Thursday, Oct. 18, 2018

Unsure If a “Guaranteed” Income Annuity is Right For You?

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September 15, 2018

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Unsure If a “Guaranteed” Income Annuity is Right For You?

Recently, several financial institutions started marketing an annuity targeted for retirees which “guarantees” a certain level of income paid periodically to the recipient of the annuity.

Take a look at the factors you should consider before deciding on a Guaranteed Income Annuity.

What is a Guaranteed Income Annuity?

A guaranteed income annuity is an insurance contract in which the annuity provider agrees to make minimum regular payments to you in exchange for a lump sum initial payment or a series of payments made by you. The annuity is considered to be a hybrid product with certain characteristics of a variable annuity (exposure to the market) and also fixed annuity features (guaranteed minimum income levels).

How Long it Lasts?

You can elect to receive payments for life (Lifetime Annuities) or a predefined time period (Term Certainty Annuities; usually 1-25 years).

When You Receive Payments

You can elect to receive payments monthly, quarterly, half-year, or yearly.

Fees

The annuity provider often charges a sales commission % (~5-10%) for the transaction in addition to the annual administrative fee (~1.5%). For instance, before you invest the $ 100,000 in an annuity product, you may be charged a sales commission of $ 10,000 and after the 1st year a administrative fee of $ 1,350. In addition, most annuities have a clause that if you sell or withdraw from an annuity 6 to 8 years after the initial purchase was made, you will face a surrender fee of ~7%.

Tax Implications

Investor makes premium payments using AFTER-TAX Dollars
Tax-free Appreciation on the Principal until you make a withdrawal that is taxed at ordinary income levels (~10%-35%, dependent on your tax bracket)
You may transfer your funds from one investment option to another without bearing any taxes
Early Withdrawal Penalty – Usually if the investor withdraws the principal amount prior to the age of 59 1/2, the investor will be burdened with an additional 10% penalty tax to the ordinary tax (~10-35%) you already owe on the amount withdrawn.

Primary Benefit vs. Other Variable/Fixed Income Annuities
These types of annuities can be invested in the Market while guaranteeing a minimum amount of retirement income (limits downside risk).

Primary Drawback vs. Other Variable/Fixed Income Annuities
These types of annuities usually cost more since there is a guaranteed income component.

Some Questions to Ask Yourself when Considering this Type of Annuity

Is the annuity provider a financially stable company with steady cashflow?

If not, you probably want to consider using another provider because this will no longer be considered a safe investment.

Do I know how the annuity works and all of the terms associated with the contract?

Make sure you read and understand the contract. The financial advisor providing the contract may explain the product to you over the phone but it is very important that you read and understand all of the fineprint associated with the contract.

What is the Fee Structure?

Worst-case scenario, you want to know what will be leftover if the market plunges and for how long you are guaranteed that income.

How long is the surrender period and what will I be charged if I withdraw during this period?

As previously noted, you can be penalized for withdrawing during the surrender period (typically 6-8 yrs).

Does the guaranteed income step-up only during a rising market or also during a falling market?

If there is no step-up income provision during a falling market then essentially there is no guaranteed income level.

A Fixed Annuity is Another Potential Option
A fixed annuity pays a set interest rate during the accumulation period and a predetermined amount during the annuitization period.

Key Features

1) Steady stream of cash flow
2) Similar to CDs (Certificate of Deposit) but offer a higher premium
3) Similar to Bonds but principal value doesn’t fluctuate
4) Susceptible to inflation unless a clause is applied to the annuity that protects that investor from the inflation

Ryan S. Himmel is the founder of the newly launched website, BIDaWIZ, the online marketplace for trusted answers from licensed business professionals (i.e. CPAs, CFAs, CFPs & More).

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