Category Archives: Annuities

Retiring early – A reality check

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A letter published online by an ‘early’ retiree who encountered health difficulties has generated a lot of negative comments regarding early retirement. I thought it might be helpful to provide you with my perspective on the subject. Retiring early often means that there is NO paid work and that your assets are the only source of income for all living needs. The income from those assets needs to be able to support your chosen lifestyle for your entire life. For this reason, it is essential that this planning be completed with details based on your life and potential worse case scenarios. In this letter there seemed to have been little planning for healthcare, unexpected market changes, and potential disability which are essential in any retirement plan and particularly in one that would need to last 40+ years. The negative outcome for this early retiree might have been prevented with comprehensive retirement planning and annual adjustments.

Of course, the assets to support early retirement need to be much higher if retiring before age 65 when Medicare healthcare becomes available. In addition, retiring before age 59.5 needs to include significant non-retirement assets (or a willingness to annuitize retirement assets) to avoid a 10% early withdrawal penalty for retirement accounts. Early retirement must also account for retirement cash flow distributions over very long periods (longevity investment planning) which requires a careful combination of investment strategies to ensure that cash is available regardless of market behavior. A portfolio that needs to provide support for long periods of time must include sufficient growth potential with protections against the likely downturns.

If you are contemplating early retirement and have not yet discussed it with us, then let’s create planning scenarios for your situation and see how and if your assets will support your ideal ‘early’ retirement life.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Guaranteed income at what price? – An introduction to annuities – a tool to provide guaranteed income but not to replace your portfolio

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Retirement planning entails finding ways to cover expenses for the rest of our lives when we ultimately cease or reduce our working income. The goal is to ensure that we don’t outlive our assets, regardless of our longevity. Although Social Security is our best guaranteed income another tool can also provide guaranteed income: Annuities.

 Annuities are a contract that you enter into with a company (an annuity carrier such as an insurance company). You provide the payment and they guarantee a certain amount of ‘income’ for a period of time or for life. This is not the same as purchasing a CD or buying a mutual fund since once the annuity is purchased the assets used for the purchase are no longer yours.

 It is clear that annuities can’t beat a well-diversified portfolio in projected performance but they do provide a guaranteed cash flow that a portfolio can’t provide. For example, when you decide to take a lifetime-income stream from an annuity, you are in essence betting against the annuity carrier that you will live longer than they think you will live. This transfer of risk is the true value proposition of any annuity that is based on guaranteeing a lifetime income. It is therefore most important that we use only the guaranteed aspects of an annuity when deciding its place in a retirement plan. It is equally important that we consider the importance of actual purchasing power for the annuity.

 Annuities come in many flavors but can be classified as either fixed or variable types. These types differ in many ways including how the assets in the annuity will grow and how the benefits will be calculated. Annuities can be purchased with a lump sum (immediate annuities) or with regular contributions (deferred annuities). The benefits are received within a year in the first case and at a much later time in the second. Immediate annuities can be useful to fill a specific role in the very near future that requires a guaranteed income stream. Whereas deferred annuities are used when we want to guarantee income at a later date, like retirement (we find this necessary when Social Security is lacking or missing).

 The tax nature of annuities can differ BUT most annuities today are funded with tax deferred dollars so the gain will be taxed at ordinary tax rates. When planning to receive benefits from an annuity prior to age 59 ½ make sure you let us review it to ensure that the 10% IRS penalty doesn’t apply.

 Although annuities can be a useful tool in certain scenarios, too often unpleasant surprises reveal themselves (to annuity owners) within the fine print. If you’re considering purchasing an annuity talk to us and let’s review the contract before making your purchase.

 There is NEVER a need to RUSH into buying an annuity. Take the time to determine what will be the best way to deploy your assets and use the best available tools before and after retirement. The goal is to meet your specific goals and have your assets last you through your entire retired life.

 

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Raymond James Poorly Managed Elderly client Contractor

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Raymond James Financial Services over will need to pay fines for poorly supervising a former independent contractor because of how he handled the finances of an elderly Texas man and the estate of his deceased wife.*  The elderly couple portfolio included life insurance and variable annuities. It is seldom best to switch from annuities to other investments and back.

The former employee had apparently switched the couple out of their municipal bond portfolio entirely, and put them into high-commission variable annuities and life insurance policies. Without their knowledge, he then moved them from one variable annuity to another, costing the couple large surrender fees and commissions. He also orchestrated loans against the insurance policy and used the proceeds to buy other annuities.

Raymond James previously said that the couple actually turned an $800,000 profit on their investments while the former employee remained at the broker-dealer. The couple willingly followed the employee when he changed jobs and joined LPL in 2006, and brought their accounts with them. Subsequent trading at LPL incurred the losses at the heart of the complaint, the company said. The couple has settled damages with LPL before the arbitration with Raymond James.

“Raymond James continues to believe that the award in this matter is a miscarriage of justice,” according to an email statement from Robert M. Rudnicki, the firm’s vice president and director of litigation. “Raymond James believes the panel erroneously held Raymond James responsible for those losses.”

*Material for this post is mainly from “Appeal Denied: Raymond James Must Pay $1.7 Million to Elderly Investor” by Donna Mitchell, Financial Planning, Dec. 1, 2011

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

 

Fixed Annuities – apply them with care

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Fixed Annuities
– A limited but essential role in some retirement plans

Fixed annuities represent a contract between an individual and an insurance company. Annuities provide a contractual way for an individual to guarantee that he or she receives income for life or for a set period of time. Other liquid financial products like equities, can pay dividends that can be used as retirement income the income is not guaranteed. A fixed annuity will guarantee an individual a stream of income as long as he or she lives or for a set number of years.

Sometimes you can start with Deferred Fixed Annuities

Like all annuities, except those that are immediate, deferred fixed annuities have two phases. The first phase is the accumulation phase. During this phase, which can be as short as a few years or as long as several decades, the annuity owner makes regular deposits into the account. These deposits are known as premiums.

All premiums contributed to a deferred annuity grow tax-deferred which means that the growth income received at retirement will be taxed as ordinary income.

When an annuity owner, who is known as the “annuitant”, decides to have distributions start, the annuity is “annuitized”. This is a critical process that converts it to an immediate annuity and you begin receiving payouts. The distributions can be paid monthly, quarterly or annually, depending on the preferences of the annuitant. An annuitant should think about his or her distribution schedule very carefully, because once it starts, it cannot be changed. An insurance company will also typically let the annuitant choose the length of time over which the distributions are paid. Guaranteed payments can be taken for life or for a specific number of years. This selection will affect the amount of each payment.  Life annuities are the only ones that will give the promised guarantee life long income.  Consider that life long income may not support your current lifestyle particularly in high inflationary periods.

Under current federal tax law, an annuity owner cannot begin taking payouts on a tax-deferred annuity prior to age 59 ½ without incurring a 10% penalty. Any tax-deferred annuity must begin in the year in which the annuitant turns age 70 ½.

What are Immediate Fixed Annuities?

An immediate fixed annuity is funded with a single premium. The premium is typically after-tax money paid as one lump sum. You can also set this up from a mandatory distributions taken on a qualified account. The distributions made by the life insurance company begin immediately, typically within 12 months of the start of the contract.

Immediate Fixed Annuities Pros and Cons

The return % paid on fixed annuity is always fixed. It could change year over year, but once it’s set for the year it will not change regardless of stock market fluctuations. This can be of great help to those on a tight retirement budget unless the market rises and therefore inflation rises. The advantage will be that you’ll know exactly the amount of each payment that will be made. While the rate paid on a fixed annuity could vary from year to year, most insurance companies will guarantee a rate of between 3% and 5%. It’s important to note, however, this guaranteed amount might not be enough to offset any cost of living increase. Inflation is a real and significant threat to retirement savings.  It is best to do immediate annuities when interest rates are high.

You could purchase a COLA (cost of living adjustment) rider that adjusts with inflation to retain some of your future purchasing power. The COLA rider is a costly component of  a fixed annuity contract, but it will increase the amount of money that is paid out each year. The amount should be enough to counteract measured inflationary pressures.  If you can afford the COLA you might consider it or consider leaving a portion of your assets in an equity portfolio so that it growth with the economy and provides a real inflation hedge.

For some, another risk factor associated with a fixed annuity is the premature death of the contract owner. If an annuitant dies before he or she has been repaid the amount he or she paid in premiums, the insurance company will keep the balance. To offset this, most insurance companies now give a guarantee of some sort on the premium.  For example, if the annuitant has an annuity worth $300,000 and dies after having only received $50,000 back, the beneficiary will receive the remaining $250,000. Or, the annuitant can choose an option called “period certain”. If he or she chooses a period of 20 years but dies during year 10, the beneficiary will receive payouts for the remaining 10 years.

I only consider premature death an important risk factor if you have beneficiaries or a legacy you want funded.  Even so, there are other ways to cover this risk factor than to purchase this type of rider – particularly if you still qualify for life insurance.

Who Should Buy Fixed Annuities?

Retired investors who need to guarantee income for life or for a set amount of time are often advised to consider a fixed annuity. Retirees who rely on equity dividends for most of their income may also want to consider a fixed immediate annuity. Dividends can provide substantial income but are not guaranteed. They can be cancelled by the company at any time should it need to conserve cash.

A retired investor may also fear that he or she will outlive the money he or she has saved. An immediate fixed annuity will also provide financial security. The payouts will be guaranteed for as long as the annuitant is alive, regardless of the amount of the premium. Even when the amount of the payouts exceeds the premium, the insurance company is obligated to make the payouts. For those in good health with few liquid assets, a fixed annuity could make a difference in their standard of living BUT they are extremely costly and impossible to exit gracefully if your situation changes.

A fixed annuity investor should always make sure he or she has enough cash for emergencies. As outlined earlier, an annuity contract cannot be cancelled except under the extreme circumstances. Once the contract is signed, the only way an investor can receive his or her money is through the payouts.

Consumers are strongly encouraged to purchase annuities only after a thorough analysis by a NON annuity sales financial professional.  This is a major investment that once signed can’t be undone – read the fine print and understand the nuances and their impact on your entire retirement before you sign.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com