Can an annuity help your “untaxable wealth” plan?”

Our economy remains volatile. Annuities, along with specially-designed whole life insurance, can help you formulate a sound financial plan. Annuities may have a place in helping you grow and preserve your “untaxable wealth.”

As the global economy enters an exceptionally unpredictable and stressful phase, individuals across generations ponder their financial futures and seek safe havens for their money. This quest for growth with less exposure to market risk often leads pre-retirees and retirees to consider adding an annuity to their portfolios.

Working with clients to implement the Untaxable Wealth approach, I have noticed that even those twenty or more years away from retirement age have become more risk-averse. Many of these clients, especially those with inherited wealth, are now asking about the potential advantages of annuities. Although they are often younger, these individuals and business owners share the concern of outliving their money with their Boomer counterparts.

A survey conducted by Boston Research Group revealed troubling gaps in financial planning for retirement income. This finding highlights the need for having multiple income streams in retirement. Private pensions have dwindled to the point of non-existence. Qualified plans such as 401ks and IRAs can lose money when the stock market experiences an extended period of volatility. There is a real possibility that many Americans will lack the income needed to support themselves in the latter part of their lives. An annuity may make sense for specific individuals for these and other reasons.

What is an annuity, and how does it work?

In simple terms, annuities are contracts issued by insurance companies designed to give you predictable income and perhaps some growth over a specific period. With an annuity, you agree to either make a lump sum deposit or a series of payments to the annuity company. In return, the company gives you periodic payments for a specific time or life, depending on the type of annuity chosen.

There are two primary categories of annuities- deferred and immediate. As the name implies, a deferred annuity lets you make contributions through monthly installments or with a lump sum. The money in your annuity grows tax-deferred, enabling your account to compound without immediate taxation. You should, however, consult with your advisor to understand any potential tax implications in the future.

On the other hand, an immediate annuity typically starts paying benefits in the same year you deposit your cash. Payout amounts vary depending on age, gender, and the total amount invested.

What type of annuity works best?

Using a variety of structured payouts, certain kinds of annuities can help you create a safe, steady source of income that you can’t outlive. When you correctly use an annuity as part of your customized “Untaxable Wealth” plan, you could add protection and predictability to your portfolio. However, you should understand that not everyone needs an annuity. When clients come to me regarding this product, I help them clarify their reasons for wanting an annuity and determine whether it will help them achieve their financial goals.

What are the types of annuities and which one is best?

Some companies like to market annuity products that feature various whistles, bells, and options designed to convince consumers to choose that company’s offerings over those of another. Many options presented by annuity salespeople solve legitimate money issues. Other features touted are marketing devices that add to the perception of value but do little to improve your retirement plan. It’s crucial to understand the features of any annuity you’re considering and determine whether or the features it has to do anything to enhance your wealth.

Customization options aside, there are essentially three types of annuities:

Variable annuities. Variables offer investment customization, allowing buyers to allocate funds among multiple investment options. This feature lets the annuity purchaser choose how their account is invested from various options, including mutual funds. The returns on a variable annuity correlate to the performance of the selected investments, which exposes your money to risk. It is possible to lose money in a variable annuity, so I do not recommend them to my clients.

Fixed annuities. For a fixed annuity, the issuing company contracts with the purchaser to pay no less than an agreed-upon interest rate while the account grows, and the purchaser agrees to make periodic payments of specified amounts. These annuities may shield you from market ups and downs but could also have lower returns.

Fixed indexed annuities (FIAs)

A FIA is a hybrid type of annuity created to give investors market upside without exposure to the downside. FIAs link to specific market indices, such as the S&P 500. A fixed-indexed annuity guarantees a minimum contract value regardless of index performance. The type of annuity I prefer to work with is a fixed indexed annuity customized with guaranteed income riders. This kind of FIA addresses concerns about the erosion of wealth due to inflation and the need for predictable, guaranteed income in retirement.

Tax considerations

In some cases, an annuity can be helpful to those using an untaxable wealth approach to planning. However, it’s critical to understand that although annuities have some tax benefits, they are treated differently than life insurance by the IRS.

For example, gains and interest are not immediately taxed during an annuity’s accumulation phase. But, tax is triggered once distributions start. When you get your annuity payments, the portion attributable to earnings is taxed at ordinary income rates. The principle portion is not taxed. Also, early withdrawals from annuities differ from policy loans because they are not tax-free. Any early distributions from your annuity could lead to penalties, surrender charges, or tax issues.

You and your advisor must look at all potential tax issues before you purchase an annuity or any other financial product. The last thing you want when you retire is a huge tax bill!

Fees and expenses

Just like other types of financial options, annuities have fees associated with them.

Most annuities have fees and costs that can impact returns.

Although many of these fees and commissions are legitimate, you must look carefully at them to determine their potential impact on your future wealth.

Arguably, the surrender charge is the fee to which you should pay the most attention and which has the most potential to damage your net worth. A surrender charge is the annuity company’s version of an early withdrawal penalty.

Since you never know when some unexpected life challenge will require you to access your money, it is vital that you know EXACTLY how much the surrender charge will be and how long the surrender period is.

Commissions are another factor when assessing the actual cost of your annuity. Salespeople are sometimes given commissions as high as 10 percent for the initial investment and receive ongoing commissions as the account grows.

You could also be charged an annual fee or fees depending on which annuity you choose. These fees could add as much as an additional 2% a year to the cost of your annuity.

When comparing annuities, you and your retirement expert must do serious number-crunching before you decide. When I counsel my clients about their annuities, I break down the various expenses so they understand precisely how much that annuity costs them. Insist that the financial professional you work with does the same.

More tips for purchasing the right annuity

• Always check out the issuing company for stability and claims-paying ability. My company contracts only with top-rated carriers with demonstrated financial stability.
• Before changing from one annuity to another, be sure to do a thorough analysis of surrender charges (if applicable), sales commissions, fees, and potential tax liability. If you are considering changing annuities, I will happily offer you a no-obligation consultation to help you make the right decisions.
• If you are using an annuity to create an inheritance for a beneficiary, consult a financial professional to find the best kind of annuity for that purpose.

In conclusion, I believe that an annuity meshes perfectly with an Untaxable Wealth strategy in certain circumstances. Its unique, tax-efficient benefits may be pivotal in a comprehensive retirement blueprint. A carefully-selected annuity strategically integrated into your Untaxable Wealth plan could make sense if you need to diversify your portfolio and create a steady stream of money you won’t outlive.