By Frederick “Rick” Fisher, MS, CFP® | Download the PDF
The concept of an annuity has been around for centuries. Social Security is a form of an annuity. Most annuities are created and issued by insurance companies. These tax-deferred investments have grown increasingly complex over the last 30 years, and with that complexity sometimes comes misunderstanding. When used properly, annuities can be a way of creating a pension income for your life and potentially the life of your spouse. Proper due diligence is necessary since all annuities are not created equal.
To illustrate, let’s take the cases of two different investors. The first investor, Charlie, is 52 years old, and married with two children. He makes over $200k per year and maximizes his 401(k) contributions. He wants to save more for retirement in a tax efficient way. Since he does not have a traditional pension (except Social Security), he would like to create a larger cash flow in retirement that he and his wife cannot outlive. Having had to go through the market downturns of 2000 and 2008, he is concerned that another market downturn could happen when he is retired.
Charlie and his wife expect to live well into their eighties, so they are planning for a 20+ year retirement. In this case, a variable annuity may be a worthy option. Contributions to annuities grow tax deferred. Money inside the policy could be invested in equity and bond funds, and for an extra cost, could provide a feature that would guarantee a minimum income for both of their lives. These are a few of the good features available within annuities.
Some of the bad comes in the way of higher fees than other investment products and ordinary income tax treatment of gains when taking withdrawals, for both the account owner and future beneficiaries.
In Charlie’s case, the good outweighed the bad. After doing proper due diligence regarding company, product, features, and costs, he decided to invest in a variable annuity with a minimum income benefit rider that will pay him and his wife a set minimum monthly income for both of their lives.
Now let’s consider a second case: Michael, who is 82, is widowed and has one daughter. He is retired and lives on a modest income that consists of Social Security, a small company pension, and $240k Mutual Fund IRA from which he draws $1k a month. He owns his home, but still has a mortgage on it. He is finally comfortable, and his goal is to leave his modest estate to his only daughter.
In this case, an annuity would be of little value as he is no longer in accumulation mode and the goal for tax deferred investing is no longer a priority. Also, he has enough income from his social security and mutual fund, so a minimum income feature may not be worth the extra cost.
If you have been considering annuities or have one that you do not fully understand, call our office for a complimentary investment review, because part of being a successful investor starts by being well informed.
Frederick Fisher is a Registered Representative with, and Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Ostrofe Financial Consultants, Inc., a Registered Investment Advisor and separate entity from LPL Financial.
For questions or suggestions, contact Frederick at (530) 273-4425, or frederick.fisher@lpl.com, or visit ostrofefinancial.com. Branch address: 420 Sierra College Drive, Suite 200, Grass Valley.
The opinions voided in this material are for general information only and are not intended to provide specific advice of recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. The case examples provided are hypothetical examples and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59-1/2 are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value. Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges and restrictions, and the policy holder should review their contract carefully before purchasing. Guarantees are based on the claims paying ability of the issuing insurance company.