What You Need to Know About Annuities - Rodgers & Associates
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What You Need to Know About Annuities

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There doesn’t seem to be much middle ground when it comes to the use of annuities in financial planning. Some planners choose to shun annuities all together citing unfavorable tax treatment on distri­b­u­tions and high internal expenses as reasons to run the other way. Others planners think annuities should be the first place to look because they offer tax deferred growth and various guarantees that an investor can’t get anywhere else. These viewpoints are at the extremes. While there are times when annuities are sold incor­rectly and are not the best choice for consumers, there are also times that they can and should become part of your financial plan. Knowing the facts can help you make the right decision.

3 Situations When an Annuity May Be Appropriate

1. Balancing the new three-legged stool
The strongest argument for using an annuity is tax-deferral. There are no contri­bution limits placed on the amount of money that can be invested. All earnings within the contract are tax-deferred until withdrawn. There is a tax penalty on earnings withdrawn before age 59 ½ but there is no federal tax requirement to withdraw the earnings at a certain age (Some states do require withdrawals upon reaching a specified age). An annuity can be a good choice when most of your money is invested in taxable accounts.

2. Rebuilding the old three-legged stool
The old three-legged stools relied on personal savings, social security and a pension as three sources of income. There are fewer employees retiring with pensions today because most companies have elimi­nated them. You can create your own private pension by taking a portion of your assets and investing in an immediate income annuity. The contract can be set up to pay you and your spouse a lifetime income. This type of private pension is not covered by the Pension Benefit Guarantee Corp. However many states do provide insurance to cover immediate annuities as an extra measure of security.

3. Controlling distri­b­u­tions to heirs
Some of our clients are concerned about leaving a large estate to their children. In certain cases the money management skills of their children is in question. Others are concerned about their child’s spouse having access to the funds. This problem can be handled by a trust that is estab­lished in their will. However, trusts can be expensive to manage and admin­ister. Another option is to leave the money in an annuity that can be distributed over a specified number of years or over the child’s life expectancy. The child only gains control over each payment as it is made. The principal does not belong to the child so there is nothing for the spouse to gain control over in the event of a divorce or otherwise. The annuity is not as flexible as a trust but it also doesn’t have the admin­is­trative burden and expenses.

These three situa­tions are meant as examples for when an annuity investment may be appro­priate. There are drawbacks to consider in each situation. This is where a skilled wealth manager can help you evaluate the best option. Once you have decided that an annuity is a good option, it is time to do your homework to determine the best company to use.

Determine the Best Company to Use

Credit Ratings are Key – A guarantee is only as good as the company issuing it. A.M. Best, Standard & Poors, Moody’s and Fitch are the most common credit rating agencies. You can check the company’s website for their most recent rating or go to www​.insure​.com and search by company name.

Check with the State – Insurance companies are regulated by the state insurance commissioner’s office. You should inquire if the company has ever defaulted on its payments. The commissioner’s office will also have infor­mation on complaints against the company and any history of enforcement action taken.

Shop rates – Get quotes from more than one company on income annuity payments. Some companies are more aggressive when pricing income annuities. A few dollars more per month over your life expectancy adds up to a lot of money over time.

Diversify – Setting up your own private pension should be done with more than one insurance company. This portion of your investment portfolio is for your safe money. The company may have a great credit rating today but this is an investment that needs to last over your life expectancy. You should diversify these funds over several companies to minimize the chance of your insurance carrier getting into a financial bind.

Rick’s Insights

  • Don’t assume annuities are good or bad based on hearsay. It will likely depend on what you want to accom­plish.
  • Annuities can be a good solution for protecting a spend­thrift child from getting a large inher­i­tance and wasting the money.
  • Diver­si­fi­cation is an important principle to follow with annuities. AIG was a AAA rated company until 2008.