Conservative Investors

Client Scenario

Lisa and Tony

Lisa and Tony met in grad school in Atlanta. Both of their families emphasized the importance of education. Lisa’s father served many years as Principal in her hometown at the Middle School level, and Tony remembers his mother going back to school for her graduate degree in education after he and the last of his sisters entered elementary school.

Teaching seemed like the natural thing to do. After receiving their graduate degrees, both were employed by the Atlanta Public School system where they worked for 30 years and 33 years respectively.

They are now both eligible to enjoy their full retirement benefits through the Teachers Retirement System, and plan to spend more time in their community garden, where Tony has served on the board for the last 5 years.

Aside from their TRS pensions, Lisa and Tony both contributed to 403(b) accounts. Since they are now retired, they told their fee-only financial planner, Grace, of their intention to buy a CD to protect Lisa’s account from market losses, while using proceeds from the other to fund travel.

Grace knows Lisa and Tony well. She attended high school with their eldest daughter, Michelle. She knows how risk averse they are and wants to help them realize their goal of continuing to take their annual family vacation with their children and grandchildren.

After some debate, she recommended that they consider a fixed indexed annuity, instead of a CD. Since interest rates are so low, CDs have not been a very attractive investment for a decade or more. And given their rigid terms and expensive penalties, other options may be more beneficial.

A fixed indexed annuity (or FIA), she reasoned, may provide them the same confidence as a CD, but with more upside potential. She explained that a FIA doesn’t invest directly in equities, so they aren’t exposed to market risk. Instead, investors are credited interest (typically on an annual basis) for the performance in a given index like the S&P 500.

The only caveat is that interest is capped at a percentage of the index’s performance. She told them there are no explicit fees to own the product, but the capped performance is the ‘cost’ of insuring their principal against losses.

Like CDs, if held to maturity fixed indexed annuities are guaranteed to never lose principal, which is what Lisa and Tony were seeking in the first place. They also may experience flat years, when markets are down, but given their time horizon, a fixed indexed annuity checks all of the boxes.

Grace explained that there are some other important differences between CDs and fixed indexed annuities that they should be aware of. Unlike CDs, FIAs are not insured by the FDIC, and the guarantees in FIAs are subject to the claims paying ability of the issuing insurance company. She explained that interest earned in CDs is taxed if the CD isn’t held in a qualified account like an IRA, but FIAs are contracts issued by insurance companies and grow tax deferred. This was a feature that really appealed to them.

The couple also liked that, unlike CDs that charge penalties for early withdrawals, the FIA they chose charged no surrender penalties and would only be subject to market value adjustments if their withdrawals were greater than the annual 10% limit for the first five years. To them it seemed like timing the renewals of the CD might be tricky.

They are now able to withdraw up to ten percent penalty free for the next five years, which is plenty to fund their next five summers of travel. After that, the account will be fully liquid and they’ll be able to access funds as needed for things they hadn’t planned for, or to fund any surprise adventures along the way.

Lisa and Tony

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