Tag: FIA

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
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 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 Fixed Index Annuities

Fixed Index Annuity Income Rider Charge – Is It Worth It? – Part 1 of 2

Although fixed index annuities (“FIA’s”) offer a number of attractive features, not the least of which is protection from stock market downturns, I recommend them as a sustainable lifetime income strategy for a portion of my retirement income planning clients’ investment portfolios when appropriate. In order to obtain this popular benefit, it’s generally, although not always, necessary to apply for an optional income rider when you apply for a FIA.

When you add an income rider, you turbocharge your FIA. A FIA income rider offers the following five benefits that, when taken as a whole, cannot be duplicated by any other investment:

  1. Guaranteed, subject to individual life insurance company claims-paying abilities, lifetime income or lifetime retirement paycheck (“LRP”)
  2. Flexible LRP start date
  3. Potential for increased LRP amount
  4. Ability to calculate an LRP amount that you will receive beginning on a specified future date on the date of purchase
  5. Ability to adjust initial and ongoing investment amount to match one’s income needs

A charge is deducted from the accumulation value of a FIA on a monthly, quarterly, or annual basis in exchange for the foregoing five features when they are provided by an optional income rider. It’s generally calculated as a percentage of the income account value, however, the charge is sometimes calculated as a percentage of the accumulation value. A typical charge ranges between 0.75% and 0.95% of the income account value.

The income account value is used to calculate the amount of your LRP and is separate and apart from the accumulation value of your annuity contract. The starting point for the calculation is your initial and ongoing investments plus any premium bonuses offered by the life insurance company. A simple or compound growth factor is applied to the income account value for a specified number of contract years or until income withdrawals begin, whichever occurs first.

As an example, let’s say that you invest $100,000 in a FIA with an income rider that uses 6% annual compound growth for the first 12 years of the contract to calculate the income account value in exchange for an income rider charge of 0.95% of the income account value that’s deducted from the accumulation value. At the end of year 1, your income value is $106,000 ($100,000 x 1.06). An income rider charge of $1,007 ($106,000 x 0.95) will be deducted from your accumulation value. At the end of year 2, your income value is $112,360 ($106,000 x 1.06). An income rider charge of $1,067 ($112,360 x 0.95) will be deducted from your accumulation value.

The income account value will continue to increase by the 6% compound growth factor for 12 years in this example, assuming income withdrawals aren’t taken in the first 12 years. Consequently, the income rider charge will also increase for the first 12 years of the contract before it levels off and begins decreasing when income withdrawals begin.

Is the income rider charge worth it? Find out in Part 2 next week.

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
Fixed Index Annuities Retirement Income Planning

Cap Rates Are Secondary When Optimizing Retirement Income

process lifecycle

If you’ve been reading Retirement Income Visions™ for any length of time, you know that I’m a fan of fixed index annuities (“FIA’s”) with income riders, or guaranteed minimum withdrawal benefit’s (“GMWB’s”) as part of a retirement income planning solution in the right situation. The ability to create a predictable retirement paycheck with a flexible start date that includes an investment component with upside potential, downside protection, and a potential death benefit is unparalleled in the investment and insurance world.

For you horse race fans, that’s what I call hitting the trifecta! Unlike horse race betting, when you invest in a FIA with an income rider with a highly-rated life insurance company, while the results aren’t guaranteed since they’re subject to the claims paying ability of each individual insurance carrier, your bet is pretty secure given the stellar historical claims paying experience of the life insurance industry.

It’s important to understand that very few FIA’s that are sold today include GMWB’s as part of their base product. If you need sustainable lifetime income beginning at a specific age, you will generally need to purchase an optional income rider when you complete your FIA application. Only about two-thirds of FIA’s on the market today offer an optional income rider. An income rider charge of between 0.75% and 0.95% of your contract’s income account value will generally be deducted from your contract’s accumulation value each year.

Assuming that your goal is to maximize sustainable lifetime income, once you, or more likely your retirement income planner, narrows your FIA search to those that include a GMWB or optional income rider, illustrations need to be prepared for multiple products offered by highly-rated life insurance companies that are well-established in the FIA business to determine which ones will provide you with the greatest amount of income for your desired investment amount(s) beginning at various ages.

This is a difficult task due to the fact that there are several variables that are used in the calculation of annual income that will be received from a particular FIA. After analyzing hundreds of FIA illustrations, trust me, it requires a lot of skill, hands-on experience, and access to dozens of options, including appointment as a licensed life insurance agent with multiple life insurance carriers, in order to offer an independent optimal recommendation for a particular situation. One product may provide greater income beginning at age 62, however, another one may be more suitable if you don’t plan on taking withdrawals until age 70.

What about cap rates? Assuming your goal isn’t to create a predictable retirement paycheck, there’s no need to purchase a FIA with a GMWB or income rider. If this is your situation, you should be paying close attention to the caps, or limits, on interest that will be credited to your account each year that are associated with various indexing methods offered by a particular FIA depending upon its performance during the previous contract year.

If, on the other hand, your primary goal is to optimize lifetime income beginning at a particular age, cap rates, while important, should be a secondary consideration when choosing a FIA. While higher cap rates may result in a greater accumulation value that may more seamlessly absorb income rider charges associated with good market performance and may potentially result in a greater death benefit, they generally won’t affect the amount of lifetime income that you will ultimately receive from a particular FIA. This is due to the fact that the lifetime income calculation of most FIA’s is generally independent of indexing method performance. Furthermore, even if there’s no remaining accumulation value in your contract as a result of income withdrawals over many years, you will continue to receive your income so long as you’re alive.

While cap rates are often hyped by life insurance companies when promoting FIA’s, they should be a secondary consideration when your primary goal is to create and optimize a predictable retirement paycheck beginning at a specific age. If this is your situation, you or your retirement income planner should be devoting the majority of your research to locating those FIA’s offered by highly-rated life insurance companies that are well-established in the FIA business that include a GMWB or income rider that will enable you to achieve your goal.

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 Fixed Index Annuities Social Security

Delayed Gratification is the Key to Maximizing Income with Fixed Index Annuities

When you’re planning for retirement, income is the name of the game. The more sustainable income that you can generate, the less you need to worry about things like sequence of returns and major stock market downturns – before and during retirement.

The idea is to build a base, or floor, of predictable income that will cover your day-to-day expenses. For most people doing retirement income planning, Social Security is the core element of an income floor. Although pre-retirees today can plan to receive a full Social Security benefit beginning somewhere between age 66 and 67 depending upon their year of birth, the benefit that they, and potentially their spouse, will receive will increase by 8% per year for each year that they defer their start date up until age 70. This equates to as much as a 24% – 32% greater benefit depending upon your year of birth and how long you defer your start date.

Assuming that your goal is to build a solid base of sustainable income with the ability to increase your lifetime income amount similar to Social Security, one of the best ways to do this is to invest in a flexible fixed index annuity (“FIA”) with an income rider. The reason that you want to use a flexible, vs. a single, premium FIA is to provide you with the ability to add to your investment should you choose to do so. In addition, you need to purchase an income rider, which is optional with most FIA’s, in order to receive guaranteed (subject to the claims-paying ability of individual insurance companies) income.

Like Social Security, the longer you wait to begin receiving your income, the greater it will be. Unlike Social Security benefits which are increased by cost of living adjustments (“COLA’s”), the lifetime income from the majority of FIA’s available today will remain unchanged once it’s started.

To demonstrate the benefit of deferring the start date of FIA income withdrawals, let’s use one of the contracts purchased by my wife and me two years ago when we were 55 and 48, respectively. I will use my wife’s age as a point of reference for the remainder of this post since income withdrawal amounts are always calculated using the younger spouse’s age.

Per our annuity contract, my wife and I are eligible to begin income withdrawals at least 12 months after our contract was issued provided that both of us are at least age 50. It generally doesn’t make sense to take withdrawals from a FIA income rider before age 60 since the formula used to calculate the withdrawal amount is less favorable and the withdrawals will be subject to a 10% IRS premature distribution penalty and potentially a state penalty. Assuming that we plan on retiring after my wife is 60, there would be no need to begin income withdrawals before this age.

I have prepared a spreadsheet with various starting ages in increments of five years beginning at 55 through 75. The spreadsheet shows the projected percentage increase in our annual income withdrawal amount that we will realize by deferring our income start age compared to ages that are 5, 10, 15, 20, and 25 years younger, depending upon the starting age chosen.

Using an example that’s comparable to the Social Security starting age decision, suppose that we decide to defer our income start age from 65 to 70. This would result in a 31.2% annual increase in lifetime income. We will receive 120.3% more income if we begin our income withdrawals at age 70 instead of at 60. The percentage increases are significant in many cases depending upon the chosen withdrawal starting age compared to another potential starting age.

Similar to the Social Security starting age decision, there are numerous factors that need to be considered when determining the optimal age to begin income withdrawals from a FIA with an income rider, a discussion of which is beyond the scope of this post. Like Social Security, when possible and it makes sense, delayed gratification is the key to maximizing lifetime income.

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
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.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 1 of 5

Retirement Income Center - Puzzle

Judging by the number of recent posts regarding fixed index annuities (“FIAs”) with income riders, is it obvious that I’m excited about the use of this strategy as a potential piece of the retirement income planning puzzle solution? While FIAs with income riders can be used to provide guaranteed (subject to the claims paying ability of individual life insurance companies) lifetime income beginning at a future date, they aren’t the only fixed income annuity game in town.

As stated in the April 30, 2012 post, Target Retirement Income to Match Your Financial Needs, a FIA with an income rider offers 12 features that are listed at the beginning of the post, and, furthermore, is the only investment of which I’m aware that offers all 12 features. While it doesn’t have all of the bells and whistles of a FIA with an income rider, there’s another fixed income annuity option that includes a couple of retirement income planning benefits that aren’t found in FIAs with income riders. The strategy I have in mind is the deferred income annuity, or “DIA.”

Let’s begin our understanding of DIAs and comparison to FIA’s with income riders by listing the 12 features offered by FIAs with income riders. The features are color-coded as follows:

  • Green: Offered by DIAs
  • Red: Not Applicable to DIAs
  • Blue: Applicable to DIAs on a Limited Basis

Here are the 12 features offered by FIAs with an income rider, color-coded to indicate their applicability to DIAs:

  1. Guaranteed income*
  2. Lifetime income
  3. Tax-deferred income
  4. Known future income amount at time of initial and ongoing investments
  5. Flexible income start date
  6. Greater income amount the longer you defer your income start date
  7. Potential doubling of income amount to cover nursing home expense
  8. Investment value in addition to future income stream
  9. Protection from loss of principal
  10. Potential for increase in investment value
  11. Potential matching of percentage of investment amounts by financial institution
  12. Death benefit

*Guaranteed income refers to income for which an insurance carrier is contractually bound to pay to an annuitant(s) and/or an annuitant’s beneficiaries that is subject to the claims paying ability of each individual insurance carrier.

The first three features, i.e., guaranteed income, lifetime income, and tax-deferred income, are shared by all fixed income annuities. They’re the reason that fixed income annuities are a solid retirement income planning solution that let their owners sleep better at night.

Part 2 of this post will discuss the features that are offered by FIAs with income riders that aren’t included with DIAs. Part 3 will address the features that are applicable on a limited basis. Retirement income planning benefits that are unique to DIAs will be the subject of Part 4. Finally, Part 5 will answer the question, FIAs with income riders vs. DIAs: Which is right for you?