Investing in Retirement Annuities – 4 Key Points You Need to Consider
When it comes to planning for your retirement income, skip the excitment and go for stability instead.
Retirement annuities are neither sexy nor fascinating when it comes to generating financial returns on your savings. But here are 4 reasons why they are excellent as a retirement planning tool.
Four Key Points of Retirement Planning When Investing in Retirement Annuity
Unlike most financial products, annuities are more sold than bought. What this means is people sometimes need more convincing and persuasion to sign that dotted line.
Though the basic concept of an annuity is straightforward, they can still seem very complicated from the get-go. It is an investment that can grant payments for life if not for many years.
Stan ‘The Annuity Man’ Haithcock devised a way to determine the need for an annuity in his book. Titled “The Annuity Stanifesto”, it covers the decision in four purchase considerations that are key to an annuity. He sums it all up with an acronym, PILL, to cover principal protection, income, long-term care, and legacy.
While it is a good thing to have some simplicity to annuities, these investments encounter difficulty being categorized. There are some different products, like the fixed-rate, that can be conservative vehicles. They will generate a yield that rivals a bank account. However, other products may be more aggressive with variable annuities that can offer risks of the stock market as well as the returns. Investor payouts vary, while buyers make investments in different options. These options can be over time or at once. This all contributes to the complex reputation of annuities.
There are a few different features that are shared among annuities, a couple being the tax-deferred growth. Additionally, retirement income will grow until the money is taken out.
Evaluate your annuity needs with these four tips from Haithcock.
Protecting your Principal (P)
Of the different annuities, the conservative types are good at protecting your money. Especially the fixed-rate annuities. Haithcock lumps them together with money-market funds, insured municipal bonds, treasury security, and deposit certificates from banks. This is under the assumption that you are buying a fixed annuity from reputable companies, specifically those with AAA and AA ratings.
Haithcock writes that the guaranteed annuity is just as good as the company that issued it. He also states that it is important to base your decision to buy off of the company’s ability to fulfill the contractual obligations.
It can be easy to confuse fixed-rate with a different category of annuity known as variable annuities. These investments will and do fluctuate with bond and stock markets. Just like a mutual fund. Investing in variable annuities is necessarily about protection, it is appreciation potential. They are even regulated as securities and not products of insurance.
There is another version of annuity, equity-indexed. These are also different, though they act conservative, they offer only modest stock-market potential growth. Haithcock states that the problem is that the products are overhyped by salespeople.
If you want just protection, it is wiser to stick to alternatives like CD banks. They offer FDIC insurance. Or you can choose a treasury that the federal government backs. This allows you to avoid the different complexities while preventing the insurance company from facing any serious issues.
Income for Life (I)
This is the idea that annuities were founded centuries ago. And it is the fundamental reason as to why you should purchase one. You are provided different options for buyers, with fixed-rate annuities, to receive tax-deferred income. The structure of payments for an annuity can either be later or now. You can payout to yourself or a spouse, and it can go for a specific number of years, to life.
Fixed annuity income is dependent on life expectancy, as well as how the insurer’s portfolio is managed. The yields/payments correspond roughly to bond returns with maturities that are short-term.
Surrender periods are something that is usually tacked onto annuities. They can last several years after investing. During this time, you will face a penalty for canceling the contract as well as withdrawing money.
Haithcock explains that the surrender penalties exist for good reason. The insurance company goes into a bit of a hole financially when they have to pay a commission to the party that sold the contract. The surrender penalty is put into place to protect the insurer’s investment. They would charge their loss to break even if you make an early cashout or void the contract.
However, these periods and penalties should be avoided. If you are unsure about annuities, don’t buy one.
Most people manage to have regular access to a stream of payments through social security for retirement income. However, if you find yourself to not be one of those people, a steady income that is tax-deferred can be the main reason to purchase an annuity.
Long-Term Care (L)
Should you find yourself needing long-term care, there are annuities out there that help you pay for it. If you feel you can’t qualify or afford a long-term insurance policy, these annuities can be quite useful.
There are certain fixed annuities that are cited by Haithcock. The ones he cites do offer long term care riders. These are contact additions that provide benefits that you pay extra for. A rider can double the amount generated from an annuity. This is assuming that one day you will need help with basic tasks such as bathing, eating, walking, etc.. As an example, if you were to receive from annuity $12,000 a year from an annuity, a rider may double it to $24,00 in order to cover the costs of caregiving.
While you can reap some good benefits from a long-term care feature, if you are looking at long term care you may want to consider an insurance policy rather than investing in an annuity. Long term care features will help you generate more money to cover the care costs while avoiding long term policies from insurance. It doesn’t mean it is always the best option.
Proceeds do pass directly, outside of probate, to beneficiaries. These annuities are ideal for generating assets to grant to others. However, the transfers of these assets are not tax-free, unlike life insurance. This is the reason that Haithcock suggests considering a life insurance policy over an annuity for estate planning. However, it is noted that those with serious medical conditions are not likely to qualify for life insurance coverage.
Though they house more risk, variable annuities are favored as they provide to investors a large range of growth-oriented stocks. These stock funds have greater potential. With the low-interest-rate environment, you aren’t likely to produce much appreciation through fixed-rate annuities.
There are some investments that can pass outside of probate. These include individual accounts for retirement plans, 401(k) accounts, and life insurance policies. Annuities don’t have much hold over these different options.