Retirement Savings

What are annuities and who may want to use them?

Annuities are a risk management tool with a variety of guaranteed features. Investors’ seeking the greatest protection for safety of principal is a fundamental consideration for using fixed annuities.

Fixed annuities are particularly useful as a conservative complement to other investment choices.  

Investors that want to be free of the time and responsibility of investing and managing assets can use some form of an annuity.

In addition, annuities are the only investment vehicles that can guarantee investors that they will not outlive their income. An annuity protects and builds a person’s cash reserve and if elected, the income can never be outlived.

Annuities come with a host of features that give the purchaser the advantages of peace of mind and psychological security.  

Retirement or supplemental lifetime income or payment for a fixed period of years

 

Investors nearing retirement may wish to consider equity index annuities because their investment time horizon might be just five to ten years.  As there is little time to earn back any losses caused by market setbacks or investment mistakes, an investor might want to place greater emphasize on conservation.  

 

Tax-free build up within the contract and the ability to “time” the receipt of income and shift it into lower tax bracket years. This compounds the advantage of tax deferral by giving you the ability to decide when to be taxed.

Effective yield is higher on an annuity paying the same rate of interest as a taxable investment because of the tax deferred annuity interest.

Ability to reduce Adjusted Gross Income (AGI) in years where the annuity is held with no withdraws. Reducing adjusted gross income can result in tax savings because many other income tax rules are calculated based upon AGI. Generally, a lower adjusted gross income results in lower taxation and higher adjusted gross income results in higher taxation. A reduction in adjusted gross income can produce tax savings by lowering or avoiding the threshold for phase out of personal exemptions and itemized deductions. In addition, tax savings can be are created by reducing the floor threshold for deducting medical or miscellaneous itemized expenses. The amount of social security payments that are included in income can also be lowered or eliminated with a reduced adjusted gross income.   

Annuities avoid probate allowing the transfer of assets by way of contract to an heir, reducing the possibility of a contested will.   

What are Equity-Index Annuities (EIA)?

Equity indexed annuities are fixed annuities in which the annuity’s returns (the crediting rate) is tied to an external market index such as the S&P stock index. In general terms, the annuity earns interest when the underlying stock market index has increased and by limiting the investor’s exposure to downside market risk – the interest earned in any index period may be zero, however the interest earned will never be less than zero. An index period is selected by the investor with typical choices available from one, two or five year periods.

Any interest that is credited to the annuity at the end of the index period is automatically locked in and the index value is reset. This means that even if the value of the index declines in later years, the interest that has already been credited to your annuity is protected from any future downturns. This is typically referred to as the equity-index annuity reset feature. 

Can equity-index annuities (EIA) be a good buy for an individual investors considering the loss of dividend income, a cap on market gains, participation rates and annual spreads?

The benefits of eliminating market losses means the annuity investor is giving up certain limitations in interest earned on the annuity in the form of Annual Spread, Cap Rate and Participation.

Since equity-index annuities issued by one company will differ from equity-index annuities issued by another company and sometimes the differences are quite dramatic, the index strategies of each annuity under consideration must be compared. In doing so the investor should question if offsetting market returns with caps, spreads, participation rates and lack of any dividends is worth it to get protection against market losses.

However, not all equity-index annuities are the same and so the investor should look for annuities offered from quality companies with the best possible index crediting strategies.

Ask about and get answer to caps, spreads, participation rates any dividends used in calculating annuity returns.

Does the annuity place a cap on the amount of interest that may be applied to the annuity during the term of the index period?

Does the annuity limit the participation rate to something less the 100%?

Does the annuity apply a spread to any index growth that’s used to calculate interest credited to the annuity?

Does the annuity offer any Premium Bonus?

Does the stock market index used in calculating interest applied to the annuity use dividends as part of a total return calculation?  Dividends can be an important function in the total returns generated by an index fund. An annuity that does not include dividends can be a drag on performance.

However, an annuity that includes any dividends earned by the companies in the index may well be worth exploring. In a total return index changes in the index level reflect both movements in stock prices and the reinvestment of dividend income. A total return index represents the total return earned in a portfolio that tracks the underlying price index and reinvests dividend income in the overall index, not in the specific stock paying the dividend.