Annuities have gotten a bad name because of the high-pressure, "free-lunch" sales tactics many agents use to sell fixed indexed annuities linked to stock market gains. (Check my recent column on the subject.) But annuities do have some important uses in financial planning. Here are some basics.

Every annuity is a contract with an insurance company. These contracts are backed by the company itself and by state "guarantee funds" but not by the federal government. Those state guarantee funds are made up of contributions by other insurers doing business in the state.

It's important to deal with a highly rated insurance company.

Insurance products can offer some enticing yields because of the provision in federal tax law that says money growing inside an insurance contract can compound tax free. But don't let yield blind you to facts.

Immediate vs. deferred annuities

An immediate annuity lets you place a lump sum of money into the contract and immediately start getting a monthly or annual check, promised for the rest of your life (or your life and your spouse's life, which reduces the monthly amount). It's an irrevocable decision. You can't outlive this promised income, which gives you peace of mind. However, when you die (or you and your spouse die), the insurance company keeps the balance of the money -- unless you structure the payments so that any money left in the policy goes to the beneficiary, which reduces your monthly check.

There's one more problem with an immediate annuity: the impact of inflation on that fixed, guaranteed check. At only 3 percent annual inflation, the buying power of your money is cut in half in 25 years. A check that will nicely cover your expenses today could be just a pittance later in your retirement. That's why you shouldn't place all of your money into an immediate annuity.

To see how much money you could get on a monthly or annual basis from an immediate annuity, go to www.ImmediateAnnuities.com or www.SPIA.direct and fill in your age, gender and state of residence.

A deferred annuity is a contract that allows your money to grow tax deferred inside the annuity contract -- based on a promised interest rate, on your choice of investment sub-accounts or in a combination of the two (which is what a fixed indexed annuity promises). Each contract has restrictions on how and when you can withdraw money -- either by annuitizing (taking that lifetime payment promise) or simply withdrawing cash from the contract or some other formula. Those restrictions are the least understood and most challenging part of the deal.

The insurance company offsets the risk that you might want to get out of your contract early by assessing "surrender charges," which can be in effect for a decade or more. Those charges protect the insurer and help pay hefty commissions to sales agents.

A smart annuity move

If you have money outside your retirement account but want tax-deferred growth, you can purchase a short-term fixed rate annuity contract (multi-year guaranteed annuity, or MYGA) in terms ranging from three year to seven years or more. It's the insurance industry's version of a CD. The rate is higher than an FDIC-insured CD. Staggering maturities of these contracts (laddering) can ensure that if rates move higher, you'll earn more as each MYGA matures and is rolled into a new, higher-yielding contract. At some point in the future you can withdraw the money paying taxes on the earnings or even annuitize into a lifetime check.

To compare rates on these MYGAs, go to www.StantheAnnuityMan.com, where annuity guru Stan Haithcock has created an online database for current rates on short-term guaranteed annuities. Input your state and the term of the annuity to see what companies are offering. There's no sales pitch, because there's no big commission involved, so you have to do the work yourself.

All annuities carry a slightly higher risk because there's no federal guarantee. But you can get tax deferral, a higher return and also have liquidity -- if you understand annuities before you invest.

That's the Savage Truth.

Fixed Annuities are long term insurance contacts and there is a surrender charge imposed generally during the first 5 to 7 years that you own the annuity contract. Withdrawals prior to age 59-1/2 may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the financial strength of the underlying insurance company.

by Terry Savage | Apr 16, 2018

 

Author: Terry Savage

Source: Chicago Tribune

Retrieved from: www.chicagotribune.com

FINRA Compliance Reviewed by Red Oak: 487174