Annuities: Safe & Secure

A secure retirement is a dream of everyone who worked hard for years.  Yet after two brutal bear markets (2001-2002 and 2008-2009) retirement plan investors in 401(k) plans saw much of their lifetime retirement savings get walloped.

After the chaotic stock market of the past few years, capital preservation and sleeping well at night have trumped most other things. For investors dependent on interest payments for income, especially those near or in retirement, the current environment is challenging, to say the least.

The bottom line is that today’s retirees face greater challenges than ever, with diminishing sources of income, longevity risk and volatile markets that have eaten away much of their retirement portfolio.

Low yields mean low income, which has investors concerned about risk as they try to figure out how to augment their investment earnings without taking too big a gamble.

This doesn’t resonate if someone is trying to live off the investment income of a certain amount of principal. At 2007 rates, for example, you would have needed $1 million in government bonds to generate an income of $50,000 a year. Today, you’d need nearly twice that much.

It is often tempting to risk it all for the promise of a high return on your investment but you must remember that with great reward comes great risk and most of the time your security is simply not worth that particular risk.

You just can’t count on companies as we’ve seen big-name firms run into serious trouble in the last several years, including some big-name companies that were established nearly a century ago (Bear Stearns, Lehman Brothers, Enron, Worldcom) wind up defunct.

If you decide to delve into the realm of stock market investment you should be aware that every transaction costs money, that you need to thoroughly research the ins and outs of this type of investing, and that you are taking a substantial risk with your retirement investment.

History provides many lessons for all of us. There remains a need for retirement products that address volatility and attempt to generate consistent, absolute returns.  The idea of income planning, unlike other financial-planning concepts, is natural and comforting to many Boomers approaching retirement.

Perhaps they have gotten used to receiving two paychecks a month for 40 years or more. Remember the peace of mind that a steady income gave you during those years. Why would you want to give that up when you retire?

No amount of accumulated assets can replace the comfort created by a steady and guaranteed income for life, particularly an income that has built-in inflation hedges.

401(k) legislation was passed and rules crafted in the late 1970’s/early 1980’s. This 401(k) legislation was rooted in the belief that permitting investors to have more input on numerous aspects of their retirement savings was a good thing. 

These aspects included segregating each individual retirement account, offering the choice to save (defer) or not to save, ranges of deferral amounts, the ability to modify those deferral amounts, investment election choices, portability, loans and much more.  There were, however, no guarantees.

The “guarantee” was resurrected for retirement plan savers in the form of annuities. Unlike Bear Stearns and Lehman Brothers, the insurance industry has its own “insurance” in the event that one of the companies runs into financial difficulties and defaults.

Policyholders can rely on the insurance guarantee funds of the various states, to the extent that they are available. While this is not the same as a Federal guarantee, no state life insurance fund has ever let one of its members renege on its claims. The state funds typically get other stronger insurers to takeover the failed companies’ policies.

With CD rates at all-time lows, ultra-conservative investors are looking to annuity plans as a place to secure a higher return on their retirement nest egg.  Annuities that have guaranteed income benefits attached to them are appropriate for a large portion of the population. Additionally, the Fixed Indexed Annuity product has solved the market volatility problem.

What Does Standard & Poor’s 500 Index – S&P 500 Mean?

The S&P 500 is one of the most commonly used benchmarks for the overall U.S. stock market. An index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.

Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor’s. The S&P 500 is a market value weighted index – each stock’s weight is proportionate to its market value.

An indexed annuity pays out a rate of return on your money that’s tied to an economic index, such as the S&P 500. It’s considered a hybrid of the fixed and variable types because you receive a minimum guaranteed payment, but can also enjoy a higher return when there are gains in the broader market.

In a study conducted at Wharton School by authors Marrion, Babbel and VanDerPal’s, Real World Index Annuity Returns, shows that, based on data from 15 Fixed Indexed Annuities issuers, Indexed annuities outperformed conventional investments during much of the past 10 years —a  period when the S&P500’s cumulative return has been roughly zero.

The five-year annualized returns for indexed annuities, from 1997 through 2007, averaged 5.79%, compared to 5.39% for taxable bond funds and 4.73% for fixed annuities. From April 1995 through 2009, indexed annuities beat the S&P 500 over 67% of the time and a 50/50 mix of one-year Treasury Bills and the S&P 500 79% of the time.

Starting in 1997 through 2004, during eight five year periods, their data shows, the indexed annuities they looked at, offered an average annualized return of 4.19% to 9.19%, with no negative years. By contrast, an investor in the S&P500 would have seen four positive five-year periods and four negative ones.    

The question is how do Fixed Indexed Annuities maintain such an apparently even keel? In a bad equity markets, their substantial bond component offers downside protection. In rising equity markets, their equity option component increases in value.

Investors in Fixed Indexed Annuities therefore don’t need to fear the bears and aren’t as slavishly dependent on the bulls. Or, as the authors put it:  “By eliminating the prejudicial effects occasioned by significant stock market declines, and locking in returns annually or biannually, there is less of a need to try and capture large upside market swings to recover from the declines.”

Besides insulating investors from volatility, the-authors say, Fixed Indexed Annuities do, contrary to certain media reports, offer liquidity (penalty-free withdrawals of at least 10% a year) as well as tax-deferred compound growth.

The usual definition of safe money is money you cannot afford to lose. AnnuityNews.net defines a safe money place as one where your principal is protected from loss as long as you follow the initial guidelines, and if you do decide to take your money and leave, you know pretty much what leaving early will cost.

The opposite is a risk money place where if you decide to take your money you don’t know what you will get back. It could be more than you put in – risk money places offer the potential for much higher returns than safe money places – but it could also be less than you started with or even zero. 

Knowing how to make money, knowing what to do with money once you have it, knowing how to keep people from taking your money away from you, knowing how to keep your money for the long term, and knowing how to make your money work for you- is of vital importance in the quest to achieving financial freedom.

Annuities Stop “Silver Tsunami”

Juan was driving down a country lane in his pickup when suddenly a chicken darted into the road in front of him. He slammed on his brakes, but realized that the chicken was speeding off down the road at about 30 miles an hour.

Intrigued, he tried to follow the bird with his truck, but he couldn’t catch up to the accelerating chicken. Seeing it turn into a small farm, Juan followed it.

To his astonishment, he realized that the chicken had three legs. Looking around the small farm, he noticed that ALL of the chickens had three legs.

The farmer came out of his house, and Juan said, “Three-legged chickens? That’s astonishing!”

The farmer replied, “Yep. I bred ‘em that way because I love drumsticks.”

Juan was curious. “How does a three-legged chicken taste?”

The farmer smiled. “Dunno. Haven’t been able to catch one yet!”

Renewed economic uncertainty is testing our generation-long love affair with the stock market.  With over 33.12 billion dollars withdrawn from the domestic stock market in the first seven months of this year, reminds me of the three legged chicken, you can’t catch it.

U.S. households lost trillions of dollars in the first few quarters of the economic and financial crisis of 2007, 2008, and 2009. Total wealth relative to after-tax income had fallen to its lowest level since March 1995.

This sharp drop likely had a severe effect on the retirement income security of millions of U.S. households.  Small investors have lost their appetite for risk.  Now many have stopped chasing the three legged chicken and are choosing investments that they deem safer, such as Annuities.

The last few years have altered American’s sense of financial security and the notion that stocks tend to be safe and profitable investments over time seems to have been dented in much the same way that the decline in home values and in job stability has occured.

Surveys and studies regularly report how unprepared U.S. adults are for retirement. The statistics are particularly bad (and sad) for baby boomers, with a majority typically admitting that they do not have enough money left after the decline in the market to retire.

Retirement is suppose to provide freedom from the routine bounded job, but at the same time, it also introduces the fear for the future as regular income stops coming.

Adding to those fears is the third leg of the chicken, a “Silver Tsunami” is gaining force. This is tempered by another worrying problem: The Medical advances in this country is an amazing success story in that people are now living longer, many into their high 90’s.  This is called, longevity risk, or the chance that a retiree will outlive his or her savings.

Just imagine that when you are 80 years old, in reasonably good health, and you have just spent your last penny of retirement savings. You have no other sources of income. For the rest of your life, you will rely on government handouts and the charity of others.

Trying to finance your retirement with the present market risks and with the probability of a decade of a continuing underperforming market will provide less-than-anticipated retirement income for many retirees. The New York Life and Wharton Business School collaborated on a study to find the most effective way to maximize retirement income. The determination was made that fixed annuities that convert to a lifetime stream of income proved to be one of the best ways to do that. 

Annuities are considered conservative, providing the ironclad guarantees and are the perfect investment for anyone who is interested in finding a low risk investment; particularly those who have just retired and are looking for a way to protect their retirement fund from the volatility of the market. 

Annuities will provide a steady stream of income with very little risk. In addition to receiving a steady income for life, you can count on receiving allowances for withdrawal without penalties, death benefits, and probate insurance.

Compared to stock market investments, an annuity portfolio provides you with a special peace of mind, in that, unlike the stock market, you don’t have to worry about which way the market is moving. You don’t have to know when to cash in for a gain, nor do you have to know when to sell and cut your losses.

An annuity portfolio bears:

·         No administrative fees,

·         No annual maintenance fees,

·         No upkeep expenses,

·         No buy or sell expenses,

·         No personal management of assets,

·         No people on retainers to manage assets,

·         No real estate taxes,

·         No repairs,

·         No zoning commissioner or city council to contend with,

·         No storms,

·         No droughts and

·         No public liabilities

The recession is a wake-up call for many Americans and their response is an appropriate one. By preparing for and navigating an economic downturn with smart planning, they are more likely to take the actions needed to achieve financial security no matter where they are starting from.  As Baby boomers approach retirement they are shifting away from stocks and mutual funds to annuities to provide regular guaranteed income for the years when they are no longer working.

Survey of Owners of Annuities

U.S. households lost trillions of dollars in the first few quarters of the economic and financial crisis of 2007, 2008, and 2009. Total wealth relative to after-tax income had fallen to its lowest level since March 1995 by the end of 2008.

The recession is a wake-up call for many Americans and their response is an appropriate one.  By preparing for and navigating an economic downturn with smart planning, they are more likely to take the actions needed to achieve financial security no matter where they are starting from.”

Annuities are considered conservative, providing the ironclad guarantees and are the perfect investment for anyone who is interested in finding a low risk investment; particularly those who have just retired and are looking for a way to protect their retirement fund from the volatility of the market. 

2009 Gallup Survey of Owners of Non-Qualified Annuities

The Committee of Annuity Insurers has partnered with The Gallup Organization and Mathew Greenwald & Associates to conduct 10 comprehensive surveys of non-qualified annuity owners between 1992 and 2009.

The surveys create a unique profile of non-qualified annuity owners and their attitudes toward saving for retirement. The 2009 survey, conducted among 1003 annuity owners across the country, found that non-qualified annuities contribute greatly to the retirement security of middle-class Americans.

Annuity Owners Are Overwhelmingly Middle-Class

• Eight out of 10 non-qualified annuity owners (80%) have annual household incomes below $100,000, and only 4% have annual incomes greater than $200,000.
• In fact, almost half (42%) have annual household incomes below $50,000.
• Majority of Annuity Owners Are Women
• Non-qualified annuity owners are more likely to be female (58%) than male (42%). With the exception of the 2001 survey, females have outnumbered males in every survey since 1997.
• The average owner is retired, 70 years old, a woman, and has a moderate income.
• Annuity Owners Are an Older and Loyal Group
• Almost all non-qualified annuity owners (93%) report that they still own their first annuity.
• Seven in 10 (69%) are retired, which is up from 58% in 2005. 
• The average age of annuity owners increased in 2009 to 70, compared to 66 in 2005.
• Annuity Owners View Themselves as Financially Prepared for Retirement
• While many Americans believe that they are not financially prepared for retirement, 91% of non-qualified annuity owners say that the statement “you have done a very good job of saving for retirement” describes them well.
• In that regard, almost 3 in 4 (73%) say that they have set aside more money for retirement than they would have if the tax advantages of annuities were not available. Almost 9 in 10 (88%) say that keeping those advantages is a good way of encouraging long-term savings, and more than 9 in 10 (91%) say that the prospect of paying tax on money withdrawn from their annuities makes them try not to do so before they retire. The latter suggests that the current tax rules successfully encourage them to retain their savings until needed in retirement.

A Safe and Secure Way to Save for Retirement

• Despite the recent market turmoil, which led to a decline in consumer confidence about preparedness for retirement, almost 8 in 10 annuity owners (79%) say that annuities are secure and safe, an important source of retirement security, and make them feel more secure in times of financial uncertainty.
• The vast majority of annuity owners say that annuities are an effective way to save for retirement (86%) and that their annuity was a safe purchase (89%).
• More than 3 in 4 (76%) say that they intend to use their annuities for retirement income. Other intended uses include a financial cushion in case they or their spouses live well beyond their life expectancy (83%) or to avoid being a financial burden on their children (81%).
• Almost 9 in 10 (85%) agree that investment and insurance guarantees available in annuities are a very important benefit of the product.
• Gallup and Greenwald indicated that they are confident that the survey results represent the characteristics of non-qualified annuity owners with a sampling error of plus or minus three percentage points at the 95% confidence level.

SOURCE Committee of Annuity Insurers

 Retirement and old age might seem a long way off for a lot of people, but the choices you make now will almost certainly have an effect in the years to come.

People think of ideal retirement as a combination of leisure activities, financial independence and luxury vacations – all these things are possible only if you have enough money when you retire.

Life really is what you make it, it doesn’t just happen. Basically, it is never too late if someone wants to improve their situation. Yet if you prepare beforehand you save yourself a lot of anxiety and stress.”

Annuity Nuts and Bolts

You have been saving for retirement for many years and have amassed a nice nest egg of savings. Now is the time to determine the products and services that best fit your retirement needs. First of all, you need to realize that the most important part of your retirement planning is your investing.

You may have one set of products that you use during the “accumulation phase” of planning the saving and investing during your working years; and another during your actual retirement years, where the emphasis will be on wisely utilizing your nest egg.

People use stocks and mutual funds during the”accumulation phase.”  A stock is a share in the ownership of a company. For the company, a stock is a fundraising loan that they needn’t repay, but will typically yield greater income for both the company and its shareholders in the end. As an owner, you are entitled to your share of the company’s wealth.

A mutual fund is a lower-risk investment. Investors pool their money and allow professionals to select stocks for them. While stocks may generate a larger return, mutual funds are better for retirement planning because of their low risk and maintenance. 

A word of caution though, Mutual Funds can also possess much more risk than you thought you were encountering. So beware, stocks and mutual funds can be daunting since there’s always the risk that the company won’t be profitable and you’ll lose your investment. 

In the stock market, many investors will simply look at how a stock price of the company’s doing, and jump aboard only because the price is going up. There may be no profits at all behind that particular company (in fact there often aren’t) but they will still invest anyway, because their stock broker called them up and told them to.

Putting your retirement at risk doesn’t make sense to most retiree’s. What is your aversion to risk? Do you want to embrace investment risk, or do you seek to encounter as little risk as possible.  The high risk outweighs the high return to me.

But how does that nest egg translate to an income stream, and how much income can you take from your savings?

There have been dozens and dozens of studies and methodologies discussing sustainable withdrawal rates from retirement portfolios. Conventional industry wisdom considers a 4 percent withdrawal rate to be a “rule of thumb”.

However, where do you withdraw the 4 percent from? Should you take it from your 401(k), your Roth IRA, or your investment portfolio? Generally, you want to start taking withdrawals from your taxable accounts first, such as your investment portfolio.

Then start withdrawing from your tax-deferred accounts, such as your 401(k), and finally from your tax-free account, such as Roth IRAs. The thought process is that you want to allow your tax-advantaged accounts, like Roth IRAs and 401(k) s, to grow for as long possible. However, you must start taking required minimum distributions from your tax-deferred accounts when you turn 70½.

Some people prefer peace of mind and do not want to be disturbed by everyday fluctuation of the market or bothered by continuous management of one’s portfolio. For investors looking to diversify their retirement portfolio and provide a steady stream of income, annuities may offer a great choice. An annuity is one of the most popular options for investors who are approaching retirement by using an annuity to round out your retirement nest egg.

Converting to Annuity

Easy to understand and administer, this option of managing one’s retirement savings can provide a stable and guaranteed income for a specified period of time or for life. There is a fixed rate of interest associated with this. There are many annuity choices and plans available from which a retiree can make a selection.

Benefits 

For retirees looking for a steady income from a lump sum of money, an immediate annuity has several advantages over other alternatives. The monthly payment amount will usually be higher than other investments and guaranteed by the issuing insurance company. A large portion of the annuity payment will be exempt from income taxes, boosting the after-tax income compared with other investments.

Function 

An immediate annuity is usually purchased to provide a lifetime income to the annuitant. The annuity will pay a regular monthly or annual check until the annuitant dies, whether it is in a few months or after 40 years. Immediate annuities have options that will guarantee a minimum payout or payment for a minimum number of years if the annuitant dies early. Annuities will usually provide a higher level of income than CDs or bonds because the principal amount is paid to the insurance company and will not be returned. The annuity provides an income that cannot be outlived.

Significance  

The Internal Revenue Service considers immediate annuity payments a partial return of principal plus interest. The principal value is divided over the life expectancy of the annuitant at the time the annuity payments are started. For example, if the IRS life expectancy tables showed the annuitant had a 20-year life expectancy, the amount paid for the immediate annuity would be divided by 20 and that amount would be excluded from taxable income on the annuity payment. If the annuitant lives longer than the computed life expectancy, the annuity payments will become fully taxable.

Identification

The insurance company that quotes an immediate annuity will show the monthly or annual payment for the amount of annuity purchased and an exclusion percentage or amount. The exclusion percentage is the portion of each annuity payment excluded from income taxes. Subtracting the exclusion amount from the annual payment will provide the amount of taxable income from the immediate annuity.

An annuity makes regular payments to an insured individual in exchange for either regular contributions over time (a deferred annuity) or one lump sum of money (a deferred or immediate annuity). Annuity income is taxable.

Tax on Withdrawals

You are taxed at ordinary income tax rates when making withdrawals from your deferred annuity. Additionally, withdrawals are considered to be a withdrawal of interest earnings and are fully taxable. Principle is withdrawn after interest earnings have been depleted.

Exclusion Ratio

Immediate annuities are subject to an exclusion ratio. An exclusion ratio means that part of the annuity payment is considered to be principal, while part of the annuity payment is interest earnings. The principal payment is not subject to taxation but the interest earnings are. The excluded amount depends entirely on your age and the interest rate the insurance company is paying on the annuity.

Considerations

You will be taxed on 100 percent of your withdrawals in a deferred annuity, but you will have access to all of your savings in the annuity account. With an immediate annuity, you do not have access to your savings. Instead, you receive the exclusion ratio and steady payments from the insurance company.

Tax-qualified money is from retirement plans and IRAs. If qualified money is used to purchase an immediate annuity, the tax rules for those types of plans will apply. A non-qualified immediate annuity is purchased with money from other sources such as savings or investments. The immediate annuity purchased with non-qualified money pays a tax-advantaged regular income.

Reasons for using an immediate annuity

There are some upsides to any product. Ultimately, the question is whether these could sufficiently outweigh the downsides in your situation.

a) Security and stability

That annuity income is secure, stable and must provide an income until the day that you die is a major advantage. The immediate annuity is regarded as low-risk to no-risk.

b) Tax treatment

The income that you receive as an immediate annuity payout is either not subject to tax or enjoys favorable tax treatment. However, this is not a major benefit if you consider that the funds used to invest in the annuity are taxed already.

c) Creditor protection

The annuity also provides a safe haven from the lien of creditors. Annuity payouts are not normally under consideration when you file for bankruptcy or have debt obligations.

d) Qualification for State benefits

That you exchange a lump sum for reduced payments means that you’re giving up capital for income. The nature of this exchange means that for state benefits (such as Medicaid) that have a financial threshold for qualification, the lump sum allocated to an immediate annuity cannot be considered as part of your estate. This can also be used as an estate planning tool- but consultation with an estate planner is required.

The main point is to find out how much money you will need when you retire, and find the right investment vehicle for you to help get you there. Of course, this vehicle will be different for everybody depending on their retirement needs; however, annuities are a great retirement tool.