement plans).
One drawback of most annuities is that the income, once started, does not
increase with inflation. There are a few annuities that do have increasing
payments, but the starting payment is usually about 20% lower than non-
increasing annuities. This is an important factor when planning future income
with annuities: the dollar amount you need for income today will not be sufficient
to maintain your lifestyle in the future.

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DEATH BENEFITS
Death benefits are also a common feature of all annuities. Some annuities
impose surrender penalties, if still in force, at death whereas others do not. FIAs
typically have NO surrender charges applied to the death benefit no matter when
the annuitant dies.
It should be noted that death benefits from an annuity contract do not pass
income tax free as life insurance death proceeds can.
SURRENDER CHARGES
Surrender charges are common on most annuities. These are imposed
when you fully surrender the annuity (you take all the cash back) or can also be
imposed when taking an early withdrawal (before the surrender charge period has
expired) but keep the annuity in place (most FIAs give you a 10% free withdrawal
each year without a surrender charge).
The length of the surrender charge can last for as little as three years to
over ten years on most annuities. The best way to understand the surrender charge
is to look at a schedule and apply it to an account value. The following is a typical
seven-year surrender charge schedule.
Year 1 2 3 4 5 6 7 8
7 6 5 4 3 2 1 0
Surrender Charge % % % % % % % %
If you pay a $100,000 premium into an annuity with a seven-year
surrender charge and if I assumed a 5% growth rate on the annuity, the following
is the surrender value if you choose to surrender the entire annuity at year end.
Start of Year 5.00% Year-End Surrender Year-End
Year Balance Growth Balance Charge value
1 $100,000 $5,000 $105,000 $7,350 $97,650
2 $105,000 $5,250 $110,250 $6,615 $103,635
3 $110,250 $5,513 $115,763 $5,788 $109,974
4 $115,763 $5,788 $121,551 $4,862 $116,689
5 $121,551 $6,078 $127,628 $3,829 $123,799
6 $127,628 $6,381 $134,010 $2,680 $131,329
7 $134,010 $6,700 $140,710 $1,407 $139,303
8 $140,710 $7,036 $147,746 $0 $147,746
Surrender charges are misunderstood by many financial commentators and
certainly by many state insurance departments. There has been a movement
among regulators to limit the length of the surrender charge period in annuities. It
sounds consumer friendly, but it’s not. Limiting insurance companies from
offering products with longer surrender charges limits the variety of products
offered in the marketplace, and that is never good for the consumer.
What regulators do not understand is that the longer the surrender period
of the annuity the better the terms (typically). What’s important is that all the
terms of an annuity are disclosed to the person buying it (including the surrender
charge).

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If a consumer wants to buy an annuity with better terms that also has a
longer surrender period, there is nothing wrong with that so long as it is disclosed
and understood.
PENALTIES
In addition to early surrender charges that are imposed by the issuer, the
Internal Revenue Service (“IRS”) assesses a 10% penalty tax on earnings that are
withdrawn if the owner is under age 59½ at the time of the withdrawal. There are
numerous exceptions to the rule, e.g., disability, if taken in substantially equal
payments over the remaining life of the owner, or if the payments are from a
Single Premium Immediate Annuity (SPIA).
ANNUITIZATION
Annuitization is sometimes a dirty word when it comes to annuities.
When you “annuitize” an annuity, you are telling the insurance company to take
the money you have in the annuity and to guarantee a payout for a period of time
(usually the remaining life of the annuitant). When you annuitize the annuity, you
are trading the ability to withdraw cash from the annuity for the guaranteed
payout. Therefore, if you had a crisis in your life that you needed cash to fix or
mitigate it, if you annuitize your annuity, you will no longer have an ability to
take a cash withdrawal; and you are stuck with the period annuitized payment.
To many, a guaranteed payment sounds appealing. But what many are
finding more appealing are FIAs with guaranteed income riders where you DO
NOT have to annuitize the annuity to receive an income stream for life.
TAXATION OF ANNUITIZED PAYMENTS
As I previously explained in more layman’s terms, the taxation of
payments in annuitization from non-qualified funds (those not in a qualified
retirement plan such as an IRA, 401(k), etc.) is determined by the “exclusion
ratio.” The exclusion ratio is computed by dividing the amount of the initial
premium by the sum of the payment to be received (determined by the mortality
tables for life-only pay-out options). The exclusion ratio, which will always be
less than 100%, is then multiplied by the periodic payment to determine the
amount of the payment that is excluded from taxation. The amount that is not
taxed, i.e., excluded, is classified as a return of principal. Obviously, if the
annuity being annuitized contained qualified funds, then all the income would
generally be taxable if the original contributions were made in before-tax dollars.
SALES LOADS
I’ve already discussed “surrender charges” in an earlier section that
typically apply to fixed annuities.
Variable annuities (VA), on the other hand, can have up-front sales
charges (loads) as well as on-going charges for management and other expenses
associated with overseeing the portfolio of underlying assets (including back-end
sales loads). The sales and on-going charges of VAs will be listed in the
prospectus and should be reviewed carefully before purchasing.

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The average ongoing expenses in a VA are 2.2%-2.7% per year. This is a

heavy price to pay especially when there is NO principal protection in the product
(unless you add riders that also come with an additional cost).
WHAT ARE THE DIFFERENT CLASSIFICATIONS OF
ANNUITIES?
VARIABLE ANNUITIES (VAs)
The broadest classification of annuities is between fixed and variable.
VAs are “securities” because, as the name implies, their value can vary, positive
and negative, from the original amount of premium paid.
VAs are oftentimes referred to as “mutual funds inside an insurance
wrapper” because, while the earnings are tax deferred, the underlying assets are
the same or similar to those associated with mutual funds, i.e., stocks, bonds,
market indexes, and general securities. Additionally, the fee structure for variable
annuities is similar to mutual funds since they can include an up-front sales
charge as well as on-going administrative and money management fees. In the
absence of riders, the variable annuity generally does not carry any guarantees in
regards to minimum earnings, death benefits, or lifetime income amounts.
Like mutual funds, variable annuities carry the risk of loss unless the
buyer chooses one or more of the riders that prevent or reduce loss. These riders
are generally minimum guaranteed death benefits, minimum guaranteed income
benefits, and guaranteed withdrawal benefits.
The guaranteed minimum death benefit warrants that generally the value
of the annuity upon the death of the owner and/or annuitant will be the highest
year-end value reached by the annuity during the holding period.
If you add up all the fees on the various “riders” on VAs, they can add an
additional 3.20% on top of the average other typical annual fees of 2.2%-2.7% per
year. To say that VAs are very expensive would be an understatement. However,
if the annual investment return is high enough in a VA, the expenses can be
justified. (Everyone loves VAs in bull stock market runs and wishes they’d never
heard of them when the market crashes).
NO-LOAD VAs
I wanted to briefly state that there are a handful of “no-load” VAs in the
marketplace. While they do not offer protection from downturns in the stock
market, they do not carry the same heavy fees as traditional VAs. The main fee in
a no-load VA is a fee charged by the local financial planner who recommends and
manages the investments in the VA. There are also typically no surrender charges.
While I’m not a huge fan of VAs, if I were to recommend one, it would be a no-
load version.
FIXED ANNUITIES
The fixed annuity’s prime characteristic is that it guarantees some
minimum earning rate if held for the contractual term, generally defined as the
length of the surrender penalty period.

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The minimum guaranteed growth is most often stated as some base

interest rate, e.g., 2.5%, (a) during the period from the initial premium payment
until the end of the penalty, and (b) during the total time that the owner holds the
annuity in the accumulation phase. It is important to note that some issuers state
their guaranteed minimum as a given rate on a percent of the initial premium, e.g.,
3% on 90% of the initial premium. It is tempting to conclude that this
arrangement would yield a 2.7% minimum guarantee, but doing the math will
show a much lower minimum guarantee.
As I will explain, the FIAs have many of the characteristics of a variable
annuity with respect to the earnings opportunity; but it still carries some minimum
guaranteed earnings rate if held to term. The fixed annuity has sometimes been
characterized as offering a “guaranteed return” whereas the variable annuity
offers a “guaranteed opportunity” to realize a return.
SINGLE PREMIUM IMMEDIATE ANNUITY
A narrower classification identifies annuities according to the function of
how they are funded. For example, the Single Premium Immediate Annuity
(“SPIA”) involves the payment of a single premium followed no later than one
year with a stream of income payments.
SPIAs can be either fixed or variable and should not be confused with an
annuity that is in the payout phase. While both involve a stream of income
payments, the SPIA has no accumulation phase.
SINGLE PREMIUM DEFERRED ANNUITY
Annuities, both fixed and variable, may be “single premium” or “flexible
premium.” The former is referred to as SPDA (Single Premium Deferred
Annuity) and the contract allows only one initial premium whereas the FPDA
(Flexible Premium Deferred Annuity) allows additional premiums after the initial
premium. These additional premiums usually must be at least a certain minimum
amount and may be limited to one or more years following the initial premium.
TAX SHELTER ANNUITIES
A special class of annuities is the Tax Shelter Annuities (“TSA”) and is
governed by Section 403(b), 457 and others of the Internal Revenue Code. TSAs
can be fixed or variable. Generally, TSAs are available to the employees of
public institutions (school teachers and policemen, as well as those of non-profit
organizations), certain hospitals, and the clergy. Premiums are paid in before-tax
dollars, making all withdrawals subject to ordinary taxation. The TSA generally
can be opened for a very small amount, $100; and subsequent premiums may also
be small. Premium payments are routinely made through payroll deductions. The
contribution and withdrawal rules vary widely according to the individual
circumstances of the owner.
INDEXED-LINKED FIXED ANNUITIES (“FIA”)
The index-linked fixed annuity is commonly referred to as a Fixed
Indexed Annuity (FIA). When this annuity was introduced, it was linked to an
equity index only and thus the reason for the name.

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The next section of this material will fully explain how FIAs work and
their benefits, and so I will not take up time to discuss FIAs here.
USING ANNUITIES INSIDE QUALIFIED RETIREMENT PLANS
OR IRAS
One issue I have not discussed in any detailed manner but wanted to touch
on before moving on is the argument against using annuities inside qualified plans
(401(k)) or IRAs.
Many CPAs for some reason caution clients to watch out for advisors
selling tax-deferred annuities inside tax-deferred vehicles like 401(k) plans or
IRAs. The argument is that the advisor is looking to make a quick commission
when there is no benefit to using a tax-deferred vehicle inside a tax-deferred
vehicle.
What CPAs and others making this argument do not understand is that the
reason the annuity is being purchased is for its protective features (money never
goes backwards; gains are locked in annually) and/or for a guaranteed rate of
return (accumulation value) coupled with an income for life you can never
outlive.
When lecturing on the proper use of annuities, I typically recommend that
people buy them inside qualified retirement plans or IRAs because the growth on
the annuity will all be income taxable regardless of whether it is coming out of an
annuity or not.
SUMMARY OF THE BASICS OF ANNUITIES
Annuities come in many varieties, classifications, and versions; but they
all have in common the feature of tax deferral. Annuities have a place in the
financial plans for a large percentage of the individuals who are saving for
retirement or who are already in retirement and who cannot afford to take the risk
of losing some or all of their retirement nest egg.
FIXED INDEXED ANNUITIES (FIAs)
For readers who lost 40-50-60% when the stock market crashed in 2007-
2009, the following material should be somewhat exciting.
The following material will cover one of my favorite retirement tools and
why they can play a vital role in helping people grow and protect their wealth
before and in retirement.
Most FIAs have the following characteristics:
-100% principal protection (your money will never go backwards due to
negative returns in the stock market).
-Gains in a stock index are locked in every year.
Many FIAs come with the following characteristics:
-A guaranteed rate of return (accumulation value) between 5-7%* on an
accumulation value (not walk-away value) that is used to calculate/provide for
you a guaranteed lifetime income* you can never outlive.

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*Any guarantees mentioned are backed by the financial strength and

claims-paying ability of the issuing insurance company and may be subject to
caps, restrictions, fees and surrender charges as described in the annuity contract.
Does a wealth-building tool with the above-mentioned characteristics
interest you?
-What’s sadly ironic as I explain in the Bad Advisors section of this
course, the vast majority of securities licensed advisors (those who primarily sell
stocks and mutual funds to make a living) either know nothing or very little about
FIAs.
-What’s worse is that some Broker Dealers (B/Ds) who securities licensed
advisors sell their stock and mutual funds through forbid the advisors from selling
or discussing FIAs with clients and many B/Ds severely limit the type of FIAs
that their advisors can offer.
-What’s worse is that most of these same advisors who are forbidden from
selling FIAs do NOT disclose that to the clients or potential clients they are
supposedly helping build wealth.
With proper asset allocation using FIAs as a wealth-building tool, the pain
of stock market crashes can be significantly mitigated.
WHAT IS A FIXED INDEXED ANNUITY?
As the name indicates, a “fixed” indexed annuity is classified as a “fixed”
annuity. As such, the product must be equipped with guarantees that non-
fixed/variable annuities do not.
Generally speaking, most advisors explain that an FIA has a guaranteed
return of zero in any given year. Therefore, when the stock market goes negative,
the returns in the FIA do not; and the annuity owner is credited with a zero rate of
return in negative years.
There are actual minimal contractual guarantees in an FIA (although
understanding them can be a bit difficult). The following is a typical contractual
guarantee from an FIA contract:
This FIA provides a guaranteed minimum value to your annuity called the
Policy Value. The Death Benefit, the Annuitization Value, and the Cash Value can
never be less than the Policy Value. The calculation of the Policy Value is
independent of the calculation of the Accumulation Value for the first 10 Policy
Years. The Policy Value is an accumulation of 87.5% of the premium at an annual
rate of at least 2.45% for the first six Policy Years and at least 1% thereafter.
The above is probably clear as mud. The bottom line with the guarantee is
that once funded, the money will never go backwards due to negative returns in
the stock market. The guarantee, which is typically over a multi-year period,
usually doesn’t come into play due to the fact that FIAs usually yield better
returns than the minimal guarantees; and, therefore, an FIA usually will have 0%
credited in years when the measuring index goes negative.
What people are most interested in is what the word “indexed” means and
why is that used in the name of a “fixed” product?

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The indexed part of the name alludes to the fact that the gains in an FIA
track a particular stock index. The preferred stock index that has been used since
the inception of FIAs over ten years ago is the Standard and Poor’s 500 stock
index (although other stock indexes are now available such as the DJIA, Wilshire
2000, and NASDAQ).
The S&P 500 index is widely regarded as one of the best single gauges of
the U.S. equities market and represents a sample of 500 public companies in the
U.S. economy.
IF YOU ONLY KNEW!
If you only knew the stock market was going to crash in 2000-2002 and
again in 2007-2009, wouldn’t you have taken your money out of the market? Of
course, we all would have.
The following picture illustrates in general how an FIA works in both
positive and negative years in the stock market. You’ll notice that, in negative
years, the account value (represented by the dark line that looks like a ladder)
does not decrease; it flatlines.

ZERO IS YOUR HERO

A good saying when the market goes negative is that “zero is your hero.”
It’s a saying that people who had FIAs during the 2000-2002 and 2007-2009
stock market crashes started to use.
Instead of going over to your neighbor’s house and bragging about how
well your stocks did in a bull market (which many people have a tendency to do),
you would go over there and brag about how you earned ZERO.
It’s crazy; but in the volatile environment we are in, when the stock
market goes negative (or very negative) in a short period of time, zero sure is your
hero.
Let’s look at an example of zero being your hero over a five-year period
with returns of 14.71%, -22%, -11%, -9%, and 21% where the starting account
value is $100,000.

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$100,000 Invested in $100,000 Inside an FIA

Year The S&P 500 with 6% cap
1 $114,710 $106,000
2 $89,474 $106,000
3 $79,632 $106,000
4 $72,465 $106,000
5 $87,682 $112,360
As you can see, when the stock market goes backwards, so does the
account balance invested in the S&P 500 stock index. However, in those same
negative years, the FIA flatlined and held its highest value which came at the end
of year one.
Also, you’ll notice that, in the first positive year, the account value in the
S&P 500 index was higher than the FIA account balance. That’s because most
FIAs have caps on the upside growth; and in this particular example, the cap was
6% each year.
DOES THE INSURANCE COMPANY REALLY INVEST YOUR
MONEY IN THE S&P 500 STOCK INDEX?
No, although that’s exactly what I thought the insurance companies did
with the premium dollars when I first reviewed these products back in 1999. I
figured this was a risky thing for an insurance company to do, but it seemed like
insurance companies owned half the investments in this world and I figured they
could afford to take that risk.
Although the gains are linked to the S&P 500 stock index (minus
dividends), the premium dollars paid by insureds are NOT actually invested in the
S&P 500 index (which would be very risky).
What does the insurance company do with the money to generate returns
with no gains? As I explained in the section of the course on Indexed Universal
Life (IUL), the insurance company does the following:
1) The insurance company receives an annuity owner’s premium payment
and invests the money in income-producing bonds.
2) Income from the bonds is then used to purchase options on a stock
index like the S&P 500. If there is a positive return in the market over a 12-month
period, the options pay off and generate the return in the FIA. If not, then the
options are worthless; and the insurance company starts over for the next 12-
month cycle. (This is more fully explained in the IUL section of the course
material).
The option returns of an index like the S&P 500 drives the returns in the
FIA. With higher bond income and/or lower options costs, the insurance company
can buy more options that can generate better returns and higher caps in the FIA.
It is because of the above variables that the “caps” in the products
(explained in an upcoming section) will have fluctuations.

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What’s important to understand is that, even if the S&P 500 stock index
goes down 50%+ (like it did in a stretch of time between 2007-2009), the
insurance company is not overly affected when it comes to the FIA portfolio.
CASH ACCOUNT VALUE (CAV) VS. CASH SURRENDER VALUE
(CSV)
FIAs, like cash value life insurance, have a CAV and a CSV. The CAV is
the money inside your FIA that is actually growing. The CSV is what you would
receive if you said to the insurance company that you no longer wanted the
annuity and would like your money back.
The CAV and the CSV are typically the same account value after the
surrender charge period has expired.
When growth is credited to your FIA, it is credited based on your CAV.
For example: Assume you paid a $100,000 premium into an FIA that has a
10% first-year surrender charge.
If the S&P 500 index returns 5% in year one, that 5% is credited based on
your $100,000 CAV, not your $90,000 CSV.
Therefore, at the beginning of year two, the CAV would be $105,000.
If you surrendered your FIA for cash in year two, you would receive 91%
of $105,000 if the surrender charge dropped from 10% to 9% in year two.
CREDITING METHODS
One of the most popular crediting methods to calculate the gain in an FIA
is called the annual point-to-point method.
It works as follows: At the time of the initial FIA premium, the level of the
S&P 500 index is recorded as the starting point and is then compared to the level
of the index at the first anniversary date 12 months later. The difference in value
(if positive) is used to determine the amount of earnings paid into the annuity for
the first year.
Example 1: If the S&P 500 index has a value of 2,000 when an FIA is
funded on January 15th and on January 15th of the following year the value is
2,100, the FIA would be credited with growth of 4.8% (2,000/2,100 = a 4.8%
return).
Example 2: If the S&P 500 index has a value of 2,000 when the FIA is
funded on January 15th and on January 15th of the following year the value is
1,900, the FIA would be credited with growth of 0% because FIAs do not partake
in the downside of the market.
Additionally, the following year, if the S&P 500 index goes positive by
5%, the FIA would be credited with a gain starting with the already higher
account balance vs. a brokerage account that would go down with the market in
year two and where any following upturn in the market would then be based on a
lower account value (see the next chart for an example).

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The following example will illustrate how important it is to not go

backwards when the stock market goes negative and to lock in gains when the
market moves in a positive direction.
Account Balance FIA Brokerage Account Balance
Start Balance $100,000 $100,000
End of year 1 (+5%) $105,000 $105,000
End of year 2 (-5%) $105,000 $99,750
End of year 3 (+5%) $110,250 $104,740*
*This does not take into account the typical mutual fund fees applied to a
brokerage account. If a 1.2% mutual fund expense is levied upon the brokerage
account, the balance at the end of year three would be $101,060.
CAPS
From what you’ve read so far you may be saying to yourself that FIAs are
the greatest thing you’ve ever heard about. No losses, locking in of gains
annually, etc.
As we all know, there is no free lunch in this world (FIAs are no
different).
FIAs have “caps” on the amount of growth in the product. Most of the
FIAs in the marketplace have caps that literally cap the gains of the annuity over a
specified time frame.
With an annual point-to-point FIA, the annual cap typically would range
from 3%-12% depending on certain variables (at the time this is being published
caps are around 6% for S&P 500 index-based products).
The caps with most FIAs can change periodically. For an annual point-to-
point annuity, the cap could change annually. For example, back in 1999, the
annual caps on some FIAs were as high as 12%. When the market tanked the
following three years, the caps with some companies went down as low as 3%.
With all FIAs, there is a contractual agreement that the company will not
go below a certain cap number (like no lower than 2% annually on an annual
point-to-point product).
Those “in the know” in the financial services/insurance industry know that
certain companies like to play games with their caps. What games are played?
Some companies have a history of offering high caps in the year the FIA is issued
to entice consumers to buy their products and then lower the caps significantly the
next year (whether the economic environment dictates lowering the cap or not).
PARTICIPATION RATES AND “SPREADS”
The participation rate is the percentage return in the index that is credited
to the annuity as earnings. The participation rate today in most annual point-to-
point S&P 500 index FIAs is 100% (but with a cap).

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For example: Assume the S&P 500 index increases 16% during the year,
but the participation rate in the product is 50%.
In this case, the annuity would be credited with an earning rate of 8.00%
(50% of 16%). That’s not bad and would outperform a 100% participation rate
product with a 6% annual cap (which of course would credit 6% in this example).
Many products in the marketplace offer participation rate products with
NO cap on the measuring stock index. The participation rate on S&P 500 index
products are usually around 50% (give or take depending on the economic
environment). Other customized non-S&P 500 indexes that I’ll discuss in more
detail can come with participation rates of 120%, 150%, and some are even higher
(with no cap).
Also, some FIAs employ a fee, generally called the “spread,” which is
subtracted from the earnings rate before it is credited to the annuity.
In the foregoing example, if the spread were 2%, the 50% participation
rate annuity would be credited with 6% (8% less the 2% spread).
The participation rates, caps, and spreads may be fixed for a specified
time, or they may be guaranteed for the term of the annuity. Generally, if they are
subject to being reset at the option of the issuer, they will also include minimum
and maximum amounts that limit their variability.
The only way to determine the variables in an FIA is to carefully analyze
them. I can tell you from experience that many insurance advisors selling FIAs do
not fully understand how they work and the various moving parts, so make sure
you read the Bad Advisors section of this course and pick a good one to help you.
VOLATILITY CONTROLLED INDEXES (VCI)
If I had written this course five years ago, there would be no section in the
course on VCIs. However, in the last three years, VCIs are a tool that have been
added by nearly every major insurance carrier that offers FIAs.
Why? Because our country and really the entire world has been in a low
interest rate environment that has put a lot of pressure on the caps used in FIAs.
Back in 1999 when I first started looking at FIAs, caps on an annual point-
to-point S&P 500 based FIA were 12%. Only a handful of years ago they were as
low as 3% (although more recently they have bounced back to 6%).
What’s the problem with low caps? Clients become a lot less interested in
FIAs because growth on the accumulation value isn’t attractive enough to tie up
their money in the product.
Increasing the yield—insurance companies needed to find more yield
(returns) in their FIA products, and that’s what led to the advent of VCIs. With
the various designs in the marketplace, VCIs have “models” that show they would
have returned significantly higher internal rates of return in FIA products than the
low annual point-to-point caps on S&P 500 index-based products.

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The concept behind VCIs is simple. When the stock market becomes
volatile, the stock index changes its investment mix to become more conservative.
When volatility in the market subsides, the indexes change again to more
aggressive investments.
This differs from the passive approach of simply pegging growth in an
FIA to the S&P 500 index (the main index used by most products going back to
their inception).
In an S&P 500 based index, if the market has a big downturn during a 12-
month period, there is very little chance to recover and have a positive return.
With a VCI, the design will attempt to avoid the bigger downturns and even
benefit by getting back into the market as the market bounces up after a downturn.
Trying to explain exactly how VCIs work would take many pages of
material with charts, graphs, etc. That is not the point of this course material. My
goal is to make readers aware of VICs and have a general understanding of how
they work.
Let me try to explain how VCIs work in layman's terms.
The investment industry measures the volatility of the stock market. While
not a fully accurate statement, most people think that volatility = risk. It’s close
enough to use that as the terminology in this material.
Volatility in the stock market is measured by something called the VIX.
Here is a definition of the VIX.
The CBOE Volatility Index, known by its ticker symbol “VIX,” is a
popular measure of the stock market's expectation of volatility implied by S&P
500 index options, calculated and published by the Chicago Board Options
Exchange (CBOE). It is colloquially referred to as the investor fear index or the
fear gauge.
What you need to understand about VCIs is that most use the VIX as a
trigger when deciding how and when to change the investment mix.
A simple way of understanding how VCIs use the VIX is with an example.
In the first part of February, 2018, the VIX spiked. The VIX on January
26, 2018, was at 11.08. On February 5, 2018 it spiked to 37.32. This was one of
the quickest and largest spikes in the VIX since the 2007-2009 crash.
When the VIX spikes, that’s a trigger for a VCI to do something. For most
VCIs that will mean to go “risk off” and move money to cash or something
conservative.
When the VIX goes back down to a predetermined point, the VCI will
move the money back into the market.
The movement of money is automatic with most VCIs.
If you didn’t understand anything I just wrote about VCIs, just understand
that VCIs are NOT buy-and-hold indexes like most FIAs have offered using the
S&P 500 index over the years.

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Why do VCIs provide more opportunity for growth?

1) The cost to hedge risk can be less expensive than an S&P 500 index-
based strategy.
2) Many VCIs have no cap on earnings.
3) Many uncapped VCIs have a 100% participation rates in the index
(most uncapped S&P 500 index-based FIAs have a participation rate of 35-60% at
any given time).
4) Some uncapped VCIs have more than a 100% participation rate (some
more than 150%).
Another good way to understand the benefits of a VCI is to see a the
numbers. The following is a comparison between an FIA using an S&P 500 index
with a 100% participation and a 6% annual cap to a VCI that has no cap and a
100% participation in the index.
I’ll go back 10 years and back to 2007 (one a bull run and one picks up a
big stock market crashes).
FIA using the S&P 500 index with 100% participation and 6% cap
-10-year rate of return 4.37%
-Back to 2002 rate of return 4.12%
FIA using a VCI with 100% participation and no cap
-10-year rate of return 5.87%
-Back to 2002 year rate of return 6.74%
Just because I know readers may be curious, if you used an FIA with an
S&P 500 based index that has a 50% participation rate with no cap, the numbers
would look like the following:
-Best 10-year rate of return 6.29%
-Back to 2002 year rate of return 6.19%
Remember there is no risk of loss in either product and gains are locked in
annually in both products. These numbers are for month ending July 2020.
ARE FIAs USEFUL AS ACCUMULATION TOOLS?
This is a question many consumers and advisors have. What should a
client do with his/her “safe” money? In the old days, a financial planner would
use bonds as a safe haven. That is no longer the case.
Frankly, there isn’t anywhere in the financial services industry I know of
that provides 100% protection of principle, locks in gains annually, and is
expected to return 4-6% annual over time.
The trap that many advisors and some consumers fall into is comparing
FIAs to money that is earmarked for “growth” over time. When I say “growth,” I
mean the investor is willing to accept some or even a significant amount of risk to
try and generate an 8-10% rate of return over time.

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To compare an FIA to a typical investment account earmarked for growth

is a mistake. It’s like comparing apples to oranges.
WON’T FIAS STIFLE GROWTH OF YOUR ASSETS?
The common knock on FIAs is that, if you incorporate them into your
financial plan, it will kill or certainly depress the overall return and, in turn, the
value of your assets.
I could pontificate as to why that isn’t the case, but I’ll just show you a
few charts that prove the opposite.
Let’s look at two examples. Both examples will compare the S&P 500
stock index to a portfolio made up of 70% in the S&P 500 and 30% in an FIA
with a no-cap volatility control index.
Which one over the last ten years (a time frame in the market) would have
a greater rate of return?
Which one going back to 2007 would have a greater return?
Most people would guess that the account with 100% in the S&P 500
would kill the mix with 30% in an FIA with a 6% annual cap (locking in the gains
annually).
Ten-year comparison (ending in June 2020)
-S&P 500 rate of return = 13.84%
-S&P 500 with 30% FIAs = 11.66%
Also, keep in mind that these numbers do not include money manager fees
or taxes.
Most people are very surprised to learn that the numbers in the previous
comparison are so close in what’s been a bull market.
Comparison going back to 2007
-S&P 500 rate of return = 7.69%
-S&P 500 with 30% FIAs = 7.79%
I wonder if the second comparison will get your attention? The
comparison going back to 2007 picked up a big stock market crashes which is
why the portfolio with 30% FIA did about the same (slightly better).
What consumers should always look are the “risk adjusted returns” of
various wealth building tools and why FIAs are such a good fit to bring down the
risk of a portfolio without hurting yield.
Risk adjusted returns answers the question of which asset mix provides
better returns for the amount of risk taken.
The following numbers are from the OnPointe Risk Analzyer software. It
shows the risk score of the 70/30 stocks to FIA portfolio vs. the S&P 500 (SPY).
It also shows the maximum loss of the portfolios going back to 2007 and
the rate of return.

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The top set of numbers are for the 70/30 stock to FIA mix and the bottom
set are for the S&P 500 index.

Which asset mix has better risk adusted returns?

Considering the rate of return is nearly identical, the mix with FIAs
provides a much better risk adjusted return (you should never take more risk
necessary to reach your investment goals).
It’s because of the preveous examples that I really have a hard time
understanding why all financial planners don’t embrace the use of FIAs.
So, the answer to the question about whether FIAs depress the returns in
an overall portfolio is no (when used in moderation to mitigate risk).
INCOME FOR LIFE PLANNING
If you think about it, what are most people trying to accomplish with their
financial plan?
Is it to accumulate as much money as possible by a certain age?
Or
Is it to be able to afford a certain lifestyle in retirement no matter how long
you live?
This really is a fundamental question everyone should ask themselves
when planning for retirement.
What’s my answer to this question?
It’s to make sure I can live as I want in retirement and never run out of
money no matter how long I live.
If you agree, you will like the following material.
FIAs WITH GUARANTEED INCOME FOR LIFE
RIDERS
My goal when I write about the benefits of FIAs isn’t to sell people on
their use. It’s to educate so people know they exist and can assess whether using
them makes sense in a financial/retirement plan.
The same goes for FIAs with guaranteed income riders. There is some
debate in the financial services industry as to whether these riders make sense. As
you’ll learn, the insurance company charges a fee for the rider and, for most of the
income payments, is simply giving clients back their own money.

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Many financial planners believe it’s better to invest a client’s money in the
stock market because over time they will do better with it and be able to provide
the income a client needs in retirement.
Most financial planners assume a client is going to die at a certain age and
shoot for them to run out of money, if that’s what the client would like, at a
certain age (like age 87 as an example).
Here is the question I ask all financial planners:
Do you know when your clients are going to die?
Of course, the answer is no. Then I ask them how can they possibly budget
clients properly to run out of money at a certain age by only investing in stocks,
mutual funds, and bonds? The answer is they can’t but many believe they can.
The consequence to the advisor if they can’t isn’t too dire but can be for their
clients (especially those who have limited amount of wealth).
As you’ll read in the course material on investment risk, there are no
guarantees in the stock market.
Let me ask you a few simple questions that will set up the remainder of
this section’s course material:
1) What’s more important to you today when deciding how to grow your
wealth?
-Reaching for 8-10-12%+ growth where your money is 100% at risk to
stock market downturns and crashes?
OR
-Earning a 6-7% guaranteed return (on accumulating assets)?
2) In retirement, would you be happy if your accumulated assets could
guarantee an income stream you could never outlive with the following schedule:
4.5% if activated at age 60
5% if activated at age 65
5.5% if activated at age 70
6% if activated at age 75
Most readers will like the idea of a 6-7% guaranteed return on an asset that
can generate a guaranteed income payment.
HOW DO YOU RECEIVE A GUARANTEED RETURN COUPLED
WITH A GUARANTEED INCOME FOR LIFE?
The first question that needs to be answered is “what investment firm,
bank, or other entity is going to give someone a guaranteed rate of return and a
guaranteed income for life?”
The answer is that life insurance companies offer products with such
guarantees when a consumer purchases a particular type of annuity coupled with a
Guaranteed Income for Life Benefit (GIB) “rider.”

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A rider is a contractual option that is added onto an insurance product to

add one or more features/benefits to the base product.
HOW LONG HAVE GIB RIDERS BEEN AROUND?
Surprisingly, GIBs have been around for years. In the old days, these were
only available on a variable annuity but have more recently been added to FIAs.
VARIABLE ANNUITIES VS. FIXED INDEXED ANNUITIES
As I just indicated, until recently, you could only purchase a GIB rider on
a variable annuity (VA). However, in the last 10+ years, FIAs have been offering
GIB riders. Why? Because the American consumer is clamoring for guaranteed
income products, and they want to buy such products in a non-variable
environment.
I’m not going to cover VAs with guaranteed income riders in this course
material because most are inferior to those offered in FIAs.
GIB RIDERS—GETTING STARTED
When purchasing the annuity, you will decide if you would like to add a
GIB rider to the annuity. You must add the rider at the time you purchase the FIA.
You pay your premiums to the insurance company which, in turn, funds
the FIA just as it would any FIA.
However, if you choose to add on a GIB rider, the accounting in an FIA is
dramatically different than an FIA without the rider.
ACCUMULATION ACCOUNT VALUE VS. ACTUAL ACCOUNT
VALUE
With any FIA, the annuity owner will have a cash account value (CAV)
(the amount of money actually growing at market rates in the annuity every year)
and a cash surrender value (CSV) (the amount of money an owner would walk
away with if he/she surrendered the annuity and asked for all the available cash).
These have both been previously discussed starting on page 12.
When a GIB rider is added to an FIA, there is an additional accounting
measure that must take place. The insurance company must start an accounting
for what I like to call the “benefit base” (BB).
The BB is the account value that will increase at whatever the guarantee
being offered by the insurance company happens to be at the time you buy the
annuity with a GIB rider. If you bought an FIA with a 7% “guaranteed” return,
the guarantee is applied only towards the BB, NOT the CAV or CSV (see the
following example for a better understanding of the distinction).
The BB is NOT a walk-away account value. It is ONLY used for
calculation purposes when determining the guaranteed income-for-life payment.
Let me use an example, and I think you’ll understand how the two
different account values grow. In the following chart, you will see a BB in the
center column and the actual account value in the right-hand column (for this
example, assume the actual account value is the CAV).

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This example product has a 7% guaranteed rate of return on the BB and

a .9% fee on the income rider. For the CAV, I assumed a random rate of return.
Benefit Base Cash Account Value
Issue Age 55 $100,000 $100,000
Year 1 Age 56 $107,000 $105,046
Year 2 Age 57 $114,490 $110,347
Year 3 Age 58 $122,504 $109,354
Year 4 Age 59 $131,080 $114,871
Year 5 Age 60 $140,255 $120,668
Year 6 Age 61 $150,073 $126,757
Year 7 Age 62 $160,578 $133,153
Year 8 Age 63 $171,819 $131,955
Year 9 Age 64 $183,846 $138,613
Year 10 Age 65 $196,715 $145,607
As you can see, the center column grows at 7% and is much higher than
the actual account value in the right-hand column.
With this example, you can see the difference between the cash account
value, the benefit base (used for income purposes), and the cash surrender value.
Benefit Base Cash Account Value Surrender Value
End of Year 1 Age 56 $107,000 $105,046 $94,541
End of Year 2 Age 57 $114,490 $110,347 $100,415
End of Year 3 Age 58 $122,504 $109,354 $100,605
End of Year 4 Age 59 $131,080 $114,871 $106,830
End of Year 5 Age 60 $140,255 $120,668 $113,428
End of Year 6 Age 61 $150,073 $126,757 $120,419
End of Year 7 Age 62 $160,578 $133,153 $127,827
End of Year 8 Age 63 $171,819 $131,955 $127,996
End of Year 9 Age 64 $183,846 $138,613 $135,841
End of Year 10 Age 65 $196,715 $145,607 $145,607
Remember that virtually all annuities have surrender charges. In this
example, if you wanted to surrender (get rid of) this annuity, you would receive
what’s in the right-hand column.
You’ll notice that in year ten the CAV and the CSV are exactly the same.
That means that the surrender charge period is over after ten years.
What you should also know is that, when you buy an FIA with a GIB
rider, you can typically turn it on 12 months after purchase and NOT have the
surrender charge affect the guaranteed income benefit.

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MINI-SUMMARY
When you buy an FIA with a GIB rider, your FIA will start with three
account values.
The accumulation account value is ONLY used to calculate the guaranteed
income benefit (discussed in an upcoming section).
If you want access to all of your cash, you will be given the cash surrender
value, which in my example is the same as the cash account value starting in year
ten.
The cash account value is the actual account value as the money grows
every year in the FIA and is the amount that would pass to your heirs at death.
You can start your guaranteed income benefit while the FIA is still in the
surrender charge period; doing so has NO effect on your GIB for life.
ACCUMULATION PERIOD
FIA GIB products vary on the period of time each will allow money to
grow at the guaranteed rate. Most companies allow the money to grow in the
accumulation account for no longer than 10 years.
Some companies allow up to 15 years.
One company allows for accumulation up to age 90, but it is a bit of a
hybrid product that is somewhat difficult to explain; and, therefore, I’m not going
to cover it in this material.
As far as activation is concerned, as I stated, with most products you can
activate the GIB rider 12 months after purchasing the annuity. When you reach
the point where the GIB will no longer accumulate because you are over the
number of years for the guarantee, you are not required to activate the rider.
You’d be crazy if you didn’t activate it because you will no longer be receiving a
guaranteed roll up, but you do not have to activate the rider.
WITHDRAWAL VS. ANNUITIZATION
One of the unique features of a GIB for life rider with an FIA is that it
does NOT require annuitization. An annuitant can activate an income stream for
life; but if he/she needs a lump sum of money, the money in the actual account
value will be available. Withdrawals outside of the guaranteed income payment
will decrease future payment streams or will cause them to cease if all of the
remaining actual account value is withdrawn.
When you take a withdrawal from an FIA with a GIB rider, you are taking
the withdrawal from the actual account value, not the guaranteed accumulation
account value (Benefit Base account).
Let me give you an example of how taking a withdrawal can affect your
income benefit. Assume you had $100,000 in your actual account value. If you
had a need for $50,000 and removed that from your FIA, if you were to start your
GIB for life benefit, your income stream would be reduced by 50% (which almost
seems too logical).

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CALCULATING THE GUARANTEED LIFETIME INCOME

STREAM
The first thing you need to know is that different insurance companies
have different ways they calculate the GIB. The basics of how the income is
calculated are the same, but the amount of payments per company can vary.
The second thing you need to know/remember is that the GIB is based on
the Benefit Base (the guaranteed accumulation account value).
How does the GIB for life payment work?
It’s really quite simple. When you decide to activate the GIB for life, the
insurance company takes the guaranteed accumulation account value (BB) at that
time and then pays you a percentage of income based on that account value for
life.
An example will crystallize how it works.
Assume you are 70 years old when you activate the GIB for life rider.
Also assume that the guaranteed BB is $500,000 at that time. Finally, assume that
your FIA contract with the insurance carrier states that at age 70 you will be paid
a guaranteed income benefit for life based on a rate of 5.5%.
The math would look as follows:
$500,000 x 5.5% = $27,500.
Therefore, you would be paid an income benefit of $27,500 every year so
long as you live. If you die early, there will be an account balance that passes to
your heirs (discussed in an upcoming section). If you live until the ripe old age of
100+, the insurance company will keep on paying you.
VARIOUS GIB PAYMENT SCHEDULES
As I indicated, GIB rider terms offered by different companies in the
marketplace may vary.
Some companies use the following payment schedule:
4.5% if the rider is activated before age 65
5% if activated at ages 65-69
5.5% if activated at ages 70-74
6% if activated at ages 75-79
6.5% if activated at ages 80-84
Some companies also have worse payout bands than the above and that’s
something you need to understand as you compare different products.
The “fairest” payment schedule
Some companies have a payment schedule that is calculated by taking the
annuitant’s age at the time of activation and subtracting 15. It sounds simple
enough.

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4.5% if the rider is activated at age 60

4.8% if activated at age 63
6.2% if activated at age 77
6.9% if activated at age 84
Part of the problem with trying to assess which GIB rider FIA to use is
that they can be somewhat confusing. It’s important to know the payment bands
of the FIA with GIB riders you are considering.
Let’s look at an example for a 60 year old who pays a $500,000 premium
into an FIA with a GIB rider. We’ll look at the guaranteed incomes at age 65 and
69. With one product we’ll assume that the fairest payment schedule is used and
one we’ll assume the payment bands shift up every five years.
Typical Guaranteed "Fairer" Guaranteed
Age Payment Rate Income Payment Rate Income Difference
65 5.00% $35,463 5.00% $35,463 $0
69 5.00% $44,771 5.40% $48,353 ($3,582)
All things being equal, I would much rather see someone buy the FIA with
the fairest payment schedule. While people may think that they know when they
will be turning on the income, that rarely is the case; and a product with the fairer
payment schedule builds in flexibility.
PREMIUM BONUSES
Some FIAs come with up-front premium bonuses. What does that mean?
Well, it’s just as it sounds. When you pay your premium, the company will give
you a bonus (5%, 10%, 20%).
For example, if you paid a $100,000 premium into an FIA that has a 10%
bonus, the account value the first year would be $110,000.
Depending on the product, that bonus could be used for the Benefit Base
(to increase income), the actual account value, or both. Many companies today
only use the bonus for the Benefit Base (to add it to the actual account value is
possible but then the terms of the annuity tend to lag (lower cap and/or
participation rates)).
At first look, you may say to yourself that you always want an FIA with a
bonus, but there is no free lunch in these products. There is only so much money
to go around.
Bonus products can be designed a number of different ways to make them
better or worse for particular situations. If you are going to turn the income on in
an FIA in the first few years, using a bonus product may make the most sense.
But many of the bonus products are NOT a great fit if you are going to
wait 10 years or more to turn on the income. Usually the other terms of the
annuity are not as good (lower caps for example on the gains).

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I could write 100 pages on the FIAs in the marketplace to further explain
the differences in products. That’s not the goal of this material which is to make
you familiar with what you need to know so you can assess different products and
make an informed decision about what FIAs are best for your individual situation.
SIMPLE VS. COMPOUNDED GIB RIDERS
FIAs that offer GIB riders can come with a compounded income rider or a
simple interest rider. Sometimes in the marketing of a product companies are not
always transparent. Let’s look at a comparison between the two so you can better
understand the difference.
Simple Compound
Start/Year Interest Year-End Start/Year Interest Year-End
Year Balance 9% Value Balance 6.63% Balance
1 $100,000 $9,000 $109,000 $100,000 $6,629 $106,629
2 $109,000 $9,000 $118,000 $106,629 $7,068 $113,697
3 $118,000 $9,000 $127,000 $113,697 $7,537 $121,234
4 $127,000 $9,000 $136,000 $121,234 $8,037 $129,271
5 $136,000 $9,000 $145,000 $129,271 $8,569 $137,840
6 $145,000 $9,000 $154,000 $137,840 $9,137 $146,978
7 $154,000 $9,000 $163,000 $146,978 $9,743 $156,721
8 $163,000 $9,000 $172,000 $156,721 $10,389 $167,110
9 $172,000 $9,000 $181,000 $167,110 $11,078 $178,188
10 $181,000 $9,000 $190,000 $178,188 $11,812 $190,000
It’s interesting to look at the numbers. The 9% simple Benefit Base
account value is the same as a 6.63% compounded rate of return.
If you were going to choose one for your GIB product, you’d pick the
simple interest roll up instead of the compound because in years 1-9 the benefit
base was higher with the simple interest roll up.
The more interesting numbers are when you compare a 9% simple interest
benefit base increase to a 7% compounding return.
Simple Compound
Start/Year Interest Year-End Start/Year Interest Year-End
Year Balance 9% Value Balance 7.00% Balance
1 $100,000 $9,000 $109,000 $100,000 $7,000 $107,000
2 $109,000 $9,000 $118,000 $107,000 $7,490 $114,490
3 $118,000 $9,000 $127,000 $114,490 $8,014 $122,504
4 $127,000 $9,000 $136,000 $122,504 $8,575 $131,080
5 $136,000 $9,000 $145,000 $131,080 $9,176 $140,255
6 $145,000 $9,000 $154,000 $140,255 $9,818 $150,073
7 $154,000 $9,000 $163,000 $150,073 $10,505 $160,578
8 $163,000 $9,000 $172,000 $160,578 $11,240 $171,819
9 $172,000 $9,000 $181,000 $171,819 $12,027 $183,846
10 $181,000 $9,000 $190,000 $183,846 $12,869 $196,715

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What’s interesting about the previous chart?

1) A 7% compounding return had a $6,715 higher account value after 10
years.
2) In years 1-8, the 9% simple account value was higher.
What does that mean?
Unless you are certain you are going to wait 10 years to turn income on
(all other things being equal), it may be a more prudent decision to buy the FIA
that uses a 9% simple return instead of the 7% compounded return.
Do keep in mind as you are reading this material that I’m not trying to tell
you specifically what current FIA product in the market is best for your situation.
I’m trying to educate you on the inner workings of FIAs and FIAs with income
rider so you are armed with the knowledge to be able to understand the products
an advisor may present to you so you can make an informed decision about which
one is best.
And the previous disclaimer is a good segue to the next section of this
material.
“WHAT IF” GIB RIDERS
So far, the GIB riders I’ve covered are ones that have set terms the day
you buy them. For example, an FIA may increase the Benefit Base value at 7% a
year and have a 5% income payment at age 65.
Because insurance companies are always trying to come up with designs
to generate more income for clients, some have rolled out what I call “what if”
product designs.
Why do I call them “what if” product designs? Because you won’t know
what your income payment will be until the year you decide to turn it on.
Most of the “what if” products come with minimum guarantees that won’t
come into play because the “what if” in the product is typically tied to the returns
of the measuring stock index that won’t be zero every year.
It’s a “what if” product because we don’t know what the measuring index
will return in the future and, therefore, we don’t know the future income payment.
Why would someone use this type of product?
As I already stated, it’s a design that tries to create a higher income
payment than the static designs that will not fluctuate.
There are several different versions of this type of FIA in the marketplace.
I’m only going to cover one in this material so you can understand why you might
want to use one of these types of FIAs instead of the static Benefit Base roll up
products.
The Benefit Base used to calculate the GIB for life payment for this
particular example will grow based on two terms:
1) 4% guaranteed each year

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2) Plus whatever the index returns

An example is the best way to describe how the Benefit Base grows in this
type of product. The following example uses numbers from 2009-2018 year end
with an S&P 500 based crediting strategy that has no cap and a 40% participation
rate in the index (so if the index returns 20% the credited return would be 8.00%).
Actual return Annual Return
Year Guarantee of the stock index Credited
1 4% 8.20% 12.20%
2 4% 4.47% 8.00%
3 4% 0.00% 4.00%
4 4% 4.70% 8.70%
5 4% 10.37% 14.37%
6 4% 3.99% 7.99%
7 4% 0.00% 4.00%
8 4% 3.34% 7.34%
9 4% 6.81% 10.81%
10 4% 0.00% 4.00%
8.14% Average
You’ll notice that even with a conservative example (a 40% participation
rate in an uncapped S&P 500 strategy is conservative), the average Benefit Base
increase ended up being 8.14% (which is much higher than a 9% simple roll up
rate or a 7% compounded rate).
Let’s now look at a different example which is much more common in the
industry right now. I’ll use the same 4% guarantee plus whatever the index
returns, but I’ll illustrate it using a Volatility Control Index (VCI) (I covered VCIs
on page 15).
Actual return Annual Return
Year Guarantee of the stock index Credited
1 4% 6.17% 10.17%
2 4% 13.01% 17.01%
3 4% 5.89% 9.89%
4 4% 3.58% 9.89%
5 4% 6.00% 7.58%
6 4% 8.86% 10.00%
7 4% 0.81% 12.86%
8 4% 3.53% 4.81%
9 4% 3.86% 7.53%
10 4% 0.00% 4.00%
9.37% Average
If the previous chart doesn’t pique your interest, it should.

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Remember that the 9.37% return is used to grow the Benefit Base account
value that is only used to calculate the guaranteed income for life payment
(although it is interesting to see the actual returns in an FIA be as high as they are
in this 2009-2018 example).
And not to get too into the weeds with numbers, the average return doesn’t
really reflect how the account actually grows. Money actually grows using the
CAGR (Compounded Annual Growth Rate). The CAGR takes the actual returns
each year to grow wealth and doesn’t use the average to grow the money.
Let’s see how the last chart would have translated into a guaranteed
income payment after ten years.
Credited Credited Year-End
Year Benefit Base Return Growth Balance
1 $100,000 10.17% $10,170 $110,170
2 $110,170 17.01% $18,734 $128,904
3 $128,904 9.89% $12,743 $141,648
4 $141,648 9.89% $14,003 $155,651
5 $155,651 7.58% $11,801 $167,453
6 $167,453 10.00% $16,750 $184,203
7 $184,203 12.86% $23,681 $207,884
8 $207,884 4.81% $9,999 $217,883
9 $217,883 7.53% $16,402 $234,286
10 $234,286 4.00% $9,371 $243,657
Do you remember what the Benefit Base was using a 9% simple or 7%
compound growth rate when using the typical static set in stone from the start FIA
with GIB?
They were $190,000 and $196,715.
This is why many consumers are opting for the “what if” GIB rider
product. They want the opportunity for more income while still knowing there is a
minimum guarantee.
I’m personally a big fan of the “what if” products and think they make
more sense from a mathematical probability standpoint than the static products.
ONE, TWO, THREE, FOUR, AND FIVE-YEAR POINT-TO-POINT
I’ve mainly gone over this section of the material on FIAs discussing
products that lock in gains annually.
There are some products in the market that have multi-year point-to-point
crediting methods.
Why would companies offer multi-year point-to-point strategies?
The simple answer is that the cost to hedge risk in the FIA index is less
and, therefore, the multi-year caps and participation rates on products can be
higher.

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That sounds great, right? Why not use a five-year point-to-point and get
really high caps and/or participation rates on the measuring stock index? Because
there is a very real element of danger in the product.
If you have a multi-year point-to-point crediting strategy in an FIA, here
are the pros and cons:
-The opportunity for growth will be higher or even much higher.
-If you get a big downturn in the measuring stock index before the end of
the term, you could wipe out two, three, four, or even five years worth of positive
returns all at once.
The type of risk associated with multi-year point-to-point strategies I find
a bit odd in products that are supposed to lock in gains and are considered safe
money tools. For me, multi-year products may look good on paper; but I wouldn’t
want to have to go to my clients and tell them that, even though the measuring
stock index was up 10% or even 20% or more over a 23-month period, because
the index crashed in month 24, they ended up with a zero crediting rate for the
entire 24-month period.
COST OF THE GIB RIDER
It would be nice if the insurance companies added guaranteed benefit
income riders (GIBs) for free with their annuities. Unfortunately, that is not the
case.
The GIB for life rider for FIAs varies per company but most range from
0.80% to 1.2% annually.
Be careful of how the companies remove this fee from your FIA. Some
charge the fee based on your actual account value. Some charge the fee on your
higher Benefit Base value. Over time this difference is significant.
RETURN OF RIDER FEE
A few companies offer an option to get your rider fee back should you not
use it. One company will let you make that decision at the end of ten years. If you
didn’t use it or don’t want to use the GIB rider, they will credit back to your
actual account value the fees they charged for the rider.
HOW CAN INSURANCE COMPANIES AFFORD TO GIVE YOU A
GUARANTEED RETURN AND A GUARANTEED PAYMENT FOR
LIFE?
This question has probably been in the back of your mind as you’ve been
reading this material. It had me scratching my head for a few minutes until I fully
researched how these products are priced.
Remember that with an FIA the product is already designed to never have
its account value go backwards due to negative market returns. Additionally, the
gains are locked in annually.

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THE GIB PAYMENTS ARE COMING FROM YOUR OWN FIA

ACCOUNT
When the insurance company starts paying you a lifetime income stream,
it is taking the money from your own FIA’s actual account value. In essence, the
insurance company is giving you back your own money.
You may think that removing money from your actual account value will
quickly reduce the account value; but remember, the actual account value will still
grow in years when the measuring stock index is positive with those gains locking
in (which reduces the speed at which the account value is diminished).
Additionally, the insurance company has priced the product with the
additional rider fee annually to help make sure the product is profitable.
Let’s look at the actual numbers from an example so you don’t have to
take my word for it. I’m going to use an example where you can see the numbers
for yourself.
As I alluded to earlier, in the “old days,” one of the only ways to receive a
guaranteed income benefit for life was to buy a Single Premium Immediate
Annuity (SPIA). A SPIA is typically designed to pay for a set period (such as 10
years) or for someone’s lifetime. The kicker is that, if you live past the ten-year
period and die, with a life-only SPIA, your heirs get nothing. As you will see in
the following chart, there is an account balance that will pass to the heirs until age
86.
What you’ll also notice in the following chart is the fee for the GIB rider.
It will be painful to look at; but if you want to put it into perspective, if the
annuity owner had his/her money in a typical mutual fund that provides NO
downside protection in the market (let alone a 6%-7% guaranteed return on an
accumulation account), the average mutual fund expense in addition to the local
money manager fee would be 2-3 times that of the fee for the GIB rider.
The following are the variables used for the following chart:
-Age 55
-$500,000 premium
-9% simple roll up (6.63% compound) upon the Benefit Base guaranteed
account (which you don’t see in the numbers below (the numbers below only
reflect the actual account value minus fees)).
-The crediting method is random where the average rate of return over
time is 5%.
-Guaranteed income payments start at age 65.

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To heirs
Start at
Year Balance Income Growth Fee Death
55 $500,000 $30,000 $5,300 $524,700
56 $524,700 $0 $0 $5,247 $519,453
57 $519,453 $0 $8,415 $5,279 $522,589
58 $522,589 $0 $32,192 $5,548 $549,233
59 $549,233 $0 $61,679 $6,109 $604,803
60 $604,803 $0 $43,606 $6,484 $641,925
61 $641,925 $0 $40,120 $6,820 $675,225
62 $675,225 $0 $0 $6,752 $668,473
63 $668,473 $0 $48,331 $7,168 $709,635
64 $709,635 $0 $31,579 $7,412 $733,802
65 $733,802 $47,504 $41,178 $7,275 $720,201
66 $720,201 $47,504 $0 $6,727 $665,969
67 $665,969 $47,504 $10,019 $6,285 $622,199
68 $622,199 $47,504 $35,401 $6,101 $603,995
69 $603,995 $47,504 $62,494 $6,190 $612,794
70 $612,794 $47,504 $40,757 $6,060 $599,987
71 $599,987 $47,504 $34,530 $5,870 $581,143
72 $581,143 $47,504 $0 $5,336 $528,302
73 $528,302 $47,504 $34,762 $5,156 $510,403
74 $510,403 $47,504 $20,599 $4,835 $478,663
75 $478,663 $47,504 $25,870 $4,570 $452,458
76 $452,458 $47,504 $0 $4,050 $400,904
77 $400,904 $47,504 $5,725 $3,591 $355,533
78 $355,533 $47,504 $18,975 $3,270 $323,733
79 $323,733 $47,504 $31,021 $3,072 $304,177
80 $304,177 $47,504 $18,506 $2,752 $272,427
81 $272,427 $47,504 $14,058 $2,390 $236,590
82 $236,590 $47,504 $0 $1,891 $187,195
83 $187,195 $47,504 $10,100 $1,498 $148,292
84 $148,292 $47,504 $4,485 $1,053 $104,220
85 $104,220 $47,504 $3,403 $601 $59,517
86 $59,517 $47,504 $0 $120 $11,893
87 $11,893 $47,504 $0 $0 $0
90 $0 $47,504 $0 $0 $0
95 $0 $47,504 $0 $0 $0
100 $0 $47,504 $0 $0 $0

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What’s interesting about the previous chart?

1) The income continues to pay even though there is no money in the
actual account value (that’s the whole point of buying a GIB rider FIA).
2) There is a sizable death benefit depending on when the insured dies.
3) The total amount of fees paid ($150,812) is approximately three years
of guaranteed income.
I personally do NOT think the fees outlined in the previous chart are
outrageous. As I indicated, if you had your money in a typical mutual fund with
an annual expense of 1.5% every year along with the typical local money manager
fee, the fee would be more than double what the GIB rider fee is for an FIA.
A financial planner may look at the previous chart and say…why would
you want to pay those fees just so the insurance company can give you back your
own money. If you give me your money, I’ll put it in a proper mix of stocks,
bonds, mutual funds, and I’ll get you more money in retirement without the fees.
Is it possible a financial planner could do better than the FIA with
guaranteed income rider?
Sure, it’s possible.
But then I think of a few things that bring me back to my conclusion,
which is that I’m a big fan of GIB riders.
1) No one knows when they will die and, therefore, it is impossible to
realistically budget the same amount of retirement income from a proper mix of
stocks, bonds, and mutual funds as would be provided from a GIB rider FIA. In
order to realistically put together an investment mix that will provide income until
age 100, the mix would have to be far too conservative and wouldn’t be able to
generate the same income as provided by a GIB rider.
2) As the DALBAR Study consistently indicated, the average investor has
earned less than 4% going back 20 years (which includes a bull run that has
exceeded ten years). Such returns would not be nearly sufficient to generate the
income that is provided by a GIB rider FIAs.
As a general rule, the less money someone has, the more apt I am to
recommend a GIB Rider annuity. Those with substantial or excess wealth can
afford to take risks in the stock market. Those who don’t really can’t.
TIME FRAME TO ACTIVATE THE GIB RIDER
As briefly stated earlier, a GIB rider on most FIAs can usually be activated
anytime after owning the annuity for 12 months. However, the annuitant for most
FIAs must be age 60 or older to activate it.
ENHANCED INCOME BENEFIT
Some FIAs will provide an increased income benefit that acts like a long-
term care benefit (LTC).

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LTC insurance policies typically activate and pay benefits when you can’t
perform two of your six ADLs (Activities of Daily Living: eating, bathing,
dressing, toileting, transferring (walking), and continence).
The best enhanced benefit I know of in the marketplace doubles the
guaranteed income stream. Therefore, if an annuitant is 75 years old, the normal
income stream would typically be 6%.
If the annuitant can’t perform two of six ADLs, that income stream would
be increased to 12%.
This enhanced benefit on some FIAs is free.
However, with the vast majority of (if not all) enhanced benefit riders,
when the actual account value reaches $0, the monthly benefit drops back the
amount provided before the rider was triggered. Additionally, most of these riders
have a maximum payout period of two years or until the account value drops to
$0.
PRODUCTS ARE CONSTANTLY CHANGING
I did want to point out the FIA products are constantly changing. While it
would be nice to always have the products covered in this material up to date, that
is impossible.
Therefore, if you determine based on what you’ve read that an FIA might
be a good tool you can use to grow and protect your wealth or because you are
interested in a guaranteed income for life payment, it’s best to sit down with your
locally trusted professional who can go over the FIAs that are currently available
in the marketplace.
SUMMARY ON GUARANTEED INCOME BENEFIT RIDERS ON
FIXED INDEXED ANNUITIES
If your head is spinning with all the numbers I’ve thrown at you in this
chapter, don’t worry. The bottom line with GIB riders on FIAs is very simple to
understand.
The benefits to an FIA with a GIB rider are as follows:
1) Your money will never go backwards when the stock market declines.
2) You will be given a guaranteed rate of return of between 6-7% on an
accumulation account inside the product.
3) You will be given a guaranteed income for life you can never outlive
(which is based on the guaranteed accumulation account value when activated).
4) You have access to the money in your FIA at all times (subject to the
typical surrender charges).
5) When you die, the account value will pass to your beneficiaries.
6) The guaranteed rate of return can roll up for 15+ years with certain
products.

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WHO ARE THE MOST LIKELY CANDIDATES TO USE FIAs TO

GROW WEALTH?
A better question is who is NOT a candidate to use FIAs to grow their
wealth. Let me list who I believe are NOT the ideal candidates to use FIAs to
grow their wealth.
1) People who need a lot of liquidity with the money that could be
allocated to the FIA.
While surrender charges typically range from 5%-12% depending on the
FIA purchased and last typically less than 12 years, if you know you may need the
money, an FIA may not be suitable for you. However, there is also the ability to
take a 10% annual free withdrawal (and 20% as a one-time amount with some
companies); but again, if much or most of the money may be needed in liquid
form, then using an FIA to grow wealth will not be a good fit.
2) Anyone looking to access the funds prior to age 59½ years old.
Tax-deferred annuities are similar to qualified-retirement plans/IRAs in
that there is a 10% penalty from the IRA if you take money out prior to age 59½.
This can be avoided by taking a systematic income stream vs. the ability to
take a lump sum withdrawal; but as a general rule, again, if you need access to the
funds prior to age 59½ years old, building wealth in an FIA may not be an
appropriate place.
3) If you like action in the stock market and the potential to average 8-
10%+ a year in a brokerage account, you are not a candidate for growing wealth
with an FIA (but remember the DALBAR Study from the other section of the
course material which indicated the average investor has averaged ONLY 3.88%
over the last 20 years).
4) If you are under the age of 60 and can systematically fund X amount of
dollars into a properly designed cash value life insurance policy, you may not be a
candidate to grow wealth in an FIA. That’s not to say that an FIA still isn’t a good
tool to use for a conservative portion of anyone’s (at any age) portfolio.
Cash value life insurance can be a much better wealth-accumulation tool,
and it is a more tax-favorable/wealth-building tool due to the fact that money can
be removed from a policy income tax free.
The bottom line is that FIAs are a tremendously powerful and protective
wealth-building tool that not enough advisors or their clients know about and use.
SUMMARY ON ANNUITIES
Many people and some advisors have a negative stigma about annuities.
Now you know that there is a lot to like about annuities.
While the variety of annuities can be intimidating, if you know the content
from this section of the course material, you will know more about the basics than
many advisors selling them. Use that knowledge when working with your locally
trusted advisor to pick annuities that are best to help you accomplish your
retirement planning goals.

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