Fixed annuities aren’t exactly flashy as financial tools. These insurance contracts offer a moderate fixed return for either a premium or a lump amount of cash. They provide a steady income for the rest your life, as well as that of your spouse or partner. Sara Wiener, Assistant Vice President of Annuities at Principal Financial Group, Des Moines, Iowa, says, “It’s almost like having your own private pension plan.”
An immediate annuity can be set up with a lump-sum deposit to start receiving income immediately. Or, you can pay premiums either monthly or annually for a deferred, which will begin paying you at a later date. You stop paying premiums once you start drawing income.
Some contracts can be set-up for as low as $5,000. However, the more money you put into your fixed annuity the higher your monthly income. According to Charles Schwab’s fixed-annuity calculator, a 65-year old man can earn $1,252 per month for the rest his life if he buys a $250,000 fixed-immediate annuity. A 55-year old who plans to retire in 10 or more years will need to make a contribution of approximately $1,800 per month to a deferred income annuity to generate the same guaranteed lifetime income.
Annuities don’t have the greatest reputation. Annuity issuers can charge high fees and commissions. You lose control of the money once you have paid a lump sum. You will be charged a surrender fee if you decide to change your mind or tap the funds before the money disappears completely. This charge is usually about 7% of the withdrawal amount. Annuities are complex and expensive. It is important to do your research and get impartial advice from a financial advisor who does not have any interest in selling you one.
Fixed annuities can be simpler than variable and indexed annuities. They are generally cheaper, have a predictable return, and are usually less expensive. Fixed annuities are also versatile and can be used for more than just generating reliable retirement income. Wiener states that today’s annuities are more user-friendly and multipurpose than they were in years past.
Annuities can be used to help people manage their money, pay long-term care costs, or simplify estate planning. Fixed annuities can be used for specific purposes, such as to donate to charity. Others can be used to reduce the minimum distributions required from traditional retirement savings accounts.
The Bucket Strategy to Manage Your Annuities
Fixed annuities don’t fluctuate with stock markets so retirees know exactly how much they can live on. This is especially important for early retirement, when many people want to spend more simply because they can.
You could use a bucket strategy to allocate funds for short-term, medium-term and long-term expenses in order to stay within your budget. If you are just retiring, you could set up one contract to begin payments immediately, another for five years when your spouse will retire, and a third for 10 years if you anticipate higher health care costs. While you’ll get some money now, the deferred annuities will continue growing and offer higher payments in the future.
You can try a bond market hedge
You don’t have to choose lifetime payments. Annuity payments can be structured for a specific number of years. This opens up more options, especially when it comes to investing. Annuities can be a great option to bonds and certificates of deposit as a short-term investment. Michael Foguth is the founder of Foguth Financial Group, Brighton, Mich.
CDs and bank accounts currently pay almost nothing. Bonds may be more attractive, but they are also more susceptible to interest rate rises and bonds prices falling. Foguth asked a client, who had 20-year bonds: “Do you think rates are going to go up sometime in next 20 years?” It was a rhetorical question. Foguth said to his client, “Of course they’ll, and when they do these bonds will get hammered.”
Interest rates can rise and holders of long-term bonds may choose to keep them at a lower rate than the market or sell them for more interest. Foguth believes fixed annuities offer a better deal. They pay more than CDs or the bank, but they don’t carry the risk of a rising bond interest rate. You’ll still be earning the same income, and your deposit will be returned by the end. Foguth recommends that you set up an immediate fixed annuity, which will pay out over a period of two to three years. This way, your money will be able to return to you if interest rates rise.
Transfer wealth to your heirs
An annuity allows you to pass wealth on to others. This can be done in a variety of ways. An annuity that includes a death benefit transfers the contract’s remaining value to a beneficiary as a lump sum, or in a series of monthly payments. A joint life annuity policy is also possible. This is most common with a spouse. However, you can choose any person, even your child. You receive the payments first, and your survivor will continue to receive them.
These inheritance strategies can reduce your monthly income from an annuity. If the annuity is only paid for her lifetime, for example, a 75 year old woman will get $1,960 per monthly if she buys a fixed-rate annuity worth $300,000. She can set up a $300,000.00 life annuity that will pay $1,538 each month. If she dies, her heirs will receive the remainder. One-month payments of $1,142 are available for a joint life contract she has with her 50-year old son.
John Williams, regional sales director for individual annuities at The Standard (an annuity provider), says that annuities offer two benefits when it comes to transferring wealth. The first is that annuities can be used to rein in a spending heir. An adult child’s mother may be concerned about their spending habits and set up an annuity death benefit that is paid over time. It could pay 10 years of regular payments instead of a lump sum. It also spreads the tax burden of inheritance for your heirs. They only pay income tax when they receive the annuity payments. The annuity is exempted from probate, so the named beneficiary inherits it immediately. However, the value of the contract at the death of the annuitant still counts as part the estate and is subject estate taxes.
Do not delay taking your Social Security benefits
Wiener recommends purchasing a fixed annuity to pay your bills. This will allow you to delay applying for benefits if you have not yet started taking Social Security. You can begin receiving Social Security benefits at age 62. However, your monthly benefit will increase each year that you wait until you reach 70.
This can make a significant difference. Social Security provides an example: A $708 per month benefit at age 60 for someone who begins taking it at age 65 becomes $1,013 at the age of 67 and $1.253 at 70. These higher benefits can last you your whole life. They also continue for a spouse with a lower income, who could possibly swap your smaller benefit for your bigger one.
This method of using an annuity has its downsides. Wiener says that if you die before you reach retirement age, you won’t have any Social Security funds left to give to your spouse. You’re able to spend assets that could have been passed on to your heirs in exchange for a higher benefit. This strategy works best for those in good health and who desire a steady income.
Purchase Long-Term Care Coverage
An annuity that includes a long-term-care rider can be purchased to help you cover long term care costs. Your care is covered by a portion of the funds, with any money left over going to your heirs. Martin Powell, head annuity distribution at CUNA Mutual, said that long-term care payments are exempt from tax under the Pension Protection Act. He also added, “This includes any investment gains from annuities themselves.”
An additional advantage is the ease of underwriting annuities that include long-term care coverage. Powell says that although people may not be eligible for standalone insurance policies, they may still qualify for an annuity with long-term care coverage.
Powell recommends that you have a long-term care policy if you are healthy and want to get more coverage. The premiums can be covered by regular annuity payments. He says that pure long-term insurance usually has a greater benefit.
Apply for Medicaid Faster
To be eligible for Medicaid, you will need to liquidate most of your assets. However, this can leave your spouse without enough to live on. While requirements will vary from one state to the next, you need to reduce your assets to $2,000 (with some exceptions for your personal residence or one vehicle).
An annuity that is Medicaid-compliant allows you to keep more of your savings. This pays income for you and your spouse for life, and doesn’t count towards the Medicaid asset test. It will allow you to qualify quicker. The annuity must be Medicaid-compliant. It must begin immediately and the state must be named as the beneficiary. Any remaining payments are paid to the state after you and your spouse have died.
Donate money to charity
A charitable gift annuity allows you to make a substantial donation to charity and still generate some income for retirement. A donor who wishes to donate $250,000 to charity can buy a charitable gift thenuity instead of writing a check. An annuity provides lifetime payments to the donor as well as one beneficiary (e.g. a spouse) with the money going first to the donor.
A partial deduct is also available to the donor for contributions exceeding $250,000 in the year of the annuity’s creation. The IRS does not allow for a deduction of any portion because it considers the remainder an investment that will generate future income. Annuity providers calculate the total deduction based upon the age of the donor, the beneficiary and the expected amount of annuity payments. The charity will receive the remainder of the annuity value after the beneficiary and donor die.
Foguth can see a few situations where this strategy is appropriate. He says that clients might consider this if they have a higher taxable year than usual, such as when their business is sold or bought out. A charitable gift annuity is a way to offset these significant tax impacts. He says that this strategy can be used by some people to give to charity or minimize estate taxes. The money used to fund the charitable gift annuity does not count towards the taxable estate.
He warns you that once the charitable gift annuity is purchased, it will be irreversible. The income payments are also smaller than an ordinary fixed annuity. Foguth states that the strategy is intended for large donations. This is not something you’d see with donations of $5,000 or $10,000. This is more common for large donations of five- to six-figures.
If you have the resources and desire to help a charity, it is an effective way to go. Foguth says that in addition to making the initial donation through the purchase of a charitable gift annuity they can also double down on their income by donating any income from the contract.
Reduce your RMDs
It may seem like a waste to use your retirement savings in an IRA, 401(k), or 401(k) in order to purchase an annuity. Williams says that there is a misconception that this should be avoided. One, taxes on annuity gains are delayed until money is taken out. However, you already have this advantage in an IRA and 401(k). Another reason is that money taken from a retirement account from an annuity, or any other investments, is treated the same as regular income.
A fixed annuity within a retirement account will not reduce required minimal distributions. These RMDs must be taken even if you are 72 or 70 1/2 years old before 2020. The amount is based on your account’s total worth, including the annuity. This obligation can be met by both collecting fixed annuity payment and cashing out other investments. Some insurers will waive surrender fees if you tap the money earlier than the RMD-satisfying annuity payments.
You can transfer a portion of your retirement account balance to a qualified life insurance contract if you’re concerned about RMDs requiring you to take taxable withdrawals that you don’t need. You can delay the age 85 date by transferring the amount into the deferred income annuity. The RMD formula no longer considers the transfer. Your RMDs can be reduced now, while you create future lifetime income.
There are other benefits to using retirement funds for annuity purchases. You don’t need to withdraw taxable funds to purchase an annuity. Instead, your taxable gains can be deferred until you receive the annuity payment.
No matter how you use an annuity in any way, it is important to shop around. There are many annuity companies that offer different rates and benefits. This is especially true for large purchases over a lifetime.