Deferred Instead of Immediate Annuities
Last week I shared two big drawbacks of traditional immediate annuities that make them a poor choice for retirement income: 1. You can’t cancel and get a refund and 2. The insurance company often keeps whatever is left over from your original purchase amount when you die. A deferred annuity can avoid these shortcomings and be a better way of securing your retirement income.
Basics: Deferred annuities are often issued with a five to ten-year term. The insurance company typically will assess a “surrender charge” if withdrawals exceed 10% per year; however, these charges are commonly waived at death. Income taxation of interest and gains is deferred until withdrawals are made. Deferred annuities come in three varieties, each with distinct features as well as notable advantages and disadvantages:
Variable Annuities invest your money in “sub-accounts,” which are a lot like mutual funds. Advantage: Upside potential of stock and bond market investing. Disadvantages: 1. Downside risk of stock and bond market investing; 2. Limited number of investment choices; and 3. Fees can be hard to identify and can get costly if too many optional features are added.
Fixed-Rate Annuities are aptly named as they earn a fixed rate for a certain number of years or a rate that is declared quarterly by the insurance company. Advantage: Principal and interest are protected and are backed by the claims-paying ability of the insurance company. Disadvantages: 1. Interest rates can be higher or lower than CDs of similar term length (right now, the annuity rates are higher); 2. Earnings may not keep up with inflation.
Fixed Index Annuities work much like fixed-rate annuities, but with a twist on how interest is earned ... it is tied to the performance of a market index, like the S&P 500 Index, but funds are not invested in stocks, bonds, or mutual funds. Advantages: 1. Principal and interest are backed by the insurance company and 2. If stocks go up, interest can be higher than a fixed rate. Disadvantages: 1. Interest can fluctuate or can be zero if stocks decline; 2. Product complexity and fees vary widely by company.
Retirement income can be summoned through optional “income riders” with deferred annuities (there may be additional fees). A guarantee of lifetime income, without the immediate annuities’ shortcomings, is one of the reasons investors poured $214 billion into deferred annuities in 2013 (LIMRA SRI).
David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show at 9AM on AM1380 Ormond Beach, AM1230 New Smyrna Beach and AM1490 Deland. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.