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USING ANNUITIES TO PROVIDE INCOME The number one problem facing seniors today is the risk of outliving their money. Several factors affect the situation including longer life spans, lower interest rates and the terrible fact that too many seniors have lost too much money over the last few years due to the drop in the stock market. Many seniors still possess enough assets to insure a guaranteed lifetime income at levels which provide a decent standard of living – one which they can’t outlive. The solution is of course, the lifetime annuity. Additional information and comments on the lifetime guarantee annuity will appear later in this article. I am a huge advocate of the lifetime guarantee, but today seniors are also faced with another financial issue. – lower income from their investments. If we look at a CD rate a few years ago we find that a $100,000 CD might have generated an income of about $400 per month. The total amount of income would be taxable (assuming non-qualified funds). A 20% taxpayer would then net $320 per month after tax. That same $100,000 CD today may generate about $150 per month or $120 per month after taxes. The traditional CD investor is now looking for alternatives so he can increase income. If you listen to people who ask the tellers at your bank what the current CD rates are, you will hear the moans and groans complaining about how those low rates hurt their lifestyle. Using fixed annuities to generate income can be done in three basic methods. The decision on which method to use is based on the desire to retain the principal, the amount of income desired or the tax treatment on the income. But, the bottom line is that you can double or triple the client’s income by switching to a fixed annuity income method. Many investors and agents for that matter misunderstand the options that fixed annuities provide. I have previously written about the myths of Single Premium Immediate Annuities (see California Broker article April 2001 issue). Many seniors will not use the principal under any circumstances. “I am leaving this to my heirs.” This does not preclude the use of fixed annuities to generate income. Here are two ways to generate an income from a fixed annuity without losing the original principal. Use a deferred annuity with a systematic
withdrawal of interest. By using this method we are simply comparing the
annuity rate against the CD rate. In today’s (I wrote this in late
February) interest rate environment, fixed annuity rates on short term (5
years or less) guarantees are up to 2% higher than CD rates. A person with
a $100,000 CD would receive a monthly income of perhaps $235 per month,
while the annuity holder would get perhaps $395 per month. This is an
increase of almost 70%. How many fixed income CD investors would not
like to get a 70% raise? Use a split annuity. A split annuity
consists of 2 different annuities. One provides a guaranteed income for a
fixed term and the second annuity guarantees that at the end of the fixed
term the original principal will be fully restored. The primary advantage
to this approach is that the income would be received substantially tax free
(97% for 5 year fixed term, 85% for a 10 year term). For clients in higher
tax brackets, this method can produce a much higher after tax return. As of
this writing a 5-year split annuity can provide a monthly income of $365 per
month (97% tax free!) Where’s the catch you may ask? Well, the deferred
side has grown from $79,000 back to the original $100,000. This produces a
deferred gain of $21,000. At the end of the term the client may choose to
do another split. The tax free side will not be 97% anymore – it will be
closer to 80%. This is still better than paying tax on all the income.
Split annuities can have terms of 3 – 10 years although with this low
interest rate environment they don’t look good unless you go at least 5
years. It is also important to note that a split annuity can be created
using two different companies. One to provide the best multi-year guarantee
and the other to provide the best SPIA price (or benefit). Of course this
will be the same company at certain times. Lifetime payout Single Premium Immediate Annuity SPIA. This approach is all about peace of mind. Agents should offer the lifetime annuity with a money back guarantee (life with a refund). Clients respond quite well to the “money back guarantee” feature. Payments on lifetime annuities are also subject to a portion of each payment being received tax-free. The chart below gives some idea as to the portion of each payment, which is tax free (assumes male). Age Tax Free Portion - Excluded
60 53% 65 58% 70 62% 75 70% 80 75% 85 80%
Once the annuitant reaches the life expectancy, all future payments are fully taxable. Why? Because the entire original principal has been paid out. Future payments consist 100% of “earnings”. Had any other investment been used, payments would have stopped. Because the insurance company guarantees lifetime payments, those payments will continue till death. The SPIA provides an income stream, which can’t be outlived – definite concern of many seniors. The fixed income investors are looking for ways to safely increase their income. The fixed annuity is a great solution to their problem. Bob Affronti is President of AnnuityExperts.com. He is a 30 plus year industry veteran. A former National Annuity Director for a major insurer, Bob has been contributor to several insurance publications. You can reach him at 800-373-9697 or at www.mrspia.com. |
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