Here are some basic features of the different types of annuities and life insurance plans to consider before investing:
Term Life Insurance
- Purchased to provide income for dependent in the event of death.
- Usually purchased from individuals 25-50 years old.
- It does not accumulate money tax deferred.
- Pays out when you die typically in one lump sum.
Whole Life Insurance
- Purchased to provide income for dependents in the event of death as well as to provide financial planning needs.
- Usually purchased from individuals 30-60 years old.
- Accumulates tax deferred.
- Pays out in three different ways depending on circumstances: death, borrow against the policy, or surrender the policy.
Deferred Annuities
- Purchased to invest and contribute tax deferred.
- Buyers typically 40-65 years old.
- Accumulates tax deferred.
- Death benefit pay out can be a single sum or monthly withdrawals to give a steady cash flow.
Immediate Annuities
- Purchased to give coverage against outliving retirement income.
- Buyers typically 55-80.
- Accumulates tax deferred but only if you have early payout.
- Pay out is for a period of time but it stops when the annuitant expires, however payments will continue at death if the annuity has an option of "guaranteed period" and it hasn't expired when the annuitant expires.
A stretch annuity is not that well-known, only because not many financial firms offer it. It does have distinct advantages.
An annuity itself comes in many types and structures, one of which
is the stretch annuity. A stretch annuity is defined as an annuity
where allowances, which are tax-deferred, are provided to the
beneficiaries. This gives them more flexibility and management over
their investments. The good thing about a stretch annuity is that the
beneficiaries don’t have any wealth transfer worries, and are not
slapped with a huge tax bill which surviving members have to deal with.
The key is in the word “stretch.” This means that beneficiaries
receive payments or allowances over a longer period of time. A stretch
annuity is also known as a legacy annuity.
Who Benefits Most from Stretch Annuities?
Stretch or legacy annuities are not for everyone. Usually, it
assumes that they could be the perfect solution for very wealthy
individuals with existing annuities and whose beneficiaries are likely
to be in a high tax income bracket as well.
Exactly what kind of individuals are suited for legacy annuities? They are for people who:
- have sufficient financial means – they don’t have to use their
annuity because their financial resources are more than adequate and
will cover their lifetime expenses;
- intend to transfer a substantial portion of their wealth to their heirs;
- want to avoid paying high estate taxes on their present annuities;
- have heirs who will most likely also be high income earners.
The Skinny on Stretch Annuities
If you’re familiar with stretch IRAs, then you already know some key concepts that characterise stretch annuities.
- One, a stretch annuity diminishes whatever tax burdens your beneficiaries may face when they inherit your estate.
- Two, it can specify how and when your beneficiaries will inherit
your assets based on regulations as precribed by law. The few companies
who offer stretch annuities have come up with a cost-efficient method
of achieving this.
- Three, a stretch annuity is meant to be a multi-generational
approach. This means that its purpose is to provide the assurance to
the owner that his annuity will continue to provide income to his
future generations. It is therefore a great strategy for estate
planning, especially where taxes are concerned. An increasing number of
wealthy individuals welcome all or some of the features of a stretch or
legacy annuity.
Some of these features include:
- increasing the annuity’s value amount by spreading out tax
deferrals over a longer period of time. In some cases, withdrawals from
the annuity can be made and will not affect the value amount;
- for beneficiaries, spreading out their tax liabilities by calculating their life expectancies;
- having more room to maneuver when it comes to arranging income options (example would be systematic withdrawals from the plan);
- allowing the annuity owner to manage investments and withdrawals through generations.
Stretch / legacy annuities also make it possible for those companies
offering these financial products to develop long term relationships
with their clients because they will be dealing with existing and
future generations of the original annuity owner; hence there is the
favorable element of continuity.
The good news: Annuity products can be structured to strengthen your retirement
financial plan. In many cases, the best type of annuity for retirement is a
fixed lifetime annuity with an annual Cost of Living Adjustment that protects
your income from the affects of inflation. A fixed lifetime annuity gives you an
income stream for the rest of your life – no matter how long you live and it
offers a guaranteed payment – regardless of stock market performance.
The bad news: Annuity products can provide exactly what most retirees need –
guaranteed income. But, there are downsides to an annuity. For example, it locks
up your capital, so you lose flexibility. With an annuity you are trading
flexibility for guaranteed income.
The confusing: Not all annuities are created equal and many annuity products and
features are actually a bad bet for retirees – or anyone. In addition to
choosing between a fixed (the mostly good) or variable annuity, there is
also the matter of deciding where to purchase your annuity and which options to
include on your annuity contract. These options can be incredibly confusing.
Annuities are a safe way to save for retirement. Below are the forcasted trends for
annuities for 2010:
- Despite the recent market turmoil, which led to a decline in
consumer confidence about preparedness for retirement, almost 8 in 10
annuity owners say that annuities are secure and safe, are an important
source of retirement security, and make them feel more secure in times
of financial uncertainty.
- The vast majority of annuity owners say that annuities are an
effective way to save for retirement (86 percent) and that their
annuity was a safe purchase (89 percent).
- More than three in four say that they intend to use their annuities
for retirement income. Other intended uses include a financial cushion
in case they or their spouse live well beyond their life expectancy (83
percent) or to avoid being a financial burden on their children (81
percent).
- Almost 9 in 10 agree that investment and insurance guarantees
available in annuities are a very important benefit of the product.
Simply stated, a
529 plan is a qualified tuition program that encourages families to save for one of their most important financial obligations - their children's education
. Although officially known as "
qualified tuition plans," the 529 plan, named after Section 529 of the Internal Revenue Code that governs them, are sponsored by states, state agencies, or educational institutions. They are most often sponsored by individual states and managed by a mutual fund or other financial services company. Earnings on 529 investments accumulate tax-free, and distributions are tax-exempt as long as they are applied toward eligible education expenses such as tuition and room and board.
With most 529 plans, an account is opened on behalf of a designated beneficiary, usually a child or grandchild. The contributions are placed in a fund established by the individual state and then directed into an investment portfolio designed and managed exclusively for the program. Earnings in the account grow federal, and in most cases, state tax-free, until the time the beneficiary is ready to go to college. The funds are available to be used to pay for qualified higher education expenses at any eligible school - including two and four-year colleges, technical, vocational, and graduate schools. However, if money is withdrawn from a 529 plan and is not used for eligible college expense, there generally will be an income tax obligation and an additional 10% federal tax penalty on earnings. Some states also offer an upfront tax deduction for contributions. Certain states require that the contribution be made to that particular state's plan for it to be deductible, but not all states have that requirement. Individual states may treat withdrawal transactions differently and may have state tax consequences for residents of certain states so it is always important to discuss all potential benefits and obligations with a tax professional.
Undoubtedly, the main benefit of the 529 plan is that the principal grows tax-deferred and distributions for the beneficiary's college costs are exempt from tax. Another important aspect of the plan is the donor maintains control of the account in almost all cases. This eliminates the potential for the beneficiary to utilize funds for purposes not associated with higher learning as intended. Lastly, the dollar limits for contributing to a beneficiary are substantial, in excess of $300,000 in most states and because there are generally no income limits or age restrictions tied to eligibility, essentially everyone can take advantage of the attractive 529 savings plan.
There are different opinions and criticisms associated with
fixed annuities and their associated surrender charges. To dispel the confusion, it is important to
understand the need for the surrender charge.
First of all, surrender charges that are not disclosed by
the agent, are always bad. Obviously any aspect of a financial investment or
product, which is not disclosed, is always problematic because the client is
not able to properly rely on the product benefits or agent representations.
Surrender charges that are disclosed and explained by the agent are fine,
because this eliminates any concerns over liquidity or access to funds in later
years.
Surrender charges are a vital part of the annuity
product. They are in place so the
company issuing the annuity can guarantee the guarantees of the product. If you
think about it, any investment vehicle or product that offers benefits and a
potential return on investment has some type of fee or charge assessed for
early withdrawal. The company that
issues the annuity guarantees the safety of the principle, paying a minimum
interest rate and to pay an income stream at some time in the future if
elected. In addition, most fixed
annuities offer many peripheral benefits the client finds advantageous. An
example of a peripheral benefit is a premium bonus added to the accumulated
value of an annuity. Say the issuing
company offers a 7% bonus on an initial $100,000 deposit. Upon issuance, the accumulated value is
$107,000. The insurance company offers
the bonus knowing recovery of the $7000 will occur over time by holding the
investment. The insurance company cannot
afford to guarantee all these benefits if the client withdraws all the funds
within a period of time shorter than anticipated. The surrender charges are in place to
safeguard the annuity guarantees and benefits offered to the client.
It is important to understand, the more robust and
advantageous the benefits of the annuity are to the client, the more stringent
the surrender charges will be. A
passbook savings account from the bank doesn’t have surrender charges because
it offers no guarantees. Equally as
important to understand is the surrender charges are never assessed as long as
any withdrawals made from the annuity are not in excess of the liquidity
options offered. Annuities are typically
a long-term investment vehicle. If a
client knows access to their funds in short order is critical, they should
carefully examine and discuss the liquidity options and surrender charge
schedule with their agent to determine the best course of action.
Fixed annuities remain one of the safest, most reliable
investment vehicles today. There are many different annuities with different
rates, features, benefits and surrender charges, so it is important to shop
around to find the annuity that best fits your needs.
Pensions were originally set up to reward loyal employees
for the fruits of their labor and were once viewed as guarantees. However, since the most recent economic
downturn, many pensions that were once viewed as invincible are now being
questioned about their solvency. Due to
uncertainties pensions are proposing dramatic changes that will impact current
and retired employees.
In particular, the State Teachers Retirement System of Ohio has
proposed several changes to insure they remain solvent. The current system allows for educators to
retire after 30 years of service with unreduced benefits, which they are
looking to increase the eligibility to retire without unreduced benefits to 35
years of service. They are also looking
to increase the employee and employer contributions to the system by 2.5% of
employees’ annual income, which employees currently contribute 10% towards STRS
and employers contribute 14% of employees’ annual income. Another possible change is to increase the
final average salary from the three highest years to the five highest years of
service. In addition, they are looking
to reduce the incentive for employees to work more than 30 years by making the
annual increase a flat 2.5% instead of increasing 1% thereafter, which
decreases the percentage to 78.5% from 88.5% with 35 years of service.
Additionally, they
are not only looking to change existing employees but possibly retired
employees. For example they are looking
to decrease the cost of living adjustment, which is currently 3% simple
inflation and they are looking to reduce it to 2% over a phase in period. In addition, even though health care has not
been discussed to be reduced or eliminated for retired employees, it is a
concern that many current and retired employees worry about since it is an
elective benefit.
These proposed changes are a reflection of the financial
stress on current pension plans. In
order for these systems to remain viable and solvent the systems are going to
have to make fundamental changes that will have a direct impact on current and
retired employees. Also, these systems
could pass part of the burden onto employers which may indirectly be passed off
to consumers or tax payers.
The majority of educators have heard of the popular 403B retirement savings plan,
but many have not heard of a 457 retirement savings plan. The
457 has several features that make it more attractive than a 403B while still
having the advantage of tax deferral.
Before discussing the difference between the two vehicles it is
important to discuss the similarities of the vehicles.
Both retirement vehicles are pretax and have the same
current contribution limits of $16,500 per year with a $5,500 catch provision
for participants 50 or older. In
addition, they both require mandatory distributions at age 70 ½, and typically
they both allow loans for the account holders.
In addition, they both have the same portability to other vehicles,
unless the plan document restricts it.
Even though there are similarities between the two plans
they also have several differences. One
of the main differences is between the restrictions the employee has on taking
distributions. The 403B distributions
cannot begin until the employee is 59 ½ and if the employee takes a withdrawal
they will encounter a 10% penalty for early withdrawal from the government, and
the 457 allows the employee access once the employee separates from
service. This is a crucial difference
since many employees have the opportunity to retire before they are 59 ½. In addition, the 457 is more flexible than a
403B with gaining access to the account value when they are still working. The guidelines state that employees can take
distributions for any unforeseen reason.
In conclusion, 403B and 457 are both great vehicles that
have pretax savings for employees.
However, when comparing the two vehicles the 457 is often viewed more
attractive for employees due to its flexibility to take contributions. With 403Bs limitations 457 should continue to
gain recognition and may even surpass 403Bs popularity.
Despite the current economic conditions,
fixed annuities still remain a safe and popular financial vehicle. With total national sales exceeding $60 billion in the first half of 2009. This number represents an increase of almost 40% over sales the first half of 2008. This appeal to the conservative investor, which in general tends fall into the senior demographic, is simple; the advantages far outweigh the disadvantages, especially when the stock markets and the economy in general, are so uncertain.
The initial annuity advantage is derived from the nature of the product itself, which allows for a distribution of payments once the policy is annuitized. The amount and frequency of the payment distribution is determined by factors such as the value of the annuity, age of the investor and time period of the desired payments. Annuities can distribute payments over a "period certain" time frame such as 5 or 10 years or even for the lifetime of the investor, depending on their needs. Investors may need to utilize this income stream to supplement the loss of earnings from retirement, a spouse's social security or even increased expenses due to medical costs.
Unlike many other investment vehicles, the fixed annuity offers one very important advantage, which is protection of principle from market volatility. Products such as variable annuities, securities, and other investments can and do lose value when markets fluctuate. Over the last decade many investors have fallen victim to the stock market declines and lost the majority of their portfolio value. A 40 year-old employed investor has approximately 20 years and income which will aid in correcting market losses before retirement, whereas a retired 70 year-old has neither and therefore cannot afford risky investment vehicles. The fixed annuity performance is not directly tied to market performance and therefore the accumulated value never dips below the original principle.
A fixed annuity may not offer the robust potential of double-digit returns; it establishes guaranteed interest rates, which only add to the accumulated value of the investment, regardless of market losses. This provides the conservative investor a predictable and reliable rate of return. Substantial market losses may impact the renewal interest rate, however the fixed annuity has minimum guarantees, which prevent negative returns. Planning for retirement becomes less stressful and more peaceful when the investor has guaranteed rates built into the contract of the investment vehicle.
Although there are other advantages and options to explore concerning the fixed annuity, the three most important are income distribution, protection of principle and guaranteed rate of return.
Annuity Payment Frequency
Most Insurance companies will allow you to choose how often your income is paid: monthly, quarterly, half-yearly or yearly and you can choose whether you want this to be paid up front or at the end of the first year. For example, annuities paid at the end of the year will be higher then annuities paid yearly in advance (payment starting immediately), and annuities paid monthly in advance, over the course of a year will pay more than a yearly in advance.
Level Annuities
If you select an income that does not increase, you will generally receive a much higher initial income than an annuity that does increase. However you should bear in mind that, as time goes by, the real value of your income will be eroded by the effects of inflation.
Increasing Annuities
If you are worried about the effect inflation may have on your retirement income, you can choose to have your income increased each year. If you opt for an inflation proofed annuity you will receive a smaller starting income compared with a level annuity. However, you will have the peace of mind knowing the real value of your income is protected. You can choose for your income to increase in line with inflation and therefore maintain its buying power or you can choose a fixed percentage increase each year such as 3% or 5%.