Annuities - What to Consider?

Valerie Johnson, CFP ®, Director of Wealth Management, Kolb+Co. Financial Advisers, LLC   email | bio
June 2009
 

In the wake of the rocky stock market, annuities are suddenly front-of-mind for those planning for retirement. Annuities are contracts with insurance companies that can provide guaranteed income streams that an individual cannot outlive. Annuities can offer a safer option for investors who are worried about or have experienced the fluctuating stock market and those concerned about the current low returns from bonds. As a financial planning risk management tool, annuities can play an important role in diversification of the overall plan and provide more options.

What are the various annuity types?

An immediate annuity is a contract that is purchased with a single lump sum deposit, and income payments begin within 12 months. Upon “annuitization” immediate annuities pay a fixed or variable amount each payment period. Payments can be guaranteed for a specific time and amount or up to life for the annuitant and their spouse or beneficiary. In some contracts, payments are guaranteed with increases to reflect increases in the consumer price index.

A deferred annuity is a contract purchased either with a single premium or periodic payments. The contract holder determines the point at which accumulated principal and earnings are converted into an income stream - usually after age 59½ to avoid tax penalties for early withdrawal of earnings. Deferred annuities can be invested in various ways.

• Fixed annuity- a contract that pays a stated interest rate with a guaranteed minimum interest rate. Annuities are not FDIC insured; guarantees are backed by the issuing insurance company.
   
• Variable annuity- a contract which has subaccounts of investment portfolios that you allocate to, including stocks, bonds and cash vehicles (no guaranteed minimum return and it can lose value).
   
• Combination of the two- fixed and variable options in separate contracts or in the same contract.

Annuities allow for tax-deferred accumulation of earnings, and if purchased with after-tax dollars when income is received, a portion of each payment is attributed to return of principal (not taxable) and to earnings (taxable). Variable annuities may offer additional living benefit rider features such as Guaranteed Minimum Withdrawal Benefits (GMWB), Guaranteed Minimum Accumulation Benefits (GMAB), Guaranteed Minimum Income Benefits (GMIB) and guaranteed values that will be paid to beneficiaries. Various riders, fees for additional protection and the number of different annuities on the market make for a complex due diligence process, which should also include insurance carriers, risk management philosophy, ratings and reserving strategies.

Annuity candidates may include individuals who:

• Are ages 50 or older (individuals aged 75+ may not be eligible for some contract riders);
   
• Are currently in a high tax bracket or 28 percent capital gains rate and may be in a lower tax bracket at retirement;
   
• Want to lock in a minimum interest rate (for life of contract) and current rate for a period of years;
   
• Want to invest in the market but are risk adverse and willing to pay to protect themselves against losses;
   
• Have no need for liquidity of the funds during the surrender period of the contract; and/or
   
• Desire guarantees for income benefits for themselves and/or death benefit values for beneficiaries.

If you have any questions, please contact Valerie Johnson CFP®  (262-754-9400).