Investing Trick: Build Your Own Annuities

If you want to start a fight in a room full of financial planners, just bring up annuities. About half the room will argue that these are valuable products that offer guarantees to worried clients, the rest will contend that the guarantees are worthless and the fees are outrageous. But the truth is advisors don’t need to turn to annuity products to allay clients’ fears about market losses.

Put simply, annuities are a contract between an insurance company and an individual. They come in many shapes and sizes, ranging from very simple — such as a single-premium immediate annuity (often called a SPIA) that promises income for life in the form of a monthly guaranteed check — to mind-numbingly complex, like the fixed indexed annuity that promises equity-linked returns without risk of principal.

All, however, are indirect investments made through insurance companies and insurance agents, which profit as intermediaries. And those profits reduce returns for our clients. So to the extent that advisors can help clients achieve annuitylike results while cutting out the intermediaries, the clients are likely to have more money for life.

Here are some methods that will let you build your own annuity to increase your clients’ returns:


This annuity promises wealth without risk. It is usually marketed by promising part or all of the “market return,” with a guarantee not to lose principal. But since regulators require the insurance company’s assets to be invested conservatively, common sense dictates that the insurance company can only return a conservative (fairly bondlike) return — less the commissions, overhead and profits the insurance company needs to cover.

Typically, returns are linked to indexes like the S&P 500 stripped of dividends, and have maximum returns — which the insurance company often retains the unilateral right to change. I just reviewed one policy that had lowered the maximum return on an existing policy to 3.5% — meaning my client would get between 0% and 3.5% annually, but had to pay 10% of his principal if he wanted his money back.

It’s a feel-good product — but it’s also a product that you can easily mimic, with dirt-low costs and guarantees backed by the U.S. government. All that your client needs is a high-paying long-term CD and a low-cost stock index fund.

As of mid-April, GE Capital Bank had an FDIC-insured 10-year CD yielding 3.3%. If the clients have $100,000, for instance, they could put $72,276.45 in this CD, which would mature in 10 years at $100,000 — that’s the guaranteed principal.

Then your clients can put the other $27,723.55 into a low-cost total stock index fund such as Vanguard Total Stock ETF (VTI), which has a 0.05% annual expense ratio. In 10 years, the client gets back the $100,000 in the CD plus the value of the stocks, which will also include the dividend reinvestment.

Clients can do even better if they are willing to take on a minimal amount of risk. Let’s face it: If the value of stocks 10 years later were zero, then the U.S. government would probably have failed, as well. So we can do better if we assume rather conservatively that the total return of stocks (including dividends) would fall no more than 50% in 10 years.

In that case, the clients put $56,588.19 in the CD and the other $43,411.81 in the stock index fund. If it’s a horrible decade for stocks, in which the S&P 500 loses 60% of its value, the total stock fund with dividends reinvested would lose about half its value, and the client CD plus that stock (at half the original value) would be worth $100,000.

But here’s the upside: If stocks return 8% annually over the next decade, the guaranteed combination will earn 4.8% annually, while the “virtual guarantee” combination (which assumes stocks lose no more than 50%) earns 5.57% annually.

The How DIY Fares chart above breaks down the approximate returns based on how stocks actually perform. The do-it-yourself options are actually far superior to an equity-indexed annuity.

They can also be more tax-efficient. If the client buys the CD within a tax-deferred account, such as an IRA, but leaves the stocks within a taxable account, the stock dividends will be taxed at a lower rate and the capital gains will be deferred until sold — when they are also taxed at a lower capital gains rate.


Clients seeking longevity insurance often turn to annuities to get a guaranteed monthly check — either via a single-premium immediate annuity or with a deferred life annuity (sometimes called a deferred immediate annuity), which defers the start of those monthly payments to some specified date in the future.

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Comments (13)
To the Editorial Staff:

There are so many falsehoods, selective calculations and embarrassing factual errors in this article, how did he make it past the editorial staff?

This is not an issue of diversity of opinion. He clearly either knows little about the structure of an annuity, especially an indexed annuity and the legal reserve methods, or is so hateful of annuities he'll use any method to avoid one... he's either ignorant or lying. Either way he's dangerous.

The various markets and annuities, BOTH are useful in financial planning, income planning, liquidity considerations and proper diversification. Too much of either is not a good thing.

For the credibility of your news organization, I would strongly reconsider using him as a source.
Posted by Kevin B | Friday, May 16 2014 at 11:28AM ET
my last four annual returns for fixed indexed annuities ranged from 7% to 17.51%; now those returns are locked in.
This guy doesn't know jack!
Posted by Gerard S | Thursday, May 15 2014 at 3:39PM ET
Robert L.

To address your questions:

To hit the soft-spots in this article, I'd have to comment on virtually every paragraph. Not today. Just a few questions --

Is a 3% Social Security CPI guaranteed? With Paul Ryan running amok, what exactly is guaranteed? No but will buying annuities change politics?

And under your schema, if I live to 120, will I get guaranteed income? Yes - reread the article and the deferred income annuity?

And there's no reinvestment or default risk? Inflation risk is a far larger risk on a fixed payment. Insurance company's have defaulted and we can't count on a 2008 government bailout again.

And if I'm sued, is your scheme exempt from creditors? Their are far more efficient ways to structure such as trusts.

And if I live to 120, will I still want to do all this work to save a few basis points? If you buy this at age 60 and live to age 120, your fixed payment will buy 17% of today's goods at 3% inflation. You charge " a few basis points"?
Posted by ROBERT L | Thursday, May 01 2014 at 10:20AM ET
Posted by Allan R | Wednesday, May 07 2014 at 1:53PM ET
Paul D,

The guarantees are typically illusions and I think a TIP is a much better guarantee. My numbers do include fees but an RIA isn't needed for this do it yourself simple approach.
Posted by Allan R | Wednesday, May 07 2014 at 1:44PM ET
Chris B.

Quite often, when I write about annuities, I get responses that are both a personal attack (you say I am unethical) and poorly researched. As far as not having a clue on how the insurance company works, you failed to look up that I've been a finance officer of two multi-billion dollar insurance companies and interviewed several officers and professors at Wharton. BTW, Wharton receives quite a bit of funding from the insurance industry.

Proceeds, after the large commissions paid, go into the general fund invested mostly in conservative bonds. I've examined the balance sheets of many insurance companies selling these.

In my opinion, these annuities should say the following on the first page of the brochure - this is an example:

1) Paying you 100% of the average annual return of the S&P 500 is equivalent to stripping out the dividends and paying you half of the return of the rest which is the equivalent of paying out 37.5% of the expected market return.

2) The maximum we pay is currently 4% per year meaning that your actual annual return is between 0% and 4%.

3) The insurance company maintains a unilateral right to change your return through changes in participation rates, spreads, and caps and we can lower your maximum return to 2% annually. You are, in effect, providing insurance to the insurance company.

4) If you want your money back in the next ten years, we will charge you a penalty of up to 12% since we need to recover the commissions we paid to the agent who sold you this policy.

A part of my practice is explaining to clients why their returns were so low when they expected market returns based on what their agent told them. Getting out is complex and occasionally I have to involve the general counsel of the insurance company.
Posted by Allan R | Wednesday, May 07 2014 at 1:40PM ET
"The do-it-yourself options are actually far superior to an equity-indexed annuity." The writer is wrong. As proved in the peer-reviewed study "Real World Index Annuity Returns" available on the Social Science Research Network, actual index annuities have generally outperformed these hypothetical never-actually-used combinations. The main reason is index annuities typically reset annually, enabling lower participation to still provide competitive yields. The second reason is protection against market loss is shown to offset the effect of not having reinvested dividends, Finally, the writer misunderstands that fixed index annuities - there hasn't been an "equity" index annuity sold in over 5 years - are designed to give savers an opportunity for a higher interest rate. They are not an investment and are never sold as an investment.
Posted by Dr. Jack M | Saturday, May 03 2014 at 9:35PM ET
The EIA products with which I am familiar don't necessarily offer a
return of principal. Some do, don't. But they do provide that the return
over any crediting period, typically a year, will not be less than zero.
So an EIA using the S&P 500 as its investment measure would have received
a zero return in 2008, whereas a holder of an S&P 500 index fund would
have experienced about a 37% loss. In 2009 the EIA owner starts off
the year with his principal as of the end of 2007 intact; the S&P 500
holder starts of 37% down. In 2009 the S&P 500 returned about 26%. The EIA owner would have had an account worth 26% more than it was worth in
2007. The S&P 500 holder would have had an account that was only worth a little about 79% of its 2007 value. Of course in Mr. Roth's strategy
only a portion of his moneys would be in the S&P fund and he would still
have the CD. But do a simple spreadsheet with some real or arbitrary
numbers and see for yourself how things might play out.

The above being said, the fees, participation rates and caps that are applicable to any particular EIA mitigate that advantage, but nothing that
a more sophisticated spreadsheet analysis couldn't take into account. I will say, though, that I believe it pays to buy EI products issued by better rated issuers who are less likely post purchase to monkey with the moving parts for financial reasons, and more reluctant to do so for competitive reasons.
Posted by Steve D | Saturday, May 03 2014 at 3:55PM ET
Pretty funny off- the- point- completely sort of article and of course the ensuing comments as well. I love it when you guys start comparing to your worldly, sageful investment advice.. I hang the articles on the wall and my clients and I laugh at them, really do. keep it up!

Here's the deal guys.. annuities never should have been nor ever should be compared in the investment game. Comparing annuities, FIAs in particular to equities is such a complete joke...THE ARE NOT INVESTMENTS. YOU DON'T BUY INTO AN FIA TO INVEST, despite what the legions of annuity salesmen and women preach

FYI annuities were designed back in the 1500s and still remain, by far the best way to create lifetime income, with increasing attributes based on age or LE credits. THERE IS nothing that comes close to the guarantees provided by them, nothing. Annuities have an actuarial stamp on them and therefore what I just said is completely true.

The wacky crediting methods are basically al lsmoke and mirrors to make them look sexy blah blah but they are really just smoke and mirrors. Making another point of two over a CD or bond IS NOT THE POINT. the point
is actuarial calcs that provided DB- like income.

read my book on Amazon "Beating the Retirement Income trap...with Financial Harmonics" so I can make 1.50 and buy a half of a cup of starbucks coffee, which i just found out as MSG in iT!!!!... what i really want is for you to learn how and why annuities have immense value .....and are the only hope to save this country from disaster!

Jay Weinsteib
Posted by jay w | Friday, May 02 2014 at 8:23PM ET
Allan, I have to say this article is is just downright unethical from so many vantage points!! Your statement of "But since regulators require the insurance company's assets to be invested conservatively, common sense dictates that the insurance company can only return a conservative (fairly bondlike) return -- less the commissions, overhead and profits the insurance company needs to cover" THAT IS INSANE! You don't even have a clue how an insurance company builds an indexed annuity. Please do some homework ONCE AGAIN! The insurance company does not invest for the clients funds ever in the indexed annuity. The premium is matched with reserve funds usually about $1.04 for every dollar of clients funds . That goes into a high grade BOND. It is ONLY the interest off that bond that is placed into a call option on a given index(S&P 500). At least read the Wharton Business School review of Indexed Policies. The insurance company is paying for the right to participate in upside from the chosen index by buying that option. As I have challenged you several times before . Show me any REAL plan you or anyone you know that had the same risk level as an indexed annuity for the last 2,3 5 years that beat the real performance and I would leave the industry! BUT it never happened. To have locked in 80-90% gains in the last 5 years with No RISK is the real testament to what the proper policy can do. And once again the fee of 1.9% can only come from GAINS! I see you are on a mission to scare people back into the market . IT is quite irresponsible! I do love the part where you reviewed 1 policy ,that is hysterical!
Posted by Blair A | Friday, May 02 2014 at 12:35AM ET
Great article Allan. I'd take the opposite question. If I live to 120, do I want to be entangled with the constraints any of the annuities will put on me?

Life is a series of trade-offs, but we've found planning and conservative asset management go as far as the annuity goes....along with flexibility and less perception of a conflict.
Posted by Chris B | Thursday, May 01 2014 at 12:12PM ET
To hit the soft-spots in this article, I'd have to comment on virtually every paragraph. Not today. Just a few questions --

Is a 3% Social Security CPI guaranteed? With Paul Ryan running amok, what exactly is guaranteed?

And under your schema, if I live to 120, will I get guaranteed income?

And there's no reinvestment or default risk?

And if I'm sued, is your scheme exempt from creditors?

And if I live to 120, will I still want to do all this work to save a few basis points?
Posted by ROBERT L | Thursday, May 01 2014 at 10:20AM ET

Interesting article. I have struggled over the years about the high cost of annuities, yet there is a subset of clients who want guarantee's but need growth to accomplish their goals. Your approach seems to make sense. I did have a couple of question's, in your analysis did you include any transaction costs for buying the low cost fund's or any fees paid to the RIA?
Posted by Paul D | Thursday, May 01 2014 at 10:10AM ET
Add your comments here.
Posted by Suzanne Y | Thursday, May 01 2014 at 10:03AM ET
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