The Many Roles of Annuities
Annuities initially were developed by insurance companies to help protect people from outliving their money in retirement. As annuities have evolved, however, they’ve also been proven to be useful in addressing a number of other retirement and financial planning issues.
“Insurance companies have done a great job responding to the changing needs of today’s consumers, allowing advisors to help their clients find the right tool for the job,” said Eric Henderson, senior vice president for life insurance and annuities at Nationwide. “However, some clients might hear the word ‘annuity’ and think of a one-size-fits-all product. That’s an opportunity for an advisor to educate them on the wide range of solutions available through annuities.”
Here are a few ways annuities can be used to manage common financial challenges:
Help to mitigate longevity risks
Annuities provide a guaranteed income stream over a given period of time—typically the life of the person who bought the annuity. If the purchaser lives longer than expected, the annuity will continue to make payments even after it has paid out the balance of the money originally invested. If you have a history of longevity in your family and are worried about the potential of outliving your retirement savings, that guaranteed income can give you some peace of mind.
Provide an alternative to long-term care insurance
Nearly three in four people over age 65 will require some form of long-term care (LTC) in their lifetime. If your age or health disqualify you from LTC insurance, however, annuities with long-term care riders may be an effective alternative.
Depending on the LTC rider offered on your annuity, you may be allowed to make withdrawals from your annuity to cover qualified long-term care expenses, such as costs associated with a nursing home or in-home care, without being charged a fee or penalty for accessing your assets early. In fact, with many contracts, these withdrawals may be tax-free when used for qualified LTC expenses. Depending upon your contract, the rider may also provide additional income to help meet your need for qualified expenses by increasing your monthly or yearly payout. And unlike LTC insurance, if the money is never needed, it’s simply paid out passed on to your beneficiary if you were to pass away.
“Thanks to the Pension Protection Act of 2006, Congress opened the door to tax advantaged annuity withdrawal options for qualified LTC expenses. Life insurance companies are constantly exploring how to offer these types of benefits on their annuity products to provide our clients additional flexibility when meeting their income replacement needs,” said Henderson.
Leave something for your heirs
Some annuities offer death benefit riders and inherited income streams that allow you to provide for spouses and children after your death. Using these riders, you can select a beneficiary to receive any remaining balance in the annuity or the amount that you originally contributed.
Depending upon the terms of those riders, the amount is paid out as either a lump-sum or through regular, periodic installments. The latter option provides heirs with an income stream that can be useful in cases where your beneficiaries may not be prepared to responsibly manage a large lump-sum inheritance. Keep in mind, however, that unlike traditional life insurance benefits which are passed onto heirs tax-free, an annuity death benefit is subject to tax.
Find an alternative investment vehicle
If you are still working and have already maxed out your allowable annual contributions to your retirement accounts, you can potentially use an annuity as an additional investment vehicle. Although your investment choices might be limited to more conservative products than are available in an IRA or 401(k), your assets in an annuity will benefit from tax-deferred savings growth. One note of caution: Unlike contributions to an IRA, annuity premiums are not tax-deductible. You may want to take full advantage of your workplace and personal retirement account options before considering the tax-deferred benefits of an annuity.
Annuities can be useful tools to solve the right problems, but they are not necessarily appropriate for everyone. For instance, annuities may not be appropriate for investors who need access to their savings in the near future. That’s because most annuities levy a surrender charge for accessing the principal in the first decade after purchasing the product. Fees typically start at around 7% of the account value and decrease each year until reaching zero. There’s also a federal tax penalty of 10% on earnings assessed for any withdrawals made before you turn age 59½.
“Those planning for retirement face a number of uncertainties. Annuities can help meet a variety of those challenges, but clients really need to consider them among all options when deciding which product, if any, makes the most sense for their unique needs,” said Henderson. “As clients consider the mix of investments in their retirement portfolio, the dynamic nature of today’s annuity products may help them meet a variety of their long-term goals, regardless of how long their time horizon may be.”