Case Study Certified Annuity Specialist®

Summary: Looking for financial guidance in retirement? Contact Tim to learn about protecting the sale of your business, managing debt and assets, and more.

This is a hypothetical example and not actual clients and their outcomes

Desi, 62, and his wife, Lucy Arnot, 55, both retired and sold their business for $150,000. The buyer will make three yearly payments of $50,000 each. Hopefully, even in this downturn brought on by coronavirus, the buyer will be able to make those payments.

Protecting the Sale of the Business

Desi and Lucy had an excellent attorney who put language into the contract that protects them if the buyer is unable to fulfill his/her obligation.

Debt & Assets

The Arnots have put themselves in a wonderful position for retirement. The debt on their house is paid, and they recently paid cash for two new cars; they have no other debts.

Current Assets

  • $500,000 in A-rated corporate bonds (7% coupon due in 2022)
  • $200,000 in the ABC Balanced Fund (Assumed allocation: 60% blue-chip stocks, 40% government, and investment-grade corporate bonds)
  • $100,000 in the XYZ Growth & Income Fund (Assumed large-cap blend)
  • $50,000 in the LMN Small Cap Growth Fund
  • $30,000 in an interest-bearing checking account
  • $700,000 in the GHI Fixed-Rate Annuity (IRA rollover, 4% annual compounding assuming Desi is the owner, Lucy is the primary beneficiary, and the kids are the contingent beneficiaries)

Total = $1,580,000


Both Desi’s and Lucy’s parents, in their 90s, are healthy and thankfully not impacted by the virus so far. Desi and Lucy have two children: one is 29, and the other is 25. (Assuming both are males) The twenty-five-year-old is a straight shooter, and they are confident he will do well. The older one earns less money, and they are a little worried about his prospects.

Risk Tolerance

Desi says he is reasonably aggressive, while Lucy says she is conservative. Their holdings ($1,580,000) are allocated with 46% in fixed annuities and cash, 37% in government and investment-grade corporate bonds, and 17% in stock mutual funds. Of the stock funds, 3% is in small-cap growth, and the other 14% in large-cap U.S. stocks.

It is essential that they both take an online risk tolerance questionnaire, either FinaMetrica or Riskalyze. Their current holdings, which I would characterize as conservative, line up more with Lucy’s risk tolerance than with Desi’s.

Social Security

They both have enough quarters to qualify for Social Security; however, both said they would like to wait until they are 66 and eligible for full benefits.

Because Lucy is retiring at age 55 and took off a few years to raise her kids, her top 35 years of income used to determine her benefit are less than Desi’s. Therefore, she will receive a lower amount. However, if Desi passes away, she can bump up to Desi’s larger amount, thus making the case that, if possible, Desi could defer taking his payment until age 70. Waiting increases his benefit by 8% a year up to age 70.

For example, if Desi is eligible for $30,000 at the age of 66, waiting till the age of 70 increases his benefit to $39,600. Also, if he were to pass away, it would then go to Lucy. That amount of Social Security equates to almost 88% of their stated goal of $45,000 of pre-tax income a year.

A Bridge

The $50,000 a year of proceeds from the sale of the business is enough to meet their $45,000 income goal for the next three years. At that point, Desi will be 65 and Lucy, 58. If Desi delays taking his Social Security until he is 70, the couple would need to generate $45,000 a year for five years.

A note: The new Retirement Secure Act pushes back when an IRA holder must begin taking distributions from age 70 1/2 to 72. It also decreases the time a non-spouse must distribute any inherited IRAs from over their life down to ten years. (The rules for spouses remain the same.) It also makes it easier for 401k retirement plans to add a payout annuity to the plan, recognizing the benefit some people reap by receiving part or all their retirement savings in the form of a lifetime income.

Should Annuities Be Part of the Bridge?

Desi and Lucy already have a substantial percentage (44%) of their holdings in one. It happens to be a fixed annuity inside of an IRA, so the tax-deferral benefit of annuities is nullified because the IRA already provides it.

A fixed annuity pays a fixed interest rate, much like a CD. Most fixed annuity contracts, if not all, have a guaranteed interest rate. With interest rates being so low today, the 4% Desi is receiving probably means that it is the minimum the contract must pay.

However, in today’s low-interest world, a 4% annual compounding interest makes this account something that should remain in their portfolio. Just for comparison, 30-year U.S. Treasury bonds are only paying 1.25%, and ten-year Treasuries pay a meager 0.61%.

That leaves the investments outside of a retirement account for a potential annuity. It may be a variable annuity that provides principal or income guarantees, which may provide Lucy with the peace of mind to put more money into stocks through the annuity sub-accounts. However, keep in mind that non-qualified annuities are not the best asset to leave to non-spouse beneficiaries as they are not eligible for a stepped-up benefit, and one of their goals is to leave a large estate for their kids.

Another alternative is an indexed annuity, which is a fixed annuity whose interest rate is based on the performance of an index such as the S&P 500. For example, say that an investor puts $50,000 into an indexed annuity tied to the S&P 500. If the S&P goes up 15% one year, the annuity holder might—depending on the terms of the contract—receive 10% interest.

Pros and Cons of Annuities

The press often disparages annuities for their high fees and use in retirement plans when the retirement program already provides for tax-deferred growth.

For any money with taxable interest, such as CDs or bonds, annuities are a competitive alternative, especially if the client takes advantage of the tax deferral for 10–15 years.

Variable annuities provide investors with the option of stock and bond subaccounts, much like mutual funds. They also offer a death benefit. If the stock or bond funds that make up the client’s portfolio drop in value, their beneficiary receives the original investment.

Some variable annuities provide for a stepped-up death benefit. The annuity locks in account values along the way, and those values become the new death benefit, protecting beneficiaries if the owner dies during a bear market.

Newer versions of variable annuities offer what is called a living benefits guarantee that is provided before death, giving the owner a guaranteed future account value or income regardless of sub-account performance. This may allow older investors to keep a higher percentage of their money in stocks, knowing that the stocks have a guarantee behind them.

One downside of annuities is that they are not eligible for a stepped-up death benefit, meaning the beneficiaries’ tax liability remains the same as the owners’ was. Other assets, such as stocks and mutual funds held outside of retirement accounts, get a new tax basis.

So, if an investor had invested $100,000 in XYZ mutual fund, and it was worth $350,000 when the investor passed away, the beneficiaries’ tax base would be $350,000.

Also, annuities generate ordinary income, even when they are invested in stocks, when stocks or stock mutual funds are held outside of an annuity or retirement account, they are eligible for lower capital gains taxes. Of course, in the future, tax rates may change. (All distributions from retirement accounts except Roth’s get taxed as ordinary income.)

How to Get Five Years of Income

If Desi waits until age 70 to take his Social Security and age 72 to begin withdrawing his RMD, the couple will need $45,000 a year for five years.

The $500,000 in corporate bonds comes due in 2022, which is the third year of the installment payment from the sale of the business. The maturing bonds plus three years of interest adds up to $605,000. Obviously, in today’s world, that is not going to generate much interest. So, they are going to need to draw down the principal or take more risks.

The three years of remaining interest, together with the maturing bonds, seems like the prime target for repositioning to provide the $45,000 of income needed if Desi waits to take his Social Security.

The ABC Balanced Fund

With an allocation of 60% in large-cap stocks and 40% in government and investment-grade corporate bonds, this fund is a potential spot for the maturing bonds as well as the three years of the remaining interest.

A review of the fund shows that it has a low expense ratio, competitive returns, and a good Sharpe Ratio. This means that it would not take excessive risk to get those returns. Adding the interest and maturing bonds to the $200,000 already in that fund would bring the total to $805,000. Using a 5% average return (not guaranteed) results in $40,000 of interest and dividends and comes close to the goal of $45,000 of income.

When Social Security and the required minimum distribution kick in, Desi and Lucy can switch from taking the distributions to reinvesting them into the fund.

The Other Holdings

The XYX Growth & Income Fund and the LMN Small Cap Growth Fund provide both stock market diversification and an inflation hedge for the Arnots’ total portfolio. More allocation in larger stocks and less in smaller stocks makes sense for retirees. Adding an international fund could help reduce risk through additional diversification.

A Word About Inflation

Inflation for the past ten years or so has been low except in one area of concern for retirees. That area is healthcare costs, including prescription drugs. If we take the required income goal of $45,000 and add a 3% inflation rate in ten years, the couple need about $60,500 of income. It jumps to roughly $81,000 in twenty years.

Lucy’s Social Security, which we assume she starts taking at age 66 together with the required required minimum distribution from Desi’s IRA, will help with the inflation-adjusted income number. And at some point, they can begin taking the interest and dividends from the ABC Balanced Fund.

Additional Risks

One big risk that the Arnots have not addressed is if one or both of them ever need to go into a nursing home. If they reach their parents’ age, the odds are high that one of them may have to. Some people reduce this risk with long-term care insurance. However, these policies have gotten expensive, as many insurance companies left the marketplace because not as many people as was hoped bought the policies; yet, the people who did, keep them.

An Annuity is a long-term financial product designed largely for asset accumulation and retirement needs. Annuities generally contain fees and charges which include, but are not limited to, surrender charges, administrative fees and for optional contract riders and benefits. Withdrawals and death benefits are subject to income tax. If withdrawals and other distributions are received prior to age 59 1/2, a 10% penalty may apply. Annuities typically carry surrender charges for several years that may be assessed against withdrawals. Certain Annuity product features, offered by some Annuity companies, such as stepped-up death benefit, a bonus credit and a guaranteed minimum income benefit, carry added fees. If you are investing in an Annuity through a tax-advantaged plan such as an IRA, you will get no added tax advantage. Under these circumstances you should only consider buying a Annuity if it makes sense because of the Annuities other features, such as lifetime income payments and death benefit protection. All guarantees of an Annuity are backed by the claims paying ability of the issuing insurer. Variable annuities are sold by prospectus. Investors should carefully consider the investment objectives, risks, fees and expenses before investing. For this and other important information please obtain the investment company fund prospectus and disclosure documents from your financial professional. Read this information carefully before investing.

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Financial Advisor Tim Hayes

I’ve held an industry securities registration for 30+ years and am subject to SEC and FINRA oversight.

Most clients pay fee-only or an hourly rate. The size and complexity of the client’s wealth management and financial and retirement planning determine that fee.

Some clients pay a commission, mainly those with smaller accounts, i.e., Roth IRAs, some public-school teachers with 403b retirement accounts, or parents or grandparents who set up a 529 college savings plan.

The first introductory and fact-finding appointment can be in-person or by phone. The next meeting where I provide my recommendations should be in-person. (For the time being, telephone, Zoom, and email are replacing some in-person meetings.)

Subsequent meetings during which we monitor your progress and investments can be done in-person or by phone, email, Zoom, or Skype – or, more likely, a combination of these meeting types.

Contact Tim

Tim has offices in Boston and South Dartmouth, Massachusetts. He’s licensed to handle securities in 8 states: Massachusetts, Rhode Island, New Hampshire, New York, New Jersey, Connecticut, Maine, and Florida.

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