Today, seniors’ top concerns tend to be outliving their assets, maintaining their independence, as well as their own health and safety issues. For seniors over age 75, the issues tend to gravitate to family and friends: leaving a legacy and maintaining their reputation.
With the future of Social Security uncertain and traditional pensions becoming a luxury of the past, the burden of financing retirement is increasingly falling on the shoulders of your clients. In this article we are going to review the “features” of an annuity. Remember, features are what the product “has” or “does,” benefits are “why” your client would want those features. In other words, features are about the product, benefits are about the client.
The Internal Revenue Service considers all annuities to be retirement plans and as such, they are subject to the early withdrawal penalties on withdrawals prior to age 59-and-a-half.
Annuities by themselves are not qualified; however, annuities may be used to fund qualified retirement plans. If the annuity is funding a qualified plan, it is then treated as qualified for tax purposes.
Life insurance is designed to create an estate that is paid at the death of the insured. Annuities, on the other hand, are designed to liquidate an estate over a period of time by making income payments to the annuitant at a time chosen by him or the beneficiary, in the event of the death of the annuitant.
Simply put, life insurance protects against dying too soon, while annuities protect against living too long. Annuities can guarantee an income for the owner’s lifetime, depending on the option chosen.
Taxation of Annuities
Traditional savings plans such as CDs, money markets, mutual funds and savings accounts are taxed every year. By postponing the taxes with a tax-deferred annuity, money compounds faster by earning interest on the money that otherwise would have been paid in taxes.
- When it is decided to withdraw the funds as income (the owner picks the time):
- The taxes will be spread over a number of years.
- Then only a portion of the income will be taxed.
- Since the retiree is usually in a lower income tax bracket, the taxes paid may be minimal.
Income for Life
The annuity is the only financial instrument by which a person can liquidate an estate over the course of his or her lifetime and be assured of an income for life. Since insurance companies work with mortality tables and assume risks, they can guarantee income over an insured’s lifetime no matter how long that may be.
Statistically, annuity owners live longer than other types of insureds; therefore, different mortality tables are used for annuities. The table currently in use for annuities is the 1983 Table ‘‘a’’. The Annuity 2000 Mortality Table, excluding mortality rates independent of sex; the 1983 GAM (Group Annuity Mortality) Table and the 1994 GAR (Group Annuity Regulations) Table are approved by the Commissioner of Insurance as annuity mortality tables for valuation. The date for this table is derived from the mortality experience of annuitants only and therefore, has a longer life expectancy than regular insurance tables.
The beneficiary is the person named to receive benefits upon the death of the annuitant. There may be one or more beneficiaries named and different classes of beneficiaries may be assigned. Distributions from the annuity may be taken as a lump sum, although any number of settlement options may be chosen.
Loads and Charges
Fixed annuities typically have no front-end loads, sales charges or administrative fees. Company expenses are recovered over time by investments in long-term bonds. The annuitant withdraws funds over the time period outlined in the contract. With an annuity, unlike other types of investments, 100 percent of the premium earns tax-deferred, compounded interest immediately.
Fixed annuities typically have surrender charges that are payable if lump-sum distributions, in excess of those allowed in the contract, and are made prior to the expiration of the contract date. These charges, sometimes referred to as back-end load, are necessary because of the way insurance companies invest annuity premiums.
Premiums paid into the insurance company are invested in long-term high-grade securities. The insurance company is required to pay acquisition expenses in the first year. It may take the insurance company several years to recoup the upfront expenses it is required to pay.
If annuities are cashed in early by the annuity owners, the company must assess surrender charges to make up for the out-of-pocket expenses that it has incurred in issuing the policy. Surrender charges disappear over time based on the company and the type of policy.
Insurance companies are required by regulation to maintain reserves to the extent of expected withdrawals. The insurance rating companies investigate insurance companies regularly to assure they have maintained the financial stability necessary to protect their ratings.
Now that we know what the annuity product “does” or “has” (features) in a future article we will look at the “benefits” of the annuity product for our client. In other words we will learn “why” our clients would want to have an annuity.
For more from Lloyd Lofton, see:
- Can We Be Optimistic? Part 2
- Invest in Stocks? Yes. But Don’t Forget About Annuities
- The Ideal Annuity Buyer