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.

Annuities Fixed Index Annuities Retirement Income Planning

Retirement Income Planner Key to Success When Investing in Fixed Index Annuities

Last week’s post presented a list of 12 questions you should ask yourself when considering the purchase of fixed index annuities (“FIA’s”). As evidenced by the questions, themselves, as well as the number of questions, this is a very technical area that requires specialized expertise.

So where do you find answers to the various questions? Assuming that investment in one or more FIA’s makes sense in your financial situation, where should you go to purchase these long-term investments? The remainder of this post will assume that you’re considering FIA’s in the context of a retirement income plan.

Unlike investing in the stock market, where you can utilize the services of an investment manager or be a do-it-yourselfer, you must purchase fixed index annuities from a licensed life insurance agent who has the requisite training to sell annuities. Life insurance agents can sell different types of insurance products, including life, disability, and long-term care insurance, as well as annuities. Life insurance companies, life insurance agents, types of products, and the specific products that can be sold, are regulated by an insurance body in each state.

Not every life insurance agent sells annuities. Some only sell variable annuities. Furthermore, there are several different types of fixed annuities, including single premium deferred annuities (“SPDA’s”), single premium immediate annuities (“SPIA’s), deferred income annuities (“DIA’s), and FIA’s. FIA’s are a unique type of fixed annuity that requires specialized expertise and training, and, as such, aren’t offered by every life insurance agent who sells fixed annuities.

Since a FIA is a unique long-term investment with several moving parts in the base product as well as the income rider that change on a regular basis in response to market conditions, it’s important to work with an independent life insurance agent who has access to at least two dozen FIA’s offered by at least six different highly-rated life insurance companies, and sells them on a regular basis.

Going beyond locating a life insurance agent who (a) sells annuities, (b) sells fixed annuities, (c) sells FIA’s, and (d) is an independent agent with access to several different FIA’s offered by several different highly-rated life insurance companies, there are other considerations to keep in mind before purchasing a FIA. First and foremost, you need to recognize and understand the fact that retirement income planning is a specialized discipline, it’s complicated, there are many risks that need to be considered, and mistakes can be costly.

Given the fact that the purchase of a FIA with an income rider for retirement income planning purposes is typically a lifetime investment that often requires a large upfront financial commitment and potentially ongoing periodic investments, it’s especially important that you work with the right individual. Specifically, the person you choose should be a professional retirement income planner. What exactly is a retirement income planner? Sounds like the subject of another post.

Annuities Fixed Index Annuities

Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities

Last week’s blog post introduced a type of investment that may not be familiar to many of you – indexed annuities. For those of you who missed it, an indexed annuity is basically a fixed annuity that offers a guaranteed interest rate for a set period of time. Two features of fixed annuities that have traditionally made them a preferred investment choice when compared to similar-duration CD’s are higher interest rates and tax-deferred growth.

Indexed annuities take it one step further. In addition to having the two aforementioned features, indexed annuities offer upside potential, i.e., a higher potential rate of return than traditional fixed annuities. While the higher rate of return isn’t guaranteed, there’s always a fixed rate of return that provides downside protection.

As such, indexed annuities fall in between fixed annuities and equity investments such as mutual funds and variable annuities on the risk tolerance scale. Unlike variable annuities, other than surrender charges for early termination that apply to all annuities, unless an income rider is added, there are no fees associated with indexed annuities.

How is upside potential provided by indexed annuities? Indexed annuities are a hybrid product, with returns directly tied to the performance of a stated stock index. Stock indexes measure the performance of a specified group of individual stocks. Some popular stock indexes include the S&P 500, Dow Jones Industrial Average, and NASDAQ, to name a few.

If you invest directly in an index, or any investment for that matter, the difference between the value of your investment and your original purchase amount equals your unrealized gain or loss on any given day. Unlike a direct investment in an index where you participate fully in all gains as well as all losses, there are two basic differences when you invest in an indexed annuity:

  1. If the index’s return is negative, no loss is posted to your account.
  2. If the index’s return is positive, only a portion of the return, often times subject to a cap, is credited to your account.

In other words, you won’t participate in losses, however, you also won’t fully participate in gains. In any given year, the floor for your return is a minimum rate of return that can vary between 1% and 3% and the ceiling is a portion of the gain in the index to which your indexed annuity is tied, both of which are defined in your contract. Depending upon the indexed annuity, the minimum rate of return may not be on the full premium paid into the policy.

If you don’t want exposure to losses, however, you’re unsatisfied with taxable CD rates and are instead seeking tax-deferred growth with an opportunity to increase your investment return by a portion of upside market returns, then you may want to consider diversifying into one or more indexed annuities. Stay tuned next week as we continue our series on this investment strategy.

Annuities Fixed Index Annuities

Shelter a Portion of Your Portfolio From the Next Stock Market Freefall

Although there have been a few bumps in the road and it’s highly unlikely that it will continue at the same pace, those of us who have been invested in the stock market for the last two years have enjoyed a very nice ride. With the Dow Jones Industrial Average closing at 12,657.20 on Friday, the index has increased by 4,478.79 points, or 54.8%, from its close of 8,178.41 on July 8, 2009.

As quickly as the market can increase in value, the opposite can also happen. Ironically, although over a shorter period of time, the Dow Jones Industrial Average experienced almost the identical percentage loss when it went from its all-time high of 14,164.53 on October 9, 2007 until it bottomed out at 6,547.05 on March 9, 2009. The loss of 7,617.48 points, or 53.8%, occurred in just seventeen months, or seven months less than the recent increase of 54.8% over the last two years.

Let’s face it, if you were in the market during the end of 2007 through beginning of 2009 plummet, it was a nail-biting, stomach-wrenching period, even for diehard stock market veterans. It was especially difficult for retirees and near-retirees, alike. Now that the market has recovered a large portion of its losses, this is an excellent time to examine strategies to shelter a portion of your portfolio from the next freefall.

One strategy that has received a lot of attention the last couple of years is indexed annuities. Since this blog post is the first of a series about this topic and my goal is to educate so that you can determine whether indexed annuities may be an appropriate investment vehicle for inclusion in your retirement income plan, I will start with some basic definitions.

For those of you who either aren’t familiar with annuities or don’t have much experience with them, although it’s lengthy, it’s worthwhile to give you Retirement Income Visions™ Glossary of Terms definition of an annuity:

A contract between an insurance company and an individual, or insured, whereby the insurance company, in exchange for receipt of a lump sum payment, or premium, or series of payments, or premiums, that is invested by the insurance company in one or more tax-deferred investment vehicles, agrees to pay the insured a lump sum, distributions of the contract balance, or the option to elect an irrevocable structured payout with a specified payment beginning at a specified date, paid at specified intervals over a stated period of months or years or for the duration of the insured’s and potentially his/her spouse’s and/or other individuals’ lifetime(s) depending upon the payout option selected. There is also a death benefit payable to the insured’s beneficiary(ies) prior to annuitization of the contract of the greater of the account value or a guaranteed minimum amount, such as total purchase payments reduced by withdrawals.

There are two basic types of annuities – fixed and variable. They are distinguished by their underlying investment vehicles and associated rates of return. An indexed annuity is a fixed annuity, defined in Retirement Income Visions™ Glossary of Terms as follows:

An annuity that offers a guaranteed interest rate for a set period of time. Premiums are invested in fixed income instruments such as corporate and government bonds in the general account of the insurance company. The insurance company guarantees to pay a fixed payout to the annuitant when annuitized, thereby assuming the investment risk.

In addition to offering tax-deferred growth, fixed annuity interest rates are generally higher than those of comparable-duration CD’s. For those of you who seeking tax deferral, are unsatisfied with traditional fixed annuity rates, and also want upside potential with downside protection, indexed annuities may be the answer for you.

Besides being a fixed annuity, what is an indexed annuity and how can it provide you with upside potential with downside protection? To learn the answer to these questions, I invite you to read next week’s blog post.

Retirement Asset Planning Retirement Income Planning Social Security

Your Social Security Retirement Asset – Part 2 of 3

Part 1 of this post last week made the point that Social Security, which has historically been taken for granted as a retirement income source, is also a retirement asset, specifically, an annuity. The post explained how Social Security, while not in strict compliance, comes pretty close to fulfilling most of the various attributes of an annuity.

If Social Security is, in fact, an annuity, then why isn’t it included as such on personal financial statements? If you own a variable or fixed annuity that hasn’t been annuitized, the life insurance company from whom you purchased your annuity periodically makes available to you a statement that includes the current value of your investment as of a specific date. The annuity and its value is routinely included as an asset in the nonretirement or retirement section of your personal financial statement, depending upon whether it’s nonqualified or qualified. Nonqualified annuities are generally owned by individuals whereas qualified annuities are owned by retirement plans, including 401(k) plans, traditional IRA’s, SEP-IRA’s, Roth IRA’s, etc.

What happens to your asset when you complete a form instructing your life insurance company to exchange the value of your investment for an ongoing irrevocable structured payout, generally monthly, with a specified number of payments or for the duration of your lifetime and potentially your spouse’s lifetime in the event that you predecease your spouse, i.e., you annuitize your annuity? Similar to your experience when you purchase a new car and it immediately loses an ascertainable amount of its value the moment you leave the car dealer, your $100,000 annuity is diminished in value the moment you receive your first annuity payment.

Just like your new car, while its value is reduced, your annuitized annuity nonetheless has a definable residual value. Unlike your car which may only be worth 85% of what you paid for it the moment after you drive it off the lot, depending on a multitude of factors, the value of your annuity could retain 99% of its previous value after receiving your first annuity payment. The diminished value of your car can be readily determined through an online service such as Kelley Blue Book and included on one’s personal financial statement. The calculation of the value of an annuitized annuity is more difficult, however, and, as a result, while it should be, it isn’t always included on personal financial statements.

Furthermore, once you annuitize an annuity, most life insurance companies cease to provide you with a statement showing you the remaining value of your investment. Why is this? Three reasons: (1) The life insurance company, while it is contractually obligated to make periodic payments to you and potentially to your survivor in the event of your premature death for a specified period of time, unless you elect some type of refund option, it generally is no longer required to return the value of your investment to you in the form of a lump sum payment, (2) The calculation of the remaining value of your annuity is complicated, requiring development and ongoing refinement of assumptions about interest rates and number of potential payments in the case of a lifetime payout, and (3) Aside from highly-skilled, technical, and experienced financial professionals who are always looking out for their clients’ best interests and who, like myself, understand and appreciate the importance and value of this information, there is currently little demand for it.

You’re probably wondering how this relates to Social Security. Unlike a traditional annuity, even though you’re investing in a future annuitized stream of payments via Social Security withholding in the case of an employee and self-employment tax in the case of a self-employed individual, while you receive an annual statement with the amount of your projected monthly benefit, Social Security Administration doesn’t provide you with a statement showing the current value of your investment. Nonetheless, similar to a commercial annuity contract that has been annuitized, although it isn’t straightforward, the value of the future payment stream can be calculated.

Even though the calculation of the current value of one’s Social Security benefits is further complicated by the uncertainty of the remaining duration of Social Security Trust Fund assets, in my opinion, it should be done routinely and the resulting value included as an asset on every qualified Social Security recipient’s personal financial statements. Who is a qualified Social Security recipient? Read Part 3 next week to find out.

Annuities Deferred Income Annuities Retirement Income Planning

Using Fixed Income Annuities to Build Your Income Portfolio Ladder

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

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

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

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

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

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

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

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

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