Tag: annuitant

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Annuities Deferred Income Annuities Social Security

Social Security – A Lifetime Deferred Income Annuity

Do you have an investment that will pay you guaranteed lifetime income totaling $870,000 to $1.87 million? This is the projected range of income that my wife and I expect to receive from Social Security during our lifetime based solely on my earnings record depending upon when I choose to start my benefits and how long both of us live. Granted that my earnings have exceeded the taxable Social Security wage base for most of my working years, however, this isn’t unusual.

Our projected benefits assume that (a) my current earnings level continues until I begin receiving Social Security, (b) either my wife or I live until at least my age 90, (c) my wife potentially lives until age 95, and (d) Social Security cost-of-living adjustments (“COLA’s”) are 2% each year which is less than the average increase of 2.6% over the last ten years. If all of these assumptions are realized, our actual benefits will likely be greater than the projected amounts since the projections don’t include COLA’s between now and retirement.

In order to truly appreciate the value of Social Security retirement benefits, it’s important to understand that it isn’t simply an entitlement program. Social Security is instead an investment; in particular, it’s a deferred income annuity (“DIA”) payable for life.

Let’s review a couple of definitions in order to put things in perspective. Per Retirement Income Visions™
Glossary, a Deferred Income Annuity is an annuity for which annuitization begins at least 13 months after the date of purchase in exchange for a lump sum or series of periodic payments. Per the Glossary, Annuitization is the irrevocable structured payout of income with a specified payment beginning at a specified date, paid at specified intervals over a stated period of months or years or for the duration of the annuitant’s and potentially his/her spouse’s and/or other individuals’ lifetime(s) depending upon the payout option selected.

Relating these two definitions to Social Security, in exchange for a series of payments, i.e., Social Security taxes paid by you and your employer, over your working years, you will receive an irrevocable structured payout of income with a specified payment beginning at a specified date paid for the duration of your, and potentially your spouse’s, lifetime, depending upon the payout option selected.

The primary difference between Social Security and a commercial DIA is the organization from which the investment is purchased and payments are guaranteed. In the case of Social Security, it is the federal government while DIA’s are purchased from, and payments guaranteed by, individual life insurance companies.

A second difference is the methodology used to calculate one’s lifetime benefit. Simply stated, Social Security benefits are calculated using a series of formulas based on one’s historical earnings relative to the taxable Social Security wage base in effect during each year of employment. Lifetime DIA payouts, on the other hand, are actuarially calculated using the amount and timing of lump sum and/or series of periodic payments, life expectancy factors, as well as current and projected interest rates.

A third potential difference between Social Security and a commercial DIA is the calculation of the payment amount after the initial year. Although a specified payment beginning at a specified date is calculated by the Social Security Administration based on various assumptions, the payment is the amount payable during the first year of benefits. Subsequent years’ payments can increase depending upon annual COLA’s. DIA payouts can increase as well if contractually provided. In some cases it’s also based on COLA’s, however, most of the time it’s determined by a predefined inflation factor.

Approximately 96% of working-age Americans are covered by the Social Security system. Social Security provides 90% of retirement income for one in three retirees and more than 50% for two in three retirees. Given these facts, Social Security is the most prevalent type of investment in the United States. Furthermore, it is, by far, the most popular DIA available in the marketplace.

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Annuities Deferred Income Annuities Fixed Index Annuities

Invest in DIA to Fund LTCI Premiums When Retired – Part 4 of 4

The first three posts in this series discussed five differences between fixed index annuities (“FIA’s”) with income riders and deferred income annuities (“DIA’s”) that will influence which retirement income planning strategy is preferable for funding long-term care insurance (“LTCI”) premiums in a given situation. If you haven’t done so already, I would recommend that you read each of these posts.

This week’s post presents a sample case to illustrate the use of a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement.

Assumptions

As with all financial illustrations, assumptions are key. A change in any single assumption will affect the results. The following is a list of assumptions used in the sample case:

  1. 55-year old, single individual
  2. Planned retirement start age of 68
  3. Life expectancy to age 90
  4. Current annual LTCI premium of $4,000 payable for life
  5. Need to plan for infrequent, although potentially double-digit percentage increases in LTCI premium at unknown points in time
  6. Given assumptions #4 and #5, plan for annual pre-tax income withdrawals of approximately $6,000 beginning at retirement age
  7. Solve for single lump sum investment at age 55 that will provide needed income
  8. Investment will come from a nonqualified, i.e., nonretirement, investment account
  9. One investment option is a fixed index annuity (“FIA”) with an income rider with lifetime income withdrawals beginning at age 68.
  10. Second investment option is a deferred income annuity (“DIA”) with no death benefit and lifetime income payout beginning at age 68.
  11. FIA premium bonus of 10%
  12. FIA annual return of 3%
  13. FIA income rider charge of 0.95% of income rider value otherwise known as the guaranteed minimum withdrawal benefit (“GMWB”)
  14. No withdrawals are taken from the FIA other than the income withdrawals.
  15. All investments are purchased from highly-rated life insurance companies known for providing innovative and competitive retirement income planning solutions.

Investment Amount

The first thing that needs to be solved for is the amount of investment that must be made at the individual’s age 55 in order to produce lifetime annual income of approximately $6,000 beginning at age 68. The goal is to minimize the amount of funds needed for the investment while choosing a strategy from a highly-rated insurance company that’s known for providing innovative and competitive retirement income planning solutions.

It turns out that an investment of $50,000 to $65,000 is needed to produce lifetime annual income of approximately $6,000 beginning at age 68. Given the fact that my goal as a retirement income planner is to use the smallest amount of investment for a fixed income annuity to produce a targeted income stream in order to preserve the remainder of a client’s investment portfolio for my client’s other financial goals, the amount of the investment needed is $50,000.

Results

There are three items we will examine to compare the results between investing $50,000 in a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement. They are as follows:

  • Annual gross income
  • Annual taxable income
  • Value/death benefit

Annual Gross Income

Per the Exhibit, the annual payout, or gross income, from the FIA is $5,764, or $236 less than the annual gross income of $6,000 from the DIA. This equates to a total of $5,428 for the 23 years of payouts from age 68 through age 90.

Annual Taxable Income

If the investment was made in a retirement account like a traditional IRA and assuming there have been no nondeductible contributions made to the IRA, 100% of the income would be taxable. This would be the case for both the FIA or DIA.

As stated in assumption #8, the investment will come from a nonqualified, i.e., nonretirement, investment account. Per Part 2 of this series, this makes a difference when it comes to taxation of the withdrawals. Per the Exhibit, 100% of the annual FIA income of $5,764 is fully taxable vs. $3,066 of the DIA income. This is because the DIA, unlike the FIA, is being annuitized and approximately 50% of each income payment is nontaxable as a return of principal. Over the course of 23 years of payouts, this results in $62,054 of additional taxable income for the FIA vs. the DIA.

The amount of income tax liability resulting from the additional taxable income from the FIA will be dependent upon several factors that will vary each year, including (a) types, and amounts, of other income, (b) amount of Social Security income, (c) potential losses, (d) adjusted gross income, (e) itemized deductions, (f) marginal tax bracket, and (g) applicable state income tax law.

Value/Death Benefit

While the present value of the future income stream of a DIA represents an asset, you generally won’t receive an annual statement from the life insurance company showing you the value of your investment. In addition, while some DIA’s will pay a death benefit in the event that the annuitant dies prior to receiving income, per assumption #10, this isn’t the case in this situation. Consequently, the DIA column of the “Value/Death Benefit” section of the Exhibit is $0 for each year of the analysis.

On the other hand, there’s a projected value for the FIA from age 55 through age 79. This value is also the amount that would be paid to the FIA’s beneficiaries in the event of death. There’s a projected increase in value each year during the accumulation stage between age 55 and 67 equal to the net difference between the assumed annual return of 3% and the income rider charge of 0.95% of the income rider value.

Per the Exhibit, the projected value/death benefit increases from $56,278 at age 55 to $68,510 at age 67. Although the assumed premium bonus of 10% is on the high side these days, this is reasonable given the fact that FIA values never decrease as a result of negative performance of underlying indexes, the assumed rate of return of 3% is reasonable in today’s low index cap rate environment, and the assumed income rider charge of 0.95% of the income rider value is on the upper end of what’s prevalent in the industry. The projected value/death benefit decreases each year from age 68 to age 79 until it reaches $0 beginning at age 80 as a result of the annual income withdrawals of $5,764.

Conclusion

As discussed in Parts 1 – 3 of this series, there are five important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums during retirement in a given situation. Two of the differences, income start date flexibility and income increase provision, haven’t been addressed in this post.

In addition to the five differences, the amount of the investment required to produce a targeted lifetime annual income amount to pay LTCI premiums, including potential increases, will differ depending upon the particular FIA or DIA strategy used. In the illustrated case, which isn’t uncommon today, an investment of $50,000 resulted in an almost identical lifetime income payout whether a FIA with an income rider or a DIA is used.

As illustrated, the taxable income associated with a DIA in a nonqualified environment is much less compared to a FIA. As previously discussed, the amount of tax savings resulting from the reduced taxable income will depend upon an analysis of several factors and will vary each year. Ignoring the potential income tax savings resulting from the tax-favored DIA payouts, the FIA with income rider would be the preferred investment choice for many individuals in this case given the presence, duration, and projected amount of, the investment value/death benefit.

The FIA edge is reinforced by the fact that, unlike most traditional DIA’s, the income start date and associated annual lifetime income payout amount for FIA’s is flexible. This would be an important consideration in the event that the year of retirement changes. Furthermore, this is quite possible given the fact that the individual is 13 years away from her projected retirement year.

As emphasized throughout this series, the purchase of LTCI needs to be a lifetime commitment. Planning for the potential purchase of a LTCI policy should be included as part of the retirement income planning process to determine the sources of income that will be used to pay for LTCI throughout retirement. Whether it’s a FIA with an income rider, a DIA, or some other planning strategy that’s used for this purpose will depend on the particular situation.

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Annuities Fixed Index Annuities

Don’t Be Fooled by Interest Rates – It’s a Package Deal – Part 1 of 2

Retirement Income Center - Mover

If you’ve read the last two posts, How is Your Fixed Index Annuity’s Income Account Value Calculated? and How Much Income Will You Receive From Your Fixed Index Annuity?, you know that there are several variables that come into play when calculating the amount of lifetime income you will receive from a fixed index annuity (FIA) with an optional income rider when you begin taking income withdrawals. One variable that receives a disproportionate amount of attention, in my opinion, is the interest, or “roll up” rate.

With fixed income investments, a natural question is, “What is the rate of return?” This is an easy question to answer with straightforward fixed income investments such as CD’s where there’s a stated rate of return for a fixed period of time, e.g., six months, one year, etc. It’s important to understand that a FIA interest, or “roll up” rate, as it is sometimes referred, unlike traditional fixed income investments, isn’t the rate of return on a FIA.

As explained in the April 2, 2012 post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, the interest rate is one of six potential variables that’s applied to initial and subsequent investments and premium bonus amounts on an annual basis to calculate the income account value of a FIA.

As discussed in the April 9, 2012 post, How Much Income Will You Received From Your Fixed Index Annuity?, you need to apply either a single or joint annuitant withdrawal percentage from your FIA’s table of maximum annual lifetime income withdrawal percentages to the income account value for the age at which you plan on beginning your income withdrawals to determine the amount of annual lifetime income you will receive.

Since it is only one of several variables that will ultimately determine the amount of income that you will receive from your FIA, interest rates shouldn’t be relied upon to determine which FIA will produce the greatest amount of income in a particular situation. A FIA may have a high interest rate, however, if the interest method is simple vs. compound, the interest period is short, and/or the withdrawal rate at a particular age is less than that of another FIA, then the lifetime income may not be as much as another product with a more favorable combination of income calculation variables.

Part 2 will discuss the two most important factors for calculating FIA income withdrawal amounts and will include an illustration to show why interest rates shouldn’t drive your decision regarding the fixed index annuity that will provide you with the greatest amount of lifetime income.

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Annuities Fixed Index Annuities

How Much Income Will You Receive From Your Fixed Index Annuity?

Retirement Income Center - Cube

Assuming that you purchase an optional income rider when you apply for a fixed index annuity (FIA), do you know how much income you will receive from your FIA when you begin taking your income withdrawals? The benefit of investing in a deferred income annuity, including a FIA with an income rider, vs. other types of investments, is the security of receiving a known, predictable income stream beginning at a specified future date payable for a specified number of years or potentially for life, depending on the product. In the case of a FIA, the payment is always for life.

After reiterating the point from a previous post that your FIA contract’s income account value will be used to determine the amount of income that you will receive each year once you begin to take your income distributions, last week’s post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, presented six potential variables that are used to calculate a FIA’s income account value. Once this is done, there is one final step required for calculating the amount of income that you will receive from your FIA.

In every FIA contract that includes an income rider that ties its income calculation to a contract’s income account value, you will find a table of maximum annual lifetime income withdrawal percentages, or lifetime payment percentages, for single and joint annuitants for different age brackets. The age brackets are generally for five-year periods of time beginning at age 50.

Annual income is determined by applying either the single or joint annuitant withdrawal percentage, as applicable, for the age at which you plan on beginning your income withdrawals to your income account value at your targeted withdrawal commencement age. In the case of joint annuitants, the younger individual’s age is always used.

As an example, suppose your husband, age 55 and you, age 52, invest $100,000 in a non-premium bonus FIA with an income rider that includes the following three contractual variables:

  1. Interest rate: 7%
  2. Interest crediting method: Compound
  3. Interest period: First ten contract years

Let’s further assume that both of you are working and you will both retire at age 65 and will begin taking lifetime income withdrawals from your FIA at your husband’s age 70 and your age 67. How much annual lifetime income will you receive from your FIA when you begin taking your withdrawals?

Per Exhibit 1, your income account value, the initial value of which is $100,000 when you make your investment at your age 52, grows at an annual 7% compound rate for the first ten contract years. Your income account value reaches its maximum level of $196,715 at age 62 and remains at that level until your husband and you begin taking your lifetime income distributions.

In order to determine the annual amount of lifetime income that you will receive beginning at your husband’s age 70 and your age 67, you need to apply a lifetime payment percentage from your FIA contract’s lifetime payment percentage table to your income account value. Per Exhibit 2, at age 67, the younger of your two ages, the applicable percentage is 4.50%. Applying this percentage to your income account value of $196,715 results in annual lifetime income of $8,852, or 8.8% of your initial investment of $100,000.

If you wait three additional years until your age 70 to begin taking lifetime income withdrawals, your annual lifetime payment would increase by $492 to $9,344 ($196,715 x 4.75%), or 9.3% of your initial investment of $100,000. If you invested $200,000 instead of $100,000 at age 52, your annual lifetime payment would be double this amount, or $18,688.

Is the security of receiving a known, predictable income stream beginning at a specified future date payable for life important to you? If so, you may want to consider investing a portion of your assets in a fixed index annuity with an income rider.

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Annuities Fixed Index Annuities

Income Account Value vs. Accumulation Value – What’s the Difference?

Retirement Income Center

The March 5, 2012 post, How Will a Premium Bonus Affect Your Fixed Index Annuity Income Distribution?, answered the eighth and final question presented in the February 6, 2012 post, 8 Questions to Ask Yourself When Analyzing Premium Bonuses. Taking a further step back, premium bonus availability was the first fixed index annuity variable included in the list of six contractual variables introduced in the January 30, 2012 post, Contractual vs. Situational Fixed Index Annuity Income Calculation Variables.

As stated in the January 30th post, there are six contractual and four situational variables, for a total of ten potential variables that are used to calculate the income, or lifetime retirement paycheck (“LRP”) amount that you will receive when you purchase an income rider with your fixed index annuity (“FIA”). Before continuing our discussion of the remaining six contractual variables, it’s important that you understand the concept of “income account value,” and how it differs from “accumulation value.”

When you purchase a FIA, the accumulation value is the value of your investment before any applicable surrender charges. This is the amount that you or your beneficiaries will receive if you terminate, or surrender, your FIA or if you die, assuming that your contract’s accumulation value is greater than its guaranteed minimum value.

If you opt for an income rider when you purchase a FIA, and assuming that you will exercise your rider by taking income withdrawals from your FIA, your contract’s income account value will determine the amount of income that you will receive each year once you begin to take your income distributions. With an income rider, you, and if applicable, a joint annuitant, are entitled to receive income for the rest of your life, or lives.

Any income withdrawals will reduce the accumulation value of your FIA, with any remaining value payable to your contract’s beneficiaries in the event of your, and your joint annuitant’s, if applicable, death(s). Assuming that income withdrawals continue for several years, it’s possible that your accumulation value will be depleted while you or a surviving joint annuitant continue(s) to receive income.

How is a FIA’s income account value calculated? Stay tuned for next week’s post.

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Annuities Fixed Index Annuities

How Will a Premium Bonus Affect Your Fixed Index Annuity Income Distribution?

Retirement Income Center

Premium bonuses have been the focus of the last four posts, beginning with the February 6, 2012 post, 8 Questions to Ask Yourself When Analyzing Premium Bonuses. This week I answer the eighth and final question, how will a premium bonus affect the amount of income you will receive from your fixed index annuity?

My goal as a retirement income planner is to design a retirement income plan that will generate income that is projected to meet or exceed my client’s projected needs when he/she is projected to need it. In line with this goal, whenever I’m analyzing the potential use of fixed index annuities (“FIA’s”) for a client, and I’m considering a product that offers a premium bonus, I analyze the affect of the bonus on the amount of income my client will ultimately receive.

When analyzing potential income payouts from FIA’s, it’s always important to keep in mind that premium bonuses are only one of ten variables used to calculate the FIA income amount. (See the January 23, 2012 post, 10 Fixed Index Annuity Income Calculation Variables for the complete list.) It is the interaction between all ten variables in a given situation that will determine the amount of income that you will ultimately receive from a FIA assuming the purchase of an income rider.

Consequently, the presence of a premium bonus, in and of itself, won’t necessarily result in a higher income payout than FIA’s that don’t offer this feature. Having said this, if you’re considering the purchase of a FIA that includes a premium bonus, this will generally result in a higher income payout than if it isn’t present. The exception to this is if the premium bonus isn’t used in the calculation of the accumulation phase of the income payout calculation.

Assuming that the FIA that you’re considering includes a premium bonus, how much additional income will you actually receive as a result of the premium bonus? The answer to this question is complicated since it depends on the interaction between all ten variables used to calculate the FIA income amount and various assumptions made in a given situation. Seven key assumptions are as follows:

  1. Initial investment amount
  2. Subsequent investment amounts and timing of same
  3. Premium bonus payable on initial and subsequent investment amounts
  4. Marital status
  5. Age(s) at the time of investment
  6. Number of years from date of investment until date of initial income payout
  7. Number of years from date of initial income payout until death of annuitant if single or the surviving spouse if married assuming a joint life payout is elected.

To illustrate the affect of a premium bonus on the amount of the distribution from a FIA, I made the following five assumptions: (a) initial investment amount of $200,000 with no subsequent investments, (b) husband and wife, (c) both age 50 at the time of investment, (d) joint life income payout beginning 15 years after date of investment at age 65, and (e) surviving spouse lives until age 90.

I applied the foregoing assumptions to each of the 19 FIA’s offered by my life insurance agency that includes both a premium bonus and an income rider. The presence of a premium bonus had no affect on the income payout for two of the 19 FIA’s since the premium bonus isn’t used in the calculation of the accumulation phase of the income payout calculation. In addition, I was unable to calculate the income payout for two other FIA’s that use the contract value to determine the payout without making additional assumptions which is beyond the scope of this post.

Per Exhibit 1, the following are the results of my illustration for the remaining 15 FIA’s, the premium bonuses of which ranged from 3% to 10%:

  • Higher premium bonus percentages generally resulted in greater income.
  • The annual amount of additional income resulting from the premium bonus ranged from $543 to $1,696.
  • The total amount of additional income over the 26 years of income payout, i.e., age 65 – 90, ranged from $14,108 to $44,088
  • The total amount of additional income over the 26 years of income payout as a percentage of the original investment amount of $200,000 ranged from 7.1% to 22.0%.

In summary, a premium bonus will generally, but not always, increase the income payout from a FIA that includes an income rider. Furthermore, the inclusion of a premium bonus, in and of itself, won’t necessarily result in a higher income payout than FIA’s that don’t offer this feature. This is due to the fact that there are nine other variables that affect the amount of income that you will ultimately receive from a FIA.

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Annuities Fixed Index Annuities

Don’t Neglect Your Fixed Index Annuity Fixed Account

Retirement Income Center

Last week’s post, Diversify Your Fixed Index Annuity Indexing Methods discussed four basic strategies that you can use to diversify your fixed index annuity indexing methods to reduce the pressure of picking the “winning horse” and improve your chances for obtaining interest crediting in a particular year. One of the strategies, allocation of accumulation value to the fixed account, is the topic of this week’s post.

Per last week’s post, unlike indexing methods that are generally tied to the performance of a stock market index, the fixed account credits a predetermined fixed interest rate for the percentage of your fixed index annuity that is allocated to this investment choice. The fixed account offers three advantages over traditional index crediting methods

  1. Guaranteed return
  2. Pre-determined return
  3. Opportunity to offset a portion or all of an income rider charge in the event of a negative indexing method return

Guaranteed Return

Even though you will improve your chances for obtaining interest crediting by implementing one of the first three fixed index annuity indexing method diversification strategies per last week’s post, i.e., select multiple methods, choose a blended index if available, or purchase multiple fixed index annuity contracts, you won’t be guaranteed to receive interest crediting in a particular contract year. This is due to the fact that interest is only credited with the vast majority of indexing methods when the result of the calculation is positive. When you choose the fixed account, you will receive a guaranteed return no matter how any of the available indexing methods perform.

Pre-Determined Return

In addition to being guaranteed, your return will be a pre-determined percentage of accumulation value allocated to the fixed account. Although the return is usually modest, typically in the neighborhood of 1% – 2% these days, it generally exceeds 1-year CD rates. Furthermore, there is also a minimum guaranteed fixed interest rate for the fixed account that’s generally 1%.

Opportunity to Offset a Portion or All of an Income Rider Charge in the Event of a Negative Indexing Method Return

While it’s true that you will never receive less than 0% interest crediting when the performance of your chosen indexing method is negative in a particular year, it’s possible that the accumulation value of your fixed index annuity will decrease as a result of an income rider charge. Although it’s optional, it’s common to add an income rider to a fixed index annuity. The purpose of this rider is to provide you and a joint annuitant, if applicable, with a pre-determined guaranteed income stream that you can turn on generally beginning one year from your contract date, with the amount of income increasing the longer you defer your income start date.

In order to offer this feature, life insurance companies assess a charge. It’s calculated as a percentage of either the accumulation value or the income account and is generally in the range of 0.6% to 0.95%. The income rider charge is deducted from the accumulation value. When the performance of one or more indexing method(s) is (are) negative, the income rider charge will result in a decline in the accumulation value. This can also occur when the performance during a particular contract year is modest.

By allocating funds to the fixed account, you have the ability to offset a portion, or potentially all, of the income rider charge in a given year in the event that the performance of the portion of your accumulation value that is allocated to one or more chosen indexing methods is negative or modest. The amount of the offset will depend upon the amount of the charge and the percentage allocated to the fixed account. The tradeoff is that your interest rate crediting may be less than the returns from one or more indexing methods when the latter’s performance is superior to that of the fixed account.

Don’t neglect the fixed account when choosing or changing your fixed index annuity allocation methods. When selected, you will receive a guaranteed, pre-determined rate of return. Furthermore, to the extent that you include an income rider with your contract, it will offset a portion, or potentially all, of your income rider charge in the event of a negative indexing method return.

Categories
Annuities Deferred Income Annuities Retirement Income Planning

Designing Your Income Annuity Plan

While one of the benefits of income annuities as stated in Immediate Income Annuities: The Cornerstone of a Successful Retirement Income Plan is reduced dependence on ongoing investment management, anyone considering the purchase of an annuity should first engage the services of a professional retirement income planner.

A professional retirement income planner, after discussing your retirement income needs with you and analyzing your financial situation, will prepare an income annuity plan that includes a comprehensive analysis and recommendations. The analysis should include multi-year cash flow, income tax, and portfolio projections that illustrate the following:

  • Use of income annuities vs. other types of annuities
  • Use of income annuities vs. other types of investments
  • Amount of taxable vs. nontaxable annuity payments in the case of nonqualified annuities
  • Taxation of projected Social Security benefits with and without single premium immediate annuities (“SPIAs”) and deferred income annuities (“DIAs”)
  • Affect of the use of income annuities on projected required minimum distributions (“RMDs”)
  • How income annuities are being used to close one’s income gap
  • Advantages and disadvantages of implementing an income annuity plan now vs. later
  • Projected portfolio assets in the event of a long-term care situation
  • Projected portfolio assets upon death
  • Projected ongoing cash flow following death to surviving spouse and other beneficiaries
  • Implementation of other planning techniques that can be used in conjunction with income annuities

If it is determined that fixed income annuities should be part of the recommended solution, the recommendations should discuss specific design parameters, including the following:

  1. Contract type: nonqualified or qualified
  2. Whether SPIAs and/or DIAs should be used
  3. Number of SPIA and DIA contracts to be purchased
  4. Initial purchase amounts
  5. Ongoing purchase amounts and timing of same
  6. Source of funds to be used for initial and ongoing purchases of each contract
  7. Whether the annuity contract is replacing another annuity contract or life insurance policy
  8. Plan type: period certain, life, joint life
  9. Payment commencement dates for DIAs
  10. Payment amount
  11. Payment frequency: monthly, quarterly, semi-annual, or annual
  12. Inflation percentage increase
  13. Number of payments in the case of a period certain
  14. Owners
  15. Annuitants
  16. Beneficiaries
  17. Life insurance companies

As you can see, the analysis and parameters associated with the design of an income annuity plan is complex, to say the least. Annuities should never be purchased as stand-alone products when used as part of a retirement income planning solution. A professional retirement income planner should always be engaged to perform the requisite analysis and make recommendations that will result in the best solution for determining, and closing, your projected income gap before purchasing any annuities.

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Annuities Deferred Income Annuities Retirement Income Planning

Using Fixed Income Annuities to Build Your Income Portfolio Ladder

Retirement Income Center

The previous two blog posts introduced the income portfolio plan strategy and the importance of designing laddered income streams to fund a retirement income plan. If you haven’t read these two posts yet, I would recommend that you do so before reading this one. This post introduces a powerful income laddering strategy that can be used to create and optimize your retirement income.

As stated in last week’s post, due to the fact that our financial situation and needs will change at different stages of our retirement years, a retirement income plan must provide for different and distinct income streams to match our expense needs associated with each stage. One of the most efficient ways to do this is through the use of a customized blend of fixed income annuities. Before discussing this technique, let’s first review some basics of annuity investing for those of you who may not be familiar with this often misunderstood type of investment.

Annuities are offered by life insurance companies through a contractual relationship between the insurance company and the owner of an annuity contract. A distinguishing feature of annuities from other types of investments is “annuitization,” or the ability to convert the annuity to an irrevocable structured payment plan with a specified payout by the insurance company to an individual(s), or “annuitant(s)” over a specified period of time through different lifetime and term certain options offered by the insurance company.

Unlike most non-retirement vehicles that have ongoing income tax consequences associated with them while you own them, a basic distinction between annuities and other types of investments is that annuities offer the tax-deferred advantages of retirement assets such as 401(k) plans and IRA’s without several of the negative tax consequences associated with the latter.

There are two basic types of annuities, both offered by life insurance companies: fixed and variable. Fixed annuities are similar to CD’s since they have a fixed, pre-defined term and interest rate and don’t fluctuate in value. Unlike CD’s which are offered by banks and are insured up to FDIC limits, fixed annuities guarantee principal subject to the claims-paying ability of individual insurance companies. Variable annuities, on the other hand, are invested in equity investments, such as mutual funds, and as such, fluctuate in value and have greater risk associated with them.

When annuities are annuitized, they are referred to as “income annuities.” Unlike any other income planning strategy, in addition to closing projected income gaps, fixed income annuities can be structured to provide predictable inflation-adjusted income streams as well as tax efficiency for the nonretirement portion of one’s portfolio. Two types of fixed ncome annuities that will be the subject of, and will be discussed in more detail in, the next two blog posts can, and generally should, be used: immediate and deferred.

Single premium immediate annuities, or “SPIAs,” make periodic payments, typically monthly, for a specified number of months or for an individual’s lifetime or joint lifetimes as applicable. The payments generally begin one month after purchase of a SPIA, hence the term “immediate.”

While the use of SPIAs is widespread, deferred income annuities, or “DIAs,” are currently offered by only a handful of life insurance companies. Like SPIAs, DIAs pay periodic income for a specified period of time or over one’s lifetime or joint lifetimes as applicable. Unlike SPIAs, however, the start date of the payments for DIAs is deferred for at least 13 months from the date of investment.

The power of the use of a customized blend of fixed income annuities, including their preference as a retirement income planning solution, will become apparent in future blog posts. Suffice it to say, this is definitely the way of the future for many retirees to benefit from predictable inflation-adjusted income streams to close projected income gaps as well as generate tax efficiency for the nonretirement portion of one’s portfolio while reducing exposure to the gyrations of the stock market.