Looking at retirement income? Here's what to know if you're shopping for annuities
Q: My spouse and I watched an annuity infomercial and then read that annuity sales were up 23% last year. Is this a good option for our retirement income?
A: According to a 2022 survey by the Life Insurance Market Research Association (LIMRA), last year nervous investors bought a record number of annuities, exceeding 2008 when fear drove sales to the previous record high.
Different types of annuities are used for different reasons. Some create income, some act as a money cop for beneficiaries, and most are sold with commissions.
Annuities are contracts with insurance companies that promise a payment to the annuitant (beneficiary) either as a single payment or a stream of payments. The owner is the person who pays the insurance company and has the authority to make withdrawals, change beneficiaries and terminate the contract. Sometimes the annuitant and the owner are the same person.
Before you can know if an annuity is good for your retirement income, coordinate retirement pensions and benefits by planning for Social Security optimization. If you delay claiming Social Security, your guaranteed benefit increases by about 8% a year. Consider taking the spouse’s benefit that is lower first to enable the higher benefit to increase. Remember there is also an annual cost-of-living adjustment. This year it increased 8.7%.
When considering buying a new annuity, or swapping an existing annuity, look at cash flow requirements and goals. These vary with life events as we move from the go-go years into the slower-go years. Eventually we’re not going anywhere and may only need funds for long-term care.
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Review the details and restrictions of the policy. Liquidity matters because we don’t know what we don’t know, and we certainly don’t know when we might need more cash. Look at the surrender fee schedule, the mortality and expense charges, sub-account fund expenses and other fees. Read the fine print. Understand the formula used to calculate index limits and downside protection. Price the riders and guarantees.
Circumstances change, and tax-free exchanges are available after the surrender period if a policy is no longer in your best interest. These 1035 exchanges are tax free. Old insurance policies and annuities may be combined to offset a tax burden. Don’t swap or buy these complex policies without professional advice.
About 5% of annuities may be purchased without commissions and are “no-load, no surrender charge, low-fund expense” products. These contracts are often less complicated.
Insurance contracts have fixed or variable income options and may be purchased with a lump sum or a series of payments. The income stream may be fixed and guaranteed. It may stop when the annuitant passes, or a lower benefit may be selected in return for a joint and survivor income stream.
When after-tax cash is used to purchase the annuity, the growth is tax deferred until withdrawn (after age 59½) when it will be taxed as ordinary income. Annuity withdrawals before age 59½ are subject to a 10% early withdrawal tax penalty. This is not as tax smart as investments that get the favorable long-term capital gains tax rate and get stepped up at death.
Before buying or swapping any retirement contracts, create a plan to maximize your Social Security and review the contract fees with your objective tax and financial professional. Be prepared and you won’t be scared.
Mary Baldwin, CFP®, is a fee-only financial planner at Buckingham Strategic Wealth in Indian Harbour Beach. Contact her at 321-428-4555 or mbaldwin@buckinghamgroup.com.
For informational and educational purposes only. Individuals should speak with a qualified financial professional based on their own circumstances to determine if the above is appropriate. The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth.®
This article originally appeared on Florida Today: Thinking about buying annuities? Here's what to know as you shop
