What 2008 taught us about retirement planning.

Imagine being lucky enough to not need IRA income. 

Sometimes the best way to explain a concept is to tell a story. The following story happens to be a true story told by John Rafferty of Rafferty Annuity Framing. It helps to explain the inspiration behind a powerful and very broadly applicable annuity sales idea that EMG Insurance Brokerage is currently promoting for use by its contracted agents. 

Imaging turning 70 ½ in December 2008. The government requires you to take distributions before April 1st of the following year. My father had the bad fortune to turn 70 ½ at this inopportune time. Born in June of 1938, he turned 70 ½ in December of 2008, in the teeth of a raging bear market that was at its most extreme. The market in December 2008 has been compared to the crash of 1929. The news gets worse: he had no choice but to withdraw money from his IRAs and 401ks no later than April 1, 2009.

My dear departed dad was lucky when it came to retirement preparations. He had pensions which my mother continues to enjoy today. That, combined with Social Security, was more than enough to sustain them in retirement. As a result, he felt comfortable having most of his IRA invested in equities for their growth potential. After all, he didn’t need that money to live on.

I don’t recall exactly when he took his first RMD in 2009 for the 2008 tax year (the IRS did kindly allow IRA holders to skip RMDs for the tax year 2009 given the market backdrop), but I know that whichever of those first 60 trading days of 2009 it was, it hurt. March 6, 2009, continues to be considered the watershed low point of that bear market that began in October of 2007 during the prior market peak.

The bull market we continue to enjoy today was born on that date almost 13 years ago. Back to my dad’s vexing situation: imagine staring at your IRA statement with your accountant in early 2009, deciding which of your highly depressed equity funds to withdraw that first RMD from? I am sure it did not feel good, knowing you had no choice but to pull almost 4% out of funds that were already down in many cases over 50% from their peak 18 months earlier. Talk about adding insult to injury.

Fortunately, that bear market ended right about the time my dad took his RMDs. His IRA had the good fortune to ride the new bull market much higher, despite 13 more years of RMD withdrawals that my now 84-year-old mom, who inherited his IRA, still is required to take today.

What if my dad had turned 70 ½ in 1999 and had to take his first RMD in 2000? The stock market did not fare well in the ten years from 2000to 2009 and lost money. The S&P 500 index, including dividends, lost almost 10 percent by the end of those ten years. Imagine having to withdraw funds from equity assets during that period -taking out 3.65% for your first RMD at age 70 in early 2000, and increasing to 5.13% by age 79? Meaning you’ve taken out roughly 40% of the value of an asset that has declined over a decade?

Here is the opportunity in this story. Forward-thinking financial professionals have opportunities to set up their clients who are within ten years of turning age 72 from mitigating if not avoiding this kind of bad confluence of events. By reallocating some of a client’s IRA assets into a fixed indexed annuity (FIA) with a guaranteed lifetime withdrawal benefit rider (GLWB) now, the high guaranteed lifetime cashflows available to the client beginning at the first RMD time may be enough to shoulder most or all of the RMD burden from all IRA assets.

For example, consider a couple who are age 67 today. They have a five-year window to prepare for their first RMDs. They want to continue growing their IRAs. While they see the value in being prepared in the event of a bear market when they take their first RMD, they don’t want to resort to having to allocate much of their IRAs to cash. They find that would be unproductive and negative in real inflation-adjusted terms.

  • Their financial professional recommends a FIA/GLWB for a portion of their IRA assets. The product he recommends will guarantee a lifetime cash flow to the couple for both of their lives. That cash flow is guaranteed at age 72 when they begin those withdrawals five years after purchase at age 67, to be no less than 7.5% of the value of their initial purchase amount. Every $100,000 they use to buy the annuity translates into a guaranteed joint lifetime cash flow of at least $7,500 a year beginning at age 72 when they start RMDs.
  • Consider the scale of that 7.0% guaranteed withdrawal relative to what the IRS requires for RMDs at age 72, which is 3.65%. This means the annuity cash flow is roughly twice the required withdrawal amount. We can use these two numbers to determine a recommended allocation split of IRA assets: how much to allocate to the annuity purchase and how much to leave in growth-focused IRA assets. Simply divide 3.65/7.0 to come up with roughly 52%. We can round it down to 50% for simplicity.
  • The 67-year-old couple follows their financial professional’s recommendation and decides to use about half of the current value of their IRAs ($1 million total), to purchase the annuity with $500,000.

Let’s fast forward to five years later with both a bull and bear case scenario:

 Bear Case:

  • The couple is now age 72, and the time for the first RMD has arrived. Unfortunately, the value of their growth-focused IRA has declined by about 20% over the last five years, from $500,000 to $400,000. Their annuity, which is not a security, has grown by about 5% due to positive interest crediting in 2 of the five years. It has a value of $525,000. The total value of their IRAs for RMD purposes is $925,000. From this, they are required to withdraw at least 3.65%, or $33,763.
  • But the annuity alone will allow them to withdraw 7% of their purchase amount, or $35,000. That annuity GLWB payment on its own will thus be able to satisfy their entire RMD obligation for that year, leaving the growth-oriented IRA unfettered by withdrawal when it’s already down 20%. That should help give those depressed asset values a better chance to reboot without the added friction of a forced withdrawal.

Bull Case:

  • What if the growth-oriented IRA asset doubled its value, from $500,000 to $1,000,000? We’ll assume the annuity grew as well but from $500,000 to $550,000. (The caps and the annual fee for the GLWB are limiting factors). Now, total IRA values for RMD purposes are $1.55 million. The 3.65% for their first RMD at 72 amounts to $56,575.
  • Their annuity’s 7% GLWB will produce $35,000 (7% of the $500,000 initial purchase), which won’t come close to covering their entire RMD. But so, what? Instead of using the annuity for their RMD in this case, the clients may instead decide to take their entire RMD from their growth assets given how much more it has grown than they’d expected. In doing so, they can leave their annuity untouched, which may help grow the GLWB amount. Many fixed indexed annuities with GLWB features will allow the guaranteed lifetime withdrawal amount to grow for each year that feature is not exercised for up to ten years. In the happy bull market case of our couple, they may decide to leave the annuity GLWB feature unused (unless and until their growth asset has a bad year.)

The moral of this IRA RMD story here is simple and powerful. For clients with significant IRA assets who are within ten years of reaching age 72, a FIA/GLWB product can be a great planning tool for the future. It can help optimize RMDs depending on the state of capital markets at the time those RMDs begin, and whatever the state of those markets, the annuity remains a store of lifetime income value.

That kind of optionality can be ideal in a frothy financial environment. If you want to protect yourself from these situations, please contact us. EMG Insurance Brokerage is a full-service brokerage general agency based in Houston, Texas. We know it is essential for advisors to access quality products, expert advice, and cost-effective solutions. We keep up to date on markets, trends and continually update our carrier offerings. Connect with today; we are here for you.

 

John R. Rafferty, Principal

raffertyannuityframing@gmail.com

(860) 559-3193

www.raffertyannuityframing.com

 

A rider is a provision of an annuity with additional costs, potential benefits, and features that should never be confused with the annuity itself. Before evaluating the benefits of a rider, carefully examine the annuity to which it is attached.

The rules governing RMDs are complex and subject to modification.

The information presented is abbreviated and is for general information purposes only.

Please note that if an individual misses taking an RMD, the penalties can be substantial. 

This material is not intended to provide investment, tax, or legal advice.