Annuity Investment Guide

May 5th, 2009

Most retirees or those about to enter retirement have at least one (if not all) of the following concerns:

 

  1. Protecting their savings
  2. Creating and protecting their retirement income stream, and
  3. Protecting their heirs.

 

Roll these concerns all up together and we see that the underlying issue is risk management. Invested properly, annuities can be a significant anecdote to these problems, especially for retirees.

An annuity is an investment designed for retirement. It is a written contract between you and an insurance company. The contract allows you to potentially accumulate funds and then provide lifetime income payments.

Fixed, Immediate, or Variable: Which Annuity is right for you?

There are two main categories of annuities immediate and deferred. Within each of these there are two sub-categories, fixed and variable.

Fixed Annuity:

With a fixed annuity, you invest your capital with an insurance company which promises to pay you interest and return your capital at an agreed upon future date. Just like a bond or C.D.

The safety has to do with the rating of the insurance company, once again, much like a bond, make sure the insurance company you are using is rated “AA” or higher. Rule of thumb: Invest in the best. After all, we are choosing this investment option for the safety. Do not compromise of this issue.

Fixed annuities, like all annuities offer the advantage of tax-deferral. You will be required to pay taxes on profits when you withdrawal the money at ordinary income tax rates. If you choose to reinvest, current tax will not be owed. This must be considered when comparing the rates on fixed annuities as compared to other fixed income investments. And that’s exactly how you should approach this investment choice. Shop and compare before you buy!

Know also that the choices of rates and maturities vary from company to company. Consulting a financial advisor before making your final decision is, as always, prudent since they should have access to many insurance providers and that will make it easy to quickly compare current rates.

Immediate Annuities

This type of annuity is a fairly straight forward investment choice. You turn over a certain amount of your money to an insurance company which in return agrees to pay you a certain amount of money for a specified period of time or the rest of your life.

Once you invest in an immediate annuity, the insurance company keeps your principal. It is not returned to you at any time. You give up the rights to your money in turn for an income stream. It is not given to your heirs either.

So when investing in an immediate annuity, be sure to live a very long time. It will drive the insurance company crazy! Knowing when you will die is the only true way to know if this choice is right for you.

The immediate annuity rate an insurance company quotes you fluctuates from week to week, just like the rates on a C.D. One week an investment in an immediate annuity may net you $1000 per month, and the next week $950. So the direction of interest rates will affect the timing of when you should purchase an immediate annuity. Once you buy it the rate is set for life so you may not want to invest your capital all at once. Spread your purchases out a bit especially when rates on moving higher.

Immediate annuities are becoming more popular as retirees look to supplement other sources of income like social security and pensions. They want to know that check is coming in month after month, year after year no matter what.

Variable Annuities:

In the first two examples, the investor knew ahead of time, at a minimum, what the return and income stream would be. When investing in a variable annuity, the return is variable and unknown.

When you purchase a variable annuity contract, your money is invested into sub-accounts. These sub-accounts are like mutual funds. They are professionally managed and invest in stocks, bonds and a wide variety of other market sectors. .

You may choose the sub account(s) you prefer just as you may choose a mutual fund. If they do well you will have more money in the pot, if they don’t you will have less.

The variable annuity does offer a guaranteed income payment based on your initial investment but the goal with a variable annuity is to grow you capital to a higher level which, at some point you can turn into a larger income stream.

Posted in Category | No Comments »

Ten Things To Know About Annuity Investment

May 5th, 2009

Deferred annuities possess characteristics found nowhere else. They play an important part in seniors’ portfolios.

Seniors hold billions of dollars in deferred annuities. However, my experience is that the average person knows little about the unique advantages of deferred annuities, much less the options they have during the holding period.

When you mention the term, “annuity”, it typically conjures up thoughts of getting a small check in the mail every month from some insurance company. It is viewed as an income.

The vast majority, however, of annuities are of the “deferred annuity” variety. They are accounts designed to grow money over a period of time in a safe environment. Over 90% of deferred annuities are never “annuitized”, that is, converted to that monthly check in the mail.

So let’s take a look at some of the attributes of annuities and, in the process, clear up many misunderstandings about this vehicle.

Tax Deferred Earnings

Deferred annuities provide “triple compound interest.” There is interest on principal, interest on interest and interest on the taxes you would have paid on an investment in a non-tax deferred environment.

For example, 6% which is taxable is equivalent to an 8% non-taxed return assuming a combined federal and state tax bracket of 25%.

Safety

While deferred annuities are not FDIC insured, like a CD with a bank, they are backed by the generally billions of dollars of the insurance company’s assets. No big risks here.

A Competitive Interest Rate

Insurance companies normally set the interest rate for a deferred annuity contract annually. You will find that it is usually one to two points above CD rates. So not only do you get a higher rate but the interest is tax-deferred, unlike a CD where you pay taxes on the interest each year.

Some deferred annuities offer a rate that is guaranteed for a number of years, such as five. If you think interest rates will fall, you can lock in today’s rate.

Minimum Interest Guarantee

When you get to the end of your annuity time frame, if your annuity has not given you at least a minimum of (generally) 3% interest per year, then the insurance company will apply their minimum guaranteed rate. Nothing to get excited about, but at least you know that you can’t lose money and there is a minimum interest rate that is guaranteed no matter what.

No Sales Charges

When you move money into a deferred annuity, 100% of the money goes to work for you from day one. There are no sales charges subtracted from your initial deposit.

No Annual Administration Fees

Some places to park money, like mutual funds, may have fees attached to the administration of the fund. Not so with deferred annuities.

Withdrawal Privileges

This is a source of major misunderstanding. Many people do not realize that their money is not as tied up as they think; there are a number of ways to access funds without surrender charge penalties.

1. First, there is the 10% annual free withdrawal privilege. Each year you can take out up to 10% of your account value free of any penalties.

2. If you ever need to go into a nursing home, most insurance companies will allow you to take out whatever you need with no penalty.

3. If your doctor diagnoses you with a terminal illness, you typically can take out any amount penalty free.

4. You can convert all, or a portion, to a guaranteed income. This can be for your life, your life plus another (i.e. husband and wife) or for a set number of years.

5. There are a handful of new products on the market which will set you up with a pay out at a guaranteed interest rate for the rest of your life, but also allow you to retain control of the principal. In other words, the annuity is never “annuitized.”

The interest rate is typically a function of your age. For example, if you are 65, the interest rate is 5%; 70 would be 6%; 75 pays 7%.

Free of Probate

This feature will vary by state, but in those states in which this feature is applied, an annuity is not included as a probate asset. Hence it is free of any probate fees or any delays in passing the funds to your beneficiaries. The normal requirement, however, is that the annuity must have a named beneficiary.

Free From Creditors

Again, this will vary from state to state. If you live in a state where this applies, this is added peace of mind that the money in your deferred annuity is safe in the event of a financial reversal.

Surrender Charges

Folks who object to deferred annuities usually bring up the fact that there are surrender charges that make getting their hands on the money costly. To a certain degree this is true. In order for the insurance company to go on the hook for the guarantees in the contract, they need to put some strings on accessing the funds.

However, these surrender charges decrease over time. Eventually they disappear altogether. In addition, after you have held your contract for a certain number of years (five is typical), you can take all or some of the money out over a five (sometimes ten) year period with no surrender charges.

The bottom line is that the surrender charge issue can be circumvented in a number of instances. Remember, deferred annuities are longer term scenarios. You certainly wouldn’t want to put emergency fund money or money you are going to use to buy a new car in two years into a deferred annuity contract to begin with.

So there you have it. Ten features of a deferred annuity, which will add to your understanding of this product.

Posted in Category | No Comments »

Things to Consider Before Purchasing Annuity Investments

May 5th, 2009

An annuity is a contract between an insurer and an annuitant whereby the annuitant makes a payment or series of payments in exchange for a lifetime payout. It is difficult to give advice about annuities in general, because there are several different types with significantly different permutations. Some annuities are immediate; others are deferred. Some operate with declared interest rates while others offer the variable returns of a mutual fund environment. Depending on your situation, an annuity may work well for you. Here are some things to consider before purchasing annuities:

1) The time left in your accumulation phase

Deferred annuities work best when you have at least 15 years for the accumulation to take place. Some people take annuities late and the compounding principle cannot properly offset the trade-off of owning an annuity. If you have 15 years or less to the time of your retirement, you may want to consider other options. You would always have the option of taking an immediate annuity later. Those would offer tax-free returns and above-average payout rates.

2) Liquidity risk

Before deciding how much to invest in annuities, consider that annuities have a higher liquidity risk as a long-term investment. This means that annuities generally lock in your investment for long periods with surrender penalties. Some annuities today may offer a penalty-free withdrawal provision with limits set. However, this provision goes against the premise of saving for retirement. It is best to be prudent. Do not stretch your income too much to finance your annuity.

3) The type of investment

Some annuities offer steady growth or evenly distributed payouts. Others operate with fluctuating returns. This applies to both immediate and deferred annuities. It is important to consider the potential returns and have a clear idea of the insurer’s performance in investing as well. Deferred annuities offer minimum guaranteed interest rates for worst-case scenarios. These should be considered as well before purchase.

4) Clauses that may be included in the policy contract

Some deferred annuities have anti-annuitant clauses that do not offer flexibility. I know of an annuity that would use your cash value to purchase a reduced paid-up annuity on non-payment of the premium. Ask about the stipulations regarding non-payment of premiums and flexibility of deposits when considering an annuity.

5) Whether you wish to leave an estate

This is a major consideration when it comes to immediate annuities. Immediate annuities are designed for those who do not wish to leave the sum invested to their estate. If you wish to leave an estate, immediate annuities should be approached carefully.

6) Tax structure

Tax deferral is a major benefit of investing in annuities. However, you need to realise that your payout would be taxed after maturity. If your payout is likely to increase your chargeable income by a lot in retirement, you may have to reconsider investing too much in a registered annuity. It may be better to develop an accumulated lump sum and invest in an immediate annuity where proceeds are tax-free.

7) Unregistered annuities versus registered annuities

Some annuities are really savings plans that happen to be registered with insurers. These plans are unregistered annuities. Typically, they offer no tax breaks and lower returns or interest rates. They are best for short to medium-term needs or accumulating a tax-free lumpsum at retirement.

Annuities may be somewhat complex and may not be easily understood by persons outside of the financial services industries. You do not need to become an expert on annuities to select one properly. All you need to do is ask the right questions and understand how your selection would impact you in the future.

Posted in Category | No Comments »

Annuity Investment

May 5th, 2009

Though popular among today’s aging Baby Boomers and members of the Mature or “Senior” markets, annuities can be traced back to ancient Greece. The term “annuity” comes from the Greek word “annus”—or “year”—and refers to annual income payments. Similarly, in ancient Rome citizens would make one-time payments to a contract called “annua” in exchange for lifetime payments made once a year.

In 17th century Europe, annuities were used as fundraising devices by governments to finance their ongoing wars with neighboring nations. These governments would offer “tontines,” which promised payments into the future to those who bought shares.

In the 18th century annuities were introduced to North America, with private insurance companies selling insurance and annuity contracts to individuals wanting to avoid outliving their resources, In 1759 in Pennsylvania a company was formed to benefit Presbyterian ministers and their families. The ministers would contribute to a fund, in exchange for lifetime payments. In 1912, the Pennsylvania Company for Insurance on Lives and Granting Annuities became the first American company to offer annuities to the public.

However, annuities experienced a huge growth in popularity during the late 1930s when the collapsing financial markets turned many people away from equities in favor of products from more secure institutions—insurance companies that could and did make annuity payments, as promised.

Early annuities were simple contracts guaranteeing a return of principal and fixed rates of return from the insurance company during the accumulation phase. At withdrawal, the annuitant chose either a fixed income for life or payments over a specific number of years.

Buyers have always been drawn to annuities by their tax-deferred status. As a consequence of being issued by insurance companies, annuities have always been able to accumulate without taxes being taken out at year-end, which has added the time value of money to their list of advantages.

The most recent major development has been the inception in 1952 of variable annuities, which offer the investment features of separate mutual fund accounts inside the annuity with the tax-deferral available from life insurance products. Variable Annuity owners choose the type of accounts to use, often receiving modest guarantees from the issuer in exchange for the greater risks assumed.

“The shift to investment-linked annuities has been so marked that 25,000 investment-linked annuities were sold [in 2001] - 9.5% of all annuity business,” reports Peter Quinton is managing director of The Annuity Bureau, adding that “it’s likely that the popularity of these annuity will continue to increase as they are the only at-retirement products that offer retirees a half-way house between the two extremes of purchasing a safe conventional annuity and opting for a investment-linked income drawdown plan, where the cross-subsidy system does not apply.” Source: Pensions Management; 12/1/2002

Wider Choices

Although long part of well-diversified financial portfolios, annuities have continued to evolve. Recent developments have included features such as adding checkbook access to Variable Annuity funds, more attractive “bonus” rates, shorter maturity periods, and guaranteed death benefits.

But consumers now have wider choices of annuity types, plus more investment options and guarantees to fit their investment and income goals. For example, some annuities offer guaranteed bonus interest rates for the first few years or guaranteed returns for the life of the contract. Other annuities guarantee beneficiaries the return of principal if the annuitant dies and the annuity stock market investments have lost value.

Although annuities have evolved, their primary objective remains the same. That is, being able to lock in a guaranteed payout that cannot be outlived. As people live longer, healthier lives–and the equities markets remain subject to unsettling fluctuations–financial products offering safety, flexibility and guaranteed returns are increasingly appealing to older consumers. However, investors of all ages are drawn to variable annuities whose return is tied to the stock market, but which also offer guaranteed minimum returns not tied to market performance.

Annuities are accessible. Because there are no contribution limits, people can invest as much or as little as they chose in annuities no matter what their income levels. And this money grows on a tax-deferred basis until the accumulated earnings are distributed, usually at retirement.

Moreover, unlike other tax-deferred investments during the distribution phase, annuities’ tax-deferred earnings are not counted in determining a person’s income taxes on Social Security benefits. At the same time, while annuitants cannot outlive their guaranteed benefits, properly structured annuity contracts and beneficiary designations can:

1) avoid probate,

2) protect assets held in trust from mismanagement by a parent of guardians, and

3) continue benefits to the annuitant’s heirs, thus making annuities effective multigenerational planning vehicles.

Market Overview

With their unique advantages, a growing market for annuities has grown among individuals with longer-term wealth accumulation and retirement planning needs, as well as individuals with immediate income needs. Let’s consider how two types of annuities can be used to address the wealth accumulation and retirement planning problems we all face. These are:

• Non-qualified Annuities — Non-qualified annuities are purchased with after-tax dollars to meet longer-term wealth accumulation or retirement planning needs–with emphasis on longer-term.

• Qualified Annuities

Non-Qualified Annuities

As noted, deferred annuities may not be appropriate for shorter-term wealth accumulation purposes — generally those that will materialize before age 59½; while immediate annuities are designed to provide long-term income — that is, income guaranteed for life.

Non-qualified annuities are used to fund cash accumulation programs that do not qualify for a front-end tax deduction; but whether an annuity is qualified or non-qualified, premiums always accumulate interest that is free of current income tax until withdrawn. But non-qualified annuities also allow owners to continue tax deferral beyond the age 70, the mandatory withdrawal age for traditional IRA’s and qualified retirement plans.

Qualified Annuities– Annuities can also accommodate tax-qualified money. A qualified annuity is used to fund a tax-qualified retirement plan such as a traditional IRA or an HR-10. Thus in most cases, premiums paid to qualified annuities are tax-deductible. For instance, when people change jobs and have 401(k) funds to move or already have IRAs and are seeking a more diversified portfolio. They can reduce their portfolio exposure by rolling the money over into an annuity without losing tax advantages.

Or suppose Alice inherits $20,000. If she doesn’t need the money right away and wants to build a long-term nest egg, she might consider putting the inheritance into an annuity. By doing so, she’ll gain the advantage of tax-deferral, and when it’s time to withdraw funds from her non-qualified annuity, Alice will only be taxed on the accumulated interest, not the principal.

Generally, annuities are not suitable estate planning vehicles, but are useful in meeting immediate and retirement income needs. Thus, iif you’re a candidate for wealth accumulation and retirement planning, remember: “The only person who can take care of the older person we will someday be is the younger person we are now.”

Posted in Category | No Comments »