“Would you rather be rich, or would you want to make absolutely sure you’ll never be poor?”
Retirement Isn’t What It Used To Be
Retirement is looming and many people are concerned about the distinct possibility that they will outlive their retirement savings. Long gone are the days of the pension to guarantee you income for life. In its place is social security, and some people are surviving on it, but they certainly aren’t thriving. It’s just not enough money to support the kind of lifestyle that many retirees want. So most people save up over the course of their working years to support the lifestyle in retirement that they’re dreaming of. It’s nice to finally take some time to travel. Perhaps going out doing things and not stuck at home all the time.
No one wants to pinch pennies and just barely get by for the rest of their lives. Some have been forced into working longer than they ever expected, or moving to foreign locales away from family and familiarity because their savings aren’t going to last long otherwise. So what’s going wrong here and why haven’t they been told about the product that can help them avoid this reality? Why haven’t they been told that they can get guaranteed income for life, enjoy the retirement that seemingly only rich people have, and provide a legacy for those loved ones that they’ll leave behind?
Guaranteed Income For Life
Most people are in retirement savings vehicles like 401ks, IRAs, and mutual funds. The problem is, these accounts are highly risky, and when the economy takes a hit, so do the values in these accounts. In 2008, many people lost just about half the value of their retirement accounts. The stock market is a risky place to put retirement funds. Don’t get me wrong, it can be a great accumulation vehicle if you stay in long enough and you have time to recover, but for someone nearing retirement, the risks aren’t necessary.
So what’s the answer here? What can provide folks with a steady growth on their savings to the tune of 5-6 percent average yearly returns that beats out most cds, bonds, and money market accounts, and doesn’t have a risk of loss? An account that can only go up, not down, and provide guaranteed income for the rest of their lives to the tune of 8 percent withdrawals, not 4 percent like other retirement savings vehicles such as 401ks and IRAs? There’s only one product on the market that can do that, and it’s called an Annuity.
Brief Explanation of What Annuities Are And What They Do
An annuity is an insurance policy that you pay into with either a lump sum or monthly payments. From that point, either immediately or whenever you decide it’s time after the account grows at a rate of 3-7 percent annual interest, it guarantees you an income that continues to earn interest for a specified period. This income period can range from 10 to 30 years, or even for a lifetime. Ok, so why would anyone want that? Why do I need an insurance company to manage my money for me? In a word, guarantees.
You’ll Get More Out of An Annuity In Retirement Than Just About Any Other Retirement Account.
The biggest benefit you can get from an annuity is the fact that you’ll generally withdraw between 5 percent, all the way up to 8 percent from the value of an account at it’s highest, and that amount keeps going up over the years. In other investments, the rule is 4 percent withdrawals, and adjustments have to be made when the account value goes down. Annuities keep going up and can’t be matched when it comes to guaranteed income for life. You’ll get more out of it than any other retirement vehicle.
But Forget the Bells and Whistles. Let’s Talk About Human Nature.
It’s nice to think that we are the best managers of our own finances, but no one is perfect. Emergencies come up, kids want things, you want things, and we are susceptible to spending our funds frivolously. It’s not necessarily a bad thing, because we’re human and life happens. However, in retirement we want to make sure we can keep up a guaranteed lifestyle, no matter what happens. This is where annuities shine and this is the sole reason they were created. Even the most frugal spenders can’t guarantee what’ll happen with their money.
Keep Control of Your Account
Now just because the insurance company is managing a guaranteed distribution for you, doesn’t mean you have to give up some control of the money you put inside. You can still get a full surrender from an immediate annuity, but it’s going to be the remaining balance of the premium after income is taken. Generally, you have to wait a few years before you can surrender the annuity value. Also, There’s also usually a commutation charge starting from the time the full surrender option is available. This charge period lasts for 10 years and starts at around 10 percent, then goes down by about a percentage point each year until it reaches zero at year 10. So as you can see, if you decide you don’t want the annuity anymore, you can get the money back, but not without a few obstacles in your path.
With a deferred annuity, you don’t have to annuitize your account to receive income. Annuitization is when you turn a deferred annuity into an immediate annuity for income. This is the way it was done in the past, but since then, carriers offer a way to receive your income without losing control of money, meaning you can take all of it out if you want. Immediate annuities work for some situations and people, but not all. With deferred annuities, you simply add an income rider when the time is right, and receive income.
Two Kinds of Annuities For Now or Later. Deferred vs Immediate
Deferred Annuities
A deferred annuity is like a savings account offered by insurance carriers, and is similar to a bond or cd where you put your money in it and grows over time. Annuities currently have a better return rate than cds, bonds, and other low risk accounts. Your investment is safe during accumulation in an annuity as the account balance only ever goes up, never down. If the stock market crashes, annuities keep gaining value, unlike traditional 401k and IRA investments. Even bonds have the potential for loss, even though the risk is low. Annuities never lose. Annuities can be qualified plans, so you can rollover funds from a 401k, IRA, or any other qualified plan into an annuity without any penalties, taxes, or fees.
Once you reach age 59 and a half and preferably after the surrender charge period (7-10 years from the time you open your policy), and of course before age 70 and a half, you can elect a minimum guaranteed yearly income option. This option pays you guaranteed income for life. You do this income option before 70 and a half to avoid a 50 percent charge, and the insurance company will give you tons of warnings so that that doesn’t happen. This 70 and a half rule only applies if your annuity is in a qualified plan like a Roth IRA, which is where you want it because of the tax deferred growth and tax free distributions. The income you receive goes up yearly, so if you receive 8,000 one year, you’ll keep getting at least that, except it goes up slightly every year to account for inflation and even surpass it. This guaranteed income is contractual and can never change for any reason.
If you happen to pass away while receiving this annuity, the balance of the account goes to your heirs. So if you have 80 grand in it, that’s what goes to your beneficiaries, and it’s tax free, won’t go to probate court, and creditors can’t access it. Income from non-qualified or qualified annuities will not effect your social security benefits. Social Security does not count pension payments, annuities, or the interest or dividends from your savings and investments as earnings. These payments do not lower your Social Security retirement benefits. If you have taxable income, you can lower it by withdrawing some or all of your money from annuities.
Immediate Annuities
The way an immediate annuity works is you pay a lump sum of cash into it and it immediately pays you a guaranteed monthly income for life that earns interest and keeps up with inflation. It’s like a savings account that earns interest, but it’s designed to pay you a contractually guaranteed monthly income. The monthly income it pays is usually between 4-6 percent of the value of the lump sum you put into the annuity.
If you want or need guaranteed income right now, this will take your money the furthest. It’s much better than just spending it from another account over time, because in an annuity, you earn a return on your investment while it’s being paid to you, and it’s guaranteed to never run out.
Qualified vs Non-qualified Annuities
For tax purposes, there are two different kinds of annuities; Qualified and Non-qualified. Qualified annuities are funded with pre-tax dollars as a part of a qualified retirement plan like defined benefits plans, Ira, etc, which means they are tax deductible. What’s even better is if an annuity is placed inside of a Roth IRA, distributions are tax free. If placed in any other retirement plan, all the same benefits apply, but taxes will be due on distributions (a.k.a. withdrawals).
Non-qualified annuities can stay outside of retirement accounts and are paid with after tax dollars (money you’ve already paid your taxes on) but the growth of the account is still tax deferred. Once you take withdrawals from an annuity, taxes will be due on earnings, but not on the principle (money you put into the policy). Whether it’s qualified or non-qualified, you have to wait until age 59 and a half until you can start withdrawing funds without a 10 percent penalty. Also, annuities come with a surrender charge that last for about 7-10 years, depending on the plan.
The Surrender Period and Surrender Charge (For Deferred Annuities)
In deferred annuities, if you pull money out during the first 10 years of the policy, you are charged a certain percentage, usually 10% at the start of your policy decreasing yearly by about a percentage point until it reaches zero. This surrender charge is on top of the 10 percent penalty before age 59 and half, as well as taxes. With the qualified plan, the penalty you pay is on the full balance of the account.
Last In, First Out Taxes In An Annuity
If taxes are due on your annuity’s distributions, because it’s not inside of a Roth Ira or it’s non-qualified, here’s how it’s going to work. When you make withdrawals from an annuity, the interest earnings come out first and the money you paid in (principal) comes out last. So if you started your annuity with 50000 (principal) and it grew to 100000 over time (50000 of interest earnings), and you decide to take out 75000 (partial surrender of 75000) the first 50000 will be taxed and have penalty. The remaining 25000 will be tax free and penalty free.
Fixed annuities Vs Indexed annuities, and We Won’t Talk Much About Variable Annuities.
When speaking of fixed annuities, first understand that these are the deferred type of annuity. Fixed annuities come in two types, fixed and fixed indexed. Fixed annuities credit an account a fixed interest rate over the course of the policy, like say 4 percent. This credited rate never goes up or down and is for the ultra low-risk taker.
Fixed indexed annuities have a rate floor and cap. The rate floor can be anywhere from 0 to 3 percent and rate cap can be around 6-8 percent, depending on your policy and plan. So if the stock market is down by 10 percent, you can still earn interest credit in your policy if the floor 1-3 percent, or at the very least not lose any money at 0 percent. On the other hand, if the market is up 20 percent, and your cap rate is 7 percent, you get 7 percent credited to your policy.
A lot of people look at the cap rate as a drawback, but in volatile markets, like what we’ve seen over the past 15 years, it actually out performs many of the riskier investments and never loses a dime. Another thing is, annuities aren’t here to replace investments that can get someone the highest possible return. They are here to be even-balanced and provide a guaranteed rate of return as well as some of the upside of the market and grow at fairly competitive rate. A balanced portfolio should have high risk and low risk investments, but if the low risk side is in annuities or permanent life insurance, expect a return much better than cds, bonds, and money market accounts, and can even perform better than the high risk investments in volatile market periods.
Comparison of Annuities to Other Similar Products Like Pensions, Cds, Money Market Accounts, 401ks, IRAs, Etc.
It’s important to understand that 401ks and IRAs are tax classifications for a set of qualified investments. 401ks, IRAs, and other qualified tax plans usually contain a mix of cds, money market accounts, stocks, bonds, real estate, mutual funds, and even annuities. An annuity is an insurance policy that can be used alongside other investments to spur growth and hedge risk in a financial portfolio, or it can be used outside of a portfolio on it’s own, like a cd account.
The great benefit of annuities is the guarantees. Guaranteed growth that never loses value, even in down markets, and guaranteed income for life. The trade-off (with fixed indexed annuities) during growth years is that the upside is capped at around 6-8 percent. Even so, annuities outperform many high risk investments in volatile market periods, because they only gain, and never lose. One could say the same about cds and money market accounts, right? Except annuities guarantee much higher returns than a cd or money market account. Let’s not forget about the guaranteed income option.
No other account can provide a set guaranteed minimum lifetime income, or period certain income, like an annuity can. The value of your annuity account keeps growing and it keeps paying you forever, usually at a rate between 5 and 7 percent of your account. That’s compared to say the general rule of 4 percent withdrawals in other accounts, and those accounts can eventually run out of value if not managed correctly.
No Market Risk Means Your Account Will Never Lose Money
Annuities never lose money. When the market is down or the economy takes a turn for the worst, equities, bonds, 401ks, IRAs, etc. lose money. Annuities have a rate floor cap, often between 0 and 3 percent. In down markets, you either lose nothing, or gain something. Annuities inside of IRAs and 401ks lose nothing as well, but the other higher risk investments in those accounts could potentially lose in down markets.
Tax Deferred Growth (And If Inside a Roth IRA, Tax Free Withdrawals)
Both qualified and non-qualified deferred annuities are tax-deferred with no income tax requirement until withdrawal (Withdrawals are tax free if the annuity is inside of a Roth IRA). This is a definite advantage over many investments like CDs, mutual funds, stocks and bonds when considering a long term retirement investment. A long term fixed index annuity acquisition may consistently outperform CDs, bonds and treasuries. Reinvesting money that would otherwise be paid out in tax over an extended period of years is always an advantage.
Unlimited Contributions
Non-qualified Annuities have unlimited contributions. If you max out one annuity, simply start another and max that one out too, and on and on until your heart’s content. However, Qualified annuities in retirement plans like Roth IRAs and 401ks are subject to the rules of those plans. So you can’t start a new IRA with an annuity and put more in the annuity than the Roth IRA limits, unless your rolling over money from another tax advantaged account. Then you can rollover however much you want.
No Income Limits
Roth IRAs have income limits, meaning if you make over a certain amount of money each year (Around 130000 for singles and 190000 for Married couples), you can’t open up an IRA. Non-qualified annuities and other investment accounts for qualified annuities don’t have these limits.
Who Should Buy Annuities?
Annuities are for people that like guaranteed income, like say for retirement, or some other period of their lives, that pay outs of for a certain period, or for life. Annuities are also beneficial to people that like low risk investments with a guaranteed decent to high return over time, with tax deferred growth, and if the annuity is placed inside of a roth ira, tax free distributions.
Even in the retirement stage of your investment strategy, annuities provide lower-risk for retirement income. Always great to diversify your portfolio. Performs much better than cds and money market accounts.
Guaranteed Income For Life With Annuities: An Explanation Part 2
I don’t think I’d go as far as to say annuities have downsides. There are however some features of annuities that people should be aware of before making the decision to purchase. In this article, we give an in depth explanation of all those “drawback” features and how to plan for them accordingly. (Continue to Article)