Tag: DIA

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Looking for a Deferred Fixed Income Annuity on Steroids?

Deferred income annuities (DIAs) have been getting a lot of attention since the Treasury and IRS finalized a regulation in July, 2014 blessing the use of qualified longevity annuity contracts, or “QLACs.” A QLAC is a DIA that’s held in a qualified retirement plan such as a traditional IRA with a lifetime income start date that can begin up to age 85. It’s subject to an investment limitation of the lesser of $125,000 or 25% of one’s retirement plan balance.

Fixed Income Annuity Hierarchy

For individuals concerned about longevity who are looking for a sustainable source of income they can’t outlive, fixed income annuities are an appropriate solution for a portion of a retirement income plan. There are three types to choose from:

  1. Immediate annuities
  2. Deferred income annuities (DIAs)
  3. Fixed index annuities (FIAs) with income riders

The overriding goal when choosing fixed income annuities is to match after-tax income payouts to periodic amounts needed to pay for specified projected expenses using the least amount of funds. Immediate annuities, with a payout that begins one month after purchase date, are appropriate for individuals on the cusp of retirement or who are already retired. DIAs and FIAs with income riders, with their built-in deferred income start dates, are suitable whenever income can be deferred for at least five years, preferably longer.

Assuming there isn’t an immediate need for income, a deferred income strategy is generally the way to go when it comes to fixed income annuities. This includes one or more DIAs or FIAs with income riders. Which should you choose?

DIA Considerations

As a general rule, DIAs and FIAs are both qualified to fulfill the overriding income/expense matching goal. Both offer lifetime income payouts. If your objective is deferred lifetime sustainable income, DIA and FIA with income rider illustrations should be prepared to provide you with an opportunity to compare income payouts.

DIAs can also be purchased for a specified term of months or years. This can be important when there are projected spikes in expenses for a limited period of time.

DIAs may also be favored when used in a nonretirement account since a portion of their income is treated as a nontaxable return of principal. Finally, if you’re looking to defer the income start date beyond the mandatory age of 70-1/2 for a limited portion of a traditional IRA, a QLAC, which is a specialized DIA, may be an appropriate solution.

Let’s suppose that you’re a number of years away from retirement and you’re not sure when you want to retire or how much income you will need each year. A DIA may not be your best choice since you lock in a specified income start date and income payout at the time of investment with most DIAs.

FIA with Income Rider Features

FIAs with income riders hold a distinct advantage over DIAs when it comes to income start date flexibility. Unlike a DIA, there’s no requirement to specify the date that you will begin receiving income when you purchase a FIA.

The longer you hold off on taking income, the larger the periodic payment you will receive. Furthermore, there’s no stipulation that you ever need to take income withdrawals. This is ideal when planning for retirement income needs ten or more years down the road.

For individuals not comfortable with exchanging a lump sum for the promise of a future income stream beginning at a specified date, i.e., a DIA, a FIA with its defined accumulation value and death benefit, offers an attractive alternative assuming similar income payouts. While an optional death benefit feature can be purchased with a DIA to provide a return of premium to one or more beneficiaries prior to the income start date, this will reduce the ongoing income payout amount.

A FIA also has a defined investment, or accumulation, value that equates to a death benefit. Unlike with most DIAs, flexible-premium FIAs offer the ability to make additional investments that will increase income withdrawal amounts in addition to the investment value.

Some FIAs offer a premium bonus that matches a limited percentage, e.g., 5%, of your initial, as well as subsequent, investments for a specified period of time. The accumulation value is also increased by contractually-defined periodic interest credits tied to the performance of selected stock indices.

Finally, a FIA’s accumulation value is reduced by withdrawals and surrender and income rider charges. Any remaining accumulation value is paid to beneficiaries upon the death of the owner(s).

Summary

A comprehensive retirement income plan is a prerequisite for determining the type(s), investment and income payout timing, and investment amounts of fixed income annuities to match after-tax income payouts with projected expense needs assuming that longevity is a concern. If you don’t have an immediate need for income and your objective is lifetime sustainable income, DIA and FIA with income rider illustrations should be prepared to provide you with an opportunity to compare potential income payouts.

With their ability to match a spike in expenses for a limited period of time, term DIAs offer a unique solution. When it comes to lifetime income payouts, FIAs with income riders, with their flexible income start date and accumulation value and associated built-in death benefit, are, in effect, a DIA on steroids.

Given the foregoing advantages and assuming similar income payouts, FIAs with income riders generally offer a more comprehensive solution for fulfilling sustainable lifetime income needs, with the possibility of a larger death benefit. A potential exception would be when investing in a nonretirement account for higher tax bracket individuals subject to one’s preference for a flexible income start date and accumulation value/death benefit in a particular situation.

Last, but not least, all proposed annuity solutions should be subjected to a thorough due diligence review and analysis of individual life insurance companies and products before purchasing any annuity contracts.

Categories
Annuities Deferred Income Annuities Income Tax Planning Qualified Longevity Annuity Contract (QLAC)

Is a QLAC Right for You?

2014 marked the introduction of qualified longevity annuity contracts, or QLACs. For those of you not familiar with them, a QLAC is a deferred fixed income annuity designed for use in retirement plans such as 401(k) plans and traditional IRAs (a) that’s limited to an investment of the lesser of $125,000 or 25% of the value of a retirement plan and (b) requires that lifetime distributions begin at a specified date no later than age 85. QLAC investment options are currently limited to deferred income annuities, or DIAs.

The purchase of deferred fixed income annuities in retirement plans for longevity protection isn’t a new concept. What’s unique about QLACs is the ability to extend the start date of required minimum distributions (RMDs) from April 1st of the year following the year that you turn 70-1/2 to up to age 85. This provides potential income tax planning opportunities for QLAC holders subject to the purchase cap.

Potential Income Tax Savings

A lot of individuals are selling QLACs short due to the purchase cap. While on the surface, $125,000 may not represent a sizable portion of a retirement plan with assets of $750,000 or more, the potential lifetime income tax savings can be significant.

The amount of savings is dependent on six factors: (a) amount of QLAC investment (b) age at which QLAC investment is made, (c) deferral period from date of QLAC purchase until income start date, (d) rate of return, (e) income tax bracket, and (f) longevity.

Illustration

I have prepared the attached exhibit to illustrate potential income tax savings achievable by investing $125,000 at three different ages in a QLAC by comparing it to a non-QLAC investment that’s subject to the RMD rules. Assumptions used in the preparation of the exhibit are as follows:

  1. $125,000 is invested in a non-QLAC vehicle at one of three different ages: 55, 60, or 65.
  2. Rate of return is 5%.
  3. RMD’s are taken from age 71 through 85, the range of ages between which RMD’s and QLAC distributions, respectively, are required to begin.
  4. Income tax brackets are 2015 federal income tax brackets plus 5% for assumed state income tax.

In addition to assumed rates of return and income tax brackets, a key assumption is the age at which the QLAC investment is made. All else being equal, purchases at earlier ages avoid greater amounts of RMDs and associated income tax liability. Per the exhibit, the amount of projected income tax savings over 15 years ranges from approximately $20,000 to $97,000 depending upon assumed QLAC investment date and income tax bracket.

Considerations

Reduction of RMDs and associated income tax liability is an important goal, however, it may not be the best strategy for achieving the overriding goal of retirement income planning, i.e., making sure that you have sufficient income to meet your projected expenses for the duration of your retirement.

There are several questions you need to answer to determine the amount, if any, that you should invest in a QLAC:

  • What are your projected federal and state income tax brackets between age 71 and 85?
  • What are the projected rates of return on your retirement funds between 71 and 85 taking into consideration the likelihood of at least one bear market during this time?
  • What is your, and your spouse, if married, projected life expectancy?
  • Which years between age 71 and 85 can you afford to forego receipt of projected net RMD income, i.e., RMD less associated income tax liability?
  • Will you need to take retirement plan distributions in excess of your RMDs, and, if so, in which years and in what amounts?
  • What other sources of income do you have to replace the projected RMD income you won’t be receiving?
  • What is the projected income tax liability you will incur from withdrawing funds from other sources of income?
  • What is the amount of annual lifetime income that you will receive from a QLAC beginning at various ages between 71 and 85 assuming various investment amounts, with and without a death benefit with various payout options?
  • Does it make more sense to invest in a non-QLAC longevity annuity such as a fixed index annuity with an income rider?
  • Should you do a Roth IRA conversion instead?

Given the fact that opportunities to reduce RMDs and associated income tax liability are limited, QLACs are an attractive alternative. Projected income tax savings are just one factor to consider and can vary significantly from situation to situation, depending upon assumptions used. There are a number of other considerations that need to be analyzed before purchasing a QLAC to determine the best strategies for optimizing your retirement income.

Categories
Annuities Deferred Income Annuities Longevity Insurance Qualified Longevity Annuity Contract (QLAC)

QLACs are Here

Since the Treasury and IRS finalized a regulation in the beginning of July blessing the use of qualified longevity annuity contracts, or “QLAC’s,” a lot of people have been wondering when and where they can buy one. Per the last paragraph of my September 15th “Don’t Expect to See QLAC’s Soon” post, speculation was that product launch may begin in the fourth quarter of this year.

The mystery is now behind us. The first QLAC to hit the market was recently released by AIG through American General Life Insurance Co with its American Pathway deferred income annuity. AIG enjoys overall high ratings from independent ratings agencies, including A+, or strong, ratings from Standard & Poor’s and Fitch Ratings, A, or excellent, from A.M. Best Company, and A2, or good, from Moody’s Investors Service.

What’s Different about QLACs?

Subject to their current investment limitation of the lesser of $125,000 or 25% of one’s retirement plan balance, QLACs offer two distinct advantages over other investment vehicles for meeting part of a retiree’s income needs as follows:

  1. A portion of retirement assets exposed to stock market declines can be exchanged for a predictable sustainable lifetime income stream beginning at a specific date up to age 85.
  2. Can defer income taxation of a portion of retirement plan balances for up to 15 years with its exemption from the required minimum distribution, or “RMD,” rules, that otherwise require taking minimum distributions from retirement plans beginning by April 1st of the year following the year that you turn 70-1/2.

Predictable Sustainable Lifetime Income Stream

QLACs are a special type of deferred income annuity, or “DIA.” A DIA is an annuity from which annuitization begins at least 12 months after the date of purchase in exchange for a lump sum or series of periodic payments. The annuitization can be for a term certain or lifetime, depending upon the terms of the annuity contract.

Fixed income annuities, including lifetime DIAs, have previously been allowed to be included in retirement plans provided that payments (a) begin by April 1st of the year following the year that the owner turns 70-1/2 and (b) are structured so that they will be completed distributed over the life expectancies of the owner and the owner’s beneficiary.

QLACs extend the potential income start date of retirement plan assets allocated to them to age 85. In addition to predictable sustainable lifetime income, this enables individuals who have other sources of income to increase the amount of annual income that they will eventually receive from QLAC investments compared to non-QLAC DIAs held in retirement asset accounts.

Circumvent RMD Rules for a Portion of Retirement Plan Assets

Other than converting retirement plan assets to Roth IRAs which often triggers income tax liability at the time of conversion, there has been no other game in town for avoiding the RMD rules prior to QLAC’s. QLAC’s offer an opportunity to defer taxation on up to the lesser of $125,000 or 25% of one’s retirement plan balance at the time of investment.

Depending upon the timing of the QLAC investment and the income start date, the reduction in RMDs and potential income tax savings can be significant. Suppose that you’re 50 and your traditional IRA, which is your only retirement plan, has a value of $600,000. Let’s further assume that you invest $125,000 of your IRA in a QLAC with an income start date of 80.

Had you not invested $125,000 in a QLAC, assuming a 4% rate of return, this portion of your IRA would grow to $273,890 when you turn 70. The first year RMD for this value would be just under $10,000. The income tax savings from not withdrawing this amount of income from your IRA and potential greater amounts for the next ten years could be significant.

QLAC Market

With the release of AIG’s QLAC, the cat is out of the bag. Other insurance carriers are either in the process, or will soon be, requesting regulatory approval for their QLAC offerings. Per my September 15th post, it was, and still is, my personal opinion that widespread availability will not occur until well into 2015. Once this happens and consumers understand and appreciate the two distinct advantages that QLACs offer over other investment vehicles for meeting part of a retiree’s income needs, I believe that demand for this unique product will increase significantly.

Categories
Deferred Income Annuities Longevity Insurance Qualified Longevity Annuity Contract (QLAC) Retirement Income Planning

Don’t Expect to See QLAC’s Soon

One of the most exciting retirement income planning opportunities since the elimination of the Roth IRA conversion income threshold in 2010 has been approved, however, it isn’t available yet for purchase.

For those of you who may not be familiar with the change in Roth IRA conversion eligibility rules, prior to 2010, only taxpayers with modified adjusted gross income of less than $100,000 were eligible to convert a traditional IRA to a Roth IRA. With the elimination of the income threshold, Roth IRA conversions have soared in popularity since anyone may convert part, or all, of his/her traditional IRA to a Roth IRA. See Year of the Conversion to learn more.

The most recent potential retirement income planning game-changer, qualified longevity annuity contracts, or “QLAC’s,” have received a fair amount of press since the Treasury and IRS finalized a regulation in the beginning of July blessing their use. I have personally written two other articles about them, beginning with 6 Ways a New Tax Law Benefits a Sustainable Retirement published July 25th in the RetireMentors section of MarketWatch and my August 4th Retirement Income Visions™ blog post, You Don’t Have to Wait Until 85 to Receive Your Annuity Payments.

What are QLAC’s?

QLAC’s came about in response to increasing life expectancies and the associated fear of outliving one’s assets. With the passage of IRS’ final regulation, retirement plan participants can now invest up to the lesser of $125,000 or 25% of their retirement plan balance in specially-designated deferred income annuities, or “DIA’s,” that provide that lifetime distributions begin at a specified date no later than age 85. Unlike single premium immediate annuities, or “SPIA’s,” that begin distributing their income immediately after investment, the start date for DIA income payments is deferred for at least 12 months after the date of purchase.

As discussed in my July 25th MarketWatch article, QLAC’s offer a new planning opportunity to longevitize your retirement in six different ways. While longevity is the driving force for QLAC’s, the income tax planning angle, which is the first possibility, has been attracting the lion’s share of media attention. Specifically, QLAC’s provide retirement plan participants with the ability to circumvent the required minimum distribution, or “RMD,” rules for a portion of their retirement plan assets. These rules require individuals to take annual minimum distributions from their retirement plans beginning by April 1st of the year following the year that they turn 70-1/2.

Where Do I Buy a QLAC?

I’ve had several people ask me recently, “Where do I buy a QLAC?” Unlike the Roth IRA conversion opportunity that expanded the availability of an existing planning strategy from a limited audience to anyone who owns a traditional IRA with the elimination of the $100,000 income barrier beginning on a specified date, i.e., January 1, 2010, the implementation of IRS’ QLAC regulation is much more complicated. This is resulting in an unknown introduction date for QLAC offerings.

There are several reasons for this, not the least of which is the nature of the product itself. First and foremost, although an existing product, i.e., a deferred income annuity, or “DIA,” will initially be used as the funding mechanism for QLAC’s, the contracts for DIA’s that are currently available don’t necessarily comply with all of the various provisions of IRS’ new QLAC regulation. While the three mentioned are the most important, i.e., (1) Only available for use in retirement plans, (2) limitation of lesser of $125,000 or 25% of retirement plan balance, and (3) distributions must begin at a specified date no later than age 85, there are other technical requirements that must be met in order for a DIA to be marketed and sold as a QLAC.

In addition to understanding and complying with the nuances of the IRS regulation, life insurance carriers that want to offer QLAC’s are scrambling to restructure existing DIA products and develop new products that will (a) match consumers’ needs, (b) be competitive, and (c) meet profit objectives. This requires a host of system and other internal changes, state insurance department approvals, and coordination with distribution channels, all of which must occur before life insurance companies will receive their first premiums from sales of this product.

Another important obstacle to the introduction of QLAC’s is the fact that fixed income annuities with deferred income start dates, including DIA’s and fixed index annuities, or “FIA’s,” with income riders, are a relatively new product to which many consumers haven’t been exposed. While both products are designed, and are suitable, for use in retirement income plans, most investment advisors don’t currently have the specialized education, licensing, and experience to understand, let alone offer, these solutions to their clients. See What Tools Does Your Financial Advisor Have in His or Her Toolbox?

So when will you be able to purchase QLAC’s? Although current speculation is that product launch may begin in the fourth quarter of this year, it’s my personal opinion that widespread availability will not occur until well into 2015. This will give investment advisers and consumers, alike, additional time to get more educated about fixed income annuities, including their place in retirement income plans. Once the word spreads, I believe that the demand for fixed income annuities will increase significantly, especially if the timing is preceded by a stock market decline.

Categories
Annuities Deferred Income Annuities

You Don’t Have to Wait Until 85 to Receive Your Annuity Payments

Longevity insurance was recently blessed again by the IRS with its finalization of a regulation allowing the inclusion of an advanced-age lifetime-income option in retirement plans such as 401(k) plans and IRAs.

As discussed in my July 25 MarketWatch article, 6 Ways a New Tax Law Benefits a Sustainable Retirement, “longevity insurance” isn’t an actual product that you can purchase from a life insurance carrier. It’s instead a term that refers to a deferred lifetime fixed income annuity with an advanced age start date, typically 80 to 85.

In a nutshell, IRS’ final regulation allows you to invest up to the lesser of $125,000 or 25% of your retirement plan balance in “qualifying longevity annuity contracts” (QLACs) provided that lifetime distributions begin at a specified date no later than age 85. Although the regulation leaves the door open for other types of fixed-income annuities in the future, QLAC investment vehicles are currently limited to lifetime deferred income annuities, or DIAs.

Suppose you’re concerned about the possibility of outliving your assets and you’re considering investing a portion of your retirement plan in a QLAC. Do you have to wait until age 85 to begin receiving your lifetime annuity payments? Absolutely not. So long as distributions begin no later than the first day of the month following the attainment of age 85, you will be in compliance with the regulation.

Although the regulation doesn’t define the earliest starting date of QLAC payments, based on previous legislation, it would seem to be April 2 of the year following the year that you turn 70-1/2. Why April 2? Per my MarketWatch article, regulations in effect before the new rule allow for inclusion of fixed income annuities without limit provided that the periodic annuity payments (a) begin by April 1 of the year following the year that the owner turns 70-1/2 and (b) are structured so that they will be completely distributed over the life expectancies of the owner and the owner’s beneficiary in compliance with IRS’ required minimum distribution, or RMD, rules.

Let’s suppose that you’re doing retirement income planning when you’re 60 and you’re planning on retiring at 67. In addition to your IRA which has a value of $600,000, you have a sizeable nonretirement portfolio that will not only enable you to defer your Social Security start date to age 70, there’s a high likelihood that you won’t need to withdraw from your IRA until 75.

Despite the fact that you don’t foresee needing income from your IRA until 75, IRS requires you to begin taking minimum annual distributions from your IRA beginning by April 1 of the year following the year that you turn 70-1/2. This is true, however, IRS now also allows you to circumvent the RMD rules by investing a portion of your retirement plan assets in a QLAC. Relying on these rules, you decide to invest $125,000 of your IRA in a QLAC with an income start date of 75. This enables you to longevitize, or extend the financial life of, your retirement using the six ways described in my MarketWatch article.

As you can see, there’s a lot of flexibility when it comes to selecting the start date of your lifetime income distributions from a QLAC. There’s approximately a 13- to 14-year window depending upon your birth date which falls between April 2 of the year following the year that you turn 70-1/2 and age 85. The key is that you must define your income start date at the time of applying for your QLAC. This is a requirement of all deferred income annuities, not just QLAC’s.

Finally, a QLAC may, but is not required to, offer an option to begin payments before the contract’s annuity starting date. While the amount of your periodic distributions will be greater the longer you defer your start date, you don’t have to wait until age 85 to begin receiving lifetime income.

Categories
Annuities Deferred Income Annuities Retirement Income Planning

Consider a Death Benefit When Buying Deferred Income Annuities

If you’re in the market for sustainable lifetime income, you’ve come to the right place if you’re looking at fixed income annuities. A fixed income annuity is a fixed (vs. variable) annuity that provides income payments for your lifetime or for a contractually-defined term.

There are three types of fixed income annuities, each one serving a different purpose in a retirement income plan. The three types are as follows:

The main distinction between the three types of fixed income annuities is the timing of the commencement of income payments. As its name implies, the income from a SPIA begins immediately. The actual start date is one month after the date of purchase assuming a monthly payout.

The income start date of DIA’s and FIA’s with income riders, on the other hand, is deferred. With both DIA’s and FIA’s with income riders, it’s contractually defined and is generally at least one year from the purchase date. Although you choose it when you submit your application, most DIA’s have a defined start date; with some wiggle room available on some products. The income commencement date for FIA’s with income riders is flexible other than a potential one-year waiting period and/or minimum age requirement.

Assuming that a DIA meets your retirement income planning needs, you should always consider including a death benefit feature which is optional with most DIA’s. Keeping in mind that the income start date is deferred, and it’s not unusual for the deferral period to be 10 to 25 years, especially when purchasing a DIA as longevity insurance, you probably don’t want to lose your premium, or investment, if you die prematurely.

If you purchase a DIA without a death benefit or return of premium (“ROP”) feature, and you die during the deferral period, not only will the income never begin, your beneficiaries won’t receive anything either. The death benefit or ROP feature serves the purpose of insuring your investment in the event that you die before your income distributions begin.

So how much does it cost to insure your DIA investment by adding an optional death benefit? To illustrate, I recently evaluated the transfer of $100,000 from one of my client’s IRA brokerage accounts to a DIA. My client is approaching her 65th birthday and, like all individuals with traditional IRA accounts, must begin taking annual required minimum distributions, or “RMD’s,” from her account by April 1st of the year following the year that she turns 70-1/2.

Assuming that $100,000 of my client’s IRA is transferred from her brokerage account to a DIA, and assuming that the income from her DIA begins when she turns 70-1/2, she can expect to receive lifetime monthly income of approximately $600 to $700, depending upon the DIA chosen. In one case, the monthly benefit would be reduced by $2.27, from $691.68 to $689.41 with a death benefit feature. In another case, the monthly benefit would be $1.09 less, at $664.41 without any death benefit vs. $663.32 with a death benefit.

In other words, the cost to insure the return of my client’s investment of $100,000 in the event of her death prior to turning 70-1/2 translates to an annual reduction in lifetime benefits of $13.08 or $27.24, depending on the DIA chosen. Not only is there no question about the value of the death benefit in this situation, it would be negligent in my opinion for any life insurance agent not to illustrate the addition of this feature.

Assuming that a fixed income annuity makes sense for you, and further assuming that a DIA is an appropriate solution as a piece of your retirement income plan, always evaluate your potential lifetime income payout with and without a death benefit.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 2 of 2

Part 1 of this post made the point that if your goal is to receive sustainable lifetime income, in addition to Social Security, fixed income annuities offered by life insurance companies will meet your need. Please read Part 1 to learn about the three types of fixed income annuities, including each one’s income start date.

If you’re seeking total flexibility for your lifetime income start date, then a fixed index annuity (“FIA”) with an optional income rider is your best bet. Unlike single premium immediate annuities (“SPIA’s”) and deferred income annuities (“DIA’s”) where the sole purpose is to provide sustainable income, a FIA can fulfill multiple financial needs, a discussion of which is beyond the scope of this post. When you purchase a FIA, assuming your goal is sustainable lifetime income, you must purchase an optional income rider with an annual income rider fee.

Unlike the start date for SPIA’s and DIA’s which is contractually defined, it is much more flexible with FIA’s. Most FIA income riders, also known as guaranteed minimum withdrawal benefit (“GMWB”) riders, have two requirements when it comes to the income start date:

  1. You must wait at least one year after the contract is issued, and
  2. You must be at least age 50.

Assuming that you meet both requirements, the age at which you begin taking income withdrawals from a FIA is up to you. Unlike Social Security which has an eight-year window for choosing your income start date, i.e., between age 62 and 70, the start date with FIA’s is open-ended once the two requirements have been met.

Similar to Social Security, the longer you defer your start date, the greater your lifetime income payments will be. Unlike Social Security where your benefit amount will increase 7% – 8% each year that you defer your start date, the amount of increase is defined by the income rider provision of each FIA’s contract. Also, unlike Social Security, the percentage increase is generally significantly greater when you cross five-year milestones, e.g., age 60, 65, 70, 75, etc.

Here’s an example from a recent case for one of my clients who are currently in their early to mid 50’s and have invested approximately $250,000 in a FIA with an income rider. If they begin taking income at the younger spouse’s age 63, they will receive annual lifetime income of $20,479. At age 64, the amount increases 6% to $21,708. If they wait until age 65, it increases 19.3% from their age 64 amount to $25,886.

With a FIA with an income rider, in addition to having the security of receiving sustainable lifetime income, you have the luxury of starting your income when you need it. This is in addition to several other benefits offered by FIA’s, a discussion of which has been presented in various Retirement Income Visions™ posts.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 1 of 2

There have been many articles and blog posts over the last several years about the ability to delay your Social Security retirement benefit start date in order to increase your monthly benefit. I wrote about this in my March 4, 2013 post, Increase Your Longevity Risk with Social Security. Per the post, with a choice of start dates ranging between 62 through 70, you can increase your benefits 7% – 8% each year that your start date is deferred, excluding cost-of-living adjustments (“COLA’s”).

Sources of sustainable lifetime income are few and far between these days with the widespread elimination of monthly pension benefits. The ability to receive a stream of sustainable lifetime income throughout retirement while also choosing your income start date is a rare planning opportunity, the value of which shouldn’t be underestimated.

While the opportunity to receive sustainable lifetime income with a flexible start date is limited, Social Security isn’t the only game in town. If the security of sustainable lifetime income appeals to you and you want to create one or more income streams, fixed income annuities offered by life insurance companies, preferably ones that are highly rated, will also meet your need.

There are three types of fixed income annuities, all of which are contractually guaranteed by the life insurance company from which they are purchased. The three types are single premium immediate annuities (“SPIA’s”), deferred income annuities (“DIA’s”), and fixed index annuities (“FIA’s”) with income riders.

There are several important differences between the three types of fixed income annuities that have been discussed in several Retirement Income Visions™ posts. One of the differences that are relevant to this post is the income start date. SPIA’s and DIA’s have contractually defined income start dates, while the start date of FIA’s with income riders is flexible.

SPIA’s are the most restrictive with a start date that begins one month after the contract is issued, assuming a monthly payment mode is chosen. When you purchase DIA’s, you choose the income start date at the time of application. It is contractually defined with the provision that it cannot begin earlier than 13 months after your contract is issued.

Please read Part 2 of this post next week to learn about the income start date flexibility available with FIA’s with income riders that are designed to provide you with sustainable retirement income when you need it.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance

Longevity Insurance is an App

App: A self-contained program or piece of software designed to fulfill a particular purpose (Google Definition). A smartphone would be nothing more than a paperweight if it didn’t have any apps. The most basic function of a smartphone, i.e., making and receiving phone calls, wouldn’t be possible without a phone app.

Apps are the lifeblood of a smartphone. Mobile phone and data plans generate billions of dollars of revenue each year for wireless communications companies. The phone, itself, is secondary, and, as such, is typically heavily discounted when phone and data plans are purchased.

An analogy can be made to longevity insurance. Many, if not most, people are under the mistaken belief that when they purchase longevity insurance, they’re buying a product (i.e., smartphone) whose sole purpose is to provide them with lifetime income beginning at age 85 in the event that they live to a ripe old age.

Let’s dispel two myths. First of all, there’s technically no such thing as a longevity insurance product. You won’t receive a “longevity insurance” contract from an insurance company. When you buy longevity insurance, you’re buying an app. In order to use the app, you will need to purchase either a deferred income annuity (“DIA”) or a fixed index annuity (“FIA”) with an income rider, with DIA’s being favored as the traditional longevity insurance product.

DIA’s and FIA’s with income riders are both fixed income annuities that provide the ability to (a) receive income beginning in a future year, and (b) have the income be paid for the remainder of one’s life and a spouse’s life if married. The main difference between DIA’s and FIA’s when it comes to lifetime income is the start date. With a DIA, there’s a fixed start date that’s contractually defined. FIA’s with income riders have a flexible income start date that can typically begin one year after purchase or at any time thereafter during the life of the contract.

Second, unless you purchase a DIA and choose it at the time of application, lifetime income doesn’t have to begin at age 85. There’s no fixed income starting date associated with longevity insurance. You can purchase a DIA that pays lifetime income beginning at age 75. In addition, you can purchase a term DIA where income is paid for a fixed number of months or years. As an example, income could begin at age 82 and end at age 87. Furthermore, as previously explained, if you purchase a FIA with an income rider, other than stating the earliest possible income start date, a FIA contract doesn’t require you to begin taking withdrawals on a specific date.

Although DIA’s and FIA’s with income riders may be purchased to provide what’s marketed as longevity insurance, this is only one application of both products. What is thought of as longevity insurance, i.e., lifetime income beginning at age 85, accounts for a small portion of fixed income annuity product sales. While a later starting date generally will result in a greater amount of lifetime income, all else being equal, most retirees need to begin taking income distributions to cover expenses at an earlier age.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance Retirement Income Planning

Insure Your Longevity

When people hear the term, “longevity insurance,” they immediately conjure up images of insurance agents trying to sell them an insurance policy. Longevity insurance isn’t a product in and of itself. It is instead one application of a couple of different types of fixed income annuity products offered by life insurance companies.

The Need for Longevity Insurance

It’s been my personal and professional experience that people generally underestimate how long they will live. Not only is it common to live to age 80, it isn’t unusual to survive to age 90 and even to 100. According to a March, 2012 report, The 2011 Risks and Process of Retirement Survey, prepared for the Society of Actuaries, when a couple reaches 65, there’s a 10% chance that at least one of the individuals will live to 100. There’s a 1% chance that one spouse will reach 107. More than half of retirees and pre-retirees underestimate the age to which a person of his or her age and gender can expect to live.

Given the foregoing facts, combined with the uncertainty of the sustainability of a traditional investment portfolio as a source of retirement income, there’s a need for a guaranteed lifetime income solution for the latter stage of one’s life. The income amount, when combined with other sources of sustainable income, needs to be sufficient to meet projected known and unforeseen expenses for an indefinite period of time.

Products Providing Longevity Insurance

There are two types of fixed income annuities that can be used for the purpose of longevity insurance: deferred income annuities (“DIA’s”) and fixed index annuities (“FIA’s”) with income riders. Both provide the ability to (a) receive income beginning in a future year, and (b) have the income be paid for the remainder of one’s life and a spouse’s life if married.

Deferred Income Annuities

Although DIA’s are currently offered by only a handful of life insurance companies, they’re the solution that’s typically been touted for longevity insurance up until now. Like single premium immediate annuities, or “SPIA’s,” DIA’s pay periodic income for a specified period of time or over one’s lifetime or joint lifetimes as applicable. Unlike SPIA’s which begin payments one month after date of purchase, the start date of DIA payments is contractually defined and is deferred for at least 13 months. The longer the income start date is delayed, the lower the premium, or investment, required to provide a specified amount of income.

Although DIA’s can be purchased for a specified term, e.g., ten years, when used as longevity insurance, the payout on DIA’s often starts in one’s 80’s and is for life. Depending upon the age at which a DIA is purchased, the premium can be a relatively small amount compared to the potential lifetime income that may be received.

Fixed Index Annuities With Income Riders

For those individuals who don’t want to be locked into a fixed starting date, in addition to providing an accumulation value, FIA’s with income riders offer greater flexibility than DIA’s. With FIA’s, which are more readily available than DIA’s, there’s no contractual income start date. Income withdrawals can generally begin any time at least one year after the initial investment is made. The longer the start date is deferred, the greater the amount of lifetime income. The start date can be targeted when the investment is purchased based on the amount and timing of initial and projected ongoing investments and desired amount of income. A flexible, vs. single, premium FIA is required in order to invest additional funds.

Depending upon one’s needs and marketplace availability, it may make sense to use a combination of DIA’s and FIA’s with income riders. and potentially multiple products within each category, to meet deferred lifetime income needs. As with all things of this nature, a thorough analysis should be prepared by a professional retirement income planner to determine the solution that will best meet your needs.

Categories
Annuities Fixed Index Annuities

With a Fixed Index Annuity, You Can Have Your Cake and Eat It Too

Beginning with the August 1, 2011 post, Do You Want to Limit Your Potential Gains? through the November 5, 2012 post, Invest in DIA to Fund LTCI Premiums When Retired – Part 4 of 4, there were a total of 58 posts about fixed index annuities (“FIA’s”). Not to state the obvious, however, that’s a lot of information about one subject!

The impetus for the volume of material on FIA’s was, and continues to be, the fact that a FIA with an income rider is a unique and underutilized strategy that can provide a meaningful lifetime income floor for many retirement income plans while protecting against downside risk. As evidence of this fact, fixed index annuity sales have been increasing at a rapid pace the last two years while sales of variable annuities have been on the decline. Furthermore, their use as a retirement income planning tool is affirmed by the fact that the majority of sales have included an optional income rider.

What’s so special about a FIA? In one word – flexibility. A FIA is the only fixed annuity where you can receive a stream of income and also enjoy an investment value — that comes with downside protection. The other two types of fixed annuities, i.e., single premium immediate annuities (“SPIA’s”) and deferred income annuities (“DIA’s”) fulfill the income role (immediate in the case of SPIA’s and deferred with DIA’s), however, neither one of these two vehicles has an investment value. In addition, the lifetime income stream from a DIA often isn’t as competitive as lifetime payments from a FIA income rider with the same deferral period.

Another example of the flexibility associated with FIA’s is the income start date. Unlike a DIA where there’s a contractual fixed start date, the commencement of lifetime income from a FIA is totally flexible. It can typically be turned on at any time beginning one year after the contract date. Furthermore, while the lifetime income amount generally increases the longer you defer the start date, there’s no requirement to ever begin taking income withdrawals.

While SPIA’s and lifetime DIA’s (there are also period certain, or fixed term, DIA’s), are both designed to protect against the risk of longevity, the fact of the matter is that premature death can reduce their value, in some cases significantly. Some DIA’s can be purchased with a death benefit to protect against the possibility of death prior to their deferred annuitization date, however, the added insurance protection often increases the required investment amount, all else being equal.

When FIA’s are purchased with an optional income rider, it’s usually done in conjunction with some type of retirement income planning. As such, the emphasis is on deferred lifetime income, with the investment, or accumulation, value playing a secondary role. The fact of the matter is that the investment value is the anchor that provides the following four important benefits in addition to the sustainable lifetime income from the income rider:

  • Principal protection
  • Minimum guarantees
  • Upside interest potential
  • Death benefit

Assuming that no withdrawals are taken from the accumulation value in addition to income rider distributions, the accumulation value will only decrease by the income rider charge prior to turning on the income stream. Given this fact, unlike SPIA’s and lifetime DIA’s, FIA’s will have a death benefit available from day 1 that continues for much of the life of the FIA.

Once income begins, the accumulation value, i.e., death benefit, will decrease by the amount of income withdrawals in addition to the income rider charge. An optional death benefit rider can be added to the contract at the time of purchase to provide a guaranteed death benefit that will be paid even if there’s no accumulation value.

A fixed index annuity with an income rider is truly a unique retirement income planning tool. Unlike other types of fixed annuities where income begins immediately, i.e., SPIA’s, or at a contractually fixed date in the future, i.e., DIA’s, a FIA income start date is totally flexible. In addition, unlike SPIA’s and DIA’s which are only about lifetime income, FIA’s include an investment value. Furthermore, the investment value has built-in downside protection. Who said you can’t have your cake and eat it too?

Categories
Annuities Retirement Income Planning

Is It Time to Take Some Chips Off the Table?

For those of you looking forward to reading Part 2 of the New Tax Law – Don’t Let the Tax Tail Wag the Dog post, my apologies to you. It will be published next week. After the recent surge in stock prices with the notable exception of Apple, which has lost 265 points, or 38% of its value, in just four months from its September 21st high of 705.07 to its close of 439.88 this past Friday, I feel compelled to write and publish this post first.

I was in Las Vegas attending a professional conference last week which may have been the impetus for the title of this post. As an investment advisor, when I see the Dow Jones Industrial Average increase by 792 points, or 6%, from its December 31st close of 13,104.14 to Friday’s close of 13,895.98 in less than one month, including 13 out of 17 sessions when the closing price has exceeded that of the previous day with 7 consecutive daily increases through Friday, on top of a 7.3% increase in 2012, I take notice. The phrase “reversion to the mean” comes to mind.

As a retirement income planner, I look for windows of opportunity for my clients to transfer, what amounts to slivers of their investment portfolio in many cases, from the unpredictable fluctuations of the stock market to conservative investments that are designed to provide guaranteed income* payable over a specified period of time that they can depend on throughout retirement. This includes single premium immediate annuities (“SPIA’s”), deferred income annuities (“DIA’s”), and fixed index annuities (“FIA’s”) with income riders. Since my crystal ball shattered years ago, I don’t try to time the market to determine when it has peaked in order to recommend and perform this heroic service for my clients.

While my clients are unanimously very happy with the recent increased value of their portfolios, I know from many years of experience that this state of euphoria is often short-lived. The reality is that their equity allocation is more than what is targeted for their portfolio in several cases. As a result, the risk associated with their portfolio is greater than what is appropriate for their risk tolerance level. This is inevitably a ticking time bomb unless corrective action is taken in a timely manner.

Shifting a portion of a managed investment portfolio to guaranteed income* at opportune moments has proven to be a winning strategy for my clients within 20 years of, or in, retirement. They have everything to gain and nothing to lose. Each time that a client implements this recommendation, he/she accomplishes two important goals shared by all individuals doing retirement income planning: (a) portfolio risk reduction and (b) decreased likelihood of running out of money in retirement.

Although I haven’t done any formal large-scale studies, I can confidently state from personal and client experience that this generally results in reduced short- and long-term stress levels, fewer cases of insomnia, and less health issues in general for those individuals who implement this strategy compared to those who don’t. This unequivocally trumps the short-term euphoria associated with increased portfolio values in a bull market.

Let Apple’s recent experience be a lesson for us all. Don’t be afraid to take some chips off the table, especially when your retirement, health, and happiness are at stake.

*Subject to the claims-paying ability of individual insurance carriers

Categories
Deferred Income Annuities Social Security

Social Security – The Ultimate Deferred Income Annuity

Last week’s post made the point that Social Security isn’t simply an entitlement program and is instead a deferred income annuity (“DIA”) payable for life. As discussed, 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’s the federal government while DIA’s are purchased from, and payments guaranteed by, individual life insurance companies.

It turns out that in today’s low-interest rate environment, Social Security is inarguably the ultimate DIA. To illustrate this, I will use my current Social Security benefits statement that includes the following information about my projected monthly retirement benefit beginning at various ages:

Age 62                                                        $1,870
Age 66 and 2 months (full retirement)    $2,559
Age 70                                                        $3,385

In addition to projected monthly retirement benefits, my statement also shows that through 2011, I have paid Social Security taxes totaling approximately $149,000 and my employers (including myself and my two corporations for the last 23 years) have paid approximately $94,000, for a total of approximately $243,000.These taxes have been paid over the last 40 years beginning with part-time employment when I was in high school, with the vast majority paid over the last 25 years.

In addition to my Social Security retirement benefit, my wife is entitled to receive a monthly benefit equal to one-half of my full retirement benefit, or $1,280 (50% x $2,559) if she starts receiving benefits at her full retirement age. This is referred to as a spousal benefit and is independent of any benefit to which she may be entitled based on her earnings record. Assuming my wife has no significant earnings and further assuming that I predecease her, she will receive her spousal benefit for the rest of my life at which time she will receive my higher monthly benefit for the remainder of her life.

Ignoring my wife’s spousal benefit in order to minimize complications, let’s demonstrate the value of my Social Security retirement benefit by calculating the single premium required today at my age 57 to purchase a DIA that will pay my projected monthly retirement benefit beginning at various ages with a 2% annual increase for the remainder of my wife and my lives. Per the November 12, 2012 The Smooth COLA post, Social Security cost-of-living adjustments (“COLA’s”) have averaged 2.6% over the last ten years; therefore, an assumed 2% annual increase is probably conservative.

The following is the range of DIA single premiums required to pay various joint lifetime income amounts assuming an annual 2% increase beginning at various ages using illustrations from three highly-rated life insurance carriers:

While it’s obvious that the above single premium amounts are significantly greater than the total Social Security taxes of $243,000 paid through 2011 by my employers and myself, it’s important to keep in mind the following facts when doing a cost/benefit analysis of Social Security compared to commercial DIA’s:

  • In order to receive the projected Social Security monthly income beginning at various ages, it’s assumed that my current earnings will continue until my full retirement age.
  • In order to receive the projected Social Security monthly income beginning at various ages, Social Security taxes paid by my employers and myself are projected to total $314,000 – $381,000 or greater depending upon my annual earnings, actual taxable Social Security wage bases, and when I retire.
  • Although my Social Security tax payments haven’t been segregated and invested in an account in my name and they have been used to fund Social Security benefits for other individuals, my employers and I have been paying into the Social Security Trust Fund for 40 years.
  • My projected Social Security monthly income beginning at various ages doesn’t include COLA’s between now and my Social Security starting age.
  • The DIA assumed annual increase of 2% may be greater or less than the actual Social Security COLA’s for the remainder of my wife and my lifetime.
  • Although it isn’t likely, it’s possible that my projected Social Security benefit amounts may change if Social Security law changes.
  • As previously stated, my projected Social Security benefits and the single premium DIA calculation both exclude my wife’s Social Security spousal benefits.
  • While it’s possible that less than 50% of my Social Security benefits will be taxable, under current law, it’s likely that 50% – 85% of my benefits will be taxable, depending upon the amount of my other income.
  • Depending upon when I would start receiving payments from a DIA, approximately 40% – 60% of my payments would be taxable as a result of favorable tax treatment associated with nonqualified annuity payments.
  • The required DIA single premium amounts are on the high side since they were calculated assuming that I’m a California resident when I receive my payments and, as such, take into consideration California’s nonqualified annuity premium tax of 2.35% which isn’t applicable in most states.

As you can see, a number of factors must be considered when comparing Social Security as a DIA to purchasing a commercial DIA. Despite these various factors, in today’s low-interest rate environment, it’s clear that Social Security is the ultimate DIA.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 5 of 5

Retirement Income Center - Puzzle

The first four parts of this series compared and contrasted the features available in two major types of fixed income annuities that defer the payment of their income, i.e., fixed index annuities (“FIAs”) with income riders and deferred income annuities (“DIAs”). So now that we’ve thoroughly analyzed both of these excellent retirement income planning tools, which is right for you?

The answer to this question depends upon your retirement income planning needs. The ideal retirement income planning strategy is one that will generate one or more guaranteed streams of income that will close the gap between projected expenses and projected existing sources of income with the smallest investment. Whether FIA’s or DIA’s or a combination of both strategies, will achieve this goal, will be dictated by the unique facts in a given situation.

Whenever possible, multiple FIA and DIA illustrations should be prepared to determine which strategy or strategies makes the most sense for a particular case. As discussed in the first four parts of this series, while FIAs and DIAs have much in common, each has features not found in the other.

Assuming that a similar amount of income will be produced whether a FIA or a DIA is used, the meshing of the unique features associated with each of the two types of fixed income annuities with the requirements of a particular retirement income plan will dictate what’s best for the plan. As an example, if income start date flexibility is important, a FIA will generally fit the bill. If, on the other hand, inflation-adjusted income is required over a specified term, e.g., from age 65 – 75, a DIA may be the best solution.

The presence of an accumulation value and associated built-in death benefit with FIA’s that’s not available with DIA’s often tips the scale in favor of FIAs. This is further reinforced when lifetime, vs. a specified term, income is important.

Cost is another factor that needs to be considered when comparing FIAs with income riders to DIA’s. DIA’s, as a stand-alone income-producing product, have no upfront or ongoing cost associated with them. Since the benefits of guaranteed income associated with FIA’s can generally only be obtained by purchasing an optional income rider, there’s an annual charge that’s assessed and deducted from a FIA’s accumulation value for this rider.

There are two other things to keep in mind when comparing FIAs with DIAs. Unlike FIAs with income riders, which are currently offered by numerous life insurance carriers with 169 products currently on the market, there are only a handful of carriers that offer DIA’s. One of the leading carriers, Hartford Financial Services Group, recently agreed to sell its units that develop, market, and distribute new versions of retirement income products.

A second thing to keep in mind is the ongoing tweaking of existing products and development of new products in response to marketplace demands. Of note, one of the top-rated carriers with a longstanding history introduced an innovative DIA within the last year that allows for ongoing investments as well as a flexible income start date, both features of which weren’t previously available with traditional DIA’s.

As you can see, the decision between FIAs with income riders vs. DIAs is complicated, to say the least. Determining what makes sense for you requires the skills and knowledge of an experienced retirement income planner who routinely works with these and other retirement income planning strategies.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 3 of 5

Retirement Income Center - Puzzle

I hope that you’re enjoying this series so far comparing two innovative retirement income planning tools – fixed index annuities (“FIAs”) with income riders and deferred income annuities (“DIAs”). Of the 12 features offered by FIAs with income riders that are listed in Part 1, we’ve looked at three features that are also offered by DIAs, and five that aren’t applicable to DIAs.

This post will discuss the remaining four features that are applicable to DIAs on a limited basis. They are as follows:

  1. Known future income amount at time of initial and ongoing investments
  2. Flexible income start date
  3. Greater income amount the longer you defer your income start date
  4. Death benefit

Known Future Income Amount at Time of Initial and Ongoing Investments

One of the really cool things about fixed income annuities from a retirement income planning perspective is the ability to structure a guaranteed (subject to the claims paying ability of individual life insurance companies) income stream to match one’s income needs. In the case of both FIA’s with income riders and DIA’s, the amount of the future income stream is known at the time of initial and ongoing investments.

When you purchase a DIA, a known amount of income, with or without an annual inflation factor, will be paid to you as an annuity beginning at a specified future date for either a specified number of months or for life, either single or joint as applicable. With traditional DIA’s, you make a one-time investment; however, there are a handful of products that offer you the ability to make ongoing investments.

Unlike traditional DIA’s where you generally make a single investment and you receive a specified amount of income beginning at a specified date, FIA’s with income riders have more variations. For one thing, assuming you’re working with a flexible– vs. a single-premium FIA, you have the ability to make ongoing investments in a single FIA. In addition, the income start date, which will be discussed in the next section, is flexible. While the future income amount is known at the time of initial and ongoing investments, both of these variables combine to offer a much broader range of possibilities than a traditional DIA when it comes to the income withdrawal amount.

Flexible Income Start Date

All FIAs with income riders have a flexible income start date with the ability to begin income withdrawals either in the year of purchase or one year from the date of purchase assuming you’ve reached a specified age, generally 50. There’s no requirement with FIA income riders to commit to the income start date at the time of purchase, and, furthermore, you don’t have to ever start taking income withdrawals if you choose not to do so.

Per the previous section, traditional DIAs begin their income payouts at a specified future date. There are some nontraditional DIAs that provide for a flexible income start date similar to FIAs with income riders.

Greater Income Amount the Longer You Defer Your Income Start Date

With all fixed income annuities where the income isn’t payable during the first year, i.e., single premium immediate annuities, or “SPIAs,” the longer you defer your income start date, the greater the amount of income you will receive. This is true whether the income payment is for a fixed term, as it is with some DIAs, or if it’s for life.

FIAs with income riders, with their built-in flexible income start date, include this feature. In order to obtain this benefit with a traditional DIA, you need to choose a later income start date at the time of purchase.

Death Benefit

Income withdrawal is an optional rider with FIAs. The base product has an accumulation value that’s increased by initial and ongoing investments, premium bonuses, and interest credits and is decreased by withdrawals and surrender and income rider charges. To the extent that there’s accumulation value remaining upon the death of the owner(s), it’s paid to the contract’s beneficiaries as a death benefit.

Traditional DIAs may or may not include a death benefit prior to annuitization. Once annuitization occurs, there’s generally no death benefit payable. If you opt for a traditional DIA that includes a death benefit before annuitization, the amount of the benefit will generally be equal to your investment amount; however, the tradeoff will be a reduced income amount than would otherwise be payable by a similar product that doesn’t include a death benefit.