Besides Social Security and pensions, an annuity is the only financial product that guarantees lifetime income. 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 its advantages and disadvantages. Option 1: A deferred income annuity (DIA) provides consistency and simplicity but minimal flexibility. A deferred income annuity (DIA) is a commitment made by an insurer to provide a stream of income beginning on a specified future date. This contract usually has a single premium. You can take the income for a fixed amount of time, such as 15 years, although most individuals choose the lifetime option. You can get a single-life annuity or a joint-life annuity if you want to cover both spouses. The popular optional cash-refund feature ensures that your premium money will be reimbursed to your dependents if you die before the income start date. This plan is simple. You know how much money you’ll make starting on the selected day. The disadvantage is that there is little to no flexibility. You’ve given the insurance your cash in return for future revenue. You’ve made your decision. Option 2: A fixed indexed annuity with an income rider is more flexible but more complicated and imposes fees. Fixed indexed annuities allow buyers to participate in the stock market’s profits while providing total protection against loss. They credit interest depending on the performance of a market index, such as the Dow Jones Industrial Average (DJIA) or the S&P 500. However, you lose nothing in low 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 have flexibility. Usually, when an annuity is converted into an income stream (“annuitized“), its cash surrender value becomes zero. Here, that’s the case. You continue to own the full unused value of your annuity. That gives the impression that you can “have your cake and eat it, too.” In some ways, it is, but there are downsides. One of the most significant is cost. To add an income rider, most insurers charge roughly 1% of the annuity’s assets yearly. As a result, your money will increase more slowly than it would without the rider. The lifetime income amount is defined by the value of your income account and your gender and age when you begin receiving payments. The income account value typically rises at a guaranteed yearly compounded rate of 4% to 8%, so the longer you wait, the more income you’ll get. Your contract’s income account value and cash value are separate. The value of your income account is only used to compute your guaranteed income payments. It has no monetary value, and it can’t be withdrawn. On the other hand, the contract value might be withdrawn or handed on to your heirs. Another disadvantage is fluctuating interest rates. If the market has a prolonged bear trend, you may receive nothing on your contract value for several years. Option 3: Purchasing a fixed-rate annuity now and changing it later to an immediate annuity provides flexibility and guaranteed growth, but future income might vary. That may be the best option for those who wish to maintain control of their money, but for the time being, remain flexible and generate 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 flat sum and receive a fixed interest rate for a specified period, generally two to ten years. You’ll know the exact worth of your annuity at the end of the period (assuming no withdrawals). If you reinvest the interest in the annuity, it is tax-deferred. Here’s how the strategy works. Assume you want to retire in five years. You purchase a five-year fixed-rate annuity. After the five-year period, you can explore the market for the best offer on an immediate-income annuity. If you keep your annuity in a nonqualified account, you can exchange it tax-free, for an immediate annuity, via a 1035 exchange. An immediate annuity is similar to a DIA except that income payments begin immediately. Since immediate annuity rates will have changed in the interim, you won’t know what your income will be. Here’s an example: Jane, 60, invests $150,000 in a five-year MYGA with a 4.30% annual effective rate. If she keeps the interest, the annuity will be worth $185,145 at the end of the period. She decides to buy an immediate annuity with that money. Based on current rates, joint-life insurance for her and her spouse (also 60) will pay $964.50 each month as long as one spouse is alive. (Of course, she may receive a better or worse bargain than what’s available today.) If it’s a nonqualified annuity, $464.89 is taxable income, and $499.61 is a nontaxable premium return. Payments from a standard IRA annuity will be fully taxed. All income generated by a Roth IRA annuity is entirely tax-free. But imagine that in five years, Jane decides to work for another two years. She can roll over the funds tax-free in a two-year MYGA and postpone purchasing the income annuity. She may, of course, do anything she wants with the money in her annuity. Jane can use some or all of it to travel around the world or donate to charity. Different forms of annuities are effective instruments for predicting future lifetime income. None of these three solutions is always the best option for everyone. It all depends on your circumstances and preferences.
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