Are Annuities For You?

Not everyone has heard of annuities, but for those of you who are less risk tolerant they may well be a good way to guarantee an income for the future.An annuity is an investment that pays a regular income. They are usually used during retirement when a salary is no longer received. The benefit (monthly pay out) of the annuity is made up of the original amount you invested plus interest and any other investment income earned on the capital.In most jurisdictions you will buy an annuity from an insurance company or licensed insurance broker. You can usually put an annuity into a tax-sheltered plan if you want.The greatest benefit of an annuity is that in many cases the income is guaranteed. The second best benefit is that it is automatically paid out to you monthly (or yearly) so you don’t even have to think about it. Another benefit is that because it is an insurance product it is protected from creditors, so long as a beneficiary has been named. Also, when a beneficiary has been named it moves directly to that person and is not subject to probate fees.An annuity can either be immediate (where income starts flowing back to you within a year) or deferred (where income flows back to you after – sometimes much after – one year). Self-employed people who are concerned about creditor problems in the future sometimes use the deferred annuity. However it cannot be used to hide assets during the heat of a bankruptcy. Usually the courts will look at financial transactions that took place during the last a year or two before the bankruptcy. If this is a concern to you, consult a lawyer competent in bankruptcy laws in your area.Volume 2 Number 8Not all annuities have a fixed benefit that is guaranteed by the insurer. There is also an annuity called the variable annuity, which has a varying benefit. A variable annuity usually invests in common stocks and the pay out is based on stock market performance. In theory, this type of annuity should give back a greater income than the fixed benefit annuity, but it is also riskier. With most annuities you can make early withdrawals or cash them in. There will be some fees associated with taking extra cash out so keep this in mind. There may also be a market value adjustment (MVA), which is a rather large penalty for early surrender (total cash out). However this is a good disincentive and a reason to keep your annuity intact. One of the benefits of buying an annuity in the first place is that it puts away that large lump of cash you have and pays it back to you in small amounts with earnings. For most people, if they have large amounts of cash lying around they are tempted to spend it on every temptation that comes along and sooner or later it is all gone. That’s why people who win or inherit a large amount of money have usually spent it all and invested none within 5 years. It’s sad but true.Here are some types of annuities: Term certain annuity - it provides income to a specific age or time period. It can be bought with a single lump sum or a series of premiums over time.Life annuity – it makes income payments for your entire lifetime. However because it is funded from a pool, you cannot convert this to a lump sum payment out. Once the payments begin you are locked in to receiving them for the rest of your life.The life annuity has a number of variations:Life straight annuity: pays out until you die and then stops.Life annuity with guaranteed number of
payments: pays out until you die, however if you die before the guaranteed number of payments has been paid out to you then the remaining benefits will be paid to your named beneficiary. Installment refund annuity: guarantees a set number of income payments equal to the purchase price, if you die before the payments equal the purchase price then your beneficiary gets the remainder.Cash refund annuity: guarantees income for life. If you die before receiving payments equal to the purchase price then the amount outstanding is paid to your beneficiary.Joint & last survivor annuity: provides a guaranteed income during the course of two peoples lives. On the death of one the entire income is paid to the survivor for the remainder of their life. It’s typically used by spouses but can be purchased by any two persons.The disadvantage of annuities are that they don’t pay out as much as you might get if you had simply invested the amount in exchange traded funds (ETF) and managed them properly. However ETF’s carry stock market fluctuation risk and are only suitable for those tolerant to those risks.An example of using an annuity in financial planning:Fred is 70 years old and has $1.4 million in savings. He is not very risk tolerant and has it all invested in guaranteed investments that are only paying 3.5%. His wife Wilma has already died and he has only one daughter to whom he would like to leave a substantial estate. Fred currently earns $49,000 in interest from his investment and pays 38% tax for a net income of $30,380.Fred’s financial planner suggests he invests $1 million in a life annuity and buy a $1 million term-to-100 life insurance policy naming his daughter as beneficiary. By doing this Fred’s income from the annuity will be $70,000 less the tax on the taxable portion (interest part only) of $11,400 for a net income of $58,600. He will also need to pay $25,000 per year in insurance premiums and he also has a net income (after taxes) of $8680 from his other $400,000 still in guaranteed investments. In total this means that his net income is now $42,280 (almost $12,000 higher than previous income) and his daughter will receive $1 million tax free (insurance proceeds are tax free in most jurisdictions), which is $300,000 more than she would have received if she had simply inherited the money because of the tax implications. For more information on annuities contact your local life insurance broker and have them to find the best solution for you. If you decide to approach a life insurance company directly then be sure to shop around with at least 4 other insurers as prices and benefits may vary considerably.

Scrooge