Annuities

Do you want to be a dependent senior citizen?

You likely are according to this conclusion by the Economic Policy Institute, “For the typical person approaching retirement, the value of expected future Social Security retirement benefits represents the largest single source of wealth.”  While this may be true, it’s a situation you don’t want to be in–dependent on the government and its political whims to determine your level of senior citizen retirement income.  The more you can control and rely on your other sources of retirement income, the more independent you will be.

Let’s discuss the ways in which you become independent with respect to your senior citizen retirement income.

If you have a home, use a reverse mortgage when you need it. Most seniors are simply ignorant about how reverse mortgages work and then act out of ignorance.  The other option is to find out how they work.  A revrse mortgage simply allows you to tap the equity in your home as an income source.  Right now, your home equity earns nothing, 0%.  Would you keep money in the bank at 0%?  Of course, when you die with a reverse mortgage, the equity in your home will be reduced to heirs.  But so what?  Shouldn’t you live more comfortably and enjoy a higher level of  senior citizen retirement income?  Don’t get a reverse mortgage until you need it as the payments are larger at older ages.

Another option is to annuitize your assets.  Here again, the idea is that rather than leaving an inheritance, you get the money to enjoy during your lifetime by consuming principal.  The risk in spending principal is that the principal could run out before you do.  But what if you could enjoy more senior citizen retirement income and not worry about running our of principal?  That’s exactly what an immediate annuity allows.  An insurance company will guarantee a lifetime income in exchange for a single deposit. For example, a 72 year old woman, for a deposit of $200,000 would receive a lifetime monthly income of $1590 (11/25/08).  This is likely more than the social security check received.  While this is not recommended for all of your assets (the payment is fixed and will not adjust for inflation), it makes good sense for a portion of your assets to supply senior citizen retirement income that you cannot outlive.

If you worry about leaving funds to your favorite charity, a goal you may have had for some time, you can use the option above in the form of a Charitable Gift Annuity.  Rather than deposit finds with a commercial insurance company, you deposit the funds with a charity and the charity provides a lifetime income.  The amount may be less than the commercial annuity so check and compare.  Additionally, you get a tax deduction that could shelter your income and reduce your tax bill for up to 6 years.

These are but a few ideas to increase Senior Citizen Retirement Income.  Consult an experienced retirement advisor for additional recommendations.

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What does it mean?

Put simply, to annuitize is to start taking payments from an insurance annuity that may have been accumulating for some time.  Specifically, you “trade” the accumulated annuity balance for a stream of payments over a specific term of years or life (a life annuity).

An annuity, a policy that is paid into either by lump some or regular payments by the policyholder, and gains value via investment of those funds by the insurance company that holds the policy, in a manner agreed between the two parties, has many terms attached when it is created, and there may be an option to annuitize at a certain point or date set at the start of the insurance annuity agreement.

What happens when I annuitize?

When, and how, the policy becomes annuitized is determined by the rules and terms that are agreed by the policyholder with the insurance company, and these can be varied and dependent on many different factors.

If the policy has a number of different options at which annuitization can take place, then it is up to the policyholder to decide what is best for him or her.  In many cases, if the insurance company does not hear from you, annuitization starts automatically at age 85.

When the choice is made, and one has opted to annuitize, there are a number of ways in which payments can be structured. There are options that involve continued payments within the lifetime of the policyholder, or those that pay up to a certain date (e.g. 10 years) beyond which the policyholder may live, but with no further payments. There are also options that allow a lump some payment of an agreed amount that can only be taken after a certain amount of time has elapsed on the policy, at which point the annuity is said to have matured.

Some annuities allow for the payments to be made to a partner or designated recipient (joint life annuitization), too, and there are other considerations that should be taken into account.

Should you Annuitize?

This is a question that only the policyholder can answer, but if the time has come to draw money from the annuity, some factors should be considered.

If the policyholder is collecting for himself, the lifetime payment option makes a great deal of sense, giving a guaranteed income for the rest of one’s life. The decision to annuitize, whichever option is taken, is not reversible – once done it cannot be rescinded, and the policy is deemed to have matured. (there are a few companies that now allow “commutation” which is the ability to cash in the annuity once it’s been annuitized.  You, the annuitant or owner will pay a stiff price to commute an annuity).

The most obvious reason for annuitizing is to claim the guaranteed payments that come with the policy, and this should be a consideration when deciding whether to annuitize. It may be that the policyholder needs the money in order to live, but in a large number of cases the money is used to set up a further annuity, continuing the process and effectively putting into action a chain reaction of annuities and annuitizing that creates greater income.

An annuity can be a worthwhile for those who like the option to annuitize and thereby shift the responsibility for income to the insurance company.

Learn more.  Get your copy to avoid “Annuity Owner Mistakes“

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Did you invest in an equity indexed annuity  a few years back? If you bought it seven years ago, the maturity date may be approaching fast, and you might only have a small window of time to decide whether to renew the annuity or place your money elsewhere.

If you look at what has happened to annuity rates and the markets since you bought your equity indexed annuity, you may understand why the specifications for a new contract might differ. Interest rates are at a four-decade low, and the markets have swung wildly. Therefore, there’s a good chance that you will see lower market participation rates and lower maximums (caps) on amounts credited to your equity indexed annuity. In addition, you may have to make a longer-term commitment on your new contract.

The company might now have the ability to change participation and cap rates on the annual anniversary dates, whereas, your original contract may have kept the same numbers throughout the term. However, this could work in your favor. Because if the equity markets become less volatile, there’s the chance that index option premiums will decrease, thus allowing annuity companies to offer higher annual participation levels and caps.

Times have changed and many of our investments have as well, and a new equity indexed annuity might not be identical to the one you bought before. Nevertheless, it will still provide the same opportunity for tax-deferred growth and the other features that encouraged you to make your original purchase. 

Remember that you don’t need to stay with the same annuity company or the same type of annuity.  You can 1035 exchange your annuity with surrender charge at maturity for an equity indexed annuity with another company, a traditional fixed annuity or a variable annuity.

 Note: There may be risks with equity index annuities that include, but are not limited to, the fact that the return is calculated at the end of the vesting period; often, the investor cannot access cash prior to the end of the vesting period without restriction; if the index performs well, low interest rates are irrelevant; each annuity is subject to fees and charges; and withdrawals may be subject to surrender charges. These restrictions have an impact on performance and must be considered when deciding to purchase or exchange the annuity.

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One popular benefit of a fixed annuity is that you can let the interest in the account compound each year without paying income taxes. This allows your money to possibly grow faster as compared to fully taxable investments that pay similar, before-tax returns. When you start making withdrawals, the percentage of income that is taxable depends on how you structure the distributions. Your beneficiaries, however, may not have that flexibility, and could face a big annuity tax bill on the inheritance.

Assuming your annuity is not held in a tax-qualified account, such as an IRA, your heirs will have to pay income tax on the built-up earnings when you die. Suppose that you put $250,000 into a fixed annuity a number of years ago, and now it is worth $450,000. If you died today, your beneficiaries would receive the $450,000, and would have to pay as much $70,000 in federal income taxes on the accumulated profit (maximum federal income tax rates are currently 35%).

To help your heirs keep the money you earned, you may want to consider purchasing a life insurance policy for the amount of the estimated tax bill. You could pay the premiums yourself, ask your beneficiaries to buy the policy to protect their future interests, or you could annuitize your annuity.

Annuitizing your annuity can give you a steady income that you cannot out-live. Part of the income will be a tax-free return of your original investment. The balance will be taxed as ordinary income. However, the $450,000 will no longer be available to go to your beneficiaries. To replace that money, you could use the regular income that you will receive from the annuity to help pay life insurance premiums on a $450,000 policy. After you die, your loved ones will receive the entire $450,000, free of federal income taxes.
Not everyone can qualify for a life insurance policy. Depending on the payout from the annuity, your health and other factors, the payout from the annuity may not cover the full premium payment on the life insurance. For more information about annuitization or annuities get a copy of Annuity Owner Mistakes.

Annuity taxation can be onerous or painless depending on your planning and getting qualified advice.

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Do you own an IRA, hold a Keogh, or still have assets in a qualified retirement plan that was offered by a previous employer? Then perhaps now you have to think about the best way to withdraw the funds, as the IRS requires at age 70½, while making sure that you don’t outlive your income.

One choice is to remove the money all at once and pay the tax. That step, however, may put you in a higher tax bracket is is usually not wise. Another option is to go along with the government’s guidelines and calculate the Required Minimum Distribution that you must withdraw each year after you turn 70½. But what if there was a way to not have to do those calculations and also not worry about tax law changes and market fluctuations that could affect retirement accounts every year?
 
A tax-qualified, fixed immediate annuity will spread the tax liability over your projected lifetime and automatically satisfies the IRS requirements, so you will never have to calculate the required minimum distribution. A check will arrive every month, or whichever schedule you select, for the rest of your life—no matter how many years that might be (guarantee is based on the claims-paying ability of the annuity company). All you will have to do is pay the income tax and spend the balance of the money as you wish, or save it.

Note that even if you have several IRAs, you may want to add up the balances and then use a fixed immediate annuity in just one IRA to provide the required minimum distribution for all three.  Note that you must take a required minimum distribution form each type of retirement account you have.  You cannot for example just take a distribution form your IRA if you also have a 401k account.  You must make a required minimum distribution from both accounts.

Make sure you tell the immediate annuity company that you are using the payments to meet your required minimum distributions so that the payments are properly structured and will increase as you age.

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Do you find yourself worrying about your finances? While you may think of your situation as unique, you may in fact be among the majority of seniors wtih financial worries.

A recent survey by the publishers of Senior Market Advisor Magazine revealed several seniors’ responses to the question “How much do you worry about money?”

A little                           45%
More than I should        27%
A lot                              20%
Keeps me up at night      5%
Never                              3%
Source: Senior Market Advisor, Senior Survey 2005 (July 2005)

If the same poll were taken today, there would likely be many more who answer that financial worries are at the top of their worry list.

Notwithstanding these statistical findings, financial worries do not have to control you.  A more secure retirement is possible, with smart and prudent financial planning solutions to these common retirement worries:

Retirement Savings Shortfall
Upon reaching retirement, some seniors are surprised to discover that their retirement savings will come up short–an obvious source of financial worry. Instead of pursuing leisure activities, they find that they must curtail their spending habits in order to make their savings last. However even in retirement, you can put your savings to work for you with investment strategies that are designed to help you achieve your growth and income objectives. For example, do you find that your investments are heavily concentrated in CDs and bank account deposits?  Although these investments are often a very good source of liquidity and are insured by the FDIC, an over concentration in these safe investments could expose your portfolio to inflationary risks as they simply don’t pay enough interest. 

Loss of Investment Value
If you’ve owned stocks, recent problems do not get any worse to cause financial worry. Unfortunately, market corrections are a fact of life and can show up at any time. There are things that can be done to help you weather these storms: 
1) diversifying your portfolio,
2) rebalancing your holdings so that stocks never exceed a pre-determined percentage of your portfolio, and
3) following asset allocation strategies designed to reduce your exposure to market risk.  Although asset allocation does not guarantee against the risk of loss in a declining market, it can help reduce the overall volatility of your portfolio. Has your portfolio been reviewed lately? If not, now might be a very good time to do this.

Another key is divide your retirement savings into baskets.  Your most conservative pot, money market and CDs is money you will use in the next 3 years.  The next pot, maybe bonds and preferred shares are to be used in the next 3to 6 years. The next pot, say balanced mutual funds, in the next 6 to 9 years, and stocks or equity funds, to be used in 10 years or more.  Using this approach, even when the market does decline, your stocks have 10 years to recover and won’t destroy your retirement income planning.

Annuitize Your Savings
This is a common worry among many seniors, but one with practical solutions. For instance, buying a fixed deferred or immediate annuity with lifetime income guarantees could help to provide you with a reliable and steady source of cash flow for your retirement.

Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals can also be subject to surrender charges. Annuity guarantees are also backed by the claims-paying ability of the issuer.

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As a retiree, you may have Social Security income and some pension income too. But you may want an additional but assured income to round out your financial planning for retirement. You have some investment money you can generate income with but you are leery of losing your principal because you may have to rely on that income for a long time.  What is an appropriate strategy for generating income but preserving your principal?

You could use a certificate of deposit (CD). It is federally insured. The interest rate you will get depends on how long you tie up your money in the CD. A longer term CD typically produces a higher rate. CD’s are conservative securities representing the lower region of interest rate offerings.

Nevertheless, at, say, 5% interest you can take $5,000 per year and preserve your $100,000 principal.  This interest income is fully taxed and you would be left $3,300 with under a 28% tax bracket. Let’s try a better strategy…

A strategy that can give you more income–and will also tie your money up for while–uses a Split Annuity. Actually a Split Annuity is not an annuity policy. It is simply a combination of two annuity products. A single premium tax deferred annuity (SPDA) and a single premium immediate annuity (SPIA). 

What you do here is split your investment to pay the single premium for each of two annuity policies.  You will pay the single premium immediate annuity to produce an immediate income stream guaranteed for a certain period of time. At the end of the term, all investment in this annuity will be used up.

With the remainder of your investment, you will pay the single premium of the deferred annuity for the same term. The purpose of the deferred annuity is to grow this single premium payment back to at least the amount of your full investment amount before the split.

So at the end of the term, you will have received a yearly income from the immediate annuity and have replenished your investment with the deferred annuity. But you will need an interest rate on each to achieve this. Annuities do not carry the federally insured protection of CD’s, but fixed annuities are regulated as insurance products and can offer guaranteed rates. This lends a good deal of security to your investment.
As a hypothetical example, let’s conservatively assume that you can get interest rates at least comparable to the CD analyzed above . We will appropriately split the same $100,000 investment and attribute a 5.0% rate for the immediate annuity, and 5.0% for the deferred annuity premiums.  The table shows you the hypothetical investment split and results for a term of eight years.

Even for annuity rates comparable to the CD, the immediate annuity leaves you with a yearly after tax income of $4,713 compared to the $3,600 of the CD – almost 31% more income. Note that no fees or expenses were incorporated into the annuity values illustrated, as typically, in the case of fixed annuities, the stated interest rate is net of commissions and fees. However, if additional expenses or costs were present, they would reduce performance.

Do you want to understand more about annuities?  Order you FREE copy Annuity Owner Mistakes.

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Not very long ago, investors had two options when it came to annuities. First one was variable annuity and the second one was fixed annuity. Thereafter a third type of annuity product was designed by annuity companies which is known as equity indexed annuity. An indexed annuity is designed to give a return which is close to important indices such as S&P 500 or the Russel 1000 Index.  Investors who have parked their funds in index annuities can indirectly participate in the markets. Let us find out some of the other features of Index annuities and also the genre of investors for whom this product will make a good fit. This product is definitely a good fit for investors who have a high risk appetite. Imagine this scenario. An investor who has invested in indexed annuities can expect a rate of return which is 50% to 60% of the underlying index. However, if the indices are not performing well then the investor’s rate of return for the annuity can take a serious hit.

The factor known as “participation rate” specifies the level at which the index annuity owners will participate in gains in the index. Consider this example. If the participation rate of an index annuity is 80%, then it means that for every 10% rise in that particular index, the indexed annuity account value will rise by 8%. If the index declines, the investor’s original principal remains intact and guaranteed by the annuity company.

What we have with an indexed annuity is an investment opportunity more conservative than investing in the underlying index because the original principal is guaranteed. However, the investor also cannot earn as much as being fully exposed to the index in a fund such as an index fund.

Not only is the original principal guaranteed, some insurance companies also give an assurance that no matter what the state of the stock market would be like, the annuity would always increase in value albeit by a small percentage (e.g. 2 % to 3% annually).  This is made possible by the spread that insurance companies make on the funds. The actual income earned is lesser than what is credited into the investor’s annuity fund. Indexed annuity policies are good investment options provided you understand all the features of the product that you are buying.   Because of the different products offered, get assistance from an experienced retirement advisor.

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You can exchange one retirement annuity for another, but you as a retiree need to watch out for what you may lose in the process. Often when you have one investment and see a similar but better version of it, you wonder if you can ‘upgrade’ to the new and improved version. Generally, whenever you liquidate an investment or retirement annuity, you need to pay taxes on any gain. If you buy another investment, your cost of the new investment will be its tax basis until it is sold in the future to determine gain.

However, in the case of two retirement annuities of ‘like kind’, the U.S. tax code, section 1035, allows you to simply exchange the two ‘like kind’ contrcats–if circumstances allow–so as not to have to pay tax until the latter investment is sold or pays out. In the case of retirement annuities, you need to be aware of what/how your ‘new and improved’ annuity may be different from your ‘old’ annuity.

Section 1035 allows you to exchange an existing annuity contract for a new annuity contract without paying any tax on the income and investment gains in your current retirement annuity. These tax-free exchanges, known as 1035 exchanges, can be useful if another annuity has features that you prefer, such as a larger death benefit, different annuity pay-out options, or a wider selection of investment choices.

You may, however, be required to pay surrender charges on the old retirement annuity if you are still in its surrender charge period. In addition, a new surrender charge period generally begins when you exchange into the new annuity. This means that, for a significant number of years (as many as 10 years); you typically will have to pay a surrender charge (which can be as high as 9% of your purchase payments) if you withdraw funds from the new annuity prior to term, and if the withdrawals exceed the annual allowance.
Further, the new retirement annuity may have higher annual fees and charges than the old annuity, which will reduce your returns.

So if you are thinking about a 1035 exchange, compare both retirement annuities carefully. Unless you plan to hold the new annuity for a significant amount of time, you may be better off keeping the old annuity because the new annuity typically will impose a new surrender charge period.

Also, if you decide to do a 1035 exchange with your retirement annuity, get the right retirement help and talk with a qualified tax professional to make sure you don’t violate the provisions of IRS section 1035. While insurance agents sell retirement annuities, few are well schooled in the more esoteric tax aspects.

Note: Annuities once annuitized cannot be surrendered for value. Income from retirement annuities is taxed as ordinary income and withdrawals prior to age 59½ are subject to a 10% penalty. Income from annuitization is taxed partly as ordinary income and partly as return of capital. The purchase of annuities incurs commissions and potential surrender charges. Any guarantees are based on the claims-paying ability of the insurance company. Retirement annuities should be considered long-term investments.

Get the truth about annuities

Learn the truth about annuities. If you own an annuity or are thinking about investing, get a copy of this booklet first! Get your FREE Copy

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