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 Annuities
Good or bad?
This is a question I get very often and the answer is simple. Both!
Like Fire... used properly you can Rule the world, used improperly
it will burn your house down.
Annuities are very controversial because they can be used as a very
powerful tool to avoid many of the pitfalls of the traps laid in
front of many.
CAUTION!
There are MANY
different types of annuities!
Many are in my opinion, Inappropriate for most seniors!
That being said I believe that properly selected annuities are
ESSENTIAL to many senior citizens!
Annuities
An annuity is an investment vehicle sold primarily by insurance
companies. Every annuity has two basic properties: whether the
payout is immediate or deferred, and whether the investment type is
fixed or variable. An annuity with immediate payout begins payments
to the investor immediately, whereas the deferred payout means that
the investor will receive payments at a later date. An annuity with
a fixed investment type offer a guaranteed return on investment by
investing in government bonds and other low-risk securities, whereas
a variable investment type means that the return on the annuity
investment will depend on performance of the funds (called
sub-accounts) where the money is invested. Based on these two
properties with two possibilities each, there are four possible
combinations, but the ones commonly seen in practice are an annuity
with immediate payout and fixed investments (often known as a fixed
annuity), and an annuity with deferred payout and variable
investments
(usually called a variable annuity). This article discusses fixed
annuities briefly and variable annuities at some length, and
includes a list of sources for additional information about
annuities.
Fixed Annuities
The idea of a fixed annuity is that you give a sum of money to an
insurance company, and in exchange they promise to pay you a fixed
monthly amount for a certain period of time, either a fixed period
or for your lifetime (the concept of 'annuitization'). So
essentially you are converting a lump sum into an income stream.
Whether you choose period-certain or annuitization, the payment does
not change, even to account for inflation.
If a fixed-period is chosen (also called a period-certain
annuity), the annuity continues to pay until that period is reached,
either to the original investor or to the investor's estate or
heirs. Alternatively, if the investor chooses to annuitize, then
payments continue for a variable period; namely until the investor's
death. For an investor who annuitized, the insurance company pays
nothing further after the investor's death to the estate or heirs
(neither principal nor monthly payments), no matter how many (or how
few) monthly payments you received.
Fixed annuities allow you some access to your investment; for
example, you can choose to withdraw interest or (depending on the
company etc.) up to 10% of the principal annually. An annuity may
also have various hardship clauses that allow you to withdraw the
investment with no surrender charge in certain situations (read the
fine print). When considering a fixed annuity, compare the annuity
with a ladder of high-grade bonds that allow you to keep your
principal with minimal restrictions on accessing your money.
Annuitization can work well for a long-lived retiree. In fact, a
fixed annuity can be thought of as a kind of reverse life insurance
policy. Of course a life insurance contract offers protection
against premature death, whereas the annuity contract offers
protection for someone who fears out-living a lump sum that they
have accumulated. So when considering annuities, you might want to
remember one of the original needs that annuities were created to
address, namely to offer protection against longevity.
Another situation in which a fixed annuity might have advantages
is if you wish to generate monthly income and are extremely worried
about someone being able to steal your capital away from you (or
steal someone's capital away from them). If this is the case, for
whatever reason, then giving the capital to an insurance company for
management might be attractive. Of course a decent trust and trustee
could probably do as well.
Variable Annuities
A variable annuity is essentially an insurance contract joined at
the hip with an investment product. Annuities function as
tax-deferred savings vehicles with insurance-like properties; they
use an insurance policy to provide the tax deferral. The insurance
contract and investment product combine to offer the following
features:
- Tax deferral on earnings.
- Ability to name beneficiaries to receive the balance remaining
in the account on death.
- "Annuitization"--that is, the ability to receive payments for
life based on your life expectancy.
- The guarantees provided in the insurance component.
A variable annuity invests in stocks or bonds, has no
predetermined rate of return, and offers a possibly higher rate of
return when compared to a fixed annuity. The remainder of this
article focuses on variable annuities.
A variable annuity is an investment vehicle designed for
retirement savings. You may think of it as a wrapper around an
underlying investment, typically in a very restricted set of mutual
funds. The main selling point of a variable annuity is that the
underlying investments grow tax-deferred, as in an IRA. This means
that any gains (appreciation, interest, etc.) from the annuity are
not taxed until money is withdrawn. The other main selling point is
that when you retire, you can choose to have the annuity pay you an
income ("annuitization"), based on how well the underlying
investment performed, for as long as you live. The insurance portion
of the annuity also may provide certain investment guarantees, such
as guaranteeing that the full principal (amount originally
contributed to the account) will be paid out on the death of the
account holder, even if the market value was low at that time.
Unlike a conventional IRA, the money you put into an annuity is
not deductible from your taxes. And also unlike an IRA, you may put
as much money into an annuity as you wish.
A variable annuity is especially attractive to a person who makes
lots of money and is trying, perhaps late in the game, to save
aggressively for retirement. Most experts agree that young people
should fully fund IRA plans and any company 401(k) plans before
turning to variable annuities.
Should you buy an annuity?
The basic question to be answered by someone considering this
investment is whether the cost of the insurance coverage is
justified for the benefits that are paid. In general, the answer to
that question is one that only a specific individual can answer
based on his or her specific circumstances. Either a 'yes' or 'no'
answer is possible, and there may be much support for either
position. People who oppose use of annuities will point out that it
is unlikely (less than 50% probability) that the insurance
guarantees will pay off, so that the guarantees are expected to
reduce the overall return. People who favor use of annuities tend to
suggest that not buying the guarantees is always an irresponsible
step because the purchaser increases risk. Both positions can be
supported. But the key issue is whether the purchaser is making an
informed decision on the matter.
Variable annuities are extremely profitable for the companies
that sell them (which accounts for their popularity among sales
people), but are a terrible choice for most people. Most people are
much better off in an equity index fund. Index funds are extremely
tax efficient and provide, overall, a much more favorable tax
situation than an annuity.
Annuities often invest in funds that are difficult to analyze
because independent reports such as Morningstar are not available.
However, you may find insurance companies that use portfolios for
which Morningstar reports are available, which will help with
analysis of their annuity contracts.
Annuities offer the choice of a guaranteed income for life. If
you choose to annuitize your contract (meaning take the guaranteed
income for life), two things happen. One is that you sacrifice your
principal. When you die you leave zero to your heirs. If you want to
take cash out for any reason, you can't. It isn't yours anymore.
In exchange for giving all your money to the insurance company,
they promise to pay you a certain amount (either fixed or tied to
investment performance) for as long as you live.
Equity Indexed Annuities
This is a combination of both Fixed annuities (guarantee minimum
income) and to a degree Variable Annuities (participation in gain of
a specific index (although not 100%))
Equity Indexed annuities are a difficult product and you should have
a competent professional help you to understand these
Financial/Estate Planner-
This is what I Do for a Living.
What does this mean?
I help people plan their estates so that it is
beneficial to them.
I live in California (1 in 8 Americans live in California)
Some people find this hard to believe but our governments need
money.
Those who don't plan properly are paying WAY more than their "Fair"
share.
My Credentials
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Explore my site and learn my perspective-
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This site is a personal site for information and not for advise-
You should seek the advise of a professional individually and not
make any decisions based on this personal web site.
*note* I am not an attorney and none of this can be
construes as legal advise. consult proper legal council |
