An annuity is the only investment option to ensure a steady flow of money for the rest of your life. You have three options for securing future income with an annuity. Each can be used for nonqualified (taxable) accounts, IRAs, and Roth IRAs. Each has advantages and disadvantages. Option 1: A deferred income annuity (DIA) provides predictability and simplicity but little flexibility. A DIA is a promise made by an insurer to pay a stream of income beginning on a specific future date. This contract usually has a single premium. You can take the income for a set period, such as 15 years, but most people choose the lifetime option. To cover both spouses, you can purchase a single-life annuity or a joint-life annuity. The popular optional cash-refund feature ensures that your premium payment will be refunded to your beneficiaries if you die before the income start date. Option 2: The flexibility of a fixed indexed annuity with an income rider is greater but more complex and expensive. Fixed-indexed annuities allow buyers to participate in the stock market’s gains while providing complete protection from loss. They lend money based on the performance of a market index, such as the Dow Jones Industrial Average or the S&P 500. However, you lose nothing in down years. You can ensure future income by including a lifetime-income guarantee rider. Because the income start date is not fixed when you purchase the annuity, you retain flexibility. Usually, when an annuity is converted into an income stream (“annuitized“), its cash surrender value becomes zero. This is not the case. You continue to own the entire unused value of your annuity. This gives the impression that you can “have your cake and eat it, too.” In some ways it is, but there are drawbacks. One of the most significant is the cost. Most insurers charge around 1 percent of the annuity’s annual assets to add an income rider. Because of the rider, your savings will accumulate slower than they would otherwise. A person’s lifetime income is based on their income account balance, their gender, and their age when payments begin. The value of the income account typically grows at a guaranteed annual compounded rate of 4-8%, so the longer you wait, the higher the income. Your contract’s income account value and cash value are distinct. The value of your income account is only used to calculate your guaranteed income payments. It has no monetary value and, therefore, cannot be withdrawn. The contract value, on the other hand, can be withdrawn or passed on to your heirs. Another disadvantage is that interest rates fluctuate. You might not make money on your contract value for years if the market experiences a protracted bear cycle. Option 3: Purchasing a fixed-rate annuity and converting it later to an immediate annuity provides flexibility and guaranteed growth, but future income is variable. This may be the best option for people who want to keep control of their money, for the time being, remain flexible, and build more future income. A fixed-rate deferred annuity (also known as a multi-year guarantee annuity or MYGA) functions similarly to a bank certificate of deposit. You deposit a lump sum and receive a fixed interest rate for a set period, usually two to ten years. You’ll know exactly how much your annuity is worth at the end of the term (assuming no withdrawals). If you reinvest the interest in the annuity, it is tax-deferred. This is how the strategy works. Assume you want to retire in five years. You purchase a fixed-rate annuity for five years. You can shop the market for the best deal on an immediate-income annuity near the end of the five-year term. Suppose you keep your annuity in a nonqualified account. In that case, you can exchange for an immediate annuity tax-free using a 1035 exchange. An immediate annuity is similar to a DIA, except that income payments begin immediately. Because immediate annuity rates will have changed in the interim, you won’t know exactly what your income will be. Different types of annuities are effective tools for predicting future lifetime income. None of these three options is always the best option for everyone. This is a personal decision that must take into account your needs and preferences.
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Bio:
Carl Wyllie is an advisor focused in areas of Medicare, retirement, estate planning, and crisis planning. Carl works with individuals of all ages in planning for their retirement. He is uniquely effective in building working relationships between their families and elder care law attorneys to assist them in avoiding a healthcare crisis. Carl is particularly sensitive to helping provide the means for his clients to maintain their independence and dignity when a change in their health occurs due to the natural aging process.
