One of the most difficult financial planning challenges for any financial planner when planning for any goal, retirement or otherwise, is screening, performing due diligence on, and selecting, financial products that have the greatest potential for helping a client attain his/her goals while being suited to the client’s investment temperament. This is especially true when it comes to retirement income planning given the fact that the planner’s mission is to (1) find a way to use assets to create predictable, inflation-protected, and whenever possible, tax-efficient, income streams that, (2) when combined with other sources of income (Social Security, pensions, etc.), are designed to match a client’s projected and unknown (e.g., potential uninsured long-term care expense) retirement income needs for an unknown period of time (i.e., the remainder of one or more lives), (3) while also retaining a portion of those assets to pay for lump-sum expenses (e.g., car purchases, home improvements, weddings, etc.), and (4) to also accomplish the client’s estate planning (e.g., leave money to children and/or to charitable organizations) and other objectives. Suffice it to say, this isn’t an easy task, to say the least!
Two weeks ago, Annuitization Payment Option: The Financial Decision You Will Live With for the Rest of Your Life introduced a financial strategy, annuitization, for generating guaranteed (subject to individual insurers’ claims-paying ability) and tax-favored (when used in nonretirement accounts) income, often for life. It discussed the four types of annuitization payment options available with annuity contracts: life annuity, life annuity with guaranteed payment, joint and survivor annuity, and period certain. Last week’s blog post, Lifetime Annuity Payout – Watch Out! explained that, while a life annuity payment option offers the security of lifetime payments, there are several downsides associated with this choice. As pointed out, one of the most notable is that it won’t provide for different and distinct income streams to match your retirement income needs.
The fourth type of annuitization payment option, period certain, or term certain, as it is often referred, offers perhaps the greatest potential of any type of investment strategy to provide guaranteed (subject to the individual insurers’ claims-paying ability) income to mirror retirement income needs over defined periods of time. Under this option, a life insurance company is obligated to make periodic payments to an annuitant for a specified number of months or years. The payments, which can be inflation-adjusted, can begin today, through either annuitization of an existing annuity contract or purchase of a single premium immediate annuity (“SPIA”), or at some future date at least 13 months from today, via purchase of one or more deferred income annuity (“DIA”) contracts.
Whether the period certain annuity begins today or sometime in the future, it will always be a specified payment for a specified period of time, e.g., $2,500 a month for ten years. Unlike any other type of annuitization payment option, you will always know the total payout, e.g., $300,000 in the previous example ($2,500 x 12 months x 10 years) that you will receive from a period certain annuity before you purchase it. This, in turn, provides you with the ability to precisely calculate an internal rate of return on your investment and, furthermore, compare it to other fixed-rate return investments. The internal rate of return is often provided by life insurance companies in their pre-sale illustrations.
Because of their flexibility to begin and end at any time, combined with the ability to increase payments by an inflation factor, period certain annuities can be structured to dovetail with the amount, frequency, and duration of other income sources to enable better and more predictable matching of total income to one’s retirement lifestyle needs than with most other types of investments. As an added benefit, in the case of nonretirement assets, a portion of each payment is nontaxable since it’s considered to be a return of principle.
Finally, unlike the life annuity payment option whereby payments terminate upon the annuitant’s death, payments from period certain annuities are made dead or alive. If an annuitant dies during the payout term, the life insurance company will continue to make the same payments that were being made to the annuitant to the annuitant’s beneficiary until the end of the specified term.
If your objective is to find a financial product that will provide you with predictable, inflation-protected, tax-efficient (in the case of nonretirement assets) income streams that, when combined with other sources of income, will have a high likelihood of matching your retirement income needs, you would be hard-pressed not to include one or more period certain annuities as part of your solution.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.