By Sheryl Moore
When I started in the insurance business, I was an indexed life insurance expert. I worked in a home office for years before I even learned what an annuity was. Once I learned that an annuity was just a retirement savings vehicle that provides an income you can never outlive, I wondered: why didn’t EVERYONE have annuities?
It turns out there are folks that have a vested interest in discrediting the annuity. Those that sell mutual funds, stocks, bonds and certificates of deposit (CDs) compete against these annuities for the same retirement dollars being offered by pre-retiree consumers. These individuals are often called on to be media sources and frequently provide garbage objections in an attempt to sway people against annuity purchases.
For this reason, I want to address some of these nonsensical objections below:
“Annuities lack liquidity.”
Have you ever received something in exchange for nothing? Probably not. Likewise, an annuity cannot offer credited interest to the purchaser, without some kind of tradeoff. The insurance company has to make a profit on the annuity transaction too.
Surrender charges, the period when a penalty will be imposed if the annuity owner takes out more than a specified amount of their annuity’s value, provide a disincentive for the annuity purchaser to cash out their annuity early. If the annuity owner withdrawals more than the anticipating amount, the insurance companies’ investments fall out-of-whack.
You see, when an annuity purchaser makes a premium payment into a fixed annuity, the insurance company uses that premium to purchase bonds. Generally, the bonds are high quality and mature at the same time the surrender charges expire on the purchaser’s annuity (i.e., I buy a 10-year surrender charge annuity and the insurance company then purchases 10-year Grade A bonds to cover my annuity’s guarantees). This provides a relatively safe investment vehicle for the insurer to make enough interest off of in order to earn their spread/profit and still credit interest to the annuity.
But note that, like the annuity, there is a penalty for cashing out bonds early. If the annuity purchaser cashes out their annuity prior to the end of the bond’s maturity, the insurer suffers a financial loss from cashing out the corresponding bonds earlier than anticipated. Therefore, surrender charges on annuities merely provide a method for insurance companies to mitigate their risks associated with early withdrawals of the annuity’s value.
It should also be noted that annuities provide a plethora of alternatives for liquidity, above cashing out the contract. Most annuities allow for at least 10 percent of the annuity’s value to be withdrawn each year, without facing penalties. A vast majority of annuities also allow for funds to be accessed without penalty should the annuitant become confined to a nursing home, disabled or terminally ill.
In addition, annuities provide a guaranteed income that cannot be outlived if the purchaser elects to annuitize the contract or commence income payments under an optional guaranteed lifetime withdrawal benefit (GLWB). And did I mention that most annuities pay the full account value to the beneficiaries on death? Facts being what they are, I think we can all agree that the liquidity provisions on annuities are more than fair.
“You shouldn’t use an annuity for your IRA.”
An Individual Retirement Account (IRA) is a type of retirement plan that provides tax advantages for retirement savings. A vast array of products can be used as a vehicle for an IRA: CDs, government bonds, mutual funds and more.
Annuities can be used as the vehicle for an IRA too. An annuity, however, provides tax advantages all on its own. Because of these duplicative tax incentives, some financial advisors argue that it is “silly” to use an annuity as the vehicle for your IRA.
Yet annuities have many benefits that are not offered by the free-standing IRA, much less by CDs, bonds, mutual funds and the like. The guaranteed return-of-principal on fixed and indexed annuities is not to be ignored; such guarantees are not offered in securities products such as mutual funds and stocks.
Want a guaranteed rate of return in addition to your principal? Securities products cannot offer that either. While CDs do offer a guaranteed return, their credited rates are currently averaging a mere 0.34 percent per year! Fixed annuities, on the other hand, offer guaranteed annual interest rates as high as 3.50 percent today.
And what if my primary motivation for purchasing an annuity is to guarantee that I won’t run out of money before I die? An annuity is the only product that can guarantee the purchaser a paycheck for life, no matter how long they live. For this reason alone, it may make A LOT of sense to use an annuity as the vehicle for your IRA.
“Annuities are taxed as ordinary income, once income commences.”
Many argue that annuities are not attractive because they are taxed as ordinary income. This means that once you begin taking money out of your annuity, you are taxed at your regular tax bracket on those funds (currently 10 percent - 35 percent, based on your annual taxable income). Some investments, other than annuities, are taxed at a capital gains tax rate of a lesser (current) 15 percent. If you are in the 25 percent - 35 percent tax brackets, this seems like a big argument in favor of retirement products other than annuities, doesn’t it?
In reality, it is; but only for a minority of our nation. The IRS indicates that nearly two-thirds of the U.S. fell below the 25 percent tax bracket as of 2009. This means that the ‘ordinary income’ argument is only of concern to about 33 percent of our nation. It must not be a concern to the Obama administration; they are exploring the use of annuities to guarantee retirees’ incomes, not other retirement products. With so much uncertainty regarding the future of federal income taxes, nobody really knows what will be ahead for the taxation of all retirement income products.
Regardless, some will never endorse annuities for a single one of their clients; that’s okay. Statistics, however, show that since 1950 there has been a 2,200 percent increase in the number of Americans who are age 100 or older. Today, Americans’ number one fear is outliving their income. That being said, those who don’t embrace annuities will one day live in poverty –trying to scrape-up enough cash for prescriptions, not enjoying their retirement.
Meanwhile, the “annuity haters” can envy those of us that own annuities and have guaranteed income that we cannot outlive. We’ll be happy, not struggling and rocking out every minute of our twilight years.
Sheryl Moore is President and CEO of Moore Market Intelligence, an indexed product resources in Des Moines, Iowa. She has over a decade of experience working with indexed products and provides competitive intelligence, market research, product development, consulting services and insight to select financial services companies. She may be reached at [email protected].
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