Personal Pensions: Repackaging The Annuity
August 21, 2006 | By Lisa Smith
For most people, the ideal retirement involves getting a steady check without going to work. In recent years an increasing number of privately-funded corporate pension plans have closed and experts are predicting more will follow. In other words, the ideal retirement is becoming more difficult to obtain. The trend in retirement planning is for investors to "do it themselves". Fixed deferred annuities provide a way for investors to build their own pensions. In this article, we'll show you how to determine whether annuities are right for your retirement plan and how to make the most of them.
Fixed deferred annuities are contracts with a life insurance company that guarantee a specific (fixed) interest rate. Usually, the rate on these annuities is fixed for an initial period, but after this time they are adjusted periodically. Some fixed deferred annuities can be funded with a lump sum deposit, while others can be funded with either a lump sum or multiple deposits over time. Both varieties offer a guaranteed interest rate, a guaranteed return of your principal and tax-deferred growth until you withdrawal the money. (For more insight, see Exploring Types Of Fixed Annuities and An Overview Of Annuities.)
Annuities have two phases, the accumulation phase and the annuitization phase. The accumulation phase begins when you put money into the annuity. During this phase, the money grows tax deferred. This tax-deferred growth can be a major benefit because, once they retire, most people find themselves in a lower tax bracket. Being in a lower tax bracket means that you will pay less in taxes on the money earned in your annuity when it is paid out to you during retirement than you would have paid on those earnings if they weren't tax deferred.
The annuitization phase begins when you start taking money out of your account. Some fixed deferred annuities permit you to begin making withdrawals at age 59.5, but in the United States, the Internal Revenue Service does not require you to begin taking distributions until age 70.5. Even then, once you take the required minimum distribution, you can let the remainder of your money continue to grow tax deferred. Even during the annuitization phase, you have a measure of control over taxes by controlling the amount that you withdraw each year, as your earnings are taxed only when they are taken out of the annuity.
When most investors hear the word annuity, they automatically think of it in terms of an income stream for life. While that is certainly one option, it's not the only way to take money out of an annuity. Instead of entering a payout phase where a specific amount of money is sent to you on a regular basis, you can instead choose to withdraw money as needed. You can also select a lump sum payment, but this is generally not a good idea due to the tax liability on the earnings. (Choosing your payout option can be a major challenge, so before making a decision, read Selecting The Payout On Your Annuity.)
Renewed Interest In Fixed Deferred Annuities
High fees and early-withdrawal penalties historically have made fixed deferred annuities unattractive for most 401(k) plans. As a result, many investors save for retirement by investing in mutual funds and then roll their money into an annuity as they near the time when they want to turn their savings into an income stream. Recent attention to the massive shift from company-funded, defined-benefit pension plans to employee-funded defined-contribution plans has revived interest in the use of annuities in 401(k) plans, and spurred the development of some new products. (For more information, see The Demise Of The Defined-Benefit Plan.)
In both the deferred annuity and the variable annuity areas, there have been new products released, which are aimed at providing more retirement options. MetLife's Personal Pension Builder and Genworth Financial's ClearCouse are just two examples of the new and innovative plans available. The new plans offer more flexibility in payout terms and the ages at which payouts can begin compared to traditional plans. (To learn more about variable annuities, see Getting the Whole Story on Variable Annuities.)
These more flexible, less expensive products provide a way for 401(k) plan investors to build their own pensions by purchasing a guaranteed income stream for life, either via monthly contributions or a lump sum. On the downside, it can be difficult to tell exactly how much you are paying in fees. You can't change your mind once you annuitize - if you die young, your beneficiaries may get less than the full value of your account.
Like all trail-blazing new products, the current selection is limited, as are the benefits they provide. Of course, if investors embrace these offerings, other providers will get on the bandwagon and roll out their own offerings as well. Increased competition sparks increased innovation, which means that the next generation of these investments should be even better.
Before You Buy
If adding a guaranteed check to the mix of investments in your retirement planning portfolio sounds good to you, the time is right to begin investigating the benefits annuities can offer. Start by investigating the products offered by major insurance companies.
It is important to note that insurance companies do not have Federal Deposit Insurance Corporation coverage, so it is important for your provider to be in business when you retire. Since 1995, 76 insurance companies have failed according to Weiss Ratings Inc. While, theoretically, insurance companies must have enough money set aside to cover their financial obligations in the event the firm goes out of business, faith in corporate trustworthiness is at all-time low courtesy of Enron and other scandals. Why take a chance on an unknown or poorly-rated firm when ratings services make it easy to find strong companies?
In addition to choosing your provider carefully, you must also be sure to read the annuity contract, as each contract is likely to have different fees, interest rates, withdrawal rules and other policies.
By Lisa Smith http://www.investopedia.com/articles/retirement/06/pensionannuities.asp