Which Annuity is Right for You? 
WaterStates has a complete portfolio of annuity products to meet the various needs of our clients.
Depending on your current financial situations, retirement goals and income needs, you'll need to determine if an immediate annuity or a deferred annuity is right for you.
The annuity is an attractive retirement vehicle because the money accumulating in an annuity, grows on a tax deferred basis. There are two parts to an annuity: the accumulation phase and the distribution phase.
After accumulating money in an annuity it is not mandatory that the annuitant exercise the annuitization option and relinquish control of his or her cash value and enter into the annuity distribution phase, the annuitant can simply cash out of his or her annuity.
As Financial Giants stumbled on Wall Street in Mid-September, investors are asking about the safety of their annuities. People have nothing to fear! Although annunities are not protected by Federal Guarantees; they are covered by the states. Each state has a guarantee company that pays claims of insolvent insurance firms up to a cap that is $100,000 at its lowest.
The Accumulation Phase
Features
During the accumulation phase, the fund grows tax deferred, it does not grow tax free. If the annuity was not purchased as part of a qualified retirement program such as an IRA, 401(k), TSA, or 457 plan, income taxes are paid on the earnings when money is ultimately paid out. If the annuity is part of a qualified plan the entire fund is subject to income taxes as it is withdrawn.
Surrender charges for early withdrawals. Most offer partial withdrawals free of surrender charges.
If you withdraw money from your annuity before age 59 ½ it is called a “premature distribution” and is subject to an additional 10% IRS penalty.
If a premature death should occur, the accumulated funds within the annuity are transferred to the named beneficiary, avoiding probate costs.
Annuities can vary by payment mode and are available as “single premium” (purchased with one-time payment) or “flexible premium” (purchased with recurring periodic payments). They also vary by timing of the annuity income and may be available as a “deferred annuity” (which means that annuity income payments are deferred until later) or as an “immediate annuity” (which means that annuity income starts immediately).
For fixed and equity indexed annuities there is safety of principal and earnings.
- Variable products are subject to mortality and expense charges and administrative fees not typically found with other investments.
Types
Fixed annuities
Variable annuities
Equity Indexed annuities
Fixed Annuities
In a fixed annuity, the insurance carrier:
Declares a current rate of interest for a specified time period. Once the time expires the company will set a new rate which may be higher or lower than the original rate.
Guarantees a minimum interest rate of return which is specified in the contract, and at no time may the current or renewal interest rate fall below it.
Guarantees the principal.
Variable Annuities
A variable annuity has two types of accounts:
Fixed Accounts
In a fixed account, principal and interest are guaranteed by the insurance company. Interest rates are usually guaranteed for one year but can be longer.
Variable Accounts
In a variable account, the annuity owner bears the investment risk. Policy values vary directly with market performance and may result in a loss of principal and prior earnings. Earnings are tied directly to the performance of various underlying investment vehicles which are available within the variable annuity and are selected by the owner.
Variable annuities offer a guarantee that in the event of death the beneficiary will receive at least all the premiums paid less any withdrawals made no matter what the value of the account. This means if the account fund is valued less than the original investment, the beneficiary will receive the original investment.
* Equity Indexed Annuities
An Equity-Indexed Annuity (EIA) has interest rates that are linked to growth in the equity market as measured by an index such as the S&P 500. The EIA owner enjoys the upside potential of equities but is not exposed to downside risk. Subject to fixed minimum guarantees, the value of an EIA can only increase due to market growth – it will never decline due to market movement.
There are many variations in product design. No two of the EIAs are exactly alike, and some are very different from each other. However, all the various types fall into three general categories: annual reset, point-to-point, and annual high-water mark with look-back. The following is a simple definition of each. Please call us if you would like to know more.
Annual Reset – Also known as the annual ratchet design, the annual reset design resets the starting index point annually. It also credits index increases (interest) annually and compounds annually.
Point-to-Point – The point-to-point design measures the change in the index from the start of the term to the end of the term.
Annual High-Water Mark with Look-Back – The annual high-water mark with look-back can be viewed as a variation on the point-to-point design, except that it measures the index from the start of the term to the highest anniversary value over the term.
* Some annuities allow the insurance company to change participation rates, cap rates or spread/asset/margin fees either annual or at the start of the next contract term.
If an insurance company subsequently lowers the participation rate or cap rate or increases the fees, this could adversely affect an investor's return.
Therefore, a prospective investor must carefully review his or her contract in order to examine these issues.
No index interest strategy credits higher interest each and every year. The best index interest crediting strategy for any given year depends on the performance of the index itself during the contract year.
Annual point-to-point strategies perform better in a rising market, whereas annual monthly average strategies do better in volatile and declining markets.
Uncapped participation rates generally perform better in a moderately rising market, but miss out on the upside when the market increase is significant.
Monthly point-to-point strategies perform better in rising markets, but are susceptible to volatility because monthly gains are capped, but monthly losses are not. One or two bad months can wipe out the gains for entire year.
How do individuals make decisions about the future and why is that important to investment strategies?
Individuals intuitively look to past experiences to make judgements about the future. Unfortunately, the human tendency is to place more importance on recent events and experiences and ignore or discount past event experiences leading to unwise and faulty assessments and poor decison making.
Focusing on recent past also causes individuals to chase last year's best performing index interest strategy instead of a more grounded approach of diversification among strategies.
So unless you can predict how the market will perform with certainity, it is best to allocate over at least 2 or more index interest strategies and take time to reallocate on anniversaries after conducting a annual review.
Withdrawal
Withdrawals may be made at any time. However, the withdrawal may be subject surrender charges and if done before age 59 ½ there will be a 10% IRS penalty. Some contracts allow an annual 10% withdrawal free of surrender charges.
The owner may pre-authorize a systematic periodic withdrawal plan. The owner of the contract instructs the company to withdraw a percentage or a level dollar amount from the contract on a monthly, quarterly, semiannual, or annual basis.
The Distribution Phase
As part of the distribution phase, the owner has two options, he or she can withdraw money (either in a lump sum or elect a systematic withdrawal plan) or annuitize (purchase an annuity pay out plan).
Annuitization
When the owner annuitizes the funds he or she purchases an annuity pay out plan. In a Fixed and in an Equity Indexed Annuity the owner purchases a monthly income that will be paid to him or her until death.
It is a guaranteed income that will not change. In a variable annuity, the owner has an option to do the same or transfer all or part of the contract to one or more of the sub-accounts that are available, and annuitize those funds. The funds that are annuitized in the separate accounts produce an income that will change from month to month based on the performance of the sub-account that the funds are placed in.
Annuity Pay Out Plans
Life Only - Periodic monthly payments to an annuitant for the duration of his or her lifetime and then ceases. It is for a lifetime, the annuitant cannot outlive the payments. The payments are determined at the time of purchase and are based on age and sex.
Life with 10 years certain – Payments will be made for at least ten years, regardless if the annuitant lives for the entire ten years. If the annuitant dies during the ten-year period the remainder of the ten-year payments will be made to a beneficiary. If the annuitant lives longer than ten years he or she will continue to receive payments for his or her lifetime. The guaranteed monthly payments will be less than “life only.”
Life with 20 years certain – Payments will be made for at least twenty years, regardless if the annuitant lives for the entire twenty years. If the annuitant dies during the twenty-year period the remainder of the twenty-year payments will be made to a beneficiary. If the annuitant lives longer than twenty years he or she will continue to receive payments for his or her lifetime. The guaranteed monthly payments will be less than “life only”, and “Life with 10 years certain.”
Advantages of Immediate Annuities
Annuities offer individuals an option of investing money in a manner that suits them best, in order to gain guaranteed returns from the annuities.
There are many different types of annuities and immediate annuities offer investors an opportunity of making a lump sum payment, after which they immediately begin to receive payments from their investment.
The payment from the immediate annuity begins one time period after the investment is made, for instance for monthly payments option the payments begins one month after the premium is paid.
Immediate Annuities
- The immediate annuities guarantee a regular payment for a certain amount of time or for life. The option is chosen by the investor and thus provides them a secure and guaranteed form of income.
- It is a good investment for individuals who are about to retire and have a large sum of money in their hands and are unable to decide how to invest it. The immediate annuities provide the investor the security of knowing that they will continue to get payments from the investment for their life or for a long period of time.
- For investors who don’t want to make risky investments the immediate annuities provide an ideal solution and provides them regular income immediately after the investment is made.
- Immediate annuities provide the individual flexibility in the manner in which income payments may be received. The income may be received monthly, quarterly, semi-annually or annually.
- Immediate annuities are tax deferred and you pay taxes only as you receive the payments from it.
- Immediate annuities are a safe and secure investment option where the investor does not have to worry about rising or falling interest rates, nor does the investor have to worry about managing their investment portfolio.
- Immediate annuities provide better rates of return than CDs or Treasury rates.
The income received from immediate annuities is calculated by taking into account various factors such as life expectancy of the investor and expected rate of return on the investment.
The advantages of immediate annuities make it an ideal investment for people who are averse to risky investments and wish to receive money from the investment right away.
Lock in a Lifetime of Income
Tough times in the markets are renewing interest in an old, reliable investment for retirement: Immediate Annuities.
These insurance products convert your cash into a stream of income that can be guaranteed to last the rest of your life. With many retirees staring at double-digit losses on their portfolios, that kind of reassurance is attractive.
Unlike some annuities that are complicated and expensive, immediate annuities are usually fairly straightforward. However comparison shopping among insurers is essential because their payouts vary.
An immediate annuity can function just like a pension, producing a predictable payout. As the “immediate” part of the name suggests, the distributions start shortly after the money is invested. The trade-off with annuity is the in exchange for the guarantee payout, an investor gives up control of the money.
Payouts largely depend on the investor’s age – the older the investor, the larger the checks – and the level of interest rates. These annuities are worth considering for retirees who tap their portfolios to pay day-to-day expenses and stand a chance of using up their savings.
Shifting the Risk
“You’re shifting the risk that you’ll outlive your money over to the insurance company”. If you’re relying on your portfolio for living expenses, financial planners typically suggest withdrawing no more than 4% a year, to limit the risk of outliving your funds; in contrast, with an annuity, you’ll get a bigger starting payout.
For example, an immediate annuity would convert a $100,000 investment from a 65 year old couple into $604.69 dollars a month for life. This policy comes with 100% joint survivorship, which means when one spouse dies, the survivor continues to receive the full payout. It is possible to get higher payouts for a lower survivor percentage. (Illustration: depends on company!)
How Much to Annuitize
One strategy is to get a big enough check to cover essential expenses on a continuing basis. One problem with getting a fixed payout from an immediate annuity is that over the two or three decades that a retiree may live, inflation can eat into the value of the money. It takes more than $1,700 to buy today what it cost $1,000 to buy in 1989.
Inflation Protection
You can insure against that erosion of spending power by using an annuity that adjusts to inflation. This feature comes with a cost, however. The same annuity with an inflation-adjustment rider pays out $151.00 dollars less per month initially, $453.49. That may sound like a big difference, but inflation could more than reverse that gap over the course of retirement.
If the consumer-price index rises 3% a year, the monthly payout on that inflation-adjusted-annuity would hit $609.00 per month in 10 years – matching the quote on the non-inflation-adjusted annuity – and reach $818.00 per month in 20 years.
However, under the environment, in which the inflation rate is declining, raises an additional issue: Some inflation-adjusted annuities can lower payments if consumer prices fall and then increase them again if prices subsequently rise.
Add Annuities Over Time
As an alternative way to contend with the inflation challenge, clients can annuitize portions of their portfolio over time. That allows them to increase their income stream as needed, as well as to diversify among different insurers.
How much do payouts vary among insurers? A recent sampling of eight major insurers found a difference of $108.00 dollars per month between the highest and the lowest payouts on a $100,000 dollar annuity for a 65 year-old couple. This is where we can help, you can ask 10 companies for the same exact type of annuity and get 10 different quotes, or ask us once and we do the shopping.
