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Rethinking deferred annuities; Thanks to a client who convinced me to look at them again. August 19, 2012

Posted by shaferfinancial in Uncategorized.

I am fortunate to have really smart clients. They are engineers, doctors, lawyers and business professionals. Recently, one called me up to have a discussion about deferred annuities, a product I have not liked in the past. After that discussion I spent some time researching deferred annuity products, specifically the fixed index annuities and have come to a different conclusion.

My original issues with them were the low rate of returns, who they were being sold to, and the problems with surrender fees when people changed their minds. I was really thinking about them with a general middle class audience in mind. However, since then the type of clients I have has changed. Back then I had a mortgage business as well as the insurance business and most of my clients were middle-class. I saw all the mistakes being made in the mortgage market, the limited savings most of these folks had and concluded that deferred annuities would not work for these folks.

Since then, my clients mostly come to me from my blog and web site, and have trended up in their income.
Because these folks have higher income and largely are good savers the calculus does change.
Here are my thoughts of who might want to consider a deferred annuity:
High Income
A variety of retirement income strategies [I still think an EIUL should come first because you will get a higher return inside the life insurance policy than the annuity].
Adverse to market risk.
Good Savers.

If you are in this group then you might want to consider a fixed indexed annuity.
There are some good ones on the market. One that gives you a 5% yearly return guarantee.
You will not get a high rate of return from these instruments, but if you can put a large amount of savings into them they will produce great retirement income with little market risk.
They won’t have the retirement income issues of mutual funds that I have talked about in other posts.
Their is some income tax that will be paid, but it is still less than your 401K tax commitments.

And if you combine the annuity with an EIUL you can keep your taxable income very low.

The annuities now allow you to withdraw 10% of the account each year without penalty.
They also have other means in which to withdraw without annuitizing.
So you can even use them for retirement income without annuitizing.

Let’s look at what retirement can look life for folks:
Tax free withdrawals from their EIUL [many of my clients can look for $100K or more in annual withdrawals]
Partial tax free income from their annuity. The actual taxable amount will vary depending upon your age of annuitizing. For a 62 year old roughly 50% will be taxable.

Now I would suggest annuitizing for the above client when he retires. I would suggest a second-to-die option guaranteeing income for his wife [or whoever outlives] for live. Since this increases the life expectancy it would increase the taxable amount. For example, a 65 year old man with a 60 year old wife would have a taxable amount equal to 60% of the annuity payment.

In the case of my client who initially called me about the annuity:
The annuity would produce around $130,000- $150,000 income for life for him and his wife with about 63% of it being taxable after retiring at age 62 guaranteed.

His EIULs would produce between $250,000-$300,000 of tax free income yearly [that is a very conservative number].

Upon his death there will still be a sizable death benefit for his wife to use or for his kids if his wife died before him. For example if he died at age 75 there would be around a $4M death benefit.

So him and his wife have a guaranteed $130K to $150K of which over a third is not taxable.
They can pull out up to $300K per year tax free, but could also be much more conservative to have a sizable inheritance for their kids.

And they have the opportunity to have other more risky investments without worrying about their retirement.

Since he is only 45 years old, and they save a considerable amount of their income, they will only add to their overall wealth in the next 15 years, so the numbers will look even better.

Once again the financial stability of the insurance company for annuities is critical, so I only use those with comdex’s above 90.

Hope this helps for those thinking about annuities.
Call me if you want to discuss this further.



1. John - August 20, 2012

My parents had an annuity. I helped manage its investments over its last 10 years, and it did quite well. The biggest problem after my mom passed away (last year) was the large gain. My parents also had a large amount of capital losses (thanks to 2000-2002 and 2007-2008), but we couldn’t offset a penny of them against the annuity’s gain. I guess the same thing would happen to a 401K, though. I’m sure there were better ways to manage it (probably take distributions earlier), but it’s too late now. My sibling and I had no interest in inheriting the annuity.

shaferfinancial - August 20, 2012

Sounds like a variable annuity which has different taxation rules than the fixed annuity. Or was it not annuitized? That would cause a large tax bill on the gain. Either way the tax situation would have to analyzed to minimize the tax implications. Many annuities have a death benefit that goes along with it to pass the remaining income tax free. I guess it was both good [great gains] and bad [taxes] for your parents.
Another reason I suggest annuitizing annuities, you don’t leave taxable funds. Their also are some guarantees like 10 years of the annuity payments which could have been exercised upon annuitizing.

2. Should You Consider Longevity Insurance? | DFI Wealth Management Blog - October 19, 2012

[…] Rethinking deferred annuities; Thanks to a client who convinced me … – I am fortunate to have really smart clients. They are engineers, doctors, lawyers and business professionals. Recently, one called me up to have a discussion about deferred annuities, a product I have not liked in the past. […]

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