Annuities have been around for centuries as a way to create a retirement income stream. Yet they’ve taken heat in recent years due to bad products or unscrupulous companies corrupting their image. In our higher interest rate environment, annuities are back in the spotlight, but what exactly are they, and how might they work inside an overall financial plan?
Annuities are long-term financial products sold by life insurance companies to provide individuals with income for a fixed period of time or for life. The differences lie in the ways they’re funded and managed, when they begin paying out and for how long, and whether they have any special provisions. Annuities have certain fees and charges, the amount of which depends on the product and the optional benefits you choose to purchase. Also, you don’t pay taxes on your earnings until you are ready to take distributions from the annuity. Keep in mind that the distributions are subject to ordinary income taxes and, if taken prior to age 59½, a 10% IRS penalty tax. Surrender charges may also apply.
Immediate annuities1 are funded with a lump sum of money and, as the name suggests, the owner begins receiving income immediately. These payments can last for a predetermined number of years or for life, depending on the contract.
Deferred annuities can be funded all at once or through premium payments over time. Income payments to the owner are deferred until a future date and can also last for a set period of time, or for life.
Fixed annuities guarantee2 the interest rate by which they grow will remain steady. If it is 4% the day the contract is signed, it will be 4% the day of the very last payment. This structure hedges against market volatility and makes the owner’s income very predictable. However, since the interest rate is fixed for the life of the annuity, which could be years or decades, the owner may miss out on returns that could potentially be earned by other financial products if they performed well.
Variable annuities3 invest their funds in stocks, bonds, and other assets. Therefore, they have the potential to achieve a higher rate of return. However, like other investments, there is also a risk of value loss. Some annuities offer index-linked investment options. These investment options are linked to the performance of a stock market index such as the S&P 500.4 Variable annuities are offered by prospectus that can be provided by a financial professional. The prospectus outlines the investment objectives, risks, charges, and expenses that should be considered before making a purchase decision.
Payment schedules and value accumulation strategies are combined by insurers so they can offer annuity products to suit various needs. A company may sell an immediate fixed annuity, a deferred variable annuity, or several other combinations. Annuity contracts can be further customized through the addition of optional riders that can be purchased for an additional fee. Common riders may include guaranteed income riders, death benefit guarantees, cost of living increases, and long-term care riders.
Interest rates have been on a precipitous rise in the last year as the Federal Reserve has attempted to slow inflation. For a financial product like a fixed annuity, this means today’s higher rate could be locked in for years to come, which may appeal to some buyers.
At the end of 2022, SECURE Act 2.0 was signed5. It simplified the rules around moving money out of a qualified retirement plan and into a QLAC (Qualified Longevity Annuity Contract). A QLAC is a deferred annuity that can be lump-sum-funded with up to $200,000 from a 401(k), IRA, or other qualified account. (You cannot fund it from a Roth IRA.)
Why do this? Tax-deferred retirement account holders who have yet to retire are required to begin taking distributions at 73 years old, though with SECURE Act 2.0, that age will increase to 75 years old by 2035, at which point required minimum distributions (RMDs) will be taxable. Withdrawal requirements are calculated by an IRS formula based on the value of the account and life expectancy.
Moving $200,000 from an account subject to RMDs can decrease the account’s value and, hence, the RMD calculation, which may help your IRA last longer or rebound from a volatile market. QLAC owners, not the IRS, choose when to start receiving their payments and can delay them for almost as long as they want, allowing their account to continue to grow. Because you are losing control of the money, this strategy isn’t for everyone, but it may be worth discussing with a tax advisor if you are in good health and don’t need the money right away.
Retirement can last a long time, and the reputation of the issuer of long-term financial products can’t be overemphasized. Since you may depend on annuity income for decades, you want to feel confident the issuing company you’ve chosen is steady and reliable.
New York Life is one of the oldest and largest life insurance companies, founded in 1845. Their annuities have been elemental in the retirement incomes of countless individuals. Today, they offer immediate income annuities, guaranteed period contracts, and deferred products6. Whether you want to start receiving income right away, need fixed-rate guarantees, or are willing to combine some guarantees with the potential of earning dividends later, there are options to suit different strategies.
A financial strategy’s primary goal is to accommodate your personal needs and preferences. Ideally, you’ll hold several types of accounts and products to achieve diversification. When used together, these jigsaw pieces should fit together to create a clear retirement income picture.
Annuities can work for people concerned about outliving their money, guarding their savings against market volatility, and protecting loved ones with a death benefit. But they aren’t one size fits all. It’s best to discuss your needs with a knowledgeable financial professional to understand the most efficient ways to use an annuity as well as the benefits and costs of buying one.
If you suspect an annuity may complement your financial strategy, talk to a New York Life financial professional. Together, you can examine your whole retirement strategy to determine if an annuity might help meet your future income goals.
1Fixed Annuities are subject to contract terms, exclusions and limitations, and the claims paying ability of the issuer. This contract is irrevocable, it has no cash surrender value, and no withdrawals are permitted prior to the income start date. Income payments are guaranteed at least as long as the annuitant is living, provided the annuitant is alive on the designated income start date. Contracts in which a life only payout option is selected do not provide a death benefit either prior to, or after, the designated start date.
2Guarantees are based on the claims-paying ability of the issuer.
3The variable investment options offered within variable annuities are different from mutual funds that have the same name, advisor, investment objective, and policies, as well as substantially similar portfolio securities. Also, these variable investment options are subject to market risk, including possible loss of principal.
4The S&P 500® Index includes 500 large cap stocks from leading companies in leading industries of the U.S. economy, capturing approximately 80% coverage of U.S. equities. The S&P 500® Index does not include dividends declared by any of the companies in this Index. S&P® and S&P 500® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”).
5Microsoft Word - Eye on Congress Secure Act 2.0 - 1-30-2023 - FINAL (2).docx (newyorklife.com)
6Annuities are issued by New York Life Insurance and Annuity Corporation (“NYLIAC”), a Delaware Corporation and its parent company, New York Life Insurance Company (NY,NY). Variable annuities are offered through NYLIFE Securities LLC, Member FINRA/SIPC, a licensed insurance agency and New York Life company.
This article is provided for general informational purposes only. Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.
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