[ad_1]
Annuities can be a topic of contention among financial professionals. There are some advisers who swear by them for virtually all clients, there are others who don’t look favorably upon them.
The reality is that an annuity can be a good tool for retirement planning in some cases. Also, there are good annuities and some that should probably be avoided.
Here are some things to consider when looking at an annuity as part of your retirement planning.
What can an annuity do for me?
The question here is what does adding an annuity do for you in terms of helping you accomplish your retirement planning objectives? What does it add to your retirement income planning efforts?
Annuities offer a source of guaranteed lifetime income which can augment your retirement savings in IRAs, 401(k)s and other accounts. In today’s world many private-sector employers have eliminated their defined-benefit pension plan or are considering doing so in the future. An annuity can replace this type of income stream and can be another source of regular, ongoing retirement income in addition to your Social Security benefits.
While annuities can be a beneficial addition to the retirement savings of many approaching retirement, it’s always a good idea to examine all sources of retirement income that you currently have in place before deciding to add an annuity. This can help you determine whether an annuity might fit a need, and if so what type of annuity best fits that need.
Additional tax-deferred savings
For those who are maxing out their contributions to an IRA and an employer-sponsored retirement account like a 401(k), an annuity is a way to build additional retirement savings on a tax-deferred basis.
Money in an annuity will not be taxed until it is withdrawn or annuitized in retirement. Money held in a qualified annuity inside of an IRA or other retirement account will be taxed in accordance with the rules for that type of account.
Types of annuities
There are many annuity types to consider. Here are four common ones:
Fixed annuities guarantee a fixed rate of interest over a set period. The rate is guaranteed by the insurer. Fixed annuities can be immediate or deferred.
Variable annuities are a contract that allows investments in a number of subaccounts (which are often similar to mutual funds). The amount that accumulates inside of the contract will depend upon how well these investments perform. There are generally no guarantees with a VA.
Immediate annuities are a type of fixed annuity where payments begin within a year of funding the contract. It is common for some people to divert a portion of a retirement account distribution or other type of lump-sum into an immediate annuity as they enter retirement. The annuity payments can help round out their retirement income planning.
Deferred annuities are another type of fixed annuity. With a deferred annuity, payments commence at some point in the future. Until then your investments in the contract grow tax deferred. A deferred annuity can be a way to help insure that you will have a guaranteed income stream a bit later in retirement to help prevent you from outliving your retirement savings. Note that while the income stream from a deferred annuity is fixed and won’t lose value, the annuity can lose value during the accumulation phase in the case of a variable or indexed deferred annuity.
A unique version of the deferred annuity is a QLAC (qualified life annuity contract) which is an annuity that is purchased inside of an IRA or other type of retirement plan. QLACs allow you to defer a portion of your retirement account balance until later in retirement. Money diverted to a QLAC is also exempt from required minimum distributions until distributions are taken.
Annuity riders
Beyond the annuity types discussed above, and others as well, many annuity contracts can be customized through the use of riders. The riders essentially add features to the annuity such as:
- Living benefit riders which might include things like a cost-of-living rider that adjusts for inflation, a long-term care rider and a host of others. These riders can customize the annuity to fit your needs while you are still living.
- Death benefit riders deal with the death benefit your beneficiaries would receive. Examples could include a guaranteed minimum death benefit, a rider that guarantees a surviving spouse a minimum death benefit among other rider options.
Riders do come with an added cost, so if you are looking to add them to an annuity contract be sure to understand the cost of the rider versus the benefit it offers.
Annuity taxes and penalties
Nonqualified annuities held outside of a retirement plan like an IRA or 401(k) will generally be subject to taxes in several ways.
- There is a 10% early withdrawal penalty if money is withdrawn prior to age 59 ½.
- Withdrawals from annuities are taxed on a last-in first-out basis. This means that all withdrawals are assumed to be earnings on the money invested and will be taxed as ordinary income. Once the earning pool is exhausted, additional withdrawal will be considered return of premium and not taxed.
- If a contract is annuitized, the payments will be taxed in accordance with the exclusion ratio, which is a ratio of the taxable and nontaxable portion of the funds accumulated in the contract.
Qualified annuities held in a qualified plan will be taxed in accordance with the rules of the particular retirement account when withdrawn.
Annuity expenses
There are generally expenses associated with an annuity. However, unlike vehicles such as ETFs and mutual funds these expenses are not always fully transparent. The fees and expenses inside of an annuity will ultimately reduce your benefits. It is critical that you understand all fees and expenses.
You should ask, and if needed, demand that the adviser working with you on the annuity purchase fully disclose these expenses to you so you can make the best decision regarding the annuity purchase.
Some annuities also carry surrender charges. These will kick in if you try to sell out or exchange the annuity before the passage of a specified time frame. For example if the annuity has a 5% surrender charge, the insurance company will take 5% of the value of the contract off the top if you try to sell or exchange it during the surrender period. Often surrender charge percentages will decline over time until the end of the surrender period.
Annuities can be a good addition to your retirement income planning efforts in many cases. Like anything else, there are a number of excellent annuities but also some that may not be as desirable.
If you are considering an annuity be sure that you buy one only if it is right for you and that the annuity you purchase is the best type for your needs.
There are many fine advisers and agents who deal with annuities who put their client’s needs first, but sadly there are some that seem more concerned about the commissions they make on these often lucrative products. Annuities should be bought, not sold to you.
[ad_2]
Source link
