Hosted by Randy Luebke

In this episode, I continue my deep dive into annuities, focusing on the transformative benefits of 3rd generation annuities. These modern financial tools offer a balanced and secure approach to planning your financial future. I explore 7 key benefits—flexibility, safety, liquidity, growth, tax deferral, low to no fees, and longevity protection—and discuss how these features can empower you to achieve your financial goals. Tune in to discover how 3rd generation annuities can be a cornerstone in your journey toward financial independence. 

If you missed our previous episode, I highly recommend starting there to gain a comprehensive understanding of the evolution from 1st, 2nd and 3rd generation annuities and how each generation differs. This foundation will enrich your understanding of the powerful benefits I discuss today.

Episode Highlights and Takeaways:

Annuity – A private, portable pension plan, of which there are 3 types:

1st Generation Annuity (Fixed Annuity/FA) – Similar to a certificate of deposit (CD), where all elements of this type of annuity are protected and guaranteed.  Like the CD, both the principal and earnings are protected from losses.  Unlike a CD, where interest is taxed as earned, the earnings of the 1st Generation Annuity are tax-deferred until distributed.  The primary method of distribution is called “annuitization”.  Annuitization surrenders the principle and earnings in exchange for ongoing payments/distributions.  The payments are made to the annuitant for a guaranteed period of time, ranging from a specific number of years to the lifetime of the annuitant.  Once annuitized, the distributions generally cannot be changed or stopped and, the principle is no longer available for lump-sum withdrawals.

2nd Generation Annuity (Variable Annuity/VA) – An annuity that primarily invests in stocks, bonds or mutual funds to provide the opportunity for higher earnings and growth.  Just like a 1st Generation Annuity, the earnings of a 2nd Generation annuity are deferred from taxes until distributed and the primary method of distribution is “annuitization”.  However, the 2nd Generation Annuity has no guarantees to protect the principal from potential losses.  In addition, the 2nd Generation Annuity is often subject to higher fees than other types of annuities.

3rd Generation Annuity (3GA/Fixed Indexed Annuity/FIA) – The 3GA is a hybrid that combines the safety, security and guarantees of a 1st Generation Annuity with some of the upside earnings potential of a 2nd Generation Annuity.  The 3GA is a safe, flexible and liquid annuity, that can be designed with low or even no fees.  A 3GA can be annuitized to provide income, however, most often the annuitant will choose to exercise the more flexible “Income Rider” option instead.  Similar to annuitization, the Income Rider is a private, personal and portable pension-like plan that provides a guaranteed ongoing distribution of money that one can never outlive.  The significant difference between the income rider and annuitization is that the principle is never surrendered, making it possible to receive lump-sum withdrawals of money as needed.  Additionally, the distributions can be increased, decreased or stopped altogether.

The 7 Primary Benefits of the 3GA:  Flexibility, Safety, Liquidity, Growth, Tax Deferral, No/Low Fees and Longevity Protection

1. Flexibility – The 3GA generally combines multiple earnings strategies, a variety of low/no-fee strategies, as well as a number of liquidity/distribution options to address your goals and needs today. It can also be modified if your situation changes in the future.
2. Safety – A 3GA protects both principal and earnings from losses by eliminating drawdown risk* during the accumulation phase and, by eliminating the sequence of withdrawal risk* during the decumulation phase. With the addition of an income rider, the 3GA protects against tail-risk* as well.
3. Liquidity – A 3GA provides ongoing penalty-free access to some of your principal at all times.  If serious health issues develop, then larger amounts of penalty-free withdrawals become available as well.  For example, 100% penalty-free withdrawals are always available after a specified period of time or, immediately, upon the death of the annuitant.
4. Growth – The 3GA provides a number of crediting methods to grow your account’s value, all with no market risk to the principal and earnings.
5. Tax Deferral – Earnings are deferred from income taxes until those earnings are withdrawn.
6. No/Low Fees – A 3GA generally has no trading costs, no M&E (mortality & expense) charges or management fees.  Only optional rider fees may apply, if elected.
7. Longevity Protection – The 3GA’s income rider option is a flexible, private, personal and portable, pension-like plan, that eliminates tail-risk, the risk of running out of money, by providing guaranteed ongoing income you will never outlive.

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Transcript

When do you want to start living the life you dream of? A less stressful and a more fulfilling life? How about now? Welcome to the Financial Independence Now podcast. Financial Independence, when the assets you have provides the income you need, to live the life you want, and, work is no longer a requirement, it’s an option. Hi, my name is Randy Luebke, and I am the president and founder of Lifetime Paradigm, a financial consulting, planning and advisory firm, and, of course, the creator and host of this podcast, Financial Independence Now. I always begin my podcast by saying congratulations to you, our listeners, for making the decision to invest your time today. And we promise to make this investment into you every time you listen in. 

Well, we’re going to continue on with our discussion about annuities. The first podcast in the series was about the 3 generation annuities. And if you haven’t listened to that podcast, I’d encourage you to go back one episode and listen to it so you can learn about the 1st generation, the 2nd generation and the 3rd generation annuities and the difference between the three. 

Today, part 2, we’re going to talk about the 7 primary benefits of that 3rd generation annuity.

Now those benefits are flexibility, safety, liquidity, growth, tax deferral, low to no fees, and longevity protection.

Now I’m going to drill down, of course, on each one of those 7 characteristics, but that’s them. So again, to understand this, you really need to understand what a 3rd generation annuity is, the hybrid, right? And best to listen to the previous podcast, but the short version is, it’s a hybrid annuity where the principal is generally protected from losses. There are upside potential in stock market-like investments and there are guarantees of income that can be provided to you without having to surrender the principal of the annuity to the issuer and allowing you to have more flexibility in the withdrawal side. So, with that being said, let’s dig into the 7 primary benefits of the 3rd generation annuity. 

First one, flexibility.  So, a 3rd generation annuity combines multiple earnings strategies and a variety of low-to-no fee strategies as well as a number of liquidity distribution options that address your needs and goals today as well as in the future. And it can also be modified in the future if that’s something that you want to do.

Let me drill down on that a little bit further. So, the crediting strategies inside a 3rd generation annuity are generally based on indexing options. And, I believe I’ve explained this before in another podcast, but typically in these insurance products, whether it’s a life insurance product or annuity, you’re investing in what are called “call options”. And I like to think of call options as, “Call me up if I make money. If I don’t make money, don’t bother.”

So, the idea is you take the interest that the insurance company is willing to give you as a guarantee, and instead of receiving that percentage, maybe it’s 3, 4 or 5% interest, you take that interest and invest it in options in some type of stock-like investment (I’ll explain more about that in a second). And then with interest, hope that we can make more money. So, if you’re going to give me 5%, let’s hope I can make 6, 7, 8, maybe 10% by buying these options.

Now, what kind of options would you be buying? Well, for example, the S&P 500. SP 500 is pretty simple. It’s the top 500 largest companies in the New York Stock Exchange based on market capitalization. How big the company is, right? 

And so every day, all day, you can find out what the value of the S&P 500 is, and the option says, look, I’m going to buy it today, and I’ll make up a number, at $4,000, and a year from today, if it’s up to $4,100, I will have earned a percentage of interest. That doesn’t make it $4,400, right? So, I would have earned a 10% return. And if it does, then I’m going to call you up and I’m going take that money, that 10% earnings, and add it to my principal and start it all over again.

On the other hand, if I started at $4,000 and a year from today, the index was down to say $3,600, it lost 10%. Well, I’m not going to call you. I just want my money back and I’ll start all over again. And that’s how these index options work. And again, inside of these fixed indexed annuities, you’re going to have many, many, many different types of options and combinations of options available to you that you can use to potentially earn money on. But what’s similar to all of them, regardless of the makeup, if it’s a 3rd generation annuity, your principal will never be at risk. If you start with $100,000 today and you invest the interest that typically the insurance company, the issuer, is offering you, you’re only risking the interest, never the principal, into these options. So that again, if you can make money, you get to keep it. If you don’t make money with the index bet, you don’t risk any portion of your principal. 

So, they’re very flexible, right? In terms of the types of earning strategies. And they’re also very flexible in the types of withdrawals. Again, you’re not subject to annuitization to receive a distribution. You can take lump sum withdrawals. You can put in $100,000 and typically with most 3rd generation annuities, you can take out 10% each year without any penalties whatsoever. 

So, if I put in $100,000, I could take out up to $10,000 the following year and not be subject to any penalties. If I want to take out more, I can do that too, but then I’m typically going to be subjected to an early withdrawal charge for the excess. And let’s say just to keep it simple, that the early withdrawal charge is 10% during the first year. And let’s say I wanted to take out $20,000 of my $100,000 example. I put $100,000 in, I know I can take out $10,000 dollars, 10% free of any penalty, and then I want to take out another $10,000. Well, that $10,000, it would be subject to the 10% penalty. So that would be a $1,000 penalty. But basically, I was able to pull out $20,000 and I paid the $1,000 penalty for that. I paid a 5% penalty. 

And by the way, those penalties, those early surrender penalties, generally decline every year. And typically by the end of the 9th, 10th year or so, those penalties are gone altogether. And for people concerned about that, you know, they’re always concerned about losing money. And certainly if you put money into an annuity and withdraw 100% of it the following day, you’re going to lose money. 

But I would say to you, consider this. If I put money in the stock market, is it easy to lose 10% on your money in a very short period of time? And the answer is, of course it is. So the difference between a fixed indexed annuity, 3rd generation annuity, and putting it in the stock market in terms of that risk is with the fixed indexed annuity, you have a guaranteed maximum loss. You get to control it –  Remember, you get to pull out 10% penalty free and if you want to pull out more, you’ll pay some penalty during those early years. But at least you know what it is. And your principal will never be subject to market conditions, making you take a hit on that principal balance. 

But again, the number one benefit of having a 3rd generation annuity, flexibility. So once again, let’s look at one more area of flexibility, income. And remember with the 1st generation annuity and most of the 2nd generation annuities, the primary way of receiving income is annuitization, where you surrender the principal and you surrender the earnings to the issuer in exchange for a guaranteed income stream. That income stream is typically a number of years, maybe a lifetime, maybe two lifetimes, but once you make that decision, it’s done. That decision is done. The value of the annuity is gone, in terms of the lump sum value, and it’s been traded in exchange for this income stream.

You don’t have that with the 3rd generation annuity. Again, you can use the income rider to receive guaranteed income, but you never give up the principal to the issuer allowing you to do several things.

#1 you can increase your income if you want to from year to year.

#2 You can reduce the income from one year to the next year.

#3 Or you could stop receiving income altogether, if that was the right thing for you to do. 

And again you have the opportunity to make these lump sum withdrawals. So tremendous flexibility available through these 3rd generation annuities.

The 2nd benefit, and I’ve said this few times in a few different ways, is safety. A 3rd generation annuity always protects both principal and earnings from losses by eliminating drawdown risk.

Drawdown risk, by the way, is that differential between the height of the market and the lowest point in the market before the market starts to work its way back up. So I’m not going to get these numbers exactly right, but back in 2008, we had a major correction. And the drawdown from the peak of the S&P to the bottom of the S&P was over 50%.

Now again, if you didn’t withdraw your money, it didn’t matter, because within a relatively short period of time, a number years, that loss was recovered, and all of your money would have been returned and you’d be back to where you started and then life would go on, right.

The problem is, of course, well, it’s twofold. One, when people see those losses in their accounts, they get scared, they get concerned. Sometimes they get sick to their stomach. Whatever, the motivation is, it causes them to withdraw their money from the market and when they do that, of course, now they’ve locked in those losses. They’ve, created a loss, right? If they just would have left it in there, they again, in that example, they would have been okay. But it’s hard to do psychologically because people want to get in when the markets going up, which is generally the wrong time to get in, and they want to get out when the market’s low, which is generally the wrong time to get out. That’s just human nature. 

Well, again with the 3rd generation annuity, it eliminates that problem because your principal never goes down, right? Your principal is never subject to market losses. That’s how you know you’re in a 3rd generation, or one should say, that’s one of the ways you know, you have a 3rd generation annuity, because your principal is protected. And the earnings are typically is protected as well.

So earnings you made one year is now added to the principal base and now that new amount is also going to be protected going forward. So a lot of safety. In these types of annuities, these 3rd generation annuities.

Now we’ve talked about liquidity, this is the third feature of a 3rd generation annuity. These annuities have a lot of liquidity. People are, this is one of the things people are afraid of.” Oh, if I put my money in annuity, it’s all locked up and I can’t get at it for years.” 

Well, yes or no. There is a period of time when the money inside the annuity is subject to an array of different rules. One of the biggest ones of course being the early withdrawal. But again, the early withdrawal penalty is generally subject to a declining scale, which means every year it gets smaller and smaller and smaller. It also guarantees what the loss would be if you took out 100% of your money, which you don’t have any guarantee of that in the stock market. So yeah, it does have that penalty, but the truth of the matter is you’re putting money into an annuity to do something that is for the long term. 

You’re putting money into an annuity, generally to fund your retirement. You want it to provide you with lifetime guaranteed ongoing income potentially for you and your spouse. So it does have liquidity penalties. It does have liquidity limitations and restrictions, but in general these annuities have more liquidity than anybody wants or needs. And if you need more liquidity then don’t put your money into that type of vehicle. At least all your money into that type of vehicle in the first place. 

All right, so the 4th benefit of the 3rd generation annuity is growth. Now remember in the 1st generation annuity, everything’s fixed and guaranteed. Well that’s good and bad, right. Fixed and guarantee gives you a lot of safety and protection, but it also limits your upside earnings. Well, again, with these 3rd generation annuities, where the issue is going to provide you interest credits every year. Again, you can take those interest credits and invest them in indexing options to hopefully earn more money.

And so the growth side is, well, not nearly as good as most of the variable annuities, the 2nd generation annuities, it’s limited. It does have all that downside protection, right. So it’s a trade off, right.

We talked about you know the five characteristics of the ideal investment – It’s 100% safe, 100% liquid, it’s 100% returns that are 100% tax free, and they’re 100% passive. You don’t have to do anything. And again, we know that that perfect investment doesn’t exist. What are you willing to give up? Now, apply that those five attributes to the annuity and is it 100% safe? Yes, we already said it was, that’s part of the characteristics of the 3rd generation annuity. It’s 100% liquid? No, but it’s more liquid than most people want or need. Does it give 100% rate of returns, high rates of returns? No. But it gives better rates of returns, potentially better rates of returns, than that 1st generation annuity because it does invest in the markets, or I should say along with the markets, using these indexing strategies. So it does have growth potential and the growth potential is substantial. 

The 5th characteristics is tax deferral. Remember, perfect investment, tax-free, all these are tax-free. Unless of course they’re owned inside of a Roth IRA or a Roth 401K. That’s another misnomer. People think, why would I want to own a tax deferred vehicle inside of a tax deferred vehicle? Well, it doesn’t matter. You’re not paying for the extra tax deferral. But if I had money that was inside of a Roth and I took that money inside of a Roth and invested it into an annuity, now I can turn that cash or those securities into something that’s protected from downside losses, yet provides them with ongoing lifetime income, and it’s all 100% tax free, right.

So I know I got off point there. The point is that money that’s inside of annuities are going to earn benefits, they are going to earn credits, interest, and the interest on those earnings are going to be tax deferred, which means that the whole dollar that you earn an interest gets to earn more interest, right? It’s not like you earn in a CD, well, not like a CD, but you know, in a brokerage account where you’d earn rate of return and then receive a 1099 that year. Now you if you were in the 30% marginal tax rate, you got a dollar, but they took away $0.30 and now you only got $0.70 that you’re able to earn money on the following year. Or with these tax deferred accounts, you earn a dollar. That whole dollars going to earn interest and so on and so on. So you have tax deferral. 

Point #6 – in the 3rd generation annuity, we have no or low fees. This is really important. Again, the 2nd generation annuities can be a good option, but they are almost always going to be subject to higher fees than a lot of other types of investments. Fees and mortality costs, fees and brokerage accounts, fees and fees and fees. And they’re easy to find, by the way. Well, when you know what you’re looking for, but you can spot them and those fees take away, of course from the money that goes into your pocket. 

Well with these 3rd generation annuities, you have the option of choosing a no-fee type annuity where all you get is growth year after year and you have all that downside protection. So if you’re somebody that’s really concerned about fees or fee conscious, this is a really good option to consider because you can put money into the annuity, you don’t have to worry at all about the principal being subjected to market downturns, and you get to receive interest in years where the market is positive. Again, that’s tax deferred and you don’t have to pay any fees to do it. No brokerage fees, no management fees, no mortality costs, no fees. Whatever you earn, you get right.

Is there a trade off for that? Sure, the trade off is you put, you’re probably not going to earn as much money in the same year that you would in the in the 3rd generation annuity was subject to those market conditions. So you’re exchanging some of the highs to eliminate all the lows and in this case to eliminate all the fees. So #6, load or no fees.

And then finally, longevity protection. This is really what the annuities are all about. Fundamentally, if you withdraw money from your brokerage account, there’s a rule and it’s been around for years. It’s not really a rule, it’s more of a theory, I guess. That you could withdraw about 4% of that money year after year and subject to inflation you would have about a 90% chance that you wouldn’t run out of money before you died, okay.

Now when you start unpacking that statement a little bit, you realize, well, a 90% chance of not running out of money means that there’s a 10% chance that I’ll be 100% broke. That’s not good, right? Because again, the likelihood of that happening is going to be when you’re in your later years, where you’ll have no opportunity to earn back, you know, the money you’ve lost. 

So by using the income rider on the annuity, you’re going to provide yourself with a guaranteed income stream that the income can be received once a year, it can be received quarterly, it can be received monthly. Some of the income riders will have increasing rider benefits. So that as markets improve over the years, or if they’re tied to inflation, then those benefits will go up year after year as well. But the point is, even if you spend down all your money inside the annuity, meaning you’ve withdrawn. You know I’m going to back up a little bit, if you think about what happens with these annuities, you put your money in, your money earns interest, and then when you start withdrawing the money from that annuity, initially it’s still just your money and all the interest you’ve earned on it. But, eventually, if you would live long enough, and maybe if the market did poorly enough, you could end up withdrawing 100% of the money you put in and all the interest you earned. But guess what? If you enable the income rider strategy within the 3rd generation annuity, now the insurance company will start writing you checks. So this is the insurance part of the fixed indexed annuity and they’re going to guarantee that for whatever credit and distribution period you opted into, that they’re going to provide that income.

So you could now take out 3%, 4%, 5%, maybe 6%, 6.5%, 7% of that money every year and rest certain that you’re never going to run out of income, even if the account is bankrupted, right. Even if your money’s gone, the insurance company is going to put in their money for you instead. 

How can they do that? Well, it’s simple because they know statistically, law of large numbers that, well, frankly, most people will end up not withdrawing all their money from their account before they pass. And although some people will, most people won’t.

And that’s another point, by the way, a little tangent, I’ll come back to where I was in a moment. But money inside the 3rd generation annuity that’s left, doesn’t get surrendered to the insurance company. Remember, like the 1st generation annuity. When that term of the annuitization is done, which is either done by death or the number of years that have passed, that money’s gone. But money in the 3rd generation annuity, anything leftover goes to the heirs, right. So if you get hit by that proverbial bus, you know, the day after you start withdrawing money from your account, literally all the remaining money will be available to your heirs. You’re never ever surrendering the principal balance. 

But the converse of that again is what I’m stressing here, longevity protection. For really giving up a little bit of the upside interest of the market, or let’s just be honest, I’ll say giving up some of the upside interest of the stock market, in exchange for 100% protection of your principal, you’re also going to receive 100% guarantee that for the rest of your life, or two lives, or period of years, however, you want to do it, there will be an income available to you, even if you spend down all your money.

So that’s it. The 7 benefits of the 3rd generation annuity: flexibility, safety, liquidity, growth, tax deferral, low and no fees, and finally longevity protection. 

So that’s it for today. We trust that you learned something from today’s podcast. Equally important, in fact, maybe even more important, we hope that you will do something with the information you have learned. Remember, life’s a journey and not a destination. Enjoy the trip along the way. Take a look at your life today from a new point of view, a new paradigm, a paradigm where you are living, the life you dream of starting, right now. We look forward to you joining us on our next episode of Financial Independence Now.

And in the meantime, please tell your podcast streaming host, iTunes or whomever you choose to listen to our podcast through. Tell them that you enjoyed what you heard and you valued the information we shared. Give us your five-star rating to help us grow our audience so we can connect with more people and helped them every day. Also, remember to visit our website, lifetime paradigm.com. There, you’ll find links to our past podcast episodes, webinars, and educational materials, all 100% free and available to you 24/7. You’ll also find notices of our upcoming events, both live and over the internet. And finally, be sure to subscribe to our newsletters, which are full of great information, ideas on how to save and invest, to reduce the taxes you pay, to protect you from lawsuits. And of course, even more ways to become financially independent. Well, that’s it for today. This is your host, Randy Luebke, signing off.