By Norman G. Grill
It”™s both common and understandable to feel like your retirement portfolio isn”™t quite enough. If you feel that way, a possible addition to your nest egg is an annuity.
An annuity is a contract between you and an insurance company. You put a certain amount of money down, the premium, and the insurer pays you a stated rate at regular intervals over time.
Annuities are a popular retirement planning tool because they virtually guarantee you can never outlive the income, as long as the insurer remains in business. A joint and survivor annuity ensures your spouse continues to receive payments after your death for the rest of his or her life.
Unlike an IRA or 401(k) plan, an annuity has no annual contribution limit. This may be an attractive option if you”™re near retirement and need to catch up on your savings. Additionally, the earnings grow tax-deferred, allowing more of your investment to compound over time.
Annuities vary but generally have three components including:
∙ the timing of your payout; immediate or deferred
∙ the type of investment; fixed, variable or indexed
∙ how you pay the premium; single or flexible
To find the right fit, you”™ll have to ask yourself some questions. First, when do you need the income? An immediate annuity allows you to take payments right away, while a deferred annuity begins paying later on. If you”™re in retirement, an immediate annuity may be most appropriate, while a deferred annuity will likely be best suited to an investor with a longer time horizon.
Also, what”™s your risk tolerance? A fixed annuity pays a guaranteed rate set by the insurer. In exchange for relatively lower risk, fixed annuities usually offer lower rates of return. Make sure you find out whether the fixed annuity”™s rate of return adjusts with inflation, because rising prices over time can reduce the real value of your future income payments.
A variable annuity pays a rate that fluctuates based on the performance of an underlying group of stock and bond mutual funds that you select. As such, variable annuities have relatively higher return potential but with more volatility and risk.
Last, do you intend to invest all at once or over time? With a single premium annuity, you make a one-time investment up front. In contrast, a flexible premium annuity enables you to make periodic investments over time.
Single premium annuities may be appropriate if you have a lump sum to invest. Flexible premiums are more often used with variable annuities and may be attractive if you”™re seeking an additional savings vehicle for retirement.
Recognizing the downsides
Annuities have several layers of fees that can add up quickly, and usually impose sizable early withdrawal penalties ”“ called surrender charges ”“ should you need access to your money unexpectedly. Adding features such as inflation protection or spousal benefits can reduce the income you receive, too.
Annuities are also relatively illiquid. You”™ll need an appropriate level of cash or other liquid investments before investing in one. If you need to withdraw funds early, you”™ll pay the surrender charge plus applicable income taxes and, potentially, penalties.
Regarding taxes, you should discuss an annuity with your tax advisor before investing in one, particularly if it will be part of your estate plan. Annuities grow tax-deferred but the gains are taxed at your ordinary rate when you take distributions. Therefore, an annuity may make sense if you expect to be in a lower tax bracket after retirement.
An inherited annuity is treated differently than investments such as stocks or mutual funds, so it”™s important to familiarize yourself with the potential tax consequences for your beneficiaries as well. In addition, an annuity”™s ability to provide continuous income is subject to the claims-paying ability of the annuity”™s issuer.
Norm Grill, CPA ”” N.Grill@GRILL1.com ”” is managing partner of Grill & Partners LLC, www.GRILL1.com, certified public accountants and advisers to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien, 203-254-3880.
