One of the prime principles of David Ortiz Advisors, is keeping our clients money as safe as possible. Its for this reason that many of our clients choose annuities as a part of their retirement plan. However there is more to annuities than just being a “safer” solution. Properly used and understood, annuities can be an excellent addition to a retirement plan. Annuities are contractual obligations from insurance companies, and the money you invest in an annuity contract grows tax-free until funds are withdrawn. Should your investment be withdrawn early, the assumption is that any earnings that have accumulated in the annuity are claimed first, and are therefore taxed as ordinary income. When the annuity is funded with dollars that have already been taxed, the withdrawal of those investment funds is considered a return of principal and not taxed.
You invest funds with the insurer and in return, the company promises to make regular payments to you. These payments typically continue for the rest of your life, and possibly the remainder of your spouse’s life as well. This is known as the annuitization phase. Once routine payments have begun, they’re treated as a blend of earnings and return of principal – and taxed accordingly.
Your annuity payments are determined by several basic factors, including the dollar amount you’ve invested in the contract, your age, and the year payments are scheduled to begin. The insurer estimates your life expectancy and knows how much it anticipates earning from the funds invested in the annuity contract. Annuities may be purchased and activated immediately, or over time. With an immediate annuity, your stream of payments begins right away, and the contract may be funded with either a lump-sum amount or with periodic payments.
The two broad categories of annuities are immediate and tax-deferred. With an immediate annuity, you make a lump-sum deposit and the insurance company guarantees a stream of payments that begins right away and continues until death. With a tax-deferred annuity, your payments begin at a future date specified in your agreement.
Fixed annuities are powerful savings vehicles that provide a guaranteed income stream that you cannot outlive upon retirement. They offer compound growth without the anxiety frequently created by stock market fluctuations. A fixed annuity is essentially a CD-like investment issued by an insurance company. These contracts pay guaranteed rates of interest, which is particularly appealing to risk-averse investors. The annuity payment amount depends on the life expectancy of the annuitant. The lower the life expectancy, the higher the payment. However, the fixed lifetime payments you receive won’t keep pace with inflation, and the purchasing power of these payments will decline over time. If you plan to retire early and will therefore receive annuity payments for a long time, this could be a big concern. Furthermore, if your health deteriorates and medical costs rise, the income from your annuity won’t increase to accommodate your higher medical expenses.
There’s also a type of fixed annuity known as an indexed annuity, which provides performance guarantees linked to a particular index, such as the S&P 500. This allows you to participate in stock market gains without the need to actively manage these investments. Many indexed annuities guarantee that – regardless of market performance – you’ll always recover the premiums you’ve paid into the annuity.
If you’re looking for a larger payout than the one provided by a fixed annuity – and you’re hoping to benefit from market returns and have more control over your investments – you may wish to consider a variable annuity. Variable annuities are essentially mutual funds with an insurance wrapper, combining the characteristics of a fixed annuity with the growth potential of fund investments. A variable annuity’s rate of return fluctuates with the stock, bond, and money market funds you select as investment options.
Due to the growth potential, a variable annuity may be more likely than a fixed annuity to outpace inflation. You have the freedom to transfer money from one investment option to another at any time, and at little or no cost. Since variable annuities are tax-deferred investments, you’ll pay zero taxes on your income and capital gains until you begin receiving payments. This means your investments will grow and compound tax-free year after year, increasing your payout at retirement.
Variable annuities have two phases: the accumulation phase and the distribution phase. The accumulation phase is the period during which the premiums you pay are allocated among investment portfolios, and your earnings on those investments accumulate. During the distribution phase, your insurance company guarantees a minimum payment to you based on the principal and investment returns.
With a basic annuity, the insurer promises to send you a specific amount of money – starting at some future date – for the remainder of your life. However, straight life annuities don’t offer any payout to surviving beneficiaries after the annuitant’s death. Therefore, when you pass on, any funds remaining in the annuity contract belong to the insurer – instead of your estate. This means that if you live for a very long time, the insurer doesn’t come out so well. On the other hand, the insurer’s profitability on the contract will be higher should you pass away at a relatively young age.
In the event of an earlier-than-expected death, you can provide for your heirs by selecting a joint life with last survivor annuity. This contract will continue payments to your spouse after your death for the remainder of her life. It also provides the opportunity to designate additional beneficiaries to receive payments in the event of your spouse’s death. This beneficiary may be another individual or a charity. Therefore, a joint life with last survivor annuity provides financial support to both you and your spouse for the remainder of your lives, and offers a convenient way to leave a financial legacy to a close relative or a worthy cause.
(It is because of the many different types of annuities, as well as their utility, that make them such a popular solution to give your retirement more stability than traditional market investments. Have questions? I have answers. Click the contact tab above and fill out the Contact Form. I will be happy to answer any questions you have regarding your personal situation and try to provide you with a path forward that best meet your objectives (ie; determine if an annuity is right for you).
Topics: annuities, death benefit, variable annuities, fixed annuities, annuity payments