Annuities

How Do I Organize My Money to Spend My Last Dollar the Day I Die? asked the investor
And the advisor said, “That’s no problem, Sir. What day will that be?”

Not knowing when we’ll die means making sure we arrange our finances to produce income for as long as we live. Aside from being able to live off just the earnings of our investments, only social security, pensions and annuities can pay you a lifetime income.  We would all like to have jut enough money to last until our last day and die broke.  While that seems like a wild idea, it’s doable.

Social Security gives you a lifetime income because the government can compel taxpayers to pay for it. And, if things get tight, they can print the money necessary to pay you.  And it stops the day you die.  If you do get a pension, it’s likely being paid by an insurance company in the form of an annuity.  As long as the insurance company remains solvent (large companies such as Prudential and New York LIfe lent money to the federal government during the Depression), you receive income for life that stops the day you die. If you like that idea, making optimal use of your money while your alive and then dying broke, you can also create your own private pension.

Insurance companies – generally being more fiscally responsible than the government – use the voluntary premiums of thousands of annuity holders, the premium earnings, and the statistics of mortality to assure everyone a lifetime income. Using an annuity has some other advantages for you, too. Let’s look at a few.

The application advantage

Unlike life insurance, you generally don’t need a health exam to buy an annuity. Life expectancy for annuity payout purposes is determined by insurance company experience and not as a result of a physical examination.

The later payout advantage

Because of the nature of mortality rates, beginning your annuity payouts later mean your monthly payout increases for the same investment amount. So, the longer you can hold off receiving payments, means you need less investment money to achieve the same monthly payout.  If you have a joint and survivor annuity, two lives are used in the calculation and the amount of the payout is smaller than with a single life contract.

The tax advantage

During the accumulation phase of a deferred annuity, your investment grows faster because its earnings are tax-deferred. You pay income tax only during your annuitization (payout) phase – and then only on what hasn’t been taxed.

If you purchased an immediate annuity – payouts start in about a month - with after tax money, only the earnings of your premium during the payout phase is taxed. This is a relative small fraction of each payout. If you’re able to outlive the mortality projection, you’ll receive a lot more money over and above your single premium payment.

If you purchase an annuity within your IRA, your payments must meet the Minimum Required Distribution (MRD) rules after you turn 70½. All of each payment is taxable income. The IRS has life expectancy- based table for determining the MRD amount. But with people living longer, this table is becoming dated. So the IRS will accept[1] a ‘lower’ MRD based on the insurance companies longer remaining life expectancy.

To see if you can die broke and enjoy every last dime while your kicking, consult the immediate annuity calculator.

Note: Annuities once annuitized cannot be surrendered for value.  Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.  Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.

[1] www.irs.gov/publications/p590/ch01.html#d0e1252, Special rules apply if you receive distributions from your traditional IRA as an annuity purchased from an insurance company. See Regulations sections 1.401(a)(9)-6 and 54.4974-2. These regulations can be found in many libraries and IRS offices.

closed annuity sales

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For millions of Americans, a life annuity can provide safety of principal and tax deferral. However, one disadvantage inherent in most life annuities is their inability to keep up with inflation over the long-term.

For example, assume that you invest $100,000 into a single premium immediate life annuity. as an example, a current contract from a major annuity company would then pay out $658.59 per month, for a total of $7,903.08 for the year.  The problem is if the rate of inflation is 3%, then the purchasing power of these payments will decline from one year to the next. Obviously, $7,903 will not buy in a future year what it can now. Imagine how you feel twenty years from now when the purchasing power of your life annuity is reduced by 47%!

One way that life annuity buyers can deal with this problem is to purchase a cost-of-living rider in the contract. This rider is designed to ensure that the income from the annuity stays abreast of the rate of inflation over time.
However, these will be a trade off in that less income may be received today.

For example, the same immediate life annuity contract with a 3% inflation protection rider will only pay $499.06 per month initially.  But this amount will increase by 3% each year for the duration of the payout, thus providing some protection from inflation. Of course, it is plain to see that there is a cost to this rider, as the initial monthly payment is $159.53 less than the contract without the COLA rider. However, if the annuitant should live long enough to receive payments for the next 20 years, then the payment by year 20 would be $901.36 per month or $242.77 per month more than the straight-life annuity contract payout. The longer you live, the more value the inflation rider becomes in your life annuity.

COLA riders can come in different forms, with some riders having a specific cost, while others (such as the one shown previously) merely affect the dollar amount of the monthly payout (i.e. less today and more later). Different rates of increase are also generally available, depending upon how much inflation protection the life annuity contract holder desires. For example, the contract as shown previously also has a 6% inflation protection rider option, which would result in the contract holder receiving a proportionately lower payment each month to begin with, and a higher payment at the end of the term.

Financial Professionals–annuity lead program

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Even the best experts can’t predict how certain investments will perform or the income that you’ll see from them.

Nevertheless, you might need a set amount of money each month to pay non-discretionary expenses like mortgage payments, auto loans, and life insurance premiums. Frequently these monthly outlays are fixed for a number of years.

To pay these predictable expenses, you may want to consider a fixed, immediate annuity to provide a steady stream of income for your lifetime, your spouse’s lifetime, or the duration of the loan.  And if you don’t like paying taxes, you may like the idea that part of that regular check from an immediate annuity is a tax-free return of your investment.  If you find comfort from social security check, having the fixed income stream from a lifetime immediate annuity is quite similar.

But what about expenses that you will always have and most likely will go up each year, such as real estate taxes, auto insurance, or homeowner’s premiums? Some immediate annuities offer several options to meet your future needs too, including an inflation protection rider that will let your income rise annually.

Ability to make payments based on claims-paying ability of Annuity Company. Not government backed or FDIC insured.  Exact provisions of inflation rider may vary among annuity companies and may not be available on many annuities. Additional riders are subject to additional fees and charges.
For a free illustration of how a fixed, immediate annuity can provide that money you need to meet your monthly obligations, use the immediate annuity calculator.

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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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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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The word “annuity” brings to mind different meanings for many investors.  That’s because there are different types of annuities designed for different purposes.  One of these is the immediate fixed annuity, which can provide an immediate stream of cash payments over a lifetime or a defined period of time.

If the investor has chosen a lifetime payout retirement option, he or she typically pays a single premium to an annuity company. In return, the company agrees to pay the investor regular and ongoing cash payments for life, or for a lesser amount to continue over the life of both spouses. Although many investors choose to receive monthly payments, it is also possible to receive quarterly, semi-annual, or annual payments as well.
Assuming the payments are structured over a lifetime, the investor is provided with a lifetime income he or she cannot outlive. Such an investment is useful for investors requiring additional retirement income, for support of a community spouse in the event the other spouse is in need of nursing-home care and is seeking to qualify for Medicaid (immediate annuities can be treated as exempt asset in some states), for making lifetime payments to cover long term care needs, or for paying long term care insurance premiums.

A portion of each payment is considered a return of premium and therefore not taxable to the investor. The remainder is considered interest and will be subject to federal and state income taxes.  For example, for a male investor age 70, 68% of each payment is nontaxable to age 86 (then all amounts thereafter are taxable).

One drawback to these products is an early death. In such a case, the annuity company keeps the funds and the income ends. This early-death financial risk is sometimes perceived as a negative feature among some investors. However, there is a possible solution to this concern as some annuity companies will guarantee a return of the investment to heirs in the case of an early death.  The feature is referred to as a “refund” provision.  Other companies offer “commutation” which allows the investor to change his mind and recover his initial investment (usually with a surrender charge), for example, in the case of a terminal illness.  These features make the immediate annuity more flexible and remove the chance of having one’s investment disappear in the case of untimely death.

Please note, that annuities are long-term investments that are designed for retirement purposes. Annuities are also subject to administrative fees, mortality charges, and surrender charges that can apply to early withdrawals, and these fees tend to vary from company to company. Annuity premium payments and any other guarantees are subject to the claims-paying ability of the issuing company. For this reason, it is very important to consider the financial standing of the issuing company before you purchase an annuity.

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Stability and safety are important to many seniors, and these are only two of the reasons why immediate annuities are popular investments. A check arrives every month and part of the income is considered a tax-free return of your principal. As long as the annuity company is financially sound, the payments will continue for the life of the contract (annuities are guaranteed by the claims-paying ability of the issuing company).

However, consumers sometimes believe that immediate annuities are illiquid, irreversible investments, and cannot provide for future lifestyle changes. Nonetheless, there are some immediate annuities with options that may add flexibility to your financial plan.

Immediate annuities can possibly include an option that would allow you to receive extra cash at specific anniversary dates. For example, this might be at the 5th, 10th, or 15th anniversary of your investment. Exercising this option will reduce your future payments (the distribution may be fully taxable, so consult with your tax professional).

Suppose you needed money to cover an emergency, like paying for caregivers or a home repair. Some annuity companies will let you take up to six payments at once. You would not, however, receive checks for the following six months (payments may be fully taxable so consult with your tax professional).

You may also have the ability to provide a cash benefit from your immediate annuity to your heirs. This would be a pre-determined percentage, such as 25% or 50% of the amount of your initial investment. Selecting this option will reduce your monthly annuity checks, and may have tax consequences.

Annuities are so varied and there are so many different options provided, it’s essential to speak with a retirement advisorto see a range of products and solutions available.

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Could underestimating your longevity mean you’ll run out of retirement money?

At age 65, the average life expectancy is 81.8 years for a man and 84.8 years for a woman. At age 75, the average life expectancy is 85.5 years for a man and 87.6 years for a woman. Note that as you grow older, you’re expcted to live longer!  With recent advances in medical science, it’s no longer a stretch to think that you could live to be 100. In fact, the US Census Bureau projects that by 2050 there will be nearly one million centenarians.

No one wants to die sooner, so that’s great news. The problem: If your retirement plan doesn’t recognize the possibility of a long retirement, then you could potentially outlive your money. But read on for a solution.

Consider the following hypothetical example. Assume you’re 64 years old and earn $60,000 per year. You plan to retire next year at age 65. You’ve accumulated $1,000,000 in retirement savings, which you think will return a hypothetical six percent per year throughout your retirement. And, you have a $60,000 annual retirement need (excluding Social Security). If you have a 15-year retirement from ages 65 to 80, you’ll have no shortfall in retirement funds; in fact, you’ll end up with almost $696,000 to pass on to your heirs. On the other hand, if you have a 30-year retirement from ages 65 to 95, you’ll run out of money at age 83 as the table below illustrates. Of course, this example  is hypothetical and for illustrative purposes only. It is not meant to represent the performance of any particular product.

Source: Burling Bank. Assumes $1,000,000 in retirement savings has already been accumulated; another $60,000 is added. The money grows at a hypothetical 6 percent pear year; $60,000 (in today’s dollars) in withdrawn each year. This example above is hypothetical and for illustrative purposes only. It is not meant to represent performance of any particular product.

Because the risk of outliving your funds is real, annuitization may be an option.  Annuitization is the process of converting your assets into an income stream.  For example, maybe you plan to leave your heairs$250,000.  You could turn that $250,000 into an income stream you cannot outlive with an immediate annuity.  For example, a femaelage 70 could invest $250,000 into an immediate annuity and get $1765 a month for life – an income she cannot outlive.  To see the amount you can receive, use the immediate annuity calculator.

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One major advantage of an immediate fixed annuity is the security of a guaranteed income. You can count on those regular monthly payments. If returns on other investments diminish–because of a fall in interest rates or a stock market slump–your annuity payments remain steady.

Offsetting this advantage is if interest rates are down when you purchase your annuity, your monthly payments will be less and may not keep up as easily with inflation. Is there a way to offset this situation?

First, realize that once your immediate annuity begins, it is irrevocable. You cannot change your mind; there’s no lump-sum repayment provision (there are a few companies that offer commutation–the ability to get your principal back at a discount). So, shop for the best deal when you buy.

The amount of your monthly annuity check is based on the size of your investment, your age, and what the insurance company estimates it will earn on their contract with you. But realize, too, that the monthly payment on the same size investment can vary significantly from company to company. Get several different proposals to ensure you are getting a good deal.  Do not let anyone rush you into making a purchase. The consequences are permanent. Check out a company’s rating from Standard & Poor or A.M. Best & Company. You will be counting on those monthly payments for quite a while.

Now, if you are ready to buy an annuity but interest rates seem historically low, you might consider laddering your annuity investment to take advantage of hopefully higher interest rates in the future.  To do this, simply take the total amount of money you have set aside for purchasing an annuity and divide it evenly into several amounts.  Purchase an annuity with the first amount now according to prevailing interest rates and the best deal you can find. Then do the same with the remaining amounts spread out over the next five or six years.  This is referred to as “laddering annuities” or an “annuity ladder.” Hopefully interest rates will ratchet up for your later purchases. 

You can in fact purchase all of the annuities today to create your annuity ladder.  The first one, which will start the payments immediately and the other will be deferred annuities.  After the first year, you will convert deferred annuity “A” into an immediate annuity (i.e. you will annuitize the contract).  After 2 years, you will do the same with annuity “B” and so on.  Or, maybe you do this at 5 year intervals pictured like this

You could be better off with a higher average rate among them than if you had purchased one annuity when interest rates were low.  Of course, if interest rates seem historically high today, you’re best of by getting all of your funds into an immediate annuity and locking in a high lifetime payment.

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