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The Role of Index Annuities in Financial Planning

Jim Heafner

What role do index annuities play in financial planning? Can they provide growth or just income?

First, let’s address index annuity growth versus market growth. Since 1995, some of the better index annuities have historically averaged 4 to 5%.1 Many would dismiss this growth, compared to the stock market’s “higher returns.” The disconnect is that we often focus solely on actual market returns, pointing to the S&P or Dow during good market performance periods only, rather than focusing on actual return performance in an investor’s portfolio during good and bad times.

Dalbar’s QAIB study of 2013 tells us that over the last 20 or 30 years, the average 50/50 stock/bond investor has averaged only 2.87% and 2.20% respectively. 2

Why so little? It’s unrealistic for the average investor to match the indexes we follow — indexes like the S&P 500 or The Dow Jones Industrial Average (DJIA). Why?

First, you can’t invest in the S&P 500 or the Dow. These indexes are merely averages of the prices of the stocks in the index. They are calculated without fees, expenses, or taxes. Second, if we try to emulate an index’s performance with a index fund meant to mirror those indexes, we have to deal with the realities that the financial industry wants to get paid for its services, and the IRS wants to collect taxes on our realized earnings — capital gains, bond interest, and stock dividends, etc.

Third, people often make illogical comparisons. For example, they may expect to do as well as stock indexes like the S&P 500 and the Dow, but are invested more in cash and bonds than in stocks. Realizing that we have to factor in the reality of these additional fees and taxes, improper comparisons, plus the measured observation that consumer behavior does not always guide us to the best decisions, typically leaves investors with performance well below market indexes.

Purchasing an index fund, meant to mirror indexes like the S&P 500 or Dow, might be a suitable investment for your retirement portfolio if you have many years to allow for market volatility, but that is not the only way to achieve growth in a portfolio. There are some insurance carriers that offer annuity contracts with guaranteed rates of return that are worth including in a retirement portfolio. These annuity contracts can offer growth based on the market, without being in the market.

Secondly, how do index annuities compare with the market in providing income? While index annuities, by design, are not created to match a bull run like the 1990s, some can produce and even outpace the market during turbulent times. But indexed annuities are purchased primarily for their safety of principal and income. An index annuity can guarantee lifetime income through a rider.

Can the stock market guarantee lifetime income? No! Can the market even provide any confidence that you can receive income payments for 25 to 30 years? A recent study by Blanchett, Finke, & Pfau tells us that a safe withdrawal rate from the market is 2.8%.3 Why so low? Because withdrawing money in down years accelerates your account’s fall to zero.

Can insurance annuities provide a greater income than 2.8%?2 Absolutely! And the insurance company guarantees it. Here is an example of how an insurance annuity provides more guaranteed income than the market can be expected to provide in good and bad conditions.

Market Incomes

Hypothetically, let’s assume that you have $1,000,000 you want to use to pay the bills for the rest of your life, beginning in 10 years. What could that $1,000,000 have grown to in 10 years? Let’s consider three market possibilities: 1) 10% growth, 2) no growth, and 3) a 50% loss.

Hypothetical Example One:

  1. Let’s say a miracle happens and you earn 10% a year, compounded once a year with no monthly additions. That means your account is now worth $2,593,742. Now how much can you safely spend from this account and expect it to last? 2.8%. That is $72,625 a year, with a 90% chance it will last 30 years.3

Hypothetical Example Two:

  1. What if in 10 years your $1,000,000, after soaring and crashing, was still worth only $1,000,000? How much can you “safely” spend now? $28,000! ($1,000,000 x 2.8%)

Hypothetical Example Three:

  1. What if in 10 years the bottom fell out and your account was worth only $500,000? How much could you withdraw for the rest of your life? $14,000.

So, for rough numbers, let’s say the likely range of incomes will be $14,000 to $72,625, assuming you want your money to last 30 years or more.

Index Annuity Income

So how might an index annuity compare? The older you are and the longer you delay income, the more income you’ll get. Let’s assume a married couple, each person 60 years of age, purchases an index annuity to guarantee a joint-life income starting in 10 years, at age 70. How much income might they count on from an annuity?

A fixed indexed annuity with an income for life rider that I currently offer to some of my clients can hypothetically guarantee this couple a joint lifetime income of $86,607 per year! That is if the market does nothing. What if the market has some good years and bad years? If the market were to repeat its last 12 years (which includes the terrible 07 and 08), at that point, our couple could be guaranteed a joint lifetime income of $119,624!

So the range of possibilities for their hypothetical index annuity is a worst case of $86,607 (assuming no growth) to a more likely $119,624! Note that the insurance company’s illustrated “worst case” income is higher than the market’s likely “best case.” Note too, that $119,624 is way too large a withdrawal from most any market holdings to have a reasonable chance of lasting 30 years, but the annuity company guarantees it to last for the longer of either life, with the balance of the account going to your beneficiaries.

That means the index annuity allows you to spend less of your money to acquire the income you need, allowing more of your money to now seek unfettered growth in the market, where it is available to access!

Index annuities can be very powerful in providing realistic growth, with limited Market risk; they are uniquely capable of providing lifetime income while still allowing the owner control over the asset.

If you’re interested in using an annuity to help provide an income for life, contact Heafner Financial at

1 “Real-World Index Annuity Returns.” Geoffrey VanderPal, Jack Marrion, and David F. Babbel. Journal of Financial Planning.

2 “Dalbar Survey of Consumer Returns —Mutual Fund Returns vs. Investor Performance.” DALBAR QAIB Study 2013. This result is for a 50/50 vs. equity & bond mix.

3 “Low Bond Yields and Safe Portfolio Withdrawal Rates.” David Blanchett of Morningstar Investment Management, Michael Finke, Dept. of Personal Financial Planning at Texas Tech, and Wade Pfau, Professor of the American College. Morningstar Investment Management Report.

About the Author:

Jim Heafner develops strategies to help families protect their assets while maximizing their lifestyle and legacy. Jim is a contributor to the Wall Street Journal,, US News & World Report, The New York Post, Worth Magazine, The Fiscal Times, and is the best-selling author of SuccessOnomics with Steve Forbes. He’s also been featured on ABC, NBC, CBS, and FOX.

Investment Advisory Services offered through Retirement Wealth Advisors, (RWA) a Registered Investment Advisor. Heafner Financial and RWA are not affiliated. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

Annuity guarantees rely on the financial strength and claims-paying ability of the issuing insurer. Any comments regarding safe and secure investments, and guaranteed income streams refer only to fixed insurance products. They do not refer, in any way to securities or investment advisory products. Fixed Insurance and Annuity product guarantees are subject to the claimspaying ability of the issuing company and are not offered by Retirement Wealth Advisors.


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1 Comment

  • San Ban says:

    I am 58 years old and my souse is 54 years.
    Will the figures in your example of fixed Indexed annuity still be same?
    Thanks for your time.

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