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Episode #618 - My Advisor Recommended an Annuity - Should I Buy It

“Safety isn't expensive, it's priceless.” - Jerry Smith

Roger: Welcome to the show dedicated to helping you not just survive retirement, but to have the confidence to lean in and rock it. Hey there, Roger Whitney here. I am almost done with my last trip of the year. Well, that's not really true. I have to go to Duluth in early December. But my major trip, I'm excited to be home for a while. Today on the show we are going to have a retirement toolbox segment where we're going to talk about required minimum distributions and the basics around those. And in addition to that, we're going to answer a question from a listener where their advisor recommended annuity and they want to know whether they should buy it or not. We're going to examine some things to think about in that. In addition, we'll answer more of your questions. If you are enjoying the show, you're going to love our weekly email that comes out every Saturday called the Noodle where we give you a summary of the show and we share links to resources. So if you're not already getting that, go to thenoodle.me and you can sign up there.

RETIREMENT TOOLBOX: REQUIRED MINIMUM DISTRIBUTIONS

All right. With that, said, let's get this party started with our retirement toolbox. Between now and the end of the year, we're going to focus on tools and things that we need to consider between now and the end of the year, things that are a little bit more timely and required minimum distributions. The topic today is one of them. Now, next week we're going to talk about inherited IRAs and the rules around required minimum distributions with inherited accounts. But for today, we're going to talk about accounts that you own and have funded, not ones that you've inherited. So what is a required minimum distribution, also known as an RMD? Well, the traditional IRA and 401 deal with the IRS was you could contribute to a 401k or a traditional IRA and when you made that contribution of $1,000 or $10,000 in whatever year, you wouldn't be taxed on that amount. It would be deferred from your taxable income for that year. So you get to save on your taxes in that specific year and you had limits in which you could do that every year. And you probably have done this if you've been working for a while. And then that money within the traditional IRA or 401 grows tax deferred so as it grows and has dividends and capital gains. And if you sell something and buy something within the umbrella of a traditional IRA or 401k. You don't have to pay any taxes on those gains. Awesome. It's all deferred. But the IRS wants you to use this money for your retirement, and they have rules. Required minimum distributions. Hey, wait a second here. You've never been taxed on this money. At some point, you need to start taking it out to help fund your retirement. And if you don't, we're going to have rules to force you to take money out once you hit a certain age. So that is what a required minimum distribution is. You'll also have it referred to as an rmd.

A QUICK BREAKDOWN OF THE CURRENT IRS RULES FOR REQUIRED MINIMUM DISTRIBUTIONS, OUTLINING THE DIFFERENT START AGES BASED ON YOUR BIRTH YEAR.

All right, so what age are they going to force you to take money out of your traditional IRA or 401k? Well, this has gotten a little bit complicated. So if you were born before July 1, 1949, that age was 70 and a half when you had to start taking money out. Now, anybody born that age is already dealing with this, and they probably understand these rules. Similar to the second tier, which is if you were born July 1, 1949 to December 31, 1950, the beginning age for this requirement was 72. Again, if you're 72 or if you're born in that window, you're probably already doing this. Now, if you were born between 1951 and 1959, your required minimum distribution age that you have to start doing it is 73. This was a recent change in the Secure Act 2.5. So you're, if you're in that window, you have to start taking money from these traditional accounts at age 73. And then if you were born in 1960 or later, you have to start taking money out at age 75. So those are the years that the IRS is going to start forcing you to take money out of deferred IRAs. Traditional IRAs, we call them, or traditional 401s. Now, what accounts are subject to this rule? Traditional IRAs, SEP IRAs, which is a small employer plan, simple IRAs, another small employer plan, traditional 401k accounts, traditional 403Bs, 457s, and other qualified plans. What accounts are not required to have these required minimum distributions? Well, that's going to be a Roth IRA during the owner's lifetime, a Roth 401K, and then still working exemption around qualified accounts. That's a little bit more complicated than we want to get into today.

HOW RMDS ARE CALCULATED USING YOUR YEAR-END BALANCE AND IRS LIFE EXPECTANCY TABLES.

All right, now we know that, hey, we're going to have a required minimum distribution on these traditional accounts because they've never been taxed. We you probably pegged your birthday. And now you have an idea of the age that the IRS is going to start requiring it, and we know the accounts well. How do they decide how much I'm supposed to take out? The way they help you determine the amount that you're supposed to take out once you hit the required age is they look at the balance at the end of the prior year and then they apply what's called a life expectancy table. Generally, what's used for most account owners is the IRS uniform life table, basically how long you're going to live. So if you're in, let's say you have an IRA and you're at the age where you have to do required minimum distributions this year, they're going to look at the year end balance in 2024, and then they're going to calculate based off of life expectancy tables based on your age, the percentage that you need to take out. And then that is going to be the amount that you have to take out each year. So how does that actually work? So what does that look like in practice? So let's assume that you are 74 years old. So you were born, say January 1, 1951 and December 31 of last year, your account was worth $1 million. You would take that amount, look at the uniform life table, go to your age and they have what's called a life expectancy factor. And so for the 2025 tables, it's 25.5. So you would take your balance of $1 million, divide it by the life expectancy factor of 30, or 25.5, which would get you a required minimum distribution of $39,215.69. So if you were to reverse that calculation, as an example, that's going to work out to about 3.9% of the value and that every year you age, the percentage that you have to take out increases. Luckily for you and I, we don't have to do these calculations on a calculator. There are online calculators that will calculate this for you and show you tables of what your future requirements might be based on growth rates, etc. In the noodle email, we'll have links to the Schwab RMD calculator as well as the Fidelity RMD calculator, just so you can play around with these. But the important point for this toolbox exercise is that when you hit your required minimum distribution age every year, you're going to have to look at the balance of the prior year and do a calculation. A lot of the investment firms will do this for you and make sure that money is taken out.

WHEN SHOULD YOU TAKE YOUR MONEY OUT, AND WHAT HAPPENS IF YOU DON’T?

Now. When do you have to take it out? Well, you have to take it out by December 31st of the year that it's required. There's one quirky rule in the first year of your rmd, but we don't need to get into that today. And if you don't take it out prior to the end of the year when you are required to, there will be a 25% tax on the amount you should have taken out that you didn't take out. Now that was just recently reduced from 50%. They just did that this year. So there's a pretty stiff penalty if you fail to do your required minimum distribution. Take it from someone that has done this for a long time. It can be easy to miss. You get rushed and you say you're gonna do it in the fourth quarter of the year. And then time gets around and all of a sudden you wake up, it's January 2nd, you're like, oh my goodness, I forgot to do that. That can happen. Or the firm that you work with doesn't process it correctly because they have a crunch time towards the end of the year. Doesn't matter what firm, the back office of all of the major investment firms, they got a lot of stuff going on year end. They got charitable distributions, they have IRA contributions, they have a lot of RMDs to process for millions of people. So this stuff can happen. Now, if you do miss it and you catch it within the first two years, that penalty, that excise tax, can be reduced to 10%. And as someone who has made a mistake and failed to do an RMD for a client, once or twice in the past 30 years, you can actually plead mercy to the IRS and have the penalty waived if there's a reasonable cause. And I've actually found that they're pretty forgiving as long, long as it's not something that happens. But we definitely don't want to have to do that. So that is the basics of required minimum distributions.

HOW TO HANDLE RMDS ACROSS MULTIPLE IRAS AND 401(K)S AND WHY LONG-TERM PLANNING AND ACCOUNT CONSOLIDATION MATTER.

Now, I want to cover one more thing and then we'll talk about some considerations. Even if this is not something that you're going to have to deal with this year or in the near future. So one thing I want to cover before we get to that is, well, what happens if you have multiple accounts, you have three IRAs, and you have a 401k and you have a simple IRA? How do you do it for all of that? Well, if you have multiple traditional IRAs, SEP IRAs and simple IRAs, you can aggregate the balance of all of those when you're calculating the required minimum distribution and just take it all from one account. So as long as you get the amount right, it doesn't matter which account it comes from. It can all come from one account, it can come from a little bit of each account, etc. What you cannot aggregate are the 401ks. Those have to be done separately from each individual plan. So if you have multiple 401ks that you've never consolidated or put into an IRA, you're going to have to do a required minimum distribution from each individual account. So that's something to be aware of. One reason why it's really good to consolidate things. So now, even if you're not near the required minimum distribution age, they are something that you want to factor into your long term planning. Because if you have traditional IRA or 401k assets, these forced distributions, which will create taxable income, are going to be coming. And if you're married over time, it's likely that one of you will be in a single bracket unless you pass away together. So this is something to consider from a long term optimization standpoint. So how do you consider this? First, you can easily project your future required minimum distribution. Some of the online calculators, like the ones I mentioned, will forecast with an assumed growth rate what the future ones might be. And it's a good practice to do that in retirement to get an idea of what this RMD tax bomb might be. Because those future required minimum distributions may put you into a higher tax bracket, may impact the taxation of your Social Security, may impact your IRMAA Medicare surcharges in the future. And you want to at least have some awareness of that because you may choose to take money out early from these IRAs in order to mitigate these downstream risks. So it's always good to have a projection of what your future required minimum distributions are when you're doing your long term planning. And when you look at that number, consider whether you're going to need that much in required minimum distributions just simply to fund your life, or it's well in excess of what you actually need, because that will give you an idea of whether you need to pursue this further. If it's likely what you're going to need to take out anyway based off of projections in your plan of record, then maybe it's not that big a deal. But if your required minimum distributions are a lot bigger, then that might be problematic and have you start to do some longer term planning.

WHAT ARE SOME STRATEGIES TO MINIMIZE OR MITIGATE YOUR FUTURE REQUIRED MINIMUM DISTRIBUTIONS?

So what are some possible strategies to minimize your future required minimum distributions or mitigate that amount? Well, you could do qualified distributions from your Iraq or your 401k prior to the required age that they start. And this is just simply a, qualified distribution is simply taking money out of your IRA when you're 64 to help pay for your life rather than just using all of your after tax accounts. It's no more complicated than that. Perhaps because you're in a low tax year at age 64 in this example, it just makes sense to take money out and use it and you'll stay within a reasonable tax bracket. Another option, and this is one reason why we hear about them all the time, is to do Roth conversions. Rather than take the money from an IRA and use it to fund your life, you convert it to a Roth IRA which does not have the required minimum distribution need and now it can grow tax free forever and you front load the tax and then another one. Another option is to use what we talked about last week, qualified charitable distributions starting at age 70 and a half to start to get money out of the IRA. So that is a primer on required minimum distributions, what they are when they start, how they're calculated, and also some things to think about even if you're not close to the age that they're going to have to start.

LISTENER QUESTIONS

SUBMIT YOUR QUESTIONS THROUGH ASKROGER.ME, AND WE’LL HELP YOU TAKE A BABY STEP TOWARD A ROCK-SOLID RETIREMENT.

Now it's time to get to your questions. If you have a question for the show, go to AskRoger Me M& you can type in a question or leave an audio question and we'll do our best to help you take a baby step to rock retirement. If you leave an audio question, we try to bump those to the top of the list. So if you have a question and you're willing to share your voice, that's the best way to do it.

OUR TITLE QUESTION COMES FROM RICH, WHO ASKS IF A FLEXIBLE PREMIUM DEFERRED INCOME ANNUITY WOULD BE A GOOD IDEA GIVEN HIS RETIREMENT SAVINGS, SOCIAL SECURITY, PENSION, AND MINIMAL DEBT.

So our title question comes from Rich, who is considering an annuity. So, here's Rich's comments and question. Hey Roger. I listen to the show all the time and I love it. So I have $2 million in retirement savings at Fidelity with one portfolio, my Roth account, professionally managed by Fidelity, and the remaining portfolio self directed by me. I have been assigned a Fidelity wealth manager and we've been working together for a bit now. And I really like him. He seems straightforward. Because I don't have much of a legacy to leave my money to, he's recommending a flexible premium deferred income annuity offered by, he names a company basically for $436,000 payment upfront, I can get $3,000 a month for the rest of my life, which it works out to about an annual payout of about 8.24% until I die. And there's some death benefit that can be factored in there with my Social Security benefit, my pension. And if I bought the annuity, I would have a monthly salary in retirement of about $7,800 a month without touching my investments. Currently own a home, and I have about $1,800 a month payment on it and no other debt. My question is, do you think this particular annuity is a good idea? For me, I think it is, but I wanted to see what you think. I always trusted fidelity and never had a problem with them. so obviously I can't answer this question for you, Rich. I don't. Don't even know your age, so there's a lot of missing information. And even if you gave me the age, there's a lot of considerations to come in here that come into play here. So let's talk about some of the things to consider. Rich, as you navigate this, my first question is, what is it you are trying to achieve with this decision? It sounds like this was a proposed product rather than something that you were seeking out. Now, that is not necessarily bad, but it's something to understand. It's a solution looking for a problem, not a problem that you articulated that you had, that you went looking for a solution for. And there's an importance in that difference, that differentiation. So what is it you're trying to achieve with your retirement plan? In my world, you would already have a retirement plan of record where you've mapped out your base great life, your wants and your wishes. You would organize your assets, you would know the feasibility of it and how funded you are. You overfunded or underfunded, and then you would have made it resilient in some way. This is going to be an optimization question of the pathway to have a feasible, resilient plan. Without that, that is table stakes for me. So without those things, you're a little unmoored in terms of filtering an offer of a product or go off and trying to find a solution. So I would suggest following that protocol first, because you're going to be in a much better position to make a decision. Now, how does this annuity fit into that plan of record? Again, if you have that scaffolding, you can figure that out. Now, why would you buy an annuity like this? And this is something Kevin Lyles and I talk a lot about in the club, we talk a lot about it on the show, is if you have a feasible plan that you already know is resilient. It's important outside of the math of whether it's the best investment to make sure your withdrawal strategy empowers you or gives you the comfort to actually rock retirement. And that is going to be a qualitative decision based on who you are. So even if the math says you can be 100% equities and just sell when you need it, you can easily go on that roller coaster and be fine. It doesn't mean you want to like, I physiologically can go on a roller coaster. And all the math would say I'm great with that, but I don't go on them anymore because I just don't enjoy them. And that is important. You need to have a retirement strategy that you are comfortable with regardless of what the math says. And that is the difference between a safety first approach versus a systematic withdrawal approach, et cetera. And the RISA, which is a personality test that helps identify what, what that qualitative aspect is for you, was created by Wade Pfau and the People at Retirement Research. We'll have a link to that in the show notes or in our excuse me, in our noodle email. Might be worth spending, you know, the 70 bucks or whatever it costs to take just to take that self assessment to see if you lean more to a safety first approach. and by the way, we're going to do a theme, a month long theme in 2026 on how do you implement a safety first approach. I'm working on the 2026 content calendar for the show. So we'll dive into that in a more organized way. But essentially rich. Using an annuity like this to give you guaranteed income for as long as you live, which when combined with the other income sources gives you $7,800 a month, is a way of implementing a safety first approach. And you have about 2 million in assets. You're using about 436,000 to purchase this pension. Essentially you're taking your money and you're basically buying a pension that leaves you about one million and a half dollars or a little bit more to be invested or to have liquidity. So that's a reasonable amount. I like that because you still have a lot of liquidity for using your money in retirement. And perhaps having this guaranteed income source gives you more comfort in spending your money because you know you have this fail safe of this pension plus your annuity, plus your Social Security I think that is a safety first approach, which I think is totally appropriate.

So first is, what are you trying to achieve? And do you want to have a safety first approach or do you need to have one? If the answer is yes, then an annuity can definitely be a part of giving you that comfort and confidence to rock retirement. So let's assume that's the case here, Rich. You do this and you say, yeah, I would love just to have this taken care of. And I know, you know, worst case, I'm going to have this income and it helps protect me against fraud. When I get older, I don't have to worry about managing assets. It just simplifies my life and maybe allows you to spend a little bit more because you have this backstop. Let's assume that's the case. Then the next question is, is this the best annuity to achieve that? That is separate from whether this is something you're trying to solve for. If we assume it's something you're solving for, is this the best annuity? It's the one that you were presented with. So it's easy to focus on that one first. But I would recommend, Rich, that you shop around and look at what annuities are available that will give me what I want. That way you can use the best tool or, you know, there's never the best, but you can feel comfortable that this is an appropriate tool and you're not short changing yourself just simply because this is what was presented to you. So when you're implementing this type of approach, Rich, you're essentially going to look at a few different types of annuities. You're going to look at the type that you mentioned, a flexible premium deferred annuity. You're going to look at maybe a single premium immediate annuity or single premium deferred annuity. You could also look at an indexed annuity. Now, an indexed annuity is a little bit more like a Twinkie. It has all these bells and whistles and they get a bad rap for a lot of really good reasons. But sometimes they may give you a higher guaranteed payout than the more organic products like the one that you're looking at. So when you're looking at different types of annuities, here's my suggestion. Obviously have companies that have a relatively good credit rating and pay close attention within the illustrations that they share on the annuity to understand what is the worst case scenario in terms of guaranteed income for the rest of my life or your life, Rich, because like, here's A good example, an indexed annuity generally is sold because of all the bells and whistles, downside protection, you can still have growth. And all these projections, projections of things that could happen, that's generally why they're sold. That's the Twinkie part of it. But many of them would have a guaranteed minimum payment even if none of that stuff worked out. So whatever kind of annuity you look at and including the one you're looking at now, don't look at projections of, hey, this is what you know based on these assumptions, this is what we think you can get look at if everything goes wrong, what's the minimum payment that I'm going to get for the money I'm giving you? And for the most part ignore all the potential upside and bells and whistles. So if you're going to shop for different annuities, that's the area you want to focus on. I'm trading my money to buy a pension. Everything else might have some benefit, but it's pretty much just noise. So I'm not saying there's anything wrong with this particular annuity, but I think if you want to have a safe first approach, it makes sense to shop around. Now, your Fidelity advisor, who you feel straightforward and likely they are, they may say, well, can you show me two or three different options outlining? I want a high, you know, high credit rating and I want to know what the worst case scenario of a payment I can get for the money that I'm going to give you and ask for different options. And again, we're going to dive into this a little bit more deeply. But this is one reason why you want to have a plan of record so you can think through these things in a more organized way. Now, as I'm sitting here thinking about your situation, Rich, there's a lot more nuance to this. You know what the incentive structures of the person that's presenting the product are, the tax consequences depending on how you do it, your comfort level, and how to read these types of illustrations. This is why we'll do a longer theme on this in 2020. And hopefully this gives you at least some basic things to think about as you navigate this in your future.

A LISTENER ASKS HOW TO DETERMINE HOW MUCH THEY CAN SAFELY GIVE TO LOVED ONES OR CHARITY NOW, RATHER THAN LEAVING IT AS AN INHERITANCE LATER.

So our next question is one of my favorite questions because it's an audio question.

Listener: Hi, Roger and everyone else on your team, thank you so much for the recordings, the podcast. I appreciate them and your help. To those contemplating or in retirement, I have a question. I'd like to treat loved ones to experiences while we can enjoy them together. How do I figure out how much I can safely spend on or gift to others now instead of leaving money to them after I die. I frequently hear the example that goes something like this. It's probably more impactful and appreciated to help a 30 year old with a down payment for a house or money towards the wedding than for that person to inherit a larger sum in their 50s or 60s. So my question is what process this one used to figure out how much one can safely give to such person or even to a charity?

Roger: It's a great question, how do you approach that? Because you might need the money and a lot of this is going to have to do with how old you are, how well funded you are for your retirement. So first things first, you need to feel very secure that your base great life, which are the basic spending plus the simple joys that you want to have in life, that you know that that is feasible and you've made that resilient and you have clarity that you are okay. That's job number one before even considering this. Now let's assume you've done that and that means you're going to have a feasible plan of record which is you've outlined what you think your spending needs are going to be from now until when you first, you know, estimate you're going to pass and you factored in your Social Security, any other income sources that you've had and you factored in the assets you have bank accounts, 401k accounts, IRAs, and you run a feasibility test using software. a good free one is bolden used to be new retirement. Any good financial planner can run a feasibility test and then explore whether you are really constrained and it should work, but it might not, or whether you're overfunded or whether there's other issues to deal with. You have to do that first and then make your plan resilient by mapping out exactly how you're going to provide for your life, at least for the near midterm, meaning the next three to five years. You want to have clarity on that first in an organized way. And that's what we talk about. That's all process, that's table stakes before we even think about giving money, whether it's to a charity or to someone else or to spend money on experiences.So that's step one.

We talked a little bit about this last month when we talked about goals and here's how I would suggest that you approach it. Let's assume it's creating experiences rather than thinking about what you can do each year. Come up with something that you would like to do next year, that you would like to contribute money to create that experience. Let's assume it's something local that you want to spend money on. It can be as small as to go to a festival together that's somewhere within driving distance. That cost maybe $3,000, which still seems high for the tickets and a hotel room for the night or two for whoever. You want to do this with something really local and simple that will create an experience. This doesn't have to be going around the world or anything. Come up with something that you know the people in your life and you would enjoy doing together. It could be as simple as going to a Renaissance fair and treating everybody to that and maybe a night at the hotel and a dinner. Find something because it doesn't matter how big it is, it's a matter that it creates the environment or the conditions for you to have that experience. So just think of something for next year. And then now that you've already had the table stakes of having this plan together, let's assume it's $3,000. Add this to your plan of record saying, what if I spent an extra $3,000 next year and see how that impacts the bigger plan for you. It's as simple as that. Rather than thinking if you want to do this in multi year bites, start getting very low risk repetitions in and just do it year by year in very low and maybe you feel comfortable and you do the 3,000 and you saw that it didn't have a huge impact on the long term viability of your plan. So in 2026 you start thinking about 2027 and maybe it's renting a lake house or a VRBO or something bigger. And again you could swap that out for giving to charity or giving money to someone to help them replace their air conditioning or whatever. But I think the way to approach this is first to know your plan is safe and solid and then do some low stakes tests to achieve the result you want. Because it's not about it being exotic or being big or monumental. It's about creating the conditions to achieve what you want. And you use the example of experiences that don't actually have to cost a lot of money. That could just simply be buying zoo passes for everybody. So hopefully that helps you on your journey. With that, let's go set a smart sprint. On your marks. Get set. And we're off to set a little baby step we can take in the next seven days to not just rock retirement, but rock life.

SMART SPRINT

All right, in the next seven days, I want you to do an estimate of what your required minimum distribution is going to be. Even if that's like 10 years away. Get a read as to what that will be if you don't touch your IRA or 401k, assuming some reasonable growth rates. We'll have links to two calculators that can help you do that. I think dinkytown.net is also one. We'll have a link to that one as well. That way you can get a sense for how these will factor into your retirement plan.

CLOSING THOUGHTS

So, a little update on Tanya Nichols and my merger. We officially merged our advisory firms in August. Wow. It's been a little bit now and all the work's begun and the technology ends and getting the team synced and process and everything else. One thing we're working on is the branding for our newly branded firm. So her firm was Align Financial, mine was Agile Retirement Management. And we're still operating under those names. But in 2026, we are going to have a merged name of Retire Agile. Very exciting. Which means we're going to have a unified website, we're going to have new colors and branding, we're going to have, you know, defined very clearly who we work best with, etc. So going forward we may share. At the end of this show, I'll share little updates on this and in the noodle email, it'd be great if you gave us feedback on the color palette and the fonts, etc. Because you're the people that we work with every day and we want to, you know, have you be involved in this. So you can look forward to that if you're interested here in the coming weeks and we may do some polling to get your feedback on what this new unified brand might look like. Hope you have a wonderful day.

The opinions voiced in this podcast are for general information only and not intended to provide specific advice or recommendations for any individual. All performance references are historical and do not guarantee future results. All indices are unmanaged and cannot be invested in directly. Make sure you consult your legal, tax or financial advisor before making any decisions.