What is an annuity? Why consider one?


On vacation, checking e-mails!

In  the ’80’s I reviewed an annuity with a retiring high school teacher. She was frugal and skeptical, but this seemed like a solid offer.  The stakes were high; she had charitable giving in mind for her favorite non-profits after her need for the income no longer existed. At a certain point she began receiving a monthly check which bolstered her teacher’s retirement income for the rest of her life, and took a little Europe trip. There was a pay-out at the end, and both a Native American cause and Bread for the World were among the beneficiaries, besides her church (where she sat in the front row with her mother until the lady passed at 102). Sweet and kind, she lived a ‘pay it forward’ kind of life.

A radio ‘investment talk show’ host recently slammed 401 K investments, annuities, stocks and bond investments and recommended cash on hand- as in a home safe. Callers were making rash and radical moves based on his airwave advice and scare tactics. What are annuities; what should a person look for and how can they help? Are they safe?  [It always gives us pause as professionals, when a client seeks a second opinion from their barber’s brother-in-law in a Florida retirement community, who had a  bad experience in the mid ’90’s after following such advice.]  Always address your questions upfront.

Simply put, an annuity is a source of income- as part of your overall retirement strategy-and provides a steady stream of income. Annuities are insurance products. You invest and decide how you want to be paid- whether monthly, each quarter or annually. You could even receive a lump sum. You can choose whether to get the payments over your lifetime or a fixed number of years. But don’t plan to switch annuities without understanding the fees to do so, or the ultimate returns.  We have seen clients lose a great deal of money being razzle dazzled by a flashy sales pitch. 

The AARP website explains you’ll ‘Receive fixed monthly income payments regardless of what’s happening in the economy.’ (And), ‘Guaranteed income no matter how long you live.’ (And), ‘your money won’t be lost if you pass away prematurely.’ There are all kinds of annuity products, not all of them equal represented by all kinds of companies. It’s important to really dig into this.  Let’s look at a few of the options.

A guaranteed payout is called a fixed annuity. A variable annuity is dependent on the performance of the investments the annuity relies upon. There are also combinations of the two, which our retired teacher in the example benefitted from. Annuities are a good selection for the right investor. If however, you need the cash or choose to withdraw it suddenly, prematurely, or might need it in the near future and don’t have a reserve fund, there could be a costly early withdrawal fee. [As in, you listen to the talk show guy and pull it all out in year 1 only to lose a huge chunk.]

An immediate annuity begins to provide you with payments shortly after the initial investment, while a deferred annuity could be set to commence upon your retirement or a few years into it when you are more likely to need it. By deferring the annuity, it begins to earn money and grow. Some will allow you to convert to an immediate annuity when you would like to start collecting, say at age 72- (you might have put money into the annuity in your mid ‘50’s, giving it time to grow).
Ever the tax man, I’d be remiss to mention there are opportunities to defer paying taxes and there is no yearly contribution limit. If you need to make up for lost time (say, you put the kids through college first), an annuity could allow you to put income away which will compound without taxes- just about the time you’ve lost your precious little tax deductions who are now earning their own keep!

Ideally, the annuity is not a replacement for social security, pension plans or other retirement income sources, but works beautifully alongside them. Some brokers charge steep fees upfront, or the annuities charge a high surrender rate should you withdraw the money within the first year. This charge declines to zero after a few years- at a declining rate. Also, a variable annuity may have management fees for investing the money. You’ll want to compare this with index or mutual funds with lower charges. If you’re on the younger side of 59.5, early withdrawals from your 401K or IRA will carry a penalty.

These are all considerations you’ll want to weigh and discuss with your certified financial planner/tax advisor. Because I do a complete analysis and run the numbers, we’ll know if its best for you and which combinations make sense. Make the right choices now. Ask Russ about it.

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