Hybrid Index Annuities Works. How An Exciting Family of

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1 How An Exciting Family of Hybrid Index Annuities Works Index annuities provide the guarantees of fixed annuities combined with the opportunity to earn interest based on potential market index gains without directly participating in the market. This exciting family of hybrid annuities offers enhanced benefits, including guaranteed* income that may increase every year (with purchase of rider**)

2 Table of Contents How Index Annuities Work A Closer Look at the Guarantees* and Liquidity of Index Annuities Income That You Can Turn On or Off as Needed Crediting Methods and Cap Rates Income Riders** Illustrating a Family of Index Annuities Withdrawal Percentages How a Fixed Index Annuity Might Save You $100,000 or More How This New Family of Hybrid Index Annuities May Provide You with More Income per Premium Dollar than Other Fixed Annuities Comparing Annuities: The Big Picture With a Nonvariable Annuity, Your Principal Is Protected Do You Feel Your Retirement Is Well Funded? Why Government and Corporate Employees Are Coming to Love Annuities We Can Help Find the Right Annuity for You: The Services Offered by J. D. Mellberg Financial Index annuities provide the guarantees of fixed annuities, combined with the opportunity to earn interest based on potential market index gains without directly participating in the market. This exciting family of hybrid index annuities offers enhanced benefits, including guaranteed* income that may increase every year (with purchase of a rider**). * Annuities are contracts between you and an insurance company. Annuity product guarantees rely on the financial strength and claims-paying ability of the issuing insurer. **Annuity riders may be available for an additional annual premium that may provide additional benefits and income guarantees. This report is meant to provide general information on issues that many people consider in making the decision as to whether or not they should buy annuities; and if they do decide to buy, which types of annuities and which annuity benefits and additional riders will best suit their goals and needs. This information is not designed to be a recommendation to buy any specific financial product or service. Joshua Mellberg is an independent Registered Investment Advisor in the state of Arizona and insurance licensed in all 50 states. All employees of J.D. Mellberg Financial have the appropriate licenses for the products they offer If you are unable to access any article referenced above, please call to request a copy.

3 How Index Annuities Work In this report, we will explain to you how index annuities work. We will also introduce you to a family of index annuities that offers a new combination of features and benefits. We will also address how annuities may supplement or enhance your retirement income, even if you have a pension or 401(k) plan in place. Index annuities offer an interest payment (or interest crediting), which is based on a percentage of the gains of a major stock market index such as the S&P 500. Index annuities give you the potential for upside increases in value with limited or no downside. One of the most attractive benefits of index annuities is that there is no risk to principal when the stock market declines. The annuity premiums (the funds that insurance companies collect from clients) are used to purchase government bonds, highest-grade corporate bonds, and A-rated real estate to deliver income to the insurance company that is considered to be conservative and relatively consistent over time. These conservative bonds, along with high-quality industrial and commercial real estate help keep your annuity principal safe, because it is not affected negatively by stock market volatility. The insurance company uses the interest payments and real estate revenue to support their interest rate guarantee* to policyholders. No matter how far the stock market might decline to the downside, the insurance company and its clients (including you and your family members who own annuities) are not affected, because the insurance company has not placed annuity premiums in individual stocks or mutual funds. This protection from downside losses distinguishes index annuities from variable annuities. With variable annuities, insurance companies do use funds received from clients to buy individual stocks and to invest in mutual-fund-type investments, which are called subaccounts. For this reason, variable annuities may lose a portion of their principal due to stock market losses during a time period when index annuities have no losses to principal. This guarantee* of no loss of principal comes with certain limitations. As you have probably already learned in life, there are very few guarantees that are unconditional and everlasting. Whether you buy a new television, a car, or almost anything else, the guarantee that comes with it is likely to have a number of limitations and exclusions. Let s take a look at the limitations on the guarantees offered by index annuities J.D. Mellberg Financial Copyright All rights Reserved Page 2

4 A Closer Look at the Guarantees* and Liquidity of Index Annuities If you take an early withdrawal from your annuity (a withdrawal that is more than 10% of the principal amount each year), this withdrawal could affect some of the guarantees. You may or may not find this to be restrictive. For example, if you have $200,000 in an annuity, you could, in many cases, withdraw 10% per year ($20,000) without any penalties and without affecting the annuity guarantees. How is that for liquidity? Please note that withdrawals outside of the annuitization structure can reduce the death benefits of the contract. You should also be aware that taxable amounts (on earnings from the principal) withdrawn prior to age 59½ may be subject to a 10% IRS penalty in addition to ordinary income tax. Most annuities also have a surrender period for the first five to 15 years of ownership; early withdrawal will deplete your principal by the amount of the surrender charge still in force. Withdrawals and/or a full surrender of your index annuity contract during the surrender charge period may be subject to withdrawal charges and market value adjustments. Over the course of ten years, you could withdraw virtually all your annuity without paying surrender charges. Most of our clients, however, have no intention of doing so. They would much rather enjoy the annuity s income stream for the maximum amount possible, which is guaranteed* for life, no matter how long they may live! Even if you lived to be 120 or older, your annuity would continue to pay you all the income it promised,* each and every year! How many other savings or investment vehicles can you think of that offer this benefit? Income That You Can Turn On or Off as Needed Blended or linked annuities are also called hybrid index annuities. This is the term we coined to describe this family of annuities, and it has become very popular. Therefore, we will call them hybrid index annuities in this report. Hybrid index annuities may offer more benefits and more enhanced benefits than certain other annuities through the purchase of newer types of riders.** They also offer features that can allow the hybrid index annuity to act something like a personal pension, providing a lifetime income stream in retirement. This special family of annuities can also give you better control over your money you can get to your money if needed, and can start receiving payments if and when you want to receive them. You can turn on and turn off your annuity income stream at will J.D. Mellberg Financial Copyright All rights Reserved Page 3

5 You know why you would want to turn the income on, but why might you want to temporarily turn the income off? Let s say that you received an inheritance, sold a piece of real estate, or took some money out of your stock market investments. You might very well have all the income you need for that year. You currently have no need for the extra income your annuity provides. Why not let your gains stay in your annuity, so that they can potentially grow even more? Please note that when we write of gains in your annuity, we are not speaking of stock market gains. These are gains in interest credited to your principal. The amount of interest you receive is based on index activity in the stock market. Gains are attributed via a formula that is established in the insurance company contract. Different insurance companies use different interest rate crediting formulas. There are a variety of methods and formulas available, as we will discuss in detail in the next section. The crediting method to be used is disclosed before you purchase an annuity. Whichever crediting method is used, your index annuity will pay you guaranteed* income for life all index annuities do. However, hybrid index annuities also offer riders** that can provide guaranteed,* ever-increasing income for life. There is an extra charge for riders. However, many people have decided that the extra charge is well worth the cost for the benefits they could receive. For that reason, several types of riders have become very popular, including the inflation rider. Just as its name implies, this rider offers a hedge against inflation. Since we are unlikely to experience a year with no inflation, a hybrid index annuity with an inflation rider** will pay out a guaranteed,* ever-increasing income each year to help overcome the lessening spending power of your principal. Please note that once you decide to turn on the income stream from your annuity, the income withdrawal percentage is locked in for life. The income withdrawal percentage can usually not be increased. However, there are cases in which your income can be increased if you need long-term medical or nursing care, provided you have purchased an inflation rider** or a confinement benefit rider.** (Please note that the confinement benefit rider may not require confinement to a nursing home to pay a higher level of interest. Under the terms and conditions of many confinement benefit riders, if you require long-term medical care or nursing care that you can receive in your home, you can still receive a higher rate of interest from your annuity. You need to carefully read the annuity contract and any riders you are considering to ensure that the benefits you want are provided.) Another benefit offered by many index annuities is specific control over how your money is paid out. You have an option for income payments made to yourself and/or another individual for a guaranteed period of time. (For example, you might want income payments to be made for 20 years to one of your children or to a favorite charity.) Some parents are concerned that J.D. Mellberg Financial Copyright All rights Reserved Page 4

6 if they leave a great deal of money to their children in lump sums, the children (even adult children) might misuse it. Additionally, a child may need special care, or work in a highsatisfaction but low-income career. The fact that the annuity can space out cash distributions to help support that child over 20 years (or another selected period of time) gives these parents greater peace of mind. Crediting Methods and Cap Rates We believe it is important to choose an annuity that locks in increases in value as often as possible. In annuity parlance, this is called ratcheting or ratcheting up. Think of two different annuities where one ratchets every year and the other ratchets every two years. The longer it takes to lock in increases, the higher the probability of losing any increases due to market volatility. If your annuity ratchets every year, you will be able to lock in increases every year in which the stock market goes up. In a down year, you will not lose money. Thus, over each and every year, your annuity can only move in one direction: UP. If it does not go up in value, it will maintain its current level. No matter what the stock market does, your annuity will not decline in value during any year if you have an annual lock-in of the highest value. Compare this to an annuity that ratchets every two years. Let s say that in the first year the stock market goes up 15%. In the second year, the stock market declines by 16%. If your annuity only ratchets every two years, you would show no increase for this two-year period. However, with a one-year ratchet, you would have locked in increases for the first year and you would not have lost a penny of your annuity s value during the second year. The growth of your annuity will be based on the index to which it is tied. Some of the most commonly used indices are the S&P 500, the Dow Jones Industrial Average, and the NASDAQ 100. Once a product is identified that is tied to an index you want, there may also be options for the crediting strategy you want to use. From our research, we have concluded that there are two crediting methods that are the most successful. 1. Annual point-to-point: This crediting strategy resets annually and compounds, but will not outperform the index in a big up year because of rate caps. Just as its name implies, a rate cap places an upper limit on just how high a percentage the annuity s return can be in a given year. This is the trade-off for nonexposure to the stock market receiving the benefit of the annuity never losing money, no matter how much J.D. Mellberg Financial Copyright All rights Reserved Page 5

7 the stock market might decline. In figure 1, the annual point-to-point rate cap is 8%, which means that this is the highest interest rate the annuity will pay during a given year, regardless of how high the stock market might rise. Some retirees wonder, How will I feel if the stock market has a spectacular year and I only make 8%? Obviously, if the stock market rises by 10% and you receive 8% interest in your annuity, you probably won t be too concerned. After all, you would have only missed 2% and you didn t have to deal with all the volatility of the stock market over the course of a year. But as you know, the stock market does have some strong positive years during almost every decade. For example, in 2003, the S&P rose 28.69% and in 2009, it rose 26.46%. The 1990s had several years with even stronger gains. What concerns more retirees is the possibility that the stock market might have a very strong year and they might miss a good portion of the gains. Figure 1 shows a hypothetical example of S&P 500 returns during a year where the starting value is 1,000. As you can see, the index gains 24.70%, but the investor only gains 8% because of rate caps. Figure 1 Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec S&P 500 1,053 1,031 1,044 1,118 1,104 1,123 1,114 1,157 1,194 1,209 1,222 Gain 5.30% 1.23% 7.10% 1.70% 1.90% 1.10% 3.17% 1.30% 1.10% Loss -2.10% -1.20% Total Return Actual Return 1, % =24.70% =8.00% Based on stock market history, this is the kind of return you might realistically expect to occur at least once every decade. Even during the Great Depression there were some very strong up years. For example, the S&P gained 53.99% in 1933, 47.67% in 1935, and 33.92% in ( Please bear in mind that annualized gains of 24.7% are very rare. The good news is that with a hybrid index annuity, you do not need to have the stock market rise anywhere near this much to benefit. In fact, during almost any year in which the stock market rises, your index annuity should benefit. The stock market tends to rise about 10% in the average year (i.e., it rises on average less than 1% per month). The well-known and highly respected research of Ibbotson Associates has found that from 1925 to 2004, small stocks returned on average 12.7% per year, and large stocks returned on average 10.4% per year J.D. Mellberg Financial Copyright All rights Reserved Page 6

8 There are some highly respected investment managers, such as Bill Gross of PIMCO, who believe that both stock and bond returns are likely to be below normal in the next few years. Bill Gross, whose firm manages approximately $1 trillion in assets, has spoken and written extensively about what PIMCO calls the new normal an extended period of time during which most asset classes will have subnormal returns. (Gross, William H. (Jan 2012.) Towards the Paranormal. Insights. Therefore, it may not be realistic to assume stock market returns will match their historic returns of about 10% per year. However, during those years and during almost all years in which the stock market rises, your hybrid income annuity should increase in value. The annual point-to-point crediting method could get you 80% of this average gain (8% crediting, based an annual 10% return) with none of the downside risk of the stock market. As previously noted, the stock market will not go up 10% every year. In years during which the stock market has returns that are near its average return, the annual point-to-point crediting method could match or outperform the monthly pointto-point crediting method For the protection of your principal, index annuities do not directly participate in individual stocks or the stock market. Rather, your annuity is credited with an interest rate based on the percentage gain in a stock market index or bond index. Index annuities are not insured by the FDIC, but do have other protections, which we will discuss later in this report. 2. Monthly point-to-point: The risk with the monthly point-to-point crediting method is that several months of bad performance can wipe out many months of gains. The cap or limit on gains is a monthly cap, but your gains are usually not locked in until the end of the year. Figure 2 shows an example of this crediting strategy using a 2.5% monthly cap rate with a maximum 30% annual gain (2.5% x 12 months). To make a fair comparison between the annual point-to-point and the monthly point-to-point crediting methods, we used the same monthly S&P performance data. You will notice that in January, the S&P rose 5.30%, but the annuity was credited with only 2.50% interest because of the monthly rate cap J.D. Mellberg Financial Copyright All rights Reserved Page 7

9 Figure 2 Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total Return S&P 500 Positive Negative 5.30% 2.50% -2.10% -2.10% 1.23% 1.23% 7.10% 2.50% -1.20% -1.20% 1.70% 1.70% 1.90% 1.90% 1.10% 1.10% 3.17% 2.50% 1.30% 1.30% 1.10% 1.10% 2.03% 2.03% =14.56% As you can see, the sum of the gains and losses determine the percent credited to the account. In this case, given the same performance data, the monthly point-to-point method outperformed the annual point-to-point method (14.56% interest paid vs 8% interest paid). There are a number of other crediting methods which we would be happy to explain to you. Before you select an annuity, we will provide you with guidance on what your best options might be at that time. Remember that no one can precisely predict what the stock market will do tomorrow, next month, or next year. For this reason, you may wish to diversify your crediting methods and purchase two annuities one with the annual point-to-point crediting method, and one with the monthly point-to-point crediting method. Then, if the stock market experienced one of those rare, very high return years, the monthly crediting annuity could do extremely well. However, if the stock market had more of an average year with steady (but relatively low) monthly gains, the annual crediting annuity could give you a higher return. By diversifying between two crediting methods, you may avoid the challenge of trying to guess how the stock market will behave over the next year. No matter what the stock market does, as long as it rises in value, you should enjoy an increase in value. And, if it falls, you will not lose any money all of your principal and gains from prior years will be protected! Income Riders** Some of the primary benefits of income riders are: The ability to retain access to the initial purchase value of your annuity The ability to turn the annuity s income stream on or off as desired The ability to withdraw a portion of your annuity s value every year without penalty J.D. Mellberg Financial Copyright All rights Reserved Page 8

10 In many cases, you can withdraw about 10% of the value of your annuity each year without paying an early withdrawal fee or a surrender charge. Withdrawals will, however, reduce the policy value and death benefit. Additionally, most annuities have a surrender period for the first five to 15 years of ownership; early withdrawal will deplete your principal by the amount of the surrender charge still in force. If you are under the age of 59½, you may have to pay a fee to the IRS for early withdrawals from your annuity. In the past, when an annuity account was annuitized (the income stream was started), the client lost control of the money in exchange for the guarantee* of receiving regular income payments from the insurance company. (The income stream could have been for a predetermined number of years, or for life.) When the retiree passed away, some contracts also stipulated that all payments stopped. If there was money still left in the account, it stayed with the company and did not go to heirs or beneficiaries of the annuitant. While annuities like that can still be purchased, a newer generation of fixed index annuities offers enhanced benefits that many retirees desire. With some of the new hybrid index annuities, you do not lose control of your money. Instead, you now have the ability to turn on income payments when you want them and to turn them off when they are not needed. By turning off the income payments, you could significantly reduce your taxes. Then, whenever you desire, you can turn the income payments back on. (See each annuity contract for specific features and limitations.) Depending on the length of time the income stream is turned off as well as the features, benefits, and riders of your annuity, when you turn on income payments again later in life those income payments could be bigger than ever! With almost all index annuities, you now have the ability to have your annuity cover the lifespan of two people. After you pass away, your annuity could continue to make income payments to your spouse for as long as he/she lives. And if your index annuity also has an income rider,** you and your spouse might both have the ability to turn on or turn off the income stream as desired. When one of you passes away, the surviving spouse might be able to retain this ability to turn income on or off whenever needed. The exact features and benefits of income riders differ among insurance companies offering these annuities. If this benefit is important to you and your spouse, make sure you read the annuity contract and rider language before you buy the annuity to make sure the income rider will have the benefit you want. We are happy to answer any questions you have about the exact benefits offered. When you work with us, we will show you annuities that allow the owner to receive a guaranteed income stream and have the ability to take out a large sum of money if an unexpected need arises. If you take out a large sum, this may reduce future income rider withdrawals. A very J.D. Mellberg Financial Copyright All rights Reserved Page 9

11 large withdrawal could result in a termination of the rider and all future income withdrawal amounts. But that can be prevented. We will show you how to avoid, and how to get the maximum possible benefits from your annuity. Let s say that a medical emergency arises for yourself or a loved one that is not covered by insurance or Medicare. With some of the newer annuities, you could take out money to insure that the best medical care can be obtained in a timely fashion. You can also make a large withdrawal for a happy emergency. For example, your daughter finds out she is expecting twins. You could take out money to help her furnish the new babies room or start a college fund! Depending on the amount of money you withdraw, your future income stream could be reduced. However, the choice will be yours: YOU will have control of YOUR money and will be able to use it in the manner YOU want to use it! And, you will still continue to receive a guaranteed* income stream based on the new value of the annuity. The payout amount for index annuity income is determined by a growth factor based on the client s age and income account value (which is not the accumulation value). This growth factor will vary among insurance companies and the different annuities each company offers. It is important to comparison shop to find a growth factor that might best help you reach your goals. The growth factor of any annuity might be affected by the purchase of an income rider.** An index annuity might credit your income account with 4% to 8.2% annual growth, depending on the insurance company and the annuity selected. At J.D. Mellberg Financial, we are skilled in finding suitable annuities for our clients those that offer the highest annual growth crediting and other benefits you may desire. Please note that with a basic index annuity, before your income stream starts, your account value may not grow if the stock market is flat or has a negative return. Your annuity will not lose value, but it will also not grow in value during these times. With an income rider, your annuity may have the ability to continue to grow in value as long as income is not taken. In the tables and charts we present, you will see the term Income Account Value. This term refers to the dollar amount upon which your guaranteed income payments will be based, whether the annuity illustrated is a basic index annuity or an index annuity with an income rider. Please keep in mind that the income account value is used to calculate income and is not the same as the accumulation value. Since the account is growing every year income that is deferred, the longer you wait to turn on the income, the higher your income payout will be. When you purchase an income rider,** the dollar amounts in your income account value will grow every year prior to the payout phase even if the stock market declines in value! J.D. Mellberg Financial Copyright All rights Reserved Page 10

12 Figure 3 shows the performance of a hybrid index annuity versus the S&P 500 for the period of As you can see, the S&P 500 has been volatile over the last 12 years. Investing $100,000 in the index would have lost an investor $5,884 during the time period shown. If you had invested the same $100,000 in some of the available mutual funds, you would have lost even more money, as many mutual funds did not match the performance of the S&P 500 over the past decade. ( StocksForStudents.pdf, and Figure 3 This chart was produced by researchers at the office of J.D. Mellberg Financial. As figure 3 shows, instead of losing money over this recent decade, your hybrid index annuity with an income rider** would have significantly increased in value. The income account value would have been increasing up to an annual rate of 8.20%, compounded. The account value of your annuity increased during positive stock market years and stayed level (did not lose money!) during negative stock market years J.D. Mellberg Financial Copyright All rights Reserved Page 11

13 Illustrating a Family of Index Annuities Now that you know how an index annuity works, let s take a look at a family of hybrid index annuities that we find to be very interesting. Please note that unless otherwise stated, all examples shown are hypothetical; they are based upon facts and figures currently available. However, the features and benefits of any annuity can be changed by the issuing insurance company based upon changes in interest rates, stock market returns, and other economic variables. Depending upon the annuity you select and when you decide to buy it, the returns and income stream of your annuity may vary from the returns and income streams shown in the examples provided here. Figure 4 shows the income available from one hybrid index annuity for a 70-year-old person who places $100,000 in the annuity. The calculation shown reflects an 8% return on the accumulation value before the income stream begins. There is a range on the returns different annuities pay on their income account values. The 8.0% in this example is one of the highest returns currently available. (This return may or may not be available when you decide to buy an annuity.) The income account value is growing at a compounding rate, and grows to $317,217 in 15 years. Keep in mind that the income account value is only used for the calculation of income and is not the same as the accumulation value for purposes of withdrawals and death benefit. Taking a closer look at figure 4, you can see that if the annuity owner decides to turn on income stream at age 73, he/she will have a withdrawal percentage of 6.30%. The longer he/ she waits to turn on income stream, the higher the withdrawal percentage will be J.D. Mellberg Financial Copyright All rights Reserved Page 12

14 Figure 4 End of Year Income Account Value (compounds at 8%/yr) Withdrawal Age Percentage Income Issue 70 $100, % $6,000 $12, $108, % $6,588 $13, $116, % $7,232 $14, $125, % $7,936 $15, $136, % $8,707 $17, $146, % $9,551 $19, $158, % $10,473 $20, $171, % $11,483 $22, $185, % $12,586 $25, $199, % $13,793 $27, $215, % $15,112 $30, $233, % $16,555 $33, $251, % $18,131 $36, $271, % $19,853 $39, $293, % $21,735 $43, $317, % $23,791 $47,583 This chart was produced by researchers at the office of J.D. Mellberg Financial. Home Healthcare Doubler Another annuity rider available for an extra charge with some contracts is the long-term care doubler.** For example, in year 5 of this annuity, when the owner is 75 years old, the guaranteed* annual income is $9,551 no matter what the stock market does. However, if he/she is confined (cannot perform some of your activities of daily living), the annual income will DOUBLE to $19, J.D. Mellberg Financial Copyright All rights Reserved Page 13

15 There are certain conditions that must be met in order for the long-term care doubler to be triggered. Most long-term care riders** use activities of daily living (ADLs) that a person is not able to perform unassisted, to determine if a person qualifies for the doubling of annual income. The annuity policy you will receive will have a specific list of ADLs that are considered, but some general examples are: Bathing Eating Dressing Walking Taking medications Getting in/out of beds/chairs Please note that you do NOT have to be unable to perform all of these activities. Depending on the annuity policy selected, you may only need to be unable to perform two or three of the activities unassisted on the list to receive up to a doubling of your annual income. Withdrawal Percentages Earlier in this report, we discussed having an annuity that locks in increases as often as possible. This same idea can be applied to withdrawal percentages and income. In most cases, you will benefit from owning an annuity that requires less time to increase your withdrawal percentages. Consider an example where the product features for two annuities are exactly the same, with the exception of how often withdrawal percentages increase. One increases the withdrawal percentage annually, and the other increases the withdrawal percentage once every 10 years. Which annuity might be more suitable for you? While the payout amounts are the same on both annuities for certain ages, the income amounts are higher for the years in which the withdrawal percentages show annual increase. Therefore, you will likely want to select the annuity that increases withdrawal percentages annually (if that annuity has the other features and benefits you want) J.D. Mellberg Financial Copyright All rights Reserved Page 14

16 Figure 5 contains examples of the different payout amounts we have seen for annuities. Figure 5 Annuity Payout % at Age 60 Payout % at Age 65 Payout % at Age 70 Payout % at Age 75 Payout % at Age 80 Payout % at Age 85 Payout % at Age 90 A B C* 5* 5.5* 6* 6.5* 7* 7.5* 8* *Compounds annually. 5% at age 60, 5.1% at 61, 5.2% at 62, etc. up to 8% at 90. A retiree may want to take income at a step-up age. (This may be referred to in the annuity contract as an optional reset age.) There is no difference in payout for regular step-up ages between the annuities shown. If two people with any of these annuities wanted to start their income at age 70, the payout would be 6% per year. However, if the retirees wanted to turn on their income at odd ages years other than those identified as step-up ages there could be a big difference among the three annuities. Annuity C increases the payout amount annually. If a retiree wanted to turn on his/her income at a interim age, he/she might benefit by selecting Annuity C, gaining thousands of dollars of income over the retirement years. There might be other differences between these three annuities that would lead you to select one over the other two. Even though each of them might have the same payout rate, one annuity might have additional benefits that make it more attractive to you. How a Fixed Index Annuity Might Save You $100,000 or More Let s take a closer look at how a hybrid index annuity might help you save a significant amount of money. Figure 6 illustrates that Annuity A offers: A withdrawal percentage that increases every year One of the highest bonuses in the insurance industry One of the highest available income account value growth rates J.D. Mellberg Financial Copyright All rights Reserved Page 15

17 This combination of benefits in one annuity may be worthy of your consideration. Of course, you need to remember that bonus annuities may carry higher fees and charges than annuities without the bonus feature, and may not pay the bonuses in case of early withdrawal. For this case study, we will use a hypothetical example (as we do throughout this report). John Adams is a 55-year-old client who wants $3,000 of monthly income, ($36,000 annually), beginning with payouts in 10 years at age 65. John s goal for this annuity is to provide that $36,000 per year to supplement his social security. John shared his objective for the annuity with his regular insurance agent, who told John that he would need to pay a $402, premium for a standard index annuity to achieve this income goal. While John did have that amount to spend on an annuity, he was a little disappointed that an annuity would require that sum of money to produce what he needed. He contacted us. We spoke with John at length about all of his goals and dreams for retirement. We also went over his finances and his tax situation. (We do a thorough interview like this to make sure that an annuity is appropriate and suitable for someone before we recommend any annuity or any other financial product or service.) We determined that an annuity was a suitable way for John to reach his objective. Then we used all of the data collected to help him find an annuity that might best help him. In this case, we found Annuity A as illustrated in figure 6. John s insurance agent had found a standard index annuity, labeled Annuity B. This example includes all fees, but it does not include taxes, as the tax rate for different individuals reading this report could vary significantly. In addition, your tax rate could vary from year to year in retirement depending upon whether you had outside employment (either full- or part-time), you sold stocks, bonds, or real estate during the tax year, and whether or not you had gains or losses on those sales. Bear in mind that you do not have to pay taxes on a return of principal; you only have to pay taxes on those portions of annuity payments that represent interest received. When we refer to income here and throughout this report, we are referring to pretax income. You should consult with your CPA or tax advisor to determine what taxes you might owe on the income you receive. During years in which you let your annuity s value grow and do not take any distributions, you will not have to pay any taxes. Your annuity is what is known as a tax-deferred vehicle J.D. Mellberg Financial Copyright All rights Reserved Page 16

18 Figure 6 Account Details Annuity A Annuity B "Hybrid" Index Annuity Standard Index Annuity Premium $303, $402, Income Account Growth 8.00% 6.00% End of Year Age Income Account Value (8%) Withdrawal Percentage Income Income Account Value (6%) Withdrawal Percentage Income Issue 55 $303, % $13,643 $402, % $16, $327, % $15,062 $426, % $17, $353, % $16,620 $451, % $18, $381, % $18,332 $478, % $19, $412, % $20,211 $507, % $20, $445, % $22,273 $538, % $26, $481, % $24,536 $570, % $28, $519, % $27,019 $604, % $30, $561, % $29,741 $640, % $32, $606, % $32,727 $679, % $33, $654, % $36,000 $720, % $36, $706, % $39,586 $763, % $38, $763, % $43,517 $808, % $40, $824, % $47,823 $857, % $42, $890, % $52,539 $908, % $45, $961, % $57,704 $963, % $57,811 This chart was produced by researchers at the office of J.D. Mellberg Financial. To enjoy a $36,000 income in year 10, Annuity A only required John Adams to pay $303, in a lump-sum premium. Annuity B required John to pay $402, to receive the same income in year 10. In other words, Annuity A could cost $98, less, and provide the same benefits as the other annuity in year 10 of the contract. In ten years, the income would be identical. Would you want to pay 25% more than necessary? As the table shows, Annuity A credits the income account value at the rate of 8% per year prior to beginning the payout phase, while Annuity B credits the income account value at the rate of only 6% per year. Annuity A also gives a higher withdrawal percentage than does Annuity B. As you can see, the withdrawal percentage for Annuity A starts at 4.5% per year, while the withdrawal percentage for Annuity B is only 4% per year. Notice that in year 10 of Annuity B, John would receive $36,000 in income for his $402, premium. That is a payment of 8.95% on the money he originally placed in the standard index annuity. With Annuity A, he could hypothetically receive $36,000 in J.D. Mellberg Financial Copyright All rights Reserved Page 17

19 income for the lesser premium of $303, The hybrid index annuity, then, gives him a payment of 11.87% on the money in his original premium. At J.D. Mellberg Financial, we examine more than 200 different annuities each year in our search for the ones we believe fit with the best retirement income strategies available. At this time, the annuity illustrated here as Annuity A (a hybrid index annuity) generally outperforms other annuities in the income account value increase and the withdrawal percentage guaranteed* by the insurance company. The lower initial annuity premium, higher crediting rate in the income account growth, and higher withdrawal percentage in Annuity A have the possibility of translating into more money in your pocket. By placing money in a hybrid index annuity, you can feel more confident that you could be receiving one of the highest income streams currently available from an annuity. This is true regardless of the premium amount of this index annuity; it offers you the possibility of maximizing your income stream for each premium dollar placed in the annuity J.D. Mellberg Financial Copyright All rights Reserved Page 18

20 How This New Family of Hybrid Index Annuities May Provide You with More Income per Premium Dollar than Other Fixed Annuities John Adams opted to buy the hybrid index annuity (A) for a lesser amount to provide the income he wanted. But what if he had decided to put the whole $402,000 into Annuity A with its higher return? Figure 7 shows the outcome. Figure 7 Account Details Annuity A "Hybrid" Index Annuity Premium $402, Income Account Growth 8.00% Annuity B Standard Index Annuity $402, % End of Year Age Income Account Value (8%) Withdrawal Percentage Income Income Account Value (6%) Withdrawal Percentage Income Issue 55 $402, % $18,092 $402, % $16, $434, % $19,974 $426, % $17, $468, % $22,040 $451, % $18, $506, % $24,310 $478, % $19, $546, % $26,802 $507, % $20, $590, % $29,537 $538, % $26, $637, % $32,538 $570, % $28, $689, % $35,830 $604, % $30, $744, % $39,440 $640, % $32, $803, % $43,399 $679, % $33, $667, % $47,739 $720, % $36, $937, % $52,496 $763, % $38, $1,012, % $57,708 $808, % $40, $1,093, % $63,418 $857, % $42, $1,180, % $69,972 $908, % $45, $1,275, % $76,521 $963, % $57,811 This chart was produced by researchers at the office of J.D. Mellberg Financial. As figure 6 shows, Annuity B still yields $36,000 in year 10. But the same amount of premium in Annuity A yields $47,739 in year 10. That s $11,739 more for the same amount of premium J.D. Mellberg Financial Copyright All rights Reserved Page 19

21 This increase in income does not necessarily have to be a one-time event. Rather, there is a possibility that your income could be higher in most succeeding years, depending on when you turn on your guaranteed* income stream! To enjoy a guaranteed* increasing income every year requires the purchase of an inflation or similar rider,** which is available for an extra cost. However, the example above includes the cost for the rider. That is, the $402, you place in the annuity provides all of the benefits described above. There is nothing else to buy or pay for, as this is an all-inclusive, one-time premium. You will never receive another bill for this annuity, and you do not have to pay any annual fee to continue to receive all the benefits this fixed index annuity offers. For all of the above reasons, regardless of the amount of money you have with which to purchase an annuity, you may want to seriously consider using some of your assets to purchase a hybrid index annuity. Comparing Annuities: The Big Picture We have had many people from around the country contact us to get second opinions on annuities they are considering purchasing. Many of the people who call or us believed they have found the best annuity after comparing a few different ones. They frequently bring in annuities that offer features that seem very appealing maybe a large bonus, or no rate caps, or a high level of income account growth. They are likely to ask, Can you beat this? In some cases, they have found these annuities while shopping on the Internet. In other cases, a neighborhood insurance agent presented a few annuities for their consideration. However people locate annuities, the bottom line on how helpful they will be is evaluation, and comparisons between annuities are complex. There are many factors to consider. In this section, we will examine an annuity on which a preretiree asked for a second opinion an annuity that had income account growth credited at 10% per year. Please note that we will be discussing two annuities that are different from the ones presented in figures 6 and 7. Jane Robinson is a 55-year-old client. She wants an annuity that produces immediate income. She has $100,000 to place in the annuity. As you can see in figure 8, Annuity P offers a 10% income account growth and Annuity Q offers a 6% income account growth. In this case, Jane Robinson inquired if we could beat the 10% income account growth in Annuity P. After doing our research, we presented Annuity Q, which only has 6% income J.D. Mellberg Financial Copyright All rights Reserved Page 20

22 account growth. Why would we suggest an annuity with lower income account growth? See for yourself. Figure 8 Account Details Annuity P Annuity Q Standard Index Annuity "Hybrid" Index Annuity Premium $100, $100, Income Account Growth 10.00% 6.00% End of Year Age Income Account Value (10%) Withdrawal Percentage Income Income Account Value (6%) Withdrawal Percentage Income Issue 55 $100, % $3,000 $100, % $4, $110, % $3,300 $106, % $4, $121, % $3,630 $112, % $4, $133, % $3,993 $119, % $4, $146, % $4,392 $126, % $5, $161, % $6,442 $133, % $8, $177, % $7,086 $141, % $8, $194, % $7,795 $150, % $9, $214, % $8,574 $159, % $9, $235, % $9,432 $168, % $10, $259, % $12,969 $179, % $14,327 This chart was produced by researchers at the office of J.D. Mellberg Financial. Despite the fact that Annuity P offers a higher income account growth, Annuity Q, could produce more income from the very first year the contract was in place and for every year thereafter. Whereas Annuity P paid $3,000 (3%) income in the first year, Annuity Q paid $4,000 (4%) in income that year, which is 33% more than Annuity P, starting from the very first year ($1,000 increase / $3,000 = +33%). As you can see, Annuity Q pays a higher level of interest each and every year than Annuity P. In the 10 th year, Jane Robinson would receive an additional $1,358 from Annuity Q than she would from Annuity P. Annuity Q offers a 10.47% increase in income in year 10 as compared to Annuity P ($1,358/ $12,969 = %). Please note that this 10.47% is larger than the 10% income account growth that Annuity P offered. How is it possible that an annuity that credits a lower level of income account growth could produce more income than an annuity that offers a higher level of income account growth? The answer is in all of the other features and benefits offered by the two different annuities J.D. Mellberg Financial Copyright All rights Reserved Page 21

23 What other factors can lead to an annuity with a lower income account growth producing more income than an annuity with a higher income account growth? The annuity that produces more income might have offered: A higher bonus No rate caps A higher crediting method Lower fees and expenses Or a combination of these benefits with other benefits When researching annuities, we focus our attention in two areas: 1. Finding the products that can best help our clients reach their individual financial goals. Since financial goals are as varied as our clients, we recommend different annuities to different people. 2. Finding the most suitable products that produce the highest income for our clients for the time period desired. As you learned in Jane Robinson s case, finding an annuity with the highest possible income account growth might not guarantee that you enjoy the highest level of income in retirement. The same is true for annuity bonuses. Finding an annuity that offers a large bonus does not ensure that you will be receiving the highest level of income in retirement. Additionally, remember that bonus annuities may carry higher fees than annuities without the bonus feature, and may not pay the bonuses in case of early withdrawal. Many factors need to be considered when comparing one annuity to another. It is often difficult to make an apples to apples comparison between different annuities because insurance companies offer so many different features and benefits on various annuities. Some of these features and benefits may also change over time. As you can see in figure 8, the withdrawal percentages for both Annuity P and Annuity Q change over time. Other features, such as surrender charges, also change over time. (An annuity that has higher surrender charges than another annuity in the early years may have much lower surrender charges in later years, or may end the surrender charges sooner than the other annuity.) J.D. Mellberg Financial Copyright All rights Reserved Page 22