Income For Life –Best Annuities for Seniors Retirement

best annuities for seniorsAnnuities are one of the most confounding and controversial products in the “investments” world. I put investments in quotation marks, since annuities are actually life insurance products, and not strictly investments.

Annuity contracts

are typically purchased for retirement funding, and by definition offer an income for life feature. When annuitized, annuity contracts can offer monthly income, with the payment generally a function of age, interest rates, accumulation value, and life expectancy.

Accumulation value

is another word for the account or cash value, and grows based on interest rates in a fixed annuity, and based on mutual fund-like investments in variable annuities. The death benefit – available in most deferred annuities before they are converted to lifetime income by annuitization – is often the same as the accumulation value, or the total invested, whichever is greater. Often you are guaranteed to get no less than you invested if you die.

Surrender charges

are usually imposed in the early years of an annuity contract’s life as way to reimburse insurance companies for commission costs. Many annuities are distributed by financial advisors paid on a commission basis. Consumers should carefully consider an annuity offered to determine costs and benefits before deciding to buy an annuity.

Type of annuity: immediate or deferred.

There are two basic distinctions when looking at annuities. The first is between deferred and immediate annuities. With immediate annuities, the monthly payments begin immediately, and often all access to principal is forever lost.

One basically trades their money for a lifetime stream of payments like a pension. Deferred annuities are basically accumulation vehicles, and intended to grow as retirement accounts to be converted to lifetime income at some point in the future.

Type of annuity: fixed or variable.

The other distinction is in how the accumulation value is invested. Fixed annuities pay interest at a fixed rate, and variable annuities offer mutual-fund-like investments which offer the possibility of higher returns, but also higher risk.

Type of annuity: equity index.

Another sort is the so-called “equity index annuity.” These are really fixed annuities whose interest rate is a function of some risk-based index, like the S&P 500.

Because they are fixed, equity index products are not overseen by securities regulators, which some critics have suggested reduces consumer disclosure and may promote misleading and abusive sales practices.

Also because they are fixed (see What are the types of fees associated with annuities? below) it is difficult to find the true costs in these products.

These often include high – sometimes very high – surrender charges, limitations on what you can make due to participation rates and index caps, as well as other costs such as market value adjustments (MVAs), and guarantees which are for less than what you might invest.

Tax treatment.

For annuities that are not in IRAs or other types of retirement plans, any growth occurs tax deferred. Ultimately the tax must be paid, however, and tax rate and method can often be much more expensive compared to other types of investments, since ordinary income rates (your highest bracket) instead of capital gains rates apply. There is also a pre-59 ½ 10% excise tax, and capital gains taxes are not waived at death as is the case for most other investments.

Longevity Annuities

are special products designed to insure against the risk of running out of money if you live longer than expected, and into advanced old age. With these, you pay a premium to an insurance company, in return for lifetime payments that start later in life, sometimes as late as 85.

Many have tax advantages related to avoiding normal required minimum distribution rules. The basic tradeoff is if you die younger, you lose the benefit of the capital tied up in premium, but if you live long and exhaust your other assets, the longevity annuity payments keep your lifestyle going.

What are Annuities?

Annuities are life insurance contracts designed to exchange premium payments for lifetime income. The conversion to lifetime income – called annuitization – is usually irreversible, meaning you can’t get your principal back.

Annuity Company Reviews

and annuity company ratings are very important. Unlike government bond or FDIC insurance, the guarantee to pay is only as good as the strength and integrity of the life insurance company.

Frequently Asked Questions about Annuities

include questions about commissions, costs, features, surrender charges, and investment options, and others explored here.

Tips for a Wise Buyer

include doing your homework on total costs and penalties, and understanding commissions costs which can be hard to smoke out.

What Is An Annuity?

A special kind of life insurance contract designed to pay lifetime income. At their simplest, these are basically pension-type products where you irreversibly trade a lump sum for guaranteed lifetime payments. Note the guarantee is only as good as the company, there is no FDIC insurance.

Who Should Invest In An Annuity?

People looking for guaranteed lifetime income similar to pensions or Social Security, which themselves are actually forms of annuities.

Annuity Types

include fixed, variable, equity index, deferred, and immediate.

Annuities and Income Taxes

Annuities grow tax deferred until withdrawals begin. If before 59 ½, a 10% excise tax is levied in addition to the ordinary income tax. After that, all gain is taxed before the initial investment is recovered tax free. This is called last-in-first-out or LIFO tax treatment.

If annuitized, part of each payment is taxable in proportion to the total profit over initial investment. This is called an exclusion ratio.

In many ways, annuities are taxed much more harshly than alternatives like stocks or mutual funds.

When to Invest In an Annuity

This is a highly subjective topic, depending on individual investor facts and goals. However, annuitizing during periods of low interest rates such as prevail in the early 21st century can run the risk of significant inflation erosion if rates later rise, since payments on most annuities won’t rise with inflation, and because the size of the payment itself is a function of the interest rate, just like a fixed mortgage payment.

For more on this, see When should I buy an annuity? below.

Additional Annuity Resources

Annuities can be extremely complex, and those considering purchasing them – or those who own them and wonder if they need a “rescue” strategy – are wise to deeply study and understand these products before making what could be expensive decisions.

For a very detailed plain language guide called “The Unvarnished Truth About Annuities” written by this author, click here.

I already have a 401(k) or an IRA so why should I consider an annuity?

The annuity decision is different from the tax-type of account used to hold it. While annuities have a number of tax characteristics that are similar to IRAs/401ks, which are basically redundant in these kinds of accounts, as mentioned above, their core function is to provide lifetime income.

The tax-deferral features of annuities often cost more tax in the end than other types of investments, particularly where capital gains treatment is possible (it never is for annuities or IRA-type accounts).

The decision to buy an annuity really boils down to whether it makes sense to exchange principal for lifetime payments, essentially giving up access to capital to buy a pension. This is a very complex decision which will be different for each investor.

What are the two phases of annuities?           

These are the accumulation and the annuitization phases.

During accumulation, the balance builds from cash deposits, plus interest or other forms of investment return, and minus fees, charges, and any commissions or surrender charges encountered.

During the payout or annuitization phase, the access to the accumulation account is given up, and payouts for life occur.

What is a surrender period?      

The surrender period is the term during which surrender charges may apply. This is kind of a “substantial penalty for early withdrawal” usually designed to reimburse the insurance company for the commission it paid an agent to “produce” the contract. Typically surrender periods last for years, and sometimes longer than a decade.

Surrender charges typically apply for years – sometimes many years – after policy delivery. Again, this is called the surrender period. Again, surrender charges generally reimburse the insurance company for commissions paid to agents who market these products by convincing consumers to buy the annuity. Often the percentage of the surrender charge – which is applied to the total of your deposits in the annuity – declines over a period of years as the insurance company is able to recover the commission cost by the internal charges, fees and other profit sources in the annuity product.

What are Surrender Charges?

These charges are often imposed by insurance companies on withdrawals which occur before the surrender period has elapsed. They are designed to reimburse the insurance company for costs associated with the new annuity business, chiefly sales commissions paid to agents.

Agents are often reluctant to disclose the compensation they receive on annuity sales, and some even deny that a purchaser pays a commission to the agent. This may be technically true, since the company pays the agent out of the buyer’s premium, but it can be very misleading, especially since the buyer is on the hook to pay any surrender charges if they change their mind and want to move the money.

An important rule of thumb to remember: the agent commission is often close to the first-year surrender charge. If that is 8% and a buyer puts $1,000,000 in an annuity, the commission would be estimated at $80,000. Since this money comes out of the buyer’s pocket, however indirectly, this is important to bear in mind.

What are the types of fees associated with annuities?      

Most fixed annuities don’t have declared charges, aside from surrender charges. The insurance company profits from the difference in interest it earns from investing the money you give it, and what it credits to your account. Besides surrender charges, identifying specific fees and costs can be difficult in fixed annuities, and especially in equity index annuities.

Variable annuities often disclose specific costs, like mortality charges – which are essentially life insurance charges, and can often seem excessive at around 1% when the only “insurance” is the return of your cash value as a death benefit instead of a withdrawal. Other charges can include policy fees, sub-account management and expense charges (“mutual fund” fees), and rider charges for additional insurance features. On the worst of these, we’ve seen total charges pushing 6% a year, that are often invisible to consumers because they can be so cumbersome to dig out of the many pages of disclosure.

What happens to my annuity when I die?

Annuities in the accumulation phase generally pay a death benefit related to the cash value. For annuities in the payout or annuitization phase, insurance companies generally make no death benefit payment after payees die, so if you die before receiving all of your money back plus a reasonable return, the insurance company keeps the difference. In fairness, some annuitants live longer than expected, and the insurance companies are obligated to pay for life, even if they lose money.

When should I buy an annuity?

This is an intensely personal decision, and should be based on lots of factors, including:

  1. What your total asset and retirement income situation looks like.
  2. Your age, health and life expectancy.
  3. Your spouse’s age, health and life expectancy.
  4. Your current and future tax profile.
  5. Current and expected interest rate and inflation expectations.
  6. Total costs and charges for given annuity products.
  7. Commissions, level of training, and fiduciary status of advisors recommending annuity purchase.

The decision to buy an annuity is complicated and can leave you “stuck” in a product that does not fit now, or may not in the future. Consumers are strongly advised to seek the opinion of an advisor with deep expertise and without a commission agenda. To get such an opinion from this author’s firm, click here.

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