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A Publication of WTVP

Will you have enough income to fund a retirement of 20 years, 30 years… or more?

Building a steady stream of retirement income is a top priority for many Americans, especially those nearing their anticipated retirement date. With lifespans extending into the 80s, 90s and even 100s, there is even more reason for investors to ensure they’ll have a source of income that lasts a long time.

One way to help meet that need may be an annuity. An annuity is a contract between you and an insurance company designed to help meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning right away (an immediate annuity) or at some future date (a deferred annuity).

While there are many different types of annuities, there are a number of commonalities:

Whether an annuity is right for you may depend on how much you anticipate receiving from traditional sources of retirement income, such as Social Security, a 401(k) or an employer pension. You have a choice of annuities:

Fixed Annuities
As its name suggests, fixed annuities typically present a guaranteed interest rate that is locked in for an initial period (typically one to 15 years) and may be adjusted thereafter, often annually. With a fixed annuity, you have no control over the investments—the issuing insurance company decides how to invest your assets, primarily in government securities and high-grade corporate bonds. There are two basic types of fixed annuities:

Earnings accumulate tax-deferred and are not taxable until they are withdrawn, when they are taxed as ordinary income. Withdrawal options may include a lump sum or a lifetime stream of income.

Variable Annuities
This type of annuity, in contrast, generates investment returns that fluctuate depending on how the underlying subaccounts are invested. Generally, you can make an investment selection that may include stocks, bonds, cash subaccounts or some combination of these. Available choices range from conservative—such as money market, guaranteed fixed accounts and government bond funds—to more aggressive—such as small cap, mid cap, large cap, capital appreciation, aggressive growth and emerging market investments. As with many investments, the value—and payout—of a variable annuity will change depending on the performance of the subaccounts you choose. Withdrawals are taxed as ordinary income.

In addition to offering a stream of income that cannot be outlived, many variable annuity products have “living benefits,” optional features available for an added fee that can help protect your principal investment from market declines and/or provide a minimum future income. There are three basic types:

Living benefits are increasingly evolving into new hybrid benefit options, as insurance companies seek ways to differentiate their offerings in the marketplace. This environment of expanding flexibility and functionality is helping to redefine variable and fixed annuities for a new generation of retirement investors.

Equity-Indexed Annuities
EIAs have characteristics of both fixed and variable annuities. They frequently offer a guaranteed minimum interest rate combined with an interest rate linked to the performance of a market index. At a minimum, the guaranteed minimum is 87.5 percent of the premium paid at a one- to three-percent annual interest rate, but rates can fluctuate based on the issuing insurance company. The index-based return is tied to an index, such as the S&P 500.

The index-linked interest rate may be computed in a variety of ways. Some annuities present a participation rate (for example, 80 percent) that determines how much of the index’s gain is credited to the annuity. There may also be an interest-rate cap on how much an EIA can earn. For example, if an index linked to an annuity gained eight percent and the cap rate was six percent, then the gain would be six percent. There are also a variety of indexing methods used to calculate the index-based return.

The Pros and Cons of Annuities
One reason annuities are attractive is they can help build more value over time. Money is accumulated in an annuity through contributions and investment earnings. By providing potential growth that is tax-deferred, an annuity’s investment earnings can accumulate and compound untouched by federal, state or local income taxes until you begin making withdrawals, which is usually after retirement.

In addition to tax advantages, annuities offer a choice of investment options, including fixed accounts, which may help protect principal from market risk, and variable investment accounts in stock and bond portfolios, which offer the potential for higher returns. Together, these features may make annuities attractive to those who seek investments that can help supplement future retirement benefits, and to retirees who want greater control over their income and the flexibility to continue deferring taxes on investment earnings.

While annuities certainly have some advantages, there are also a number of concerns, including:

Balance Costs and Benefits

An annuity can be an excellent retirement investment vehicle if you are able to forgo use of the money for several years. Annuities also offer unlimited contributions (subject to insurance company limitations), protection of principal in fixed accounts and/or with living benefit riders, and the potential to earn higher rates of return on your investments in variable accounts. But annuities may also entail higher fees and expenses than some other investment vehicles, in part due to the insurance feature annuities provide. Consult your financial advisor to determine if an annuity is right for you. iBi

Cathy S. Butler, CFP, CRPC is a financial advisor with the Butler/Luthy Group of Morgan Stanley. For more information, visit morganstanleyfa.com/thebutlerluthygroup.

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