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The number one problem facing
seniors today is the risk of outliving their money.
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Several factors affect the
situation including longer life spans, lower interest rates and the
terrible fact that too many seniors have lost too much money over the
last few years due to the drop in the stock market. Many seniors
still possess enough assets to insure a guaranteed lifetime income at
levels which provide a decent standard of living – one which they can’t
outlive. The solution is of course, the lifetime annuity.
Additional information and comments on the lifetime guarantee annuity
will appear later in this article. I am a huge advocate of the
lifetime guarantee, but today seniors are also faced with another
financial issue. – lower income from their investments.
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If we look at a CD rate a few
years ago we find that a $100,000 CD might have generated an income of
about $400 per month. The total amount of income would be taxable
(assuming non-qualified funds). A 20% taxpayer would then net $320 per
month after tax. That same $100,000 CD today may generate about $150
per month or $120 per month after taxes. The traditional CD investor is
now looking for alternatives so he can increase income. If you listen
to people who ask the tellers at your bank what the current CD rates
are, you will hear the moans and groans complaining about how those low
rates hurt their lifestyle.
Using fixed annuities to
generate income can be done in three basic methods.
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The decision on
which method to use is based on the desire to retain the principal, the
amount of income desired or the tax treatment on the income. But, the
bottom line is that you can double or triple the client’s income by
switching to a fixed annuity income method. Many investors and agents
for that matter misunderstand the options that fixed annuities provide.
I have previously written about the
myths of Single Premium Immediate
Annuities (see California Broker article April 2001 issue). Many
seniors will not use the principal under any circumstances. “I am
leaving this to my heirs.” This does not preclude the use of fixed
annuities to generate income. Here are two ways to generate an income
from a fixed annuity without losing the original principal.
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Use a deferred annuity with a
systematic withdrawal of interest. By using this method we are simply
comparing the annuity rate against the CD rate. In today’s (I wrote
this in late February) interest rate environment, fixed annuity rates
on short term (5 years or less) guarantees are up to 2% higher than CD
rates. A person with a $100,000 CD would receive a monthly income of
perhaps $235 per month, while the annuity holder would get perhaps
$395 per month. This is an increase of almost 70%. How many
fixed income CD investors would not like to get a 70% raise?
In this method both the CD and annuity income are fully taxable. Many
seniors do not have a tax issue anymore, so this method works. In
both cases, the principal value doesn’t drop. The term of the annuity
may be longer than the CD, which, if rates continue to fall or the
client is happy with the annuity rate can be a positive factor.For
investors who are concerned about and need to reduce their taxes, the
second method works better.
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Use a split annuity. A split annuity
consists of 2 different annuities. One provides a guaranteed income
for a fixed term and the second annuity guarantees that at the end of
the fixed term the original principal will be fully restored. The
primary advantage to this approach is that the income would be
received substantially tax free (97% for 5 year fixed term, 85% for a
10 year term). For clients in higher tax brackets, this method can
produce a much higher after tax return. As of this writing a 5-year
split annuity can provide a monthly income of $365 per month (97% tax
free!) Where’s the catch you may ask? Well, the deferred side has
grown from $79,000 back to the original $100,000. This produces a
deferred gain of $21,000. At the end of the term the client may
choose to do another split. The tax free side will not be 97% anymore
– it will be closer to 80%. This is still better than paying tax on
all the income. Split annuities can have terms of 3 – 10 years
although with this low interest rate environment they don’t look good
unless you go at least 5 years. It is also important to note that a
split annuity can be created using two different companies. One to
provide the best multi-year guarantee and the other to provide the
best SPIA price (or benefit). Of course this will be the same company
at certain times.
The use of 1 year guarantee “trust me” renewal rate products, I
believe, is not a good fit for the split annuity concept. At the end
of the term the only thing we can guarantee is that the original
principal will either be higher or lower than the end value of the
deferred side. If interest rates rise and the company fairly raises
its renewal rates, the end value may be higher than the original
principal. If rates go down or the company fails to increase the
renewal rates, the end result might be lower. My experience is that
clients investing in this concept want it to be fully guaranteed. We
can provide a guaranteed payment for a period of years and return 100%
of the original principal – guaranteed. Clients like to hear this.
We have used, however, an indexed annuity to fund the deferred side.
It is not guaranteed, but has a substantial upside potential that
offsets the guaranteed deferred annuity. With rates as low as they
are now, an EIA, with a 3% minimum guarantee is not too far below a
fully guaranteed multi-year product. To give up 100 – 150 bp for a
larger upside potential may make sense based on the client’s faith in
future EIA results. In any event it has a good risk/reward ratio.
Presenting the EIA option is done after the fully guaranteed program
is shown.
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Lifetime payout Single Premium Immediate
Annuity SPIA. This approach is all about peace of mind. Agents
should offer the lifetime annuity with a money back guarantee (life
with a refund). Clients respond quite well to the “money back
guarantee” feature. Payments on lifetime annuities are also subject to
a portion of each payment being received tax-free. The chart below
gives some idea as to the portion of each payment, which is tax free
(assumes male).
Age Tax Free Portion
60
53%
65
58%
70
62%
75
70%
80
75%
85
80%
Once
the annuitant reaches the life expectancy, all future payments are fully
taxable. Why? Because the entire original principal has been paid
out. Future payments consist 100% of “earnings”. Had any other
investment been used, payments would have stopped. Because the
insurance company guarantees lifetime payments, those payments will
continue till death.
The
SPIA provides an income stream, which can’t be outlived – definite
concern of many seniors.
The fixed income investors are
looking for ways to safely increase their income. The fixed annuity is
a great solution to their problem.
Bob Affronti is President of
FSD Financial Services. He is a 30 plus year industry veteran. A
former National Annuity Director for a major insurer, Bob has been
contributor to several insurance publications. You can reach him at
800-373-9697 or at
www.fsdfinancial.com. |
