Taxation of Annuity Income

If you purchased an annuity that provides income in retirement, the portion of the payment that represents your principal is tax-free; the rest is taxable. The insurance company that sold you the annuity is required to tell you what is taxable. 

Different rules apply if you bought the annuity with pretax funds (such as from a traditional IRA). In that case, 100% of your payment will be taxed as ordinary income. In addition, be aware that you'll have to pay any taxes that you owe on the annuity at your ordinary income-tax rate, not the preferable capital gains rate.

Source:  https://www.kiplinger.com/retirement/602564/questions-retirees-often-get-wrong-about-taxes-in-retirement

The Longevity Factor

 Roberta W. McCain, maverick mother of Sen. John McCain, dies at age 108!

She took to the presidential campaign trail at 96 on behalf of her son, Sen. John McCain of Arizona.

One of the founders of REI equipment coop lived to age 107.

Are you considering the impact of living much longer than you planned for your retirement? Roberta McCain is a great example of the value of single premium immediate annuities to insure against running out of money before running out of breath. 

Forget the 4% guideline in these low interst rate times

Based on past investment returns a 1994 study found one could expect their retirement assets to last 30 years if they took out no more than 4% each year, adjusted for inflation. If you aren't familiar with the 4% guideline for withdrawing assets in retirement, search for 4% rule in this blog. The problem with following this guideline today is that interest rates on bonds and stock returns are much lower than when the study was conducted.

The 4% rule doesn’t apply in today’s low-interest world, said retirement researcher Dr. Wade Pfau who is the author of several books on retirement planning and spending.

"The 4% rule is a rule of thumb that says you can withdraw 4% of your portfolio value each year in retirement without incurring a substantial risk of running out of money." “But interest rates are so low today that’s it’s tough to get up to the 4% withdrawal rate without risking running out of money,” Pfau said."
"Low interest rates are not the only risk to clients’ retirement today, Pfau said. Significant market losses as well as continuing market volatility and uncertainty also can destroy a client’s retirement portfolio. In addition, sequence of returns risk – or the timing of withdrawals from a retirement account – also is a factor in a client potentially running out of money. Withdrawing money early in retirement during a down market means that a retirement account balance may never recover."

Pfau listed four ways to manage volatility and longevity in retirement. They are:
1.    Spend conservatively.
2.    Spending flexibility.
3.    Reduce volatility.
4.    Use buffer assets – avoid selling at losses. Examples of buffer assets are cash, cash-value permanent life insurance and a line of credit on a reverse mortgage.

Annuities can be a good way for retirees to overcome low interest rates, Pfau said. “Annuity mortality credits are not affected by interest rates, and that makes annuities attractive in the low-interest rate environment,” he said.
Putting some of the retirement portfolio in an annuity can enable retirees to increase their withdrawal rate while managing risk, he added.


Get the details from writer Susan Rupe: https://insurancenewsnet.com/innarticle/low-interest-rates-challenge-retirement-investors#.Xqjgq5l7mCg

Worried retirement savers and retirees should consider annuities

Expert: Worried retirement savers should buy annuities

People planning to retire this year should buy an annuity to guarantee future income now because annuity payouts that have been falling because of declining interest rates could fall further, says retirement income expert Wade Pfau "The simple income annuity can fit in for anyone who's panicking about the stock market [and economy]," he says.

Full Story: ThinkAdvisor (free registration) (4/14) 

10 Annuity Tax Facts

Start with: Quiz: How Well Do You Know Annuities?

https://www.thinkadvisor.com/2019/12/16/quiz-how-well-do-you-know-annuities/

How are annuities taxed?
Fixed annuities: each payment is part taxable and part non-taxable.
How is a deferred vaiable annuity taxed during accumulation?
No income tax is owed during the accumulation period; taxes are owed when income is received.
Get all the details at:
https://www.thinkadvisor.com/2019/12/18/10-annuity-tax-facts-you-should-know/

Single Premium Immediate Annuity vs. "Safe Withdrawal" Strategy

"Economist and mathematician Michael Edesess compares a "safe withdrawal" strategy from a 60/40 stock-and-bond retirement portfolio with a single premium immediate annuity of the same value. He found the SPIA offers retirees a bigger monthly payout and decreases their chances of running out of money."

Author/researcher Michael Edesess explains:
"A safe withdrawal rate is the percentage of your assets you can withdraw each year without danger of running out of money, no matter how long you live. The seminal work on the subject was written by financial planner William P. Bengen and published in the Journal of Financial Planning in October 1994."
Bengen asked the question, with a portfolio of 60% stocks and 40% bonds, “What percentage of your starting assets can you withdraw yearly for the rest of your life without fear that you will run out?”
"His answer, based on simulations using past history, was that you can withdraw 4% a year (adjusted for inflation)."

"But in recent years, stock and bond market conditions have changed. Interest rates are historically low. This has caused some researchers to argue that 4% is not a safe withdrawal rate anymore.
In 2013, three researchers found, using their revised stock and bond market parameters, that as low as a 3% withdrawal rate would still mean a 10% chance of running out of money — too big a chance for comfort."

Edesess compared the "safe withdrawal rate" strategy to buying a Single Premium Immediate Annuity (SPIA):  A SPIA "is a financial instrument that guarantees you a consistent monthly income as long as you live."  Don't confuse a SPIA with the "more complicated, expensive, and much less useful annuities with other names, such as variable annuities or fixed-income annuities."

According to Edesess, "My own calculations show that for an investor to be 95% certain of not running out of money with a safe withdrawal strategy from a 60%/40% stock-bond portfolio, the strategy would be to withdraw 3.5% of the initial investment in real (inflation-adjusted) dollars each year."
"If the portfolio started with $500,000, for example, the average annual lifetime income would be $23,000. With the SPIA, the average annual lifetime income would be $33,500, and the certainty of achieving it is greater than 95%."
"Thus, both the certainty of not running out of money, and the lifetime income, are much greater with the SPIA than with the 'safe withdrawal' strategy."

By purchasing a SPIA you are creating your own pension. 

Read the full article at: https://www.marketwatch.com/story/this-one-investment-move-can-give-you-lifetime-yearly-income-in-retirement-2019-04-29

Income annuities increase income while reducing stress for retirees

"Incorporating an income annuity into a retirement portfolio increases income, cuts retirement stress and boosts retirees' confidence, according to a study by researchers Michael Finke and Wade Pfau from The American College. Income annuities lower the risk of outliving savings in retirement without lowering overall income, compared with an investment-only approach, the study found." Retirement Security SmartBrief, April 24, 2019.
"new research including 10,000 simulations show income annuities really do improve retirement outcomes compared to investments alone."
This is according a study commissioned by Principal Financial Group and conducted by Michael Finke, Ph.D., CFP, and Wade Pfau, Ph.D., CFP, nationally renowned researchers from The American College (who are not affiliated with Principal). Check out: https://401kspecialistmag.com/study-by-finke-pfau-shows-annuities-improve-retirement-outcomes/
To learn more about annuities, use the search function in this blog.

Fixed Indexed Annuities AKA Equity-indexed Annuities

Know These 3 Things Before You Invest in a Fixed-Indexed Annuity

"To evaluate whether a FIA is right for you, you need to understand how you'd make money on the investment, how the insurer profits and how and at what point you can get access to your funds" explains David Stone, Founder and CEO of RetireOne, writing for Kiplinger's. He explains: Offering some upside potential with a guarantee against losses, these investments are principally a trade-off: You transfer some risk to the issuing insurance company in return for limited participation in the gains of an index. On the other hand, equities offer more growth, but … they can't guarantee anything."
Who should consider fixed indexed annuities and why? "Because of the low interest rate environment, finance experts like Dr. Wade Pfau and economist Roger Ibbotson have recommended that financial advisers and their clients think of FIAs as another asset class, framing them as an alternative to fixed-income investments like bond funds."
Stone explains the big 3 factors to understand:

• How you earn money with that investment.
• How the insurance company earns money.
• How access to your money may be limited for a period of time.

Read his explanation at:
https://www.kiplinger.com/article/retirement/T003-C032-S014-know-this-before-you-buy-a-fixed-indexed-annuity.html

Check out this article by Jeff Rose from Forbes on Fixed-indexed or Equity-indexed annuities:

Don't Buy A Fixed Index Annuity Until You Read This

https://www.forbes.com/sites/jrose/2015/11/14/fixed-index-annuity/#34ec3fdb5041

FIA: Dream Investment or Potential Nightmare?

Fixed-index annuities are popular — but carry risks

by Jane Bryant Quinn, AARP Bulletin, September 26, 2017
https://www.aarp.org/money/investing/info-2017/fixed-index-annuities-jbq.html 

A Beginner's Tutorial for Fixed Index Annuities

https://www.immediateannuities.com/fixed-index-annuities/beginner-tutorial-fixed-index-annuities.html

How much to annuitize

A significant proportion of Americans are living longer than they anticipated. An income annuity is designed to protect against outliving one's assets. Mark Hulbert answers the question: "Do annuities have a place in your retirement portfolio?" Jeffrey Brown, Dean of the College of Business at the University of Illinois at Urbana-Champaign and director of the Retirement Research Center of the National Bureau of Economic Research describes the role of annuities: “the entire point of an annuity is to insure against longevity risk.”
"What is the right amount to allocate to annuities in your retirement portfolio? The answer, as you can imagine, depends on a whole host of assumptions."
"One clue comes from an analysis conducted by David Blanchett, head of retirement research at Morningstar. His focus was on deferred-income annuities, which differ from SPIAs in that their guaranteed payment begins at a later point. After analyzing more than 78,000 possible scenarios, each one of which represents a different series of assumptions, Blanchett found that the average optimal allocation across all scenarios was 30.52%."
https://www.marketwatch.com/story/do-annuities-have-a-place-in-your-retirement-portfolio-2018-11-14

Immediate Fixed Annuities are path to retirement security and success

Jonathan Clements, a longtime financial columnist and author of books on personal finance, said the "plain-vanilla immediate fixed annuity" is an excellent way to finance retirement, particularly when combined with delayed Social Security benefits. "If you reach retirement age and want regular income and to hedge against outliving your money, buying an immediate fixed annuity could be a smart purchase," he says. (Retirement Security Smart Brief, October 10, 2018). read the full interview by Jane Wollman Rusoff.

Jonathan Clements was a Wall Street Journal personal finance columnist for 20 years, is author of eight finance books, and founder of HumbleDollar.com — serving up a blog, guide and newsletter.

To quote Clements from the article:
"If clients are thinking about making money last through retirement, a combination of delayed Social Security benefits and an immediate fixed annuity could indeed ensure that they’re less likely to outlive their money. The longevity risk is a real risk."

About annuities:
"Unfortunately, the term 'annuity' has an extremely bad name. That’s mostly because of some really atrocious products, specifically, variable annuities with high annual expenses and equity-indexed annuities. But the plain-vanilla immediate fixed annuity is a great product. If you reach retirement age and want regular income and to hedge against outliving your money, buying an immediate fixed annuity could be a smart purchase. However, this is a product that financial advisors don’t tend to sell, in part, because the commissions tend to be very low."
Read the full interview at: https://www.thinkadvisor.com/2018/10/08/jonathan-clements-fund-fees-have-dropped-advisor-f/?slreturn=20180918224750

Are Indexed Annuities Really as Good as They Are Made to Sound?

"Some of the hottest selling financial products currently being sold are called indexed annuities.  They are often promoted as a way to potentially earn double digit returns with no downside risk and no risk of outliving your money.  The insurance reps and supposed advisors that sell them often prey on people’s fears of stock market crashes, unstable economies and rising taxes.  Anytime someone tries to scare you into making a decision or evoke strong emotion to compel you to do something you should BEWARE.  Additionally, if something sounds too good to be true it usually is.  Our experience with talking to those who have purchased indexed annuities as well as some of our own research has led us to conclude that in most cases the returns are usually lower single digit returns comparable to a bond return.  Additionally, the lack of liquidity and flexibility in accessing funds in the annuity often proves inconsistent with many retiree’s income needs.
For more information on this subject we have provided links to two articles that go into greater detail about indexed annuities.  The first is a FINRA Investor Alert.  FINRA is a not-for-profit organization authorized by congress to protect America’s investors and to make sure the industry operates fairly and honestly.  The second is from Fidelity Investments, which operates a brokerage firm managing a large family of mutual funds and provides fund distribution and investment advice along with retirement services, life insurance and wealth management."
FINRA Investor Alert – Equity-Indexed Annuities: A Complex Choice
Fidelity – Indexed Annuities:  Look before you leap
Thanks to Networth Advisory Group for this post. Check out their website and blog: http://networthadvice.com/net-worth-blog/

Turning a nest egg into retirement income

There are plenty of strategies for how to turn your retirement accounts into a reliable income stream at retirement. Walter Updegrave is one of my favorite financial columnists due to the high quality of his research and writing. He answers this question in an article that is short enough to absorb but also includes links to valuable tools and resources. Updegrave leads you through the process of deciding how much monthly income you need, how to determine the amount you'll get from Social Security, clearly explains the basics of annuities, and provides guidance on how to invest in retirement... all in one article! Check out: http://money.cnn.com/2016/11/30/retirement/401k-retirement-income/index.html

Qualified Longevity Annuity Contracts

What is a qualified longevity annuity contract (QLAC)? And why should you care? 
Are you age 70 1/2 or older and facing Required Minimum Distributions (RMDs) from your retirement accounts? Not a bad problem to have! Too much money!
If you anticipate a longer than average lifespan and are receiving sufficient income from Social Security, pensions, and investment returns and "you'd rather not drain your IRA, because you worry about running short when you're older and health costs increase." Then consider a QLAC which "allow savers to defer distributions from a portion of their assets in IRAs or employer-sponsored qualified plans until as late as age 85." Mark Henricks explains that the purchase is irrevocable so you need to consult a trusted fiduciary (financial professional who must put your interests first and foremost) and preferably one who does not sell the product. Learn more at: https://www.thestreet.com/story/13663150/1/how-retirement-savers-are-stretching-their-iras-the-qlac-archipelago.html

Understanding Annuities

Barbara Friedberg explains how annuities work:

1. You purchase an annuity from an insurance company with either a single payment or ongoing contributions.
2. The money in your annuity account grows at an interest rate or predetermined rate associated with a specific market rate.
3. Upon retirement, the money in the annuity account is annuitized — converted into an income stream — or withdrawn in a lump sum.

There are two broad types of annuities: immediate and deferred. Within each of these categories are fixed- or variable-payment options. Read the details at:

https://www.gobankingrates.com/investing/best-annuities-financial-plan/

Make your money last as long as you do

While there are a variety of strategies for spending down retirement investments to try to last for a lifetime, the only sure way to accomplish this is through the purchase of single payment life annuities (SPIAs). Lewis Mandell, Ph.D. explains why annuities are ideal for accomplishing this task in his book "What to do when I get stupid: A radically safe approach to a difficult financial era." See: http://lewismandell.com/. At the same time that our ability to make prudent financial decisions declines with age (after peaking at age 53 and really declining after age 70), confidence in our abilities actually increases! This is a scary combination well documented by extensive research. "The two major questions posed in the book ask how we can generate sufficient guaranteed real income to last the rest of our lives, not matter how long we live and what are the best ways to protect our lifetime income against possible irrational decisions of our future selves" (p. 152). This is a MUST READ for everyone approaching or in retirement AND for their children. I've heard too many stories of how elderly parents were taken advantage of by financial professionals with dubious interests, and by outright fraudsters, draining assets meant for heirs and leaving the adult children to support their parents.

Annuities provide security against living too long

Harold Evensky, a certified financial planner (CFP) who is considered the father of the financial planning industry, used to oppose the use of immediate annuities. But he has changed his mind and now recommends immediate annuities. Evensky considers the immediate annuity "a powerful vehicle that’s virtually the only strategy to ensure maintaining one’s standard of living in retirement." He says: My change of thinking came with the advent of lower cost annuities from firms like Vanguard, TIAA-CREF and others. They’re offering immediate annuities — also known as payout annuities, income annuities, longevity annuities and longevity insurance" as "the only way that investors can manage their mortality risk — living longer — and maintain the income they need for the rest of their lives."
http://www.thinkadvisor.com/2015/03/24/evensky-in-reversal-sees-annuities-as-vital-for-re

Indexed Annuity "over hyped sales madness"

“Indexed annuities are currently the hottest and most over promoted product in the annuity world, and the dream-return scenarios that are too often being pitched are translating into record sales.

I am one of the few people in the annuity world that hasn't drunk the hybrid annuity Kool-Aid because indexed annuities were actually designed to compete with CDs, not market returns. High-income rider percentages veiled as yield along with upfront bonus teasers combine with the false narrative of no downside with market upside . This annuity nonsense has created a toxic formula of over hyped sales madness that is sweeping the country. The fact that Internet, TV, radio, and print promotions go largely unregulated and without repercussion has spawned a new breed of annuity elixir carnival barkers.

Buyer beware is an understatement.” Read: Confessions of an indexed-annuity insider http://www.marketwatch.com/story/confessions-of-an-indexed-annuity-insider-2014-04-29