Home » OPINION » Columns » Portfolio
Start creating secure income for retirement right now

Portfolio

If you are like most consumers planning for retirement, you are concerned with creating secure income in those years when you are no longer working. How do you get assurance that the money you invest now will continue flowing, regardless of how long you live and how the markets perform? One strategic approach is to consider fixed and variable annuities to maintain your standard of living in the face of inflation.

The annuity misconception

Annuities are one of the most popular investment products available today.

Annuities are so attractive because they can work for you through every stage of your investing life – from saving, to receiving income in retirement, to leaving something to your heirs.

Annuities are a way to convert assets into steady income that will last as long as you live. This process is known as “annuitizing” or “annuitization.”

Annuities that provide a steady income stream, or a “payout,” are similar to life insurance policies. With life insurance, you pay regular premiums to an insurer that makes a lump-sum payment upon your death. However, with an annuity the insurer converts a lump-sum of cash into payments. This income can last for a special period of time. Or for as long as you live.

Fixed payout

If you choose a fixed payout amount, the size of your payout will depend on many factors, including the amount you invest, your life expectancy and how much the insurer feels he or she can earn from their money over time. For example, based on current rates, a 65-year-old man who annuitizes $100,000 might receive a guaranteed annual payment of about $7,400 for as long as he lives. This amount is based on a man`s life only. Other options, which would lower the amount, allow payments to continue to a survivor such as the man`s wife and/or guarantee a minimum number of payments. If he lives past his life expectancy, he will earn more than he could by putting the same amount into safe fixed-income investments.

So, how can an annuity pay out more income to you than you could manage on your own? Just like life insurance, the insurance company spreads their risk over a pool of many lives. Simply put, the payout amounts are based on the statistically safe assumption that some annuity holders will die reaching their life expectancy while others will live beyond their life expectancy.

Variable payout

As with a fixed payout, if you choose a variable payout, the amount you receive will depend partly on your life expectancy. However, unlike a fixed payout, the amount you receive each month will fluctuate according to how the underlying investments perform. You choose an assumed interest rate (AIR), which determines the size of your initial payment. (Some insurers allow you to pick your own AIR, while others assign one.) AIRs are typically in the range of 3% to 6%.

Then you decide how to invest your contribution among a variety of portfolios called “sub-accounts.” If your sub-account portfolio generates a return higher than the AIR, your variable annuity payments increase. If your portfolio earns less than the AIR, your payments drop.

While choosing a variable annuitization will generate a lifetime income that has a good chance of keeping ahead of inflation, payment can increase and decrease depending on the performance of you sub-accounts, which can make budgeting in retirement tricky.

Tax implications

Keep in mind that withdrawals made from an annuity before age 59 1/2 are taxed as ordinary income and may be subject to a 10% federal penalty. Also, be aware that annuities have a tax disadvantage: All gains are taxed as ordinary income.

Rest assured, however, that annuities generally offer a tax benefit when you invest taxable dollars: A portion of each payment you receive is considered a return of your capital and therefore is not taxed. This treatment increases the after-tax value of each payment.

Combining the best of both worlds

It`s clear that owning an annuity in addition to a conventional portfolio of stocks or mutual funds can substantially reduce the odds that you`ll run short of money. The longer you live, the greater the benefit an annuity can provide. Here are six tips to help you maximize the value of annuities:

1. Shop around for low fees.

2. Choose an annuity that offers a wide variety of investment options (sub-accounts).

3. Consider using an investing strategy called dollar-cost averaging, in which you invest the same amount at regular intervals.

4. Be sure to keep your investments diversified.

5. Enjoy the benefits of diversification (spreading your money around to different investment types).

6. Use annuities to pass money along to heirs quickly.

Don`t Put All Your Eggs in One Basket

Annuities are just one tool you can use as part of your long-term financial plan. Remember not to put all your money in annuities. Make sure you have emergency reserves and other accessible assets to draw upon in case you have an immediate need. Using annuities for retirement and estate planning can be quite complicated. A qualified financial advisor can help you sort through the products, potential risks and timing and determine what strategy fits best within your personal economy.

Gary N. Garner is a financial advisor and branch manager for American Express Financial Advisors Inc. in Hattiesburg.

About Contributing Columnist

Leave a Reply

Your email address will not be published. Required fields are marked *

*