Your brother-in-law has a point, about one of them
Everyone knows someone who’s sure annuities are a bad deal. There are fees, the money’s locked up, and you have no control. Sometimes he’s describing a real contract. Often he’s describing a different kind of annuity from the one you’re looking at.
“Annuity” covers several very different contracts. Three of them do most of the work in retirement planning, and each one has a single job it does well.
The paycheck: a SPIA
A single premium immediate annuity turns a lump sum into income that starts within a year, for life or for a set period. Of the three, it’s the most direct way to buy a monthly check.
Use it when you need income now to cover essentials: the gap between your bills and your Social Security, or a pension that’s about to stop.
The trade-off: once income starts, the decision is generally permanent. You’re exchanging access to the lump sum for a payment you can’t outlive, backed by the insurer’s claims-paying ability, so only the portion meant for income belongs here.
The parking spot: a MYGA
A multi-year guaranteed annuity pays a fixed interest rate for a set term, commonly three to ten years. People often compare it to a bank CD, and the comparison is fair, with one difference that matters.
Interest on a CD is taxable every year, even if you never touch it. Interest inside a nonqualified MYGA is tax-deferred until you withdraw it. For retirees with CDs they roll over year after year, that means the interest keeps compounding instead of showing up on the tax return each April.
Use it when you want a known rate for a known period and don’t need the money soon. The trade-off: taking more than the free-withdrawal amount before the term ends usually means a surrender charge.
The floor with upside: an FIA
A fixed indexed annuity credits interest based on how a market index performs, up to a cap or participation rate. When the index falls, the credit is zero, and your value doesn’t drop because of the market. You give up some upside in exchange for a floor.
Many FIAs also offer an optional income benefit that grows a separate income base at a stated rate and later converts it to lifetime income. That benefit usually carries an annual charge. Ask what it costs and exactly what it buys.
Use it when you want growth without market losses, lifetime income a few years from now, or both.
Two jobs, one design
A 72-year-old client had $100,000 in bank CDs throwing off taxable interest, and a $1,011-a-month pension scheduled to end in about four years. Cole Whitaker designed around both problems at once.
The CDs moved into a deferred annuity with a guaranteed 10% simple roll-up on the income base (a figure used only to calculate lifetime income, not cash you can withdraw) and lifetime income starting in year five, when the pension stops. The design pays $13,038 a year for life, $906 more than the pension it replaces. The interest is tax-deferred instead of taxed annually, and the income benefit can double for up to five years if care needs arise (it isn’t long-term-care insurance).
About “locked up” and “fees”
Locked up. A SPIA is built to pay out, not to be withdrawn from, but most deferred annuities today allow up to 10% a year in free withdrawals, often from the first year. Before that worries you, ask yourself how much you’ve taken out of your retirement accounts since you opened them, beyond any required distributions. When Cole asks clients that question, the answer is almost always nothing.
Fees. Ask where every fee is, what it’s for and what it costs, then compare. Many mutual funds carry fees, and many IRAs pay an advisor fee on top. A fair review puts both sides on the same page.
A SPIA pays you, a MYGA holds a rate for you, and an FIA protects the floor while leaving room to grow. Most plans use one or two, sized to the job. To see how they fit around Social Security, read when the paychecks stop, what replaces them?
General educational information. Your circumstances, applicable requirements and specific contract terms belong in an individual review with the appropriate professionals.
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