Annuities are a popular investment for anyone who is interested in creating income streams which can grow in a tax deferred account. Annuities provide a depth of investment and retirement income solutions for all investors. Purchasing an annuity can deliver important investment benefits to the investor, including predictable investment growth and deferred taxes. An annuity is a contract that is purchased between an investor and an insurance company.
Annuities can be used to defer tax obligations on the growth of the account overtime. In addition with annuities, the investor would also be able to determine his level of risk and his potential level of growth and risk. Annuities are also used for creating income streams benefits either immediately or at a later date.
Regardless of an investor would like an immediate income or deferred income stream, an annuity presents several immediate advantages. Various annuities exist to provide a mix of unique characteristics that may be appealing to different investors, including the ability to choose the level of risk, specific deferred tax benefits, and predictable income streams.
Annuities can provide the investor the option of placing money in a place where they guarantee receiving tax free growth every year or until the funds in the annuity account are withdrawn. In addition, annuities are flexible savings instruments as they can be purchased with either pre-tax or after-tax funds. Of course, the tax obligation would have to be paid at later date, but which may beneficially place the investor in a lower tax-bracket altogether. Careful retirement planning could allow the investor to reduce his or her tax burden and further grow money in a tax free account – all at his discretion.
There are several types of annuities to choose from that all have specific benefits for the investor. A “fixed” annuity, for example, can provide an investor the ability to deposit his money in an account that steadily grows at, say 3% a year. The growth may not be as dramatic as other funds, but this allows the investor to safely plan his or her income, despite what the market may be doing now or in the future.
In addition, variable annuities can provide investors with incredible flexibility to invest in any number of mutual funds within one annuity. The investor can give weight to each mutual fund or fixed fund in accordance with his or her own aversion to risk. So for example, if an investor would like to invest in higher risk international funds but maintain a balance in his annuity, he may also be able to invest in “fixed” funds in the same annuity. Variable annuities also provide and allow for a beneficiary to be named in the account. A beneficiary would be able to claim unpaid purchased on the account before the money is withdrawn, in case of the investor’s death. Index funds, on the other hand, allow the investor to tie his annuities growth to that of the market’s level of growth.
Single Premium Immediate annuities provide predictable income streams for investors during their retirement years. They are often a favorite of savvy investors because they guarantee a predictable periodic payout. Often referred to as SPIA annuity, it is contract made between an investor and an insurance contract for future payouts that are predictable and able to grow tax free.
As the term “single” determines, this is type of annuity is bought during a one-time and upfront payment to an insurance company, in which case they will turn around and begin paying the investor a predetermined amount every month or in a period that is determined. The SPIA annuity can provide for an income for the rest of the investor’s life by using pre-calculated tables that determine your life expectancy and the rate at which you want to receive during the year. Like other annuities, the growth in these funds are tax-deferred and are calculated using an exclusion ratio. The investor, for example, would not pay taxes on the initial payment into made into his investment. He or she would only be pay taxes on the growth.
There are many versions of single premium annuities for the investor who is acting based on his financial goals. A fairly popular version is the fixed payment single premium annuity. The type of account provides a fixed monthly (or a period of time previously agreed upon) for the investor, paid out by the annuity. There are also several other types of investments that can be made through single premium annuities – that are not “immediate” annuities. The single premium annuity can either be immediate or deferred. Both types of annuities can be placed in a variable or indexed fund. The growth or performance on those annuities would be strictly pegged to the performance of the funds that they are invested in.
SPIAs, like other annuities, are beneficial because they make retirement income more easily to predict. They can also be adjusted to reflect inflationary upswings throughout the life of the annuity. They can be affected tax deferred accounts that can grow with inflation. One characteristic of the SPIA is that most contracts don’t allow for a beneficiary to be designated. Therefore, if the person purchasing the SPIA were to die in the middle of his distribution phase, he would not be able to pass on the future payment to a spouse of a loved one.
In addition, like other annuities, the SPIA investments are not backed by the FDIC. It is always important for the investor to be updated on the health of the institution, usually an insurance company, that will be making the payments. Many states have insurance groups that help provide a safety net for investors. In order to maintain a healthy industry, other insurance companies have set a precedent to buy up the contracts of a company who may no longer solvent. Regardless, reading the prospectus, quarterly reports, statements, and annual prospectus can help keep an investor grounded. If the investor determines that the company in question may not be as healthy or is not offering the service an investor would want, the investor can often switch annuity companies and incur not tax charge – but might incur a charge. Nevertheless, SPIAs provide a stable, steady, and predictable income streams for either a predetermined amount of time.
Annuities have earned a stable reputation as solid savings vehicle for seasoned investors who are looking for a safe place to put their money. As a whole, annuities provide two main benefits: they offer predictable levels of investment growth and they defer any taxes on that growth until a withdrawal is made at a later date, at which point the investor would pay taxes only on that growth and not the principal, if the purchases were made with after tax dollars.
Annuities can also provide a level of control that other investments are not able to. For example, with variable annuities, the investor is able to place his or her funds into several mutual funds that may be appealing based on his or her own aversion to risk and investments needs. For example, an investor can place 30% of his funds in a fixed mutual fund, which would grow 3-4% annually. He may also place a percentage of his funds in an index fund, which would generally grow at the market level. The overall performance of the annuity would be based on the cumulative performance of each of these funds based on the percentage that is given to them.
As mentioned, there are several types of annuities, including fixed rate, variable, and indexed. These annuities each have key features which provide the investor some unique opportunities to grow his or her investment and defer taxes based on the individual financial need. For example, a younger investor may be less concerned about the market risk, and invest in a variable annuity which may offer a higher risk and higher growth mutual fund. The higher growth and higher risk would leverage the investor’s young age to increase his investments overtime. On the other hand, a more senior investor in his late 50’s may not be able be a little more cautious and averse to risk. In this case, he might consider putting his money in a solid and predictable fixed fund. An index funds would be tied to the performance of the market place.
There may be a few “cons” for investments in annuities that should be considered. Annuities are not as “liquid” as money placed in certificates of deposit accounts or money placed in similar money market accounts. Once the Annuities are purchased they need to stay in that annuity or a similar account (if a transfer is made) and remain there until the owner is at least 59.5 years of age. If an early withdraw is necessary, a 10% penalty would be required.
In addition, annuities are not backed up by the FDIC like other traditional banking instruments, such as checking or savings accounts. Nevertheless annuities, remain a solid choice among investors as individual states have created annuity groups to help the individual investor should a company become insolvent. In addition, to maintain industry health, other insurance companies would also step in to buy the insolvent company’s contract – though at a much lower rate. It is wise for the investor to stay involved with his investments by reading the prospectus and quarterly statements the insurance company delivers. Annuities provide a stable, steady, and predictable income streams for either a predetermined amount of time. Purchasing an annuity can therefore deliver an immediate or delayed check, whichever is most beneficial for the investor at the time.
As the life expectancy of retirees continues to expand, annuities are playing an increasingly important role in retirement planning. Historically, retirement planning has emphasized the accumulation of assets as the strategic objective of the retirement plan. More recently, as more retirees find themselves reaching retirement with inadequate assets, the emphasis has shifted to finding ways to convert assets into an income source that cannot be outlived. A sound retirement plan should have elements of both strategies to ensure a secure and comfortable retirement.
In planning for the accumulation and distribution of retirement assets, several factors need to be considered in order to arrive at an effective and enduring retirement solution. The factors and assumptions used in the initial planning stage, must be reviewed regularly in order to make the necessary adjustments to the plan as circumstances change.
Retirement Planning Essentials
Set Realistic and Definable Goals
Without a specific target, it is impossible to know where to aim. Accumulating retirement funds without a well-defined income goal is like shooting in the dark. The goal needs to be quantified so that the right amount of savings can be applied, and, so the progress towards the goal can be measured. A retirement income goal should take into account life style needs, increased medical expenses, and inflation.
Know Your Risks
For most people, achieving a secure retirement is their most important goal. As such, many people are reluctant to assume a lot of risk when it comes to investing their retirement funds. While it is true that investing funds in the stock or bond market presents the risk of loss, inflation presents an equally great risk in terms of the loss of purchasing power of a long period of time. A well-balanced, diversified retirement portfolio, invested over time, will mitigate both risks.
Create a Diversified and Balance Investment Portfolio
No matter your retirement time horizon, the only way to ensure that your assets grow sufficiently to provide an adequate retirement income, is to keep them diversified and balanced among different asset classes in order to reduce risk and increase stability.
Some combination of growth investments, income investments and ultra-safe fixed yield investments are needed to create long term stability. The closer you are to retirement, the balance can be shifted to emphasize income and ultra-safe investments; however, it is important to have a portion of your assets in growth investments to combat inflation.
Using Annuities as Your Income Foundation
A sound retirement portfolio will consist of several different asset classes and types of investment vehicles. And, while the right mix can produce solid, stable returns over time, investors should consider building a retirement income foundation which, even if sufficient returns aren’t achieved, will produce the base income needed to ensure a comfortable retirement.
The unique characteristics of annuities provide investors with an opportunity to add stability and predictability to their retirement portfolios. The added guarantees and safety that annuities bring to the mix comes without having to sacrifice investment returns, because they offer the same rates of return found in bank CDs, and other equivalent investments.
Here are some of the ways annuities form a solid foundation for your retirement income:
For investors in the higher tax brackets, tax advantages are the key to accumulating assets more quickly and maximizing income at retirement. The earnings in annuity accounts are not currently taxed, which can increase the rate at which your funds will grow. While, the earnings are taxed as ordinary income as they withdrawn, the tax can be deferred even longer when the annuity is annuitized, or converted to income. At that point, only a portion of your income payment is taxed because it includes a return of your principle which is not taxed.
Annuities come in many flavors which means you are able to maintain a proper mix of investments while building your retirement foundation. Fixed annuities provide a guaranteed return with absolute safety. Variable annuities enable you to allocate your funds for diversification and balance for the potential of stable, higher returns. And indexed annuities offer the opportunity to participate in gains of the market without risking your principle.
All annuities offer the guarantee of a secure income that cannot be outlived. A fixed annuity will generate a fixed income, while a variable annuity can generate an income that will increase when the markets rise. Conversely, the income will decrease when the market declines. Some variable annuities offer a minimum income guarantee (at an additional cost) which will mitigate that risk. The income from an indexed annuity is tied to the rise and fall of a stock index, but, it too has a minimum income guarantee.
The Complete Retirement Plan
Investors have several tools available to them to create a complete retirement plan. Certainly, everyone should take advantage of the qualified retirement plans that offer current tax savings, diversified investment portfolios and tax deferred growth of earnings. A well-balanced investment portfolio will form the core of your retirement assets that you will need for long term growth. At some point, when you have been able to maximize your qualified plan contributions, you should consider building the income foundation using annuities. In doing so, you will not have to sacrifice investment returns, and you will increase the stability and predictability of your future retirement income. More importantly, this foundation will ultimately generate a guaranteed income that you cannot outlive.
Anytime people invest or save their money it is exposed to some type of risk that could adversely affect its future value. It doesn’t matter whether it is put into the stock market or a savings account, your money can come under assault if you are not aware of the different types of risk. While no single savings or investment vehicle is completely invulnerable, some do provide greater protection against the various forms of risk than others. Here we explore the use of annuities to mitigate all risk.
Different Types of Risk
When people think of risk they tend to think of market risk which is the possibility that they would receive back less than what they put in. The most obvious place in which you can lose money is the stock market, or, for that matter, any market in which prices fluctuate, such as the real estate market, the bond market or the precious metals market. Each of these have inherent in them varying degrees of risk. And within each market, there are different segments with varying degrees of risk associated with them.
The one mitigating factor that makes market risk less risky than people think, is that, in order to actually realize a loss, the investment has to be sold. Just because the value of an investment declines, doesn’t mean you will incur a loss. If it is held, there is always the possibility that the price will recover and even increase to where there is a gain.
The Risk of Inflation
Over the long term, inflation can pose an even greater risk than the possibility of market losses. The prices of stocks and real estate have always trended up, so, if investors can endure the natural market cycles, the chances are their investment will increase in value over time. If, however, you are investing your money to avoid market risk by putting into low yielding fixed vehicles such as savings accounts, your money is almost guaranteed to lose value due to inflation.
The Risk of Taxation
Taxes are a certainty, and they can contribute to slow and steady erosion of assets and income over time. For people in the higher tax brackets, a 10% gain on their investments is abruptly reduced to a 7% gain if it is subject to taxes. That difference of 3% over a long time horizon can translate into thousands of dollars lost. With the many tax advantages that are available to investors through the tax code, there is very little preventing them from minimizing the risk of taxation.
Some investments or savings vehicles are less liquid than others. Everyone should have a certain portion of their assets always available to them in the case of emergencies or should their financial objectives suddenly change. Before tying your money up into a five year CD, for example, it is important to know that you have access to other savings or investments for your current use. Although mutual funds and stock and bond investments are marketable, meaning they can be converted to cash quickly, investors who are holding any of these securities at a loss, may be reluctant to sell them, so there is some liquidity risk.
Reducing Risk with Annuities
The best way to reduce risk is to create a well-balanced, diversified portfolio of investments with a mix of assets that can offset the risks associated with a single type of investment. This will have the effect of stabilizing your returns so that they are not subject to the fluctuations of any one investment. As an example, stocks will help combat inflation, and bonds are needed to counter the movements of stocks. And, certain types of stocks perform well when other types don’t, so having both types in a portfolio will create more stability.
In addition to building a balance portfolio, investors might want to consider adding annuities as a foundation that can enhance stability and provide more guarantees of future growth, less taxation, and income security. So, when all heck is breaking lose in the rest of the portfolio, the annuities will continue to keep a portion of your assets moving forward.
How Annuities Reduce all types of Risk
Minimum Rate Guarantees
Most annuities include some sort of minimum rate guarantee so that, no matter the market conditions, your money will always grow. Even variable annuities, in which the accounts are invested in the stock and bond markets, include an option that will provide a minimum rate floor. Indexed annuities, in which the rate or return is linked to a stock index, not only have a minimum rate guarantee, the account values are reset each year to lock in the prior year’s gain. In essence, you can’t lose your principle.
Two types of annuities offer investors the opportunity to earn returns that can outpace inflation. Variable annuities invest in stocks, bonds and real estate. Indexed annuities generate returns based on the performance of the stock indexes. Most immediate annuities, annuities that generate a guaranteed income, include an option that ties the income payment to an inflation index.
The earnings generated inside annuity accounts are not taxed until they are withdrawn at retirement. And, if the annuity accounts are then converted into a guaranteed income stream, the taxes are deferred even further until the earnings are received over time in income payments.
Annuities should be purchased as long term investments, however, they do allow for access to the account values at any time. One withdrawal can be made from annuity accounts each year, and, as long as it doesn’t exceed 10% of the account value, there is no charge. Any withdrawal can result in the reduction of principle. Also, early withdrawals may be subject to a 10% IRS penalty.
A sound investment strategy should account for the many different types of risk. Allocating assets for optimum balance and diversification is the best way to achieve long term, stable growth. For added stability and a measure of security, annuities can form the ideal foundation for a long term investment portfolio.