How to have an income you cannot outlive.
Written by: Donald M. Goldberg, JD, CLU, ChFC
2/3/2012
“It is better to have a permanent income than to be fascinating”
Oscar Wilde …..
These days, retirees are searching for income. They want it to provide a
good yield, be low risk and certain in its payments. And, oh yes, tax
free would be nice, too!
The problem is that fewer and fewer products meet these criteria. With
interest rates in the economy at historic lows, the usual suspects, like
CDs, Treasury bonds and Munis lack the yield needed to support most
people’s living expenses.
But there is a stalwart product that has been dusted off and suddenly
seems to come closer to the criteria that baby boomers and others are seeking than many other products.
What we are describing is an Immediate Annuity or a newer product, a Deferred Annuity with an
Income Rider. Historically annuities were high commission and had high surrender charges, but there are
some new modern ones with lower costs and AEPG only recommends no-load when available.
Immediate Annuities for a steady stream of income
An Immediate Annuity is a contract between the insurance company and the annuitant (you) from which
the annuitant will receive a steady monthly income for life in exchange for a sum of money invested
upfront. The factors that determine the payout are the age of the annuitant, the features of the contract
and the underlying interest rate to be credited.
The older a person is the higher the payout will be, since actuarially speaking, the annuitant has fewer
expected years to live.
The features commonly considered are:
Joint Life Payout – when one or both spouses are living, this continues the payment through both
lifetimes.
Cash Refund – some form of return of principal to the beneficiary if the annuitant dies before having
received back at least as much in monthly payments as originally invested.
Cost of Living – some providers allow the monthly payments to increase over time to offset the
effects of inflation.
Liquidity – a few carriers allow the annuitant to get the net investment back upon a change in mind.
Tax-Free Portion: Regardless of the benefits, any feature that adds something of value to the annuity
will either require a larger premium (investment upfront) or will result in a lower payment, but one
benefit has no cost, and that is the Annuity Exclusion factor. This applies to any Immediate Annuity not
owned by an IRA or other Qualified Plan. It simply means that part of each payment received is
considered to be a return of principal and therefore tax-free. (Once all the principal has been returned, all
future payments become totally taxable.)
While Immediate Annuities provide an income that cannot be out lived, they are essentially non liquid
products. Low interest rates have a negative impact on the rate of payment received, but this can be
mitigated somewhat by buying the fixed income needed over a period of years, like laddering a Treasury
Bond portfolio, thereby benefiting from higher interest rates that may occur in the future.
Deferred Annuities with Income Riders provide additional flexibility
The other product that has become more popular in the last
decade is a Deferred Annuity with an Income Rider. This is a
complex product and while a detailed description of how it works
is beyond the scope of this article, we can discuss in detail in
person. But the essential benefit is that a premium can be paid to
an insurance company today and it can be known, on a
guaranteed basis, what the minimum lifetime benefit amount will
be in the future. This provides a greater degree of flexibility than
a traditional Immediate Annuity in that if goals change, one
doesn’t have to annuitize the account value, but can take their
cash account instead. Although complex in nature, we have the
expertise to analyze and compare these products for you.
While inherently more flexible than an Immediate Annuity, these products can have higher fees and
longer surrender charges. One must be careful with annuities – the big print givith and the small print
taketh away --- the contractual provisions need to be scrutinized. Consequently, there are many products
of this type that we would not recommend and we strongly suggest you discuss this with us first if you
are considering the purchase of one of these products.
At AEPG we are always looking for what financial products best meet our clients’ goals. An annuity
product, such as those mentioned above, could play a part in meeting these goals. As part of our
customized wealth management service, we project how long a client’s funds will hold up under varying
assumptions and scenarios. We use sophisticated software to project the probability of success of a
client’s money holding up to age 90 or 100. What we have seen, is that for some by taking part of a
client’s investment assets and either purchasing an Immediate Annuity now or a Deferred Annuity with
an Income Rider for use in the future, is that the probability of success increases. In other words, from a
quantitative perspective, we can increase the chance that a client’s funds will survive as long as the client.
From a qualitative perspective, clients often feel more at ease knowing that regardless of market
fluctuations, a certain percentage of their expenses will be met from a guaranteed annuity payment.
Should clients outlive their liquid funds, consider under which scenario they would be better off:
A. Client runs out of money and is left with just Social Security to live on.
B. Client runs out of money and is left with Social Security and an annuity to live on.
If you would like to find out how an annuity might improve the probability of success of your retirement
plan, be sure to contact your financial planner at AEPG. If you don’t have one, contact Don Goldberg at
908-821-9781 or 908-757-5600 x781 or [email protected] and he will quickly return your request for
more information.