Talk to your co-workers about an annuity and you’ll likely get one of three answers: 1) “It’s a great investment,” 2) I am so glad I didn’t buy into one,” or 3) “What the heck is an annuity?” The third answer is apt to come from younger associates, since this financial product appeals mostly to those 50 years and older seeking less risk in funding upcoming or current retirements.
First let’s look at the “what”: An annuity is a relatively low-risk insurance product offering a predictable, guaranteed stream of future income. Specified payments are made by a life insurance company to the insured (the annuity investor) either in a lump sum, annually, quarterly or monthly, often for the recipient’s lifetime.
The two basic annuity plans include a deferred annuity, in which the investor takes future payments, usually during retirement; and an immediate annuity, in which payments start right away.
While the “yeahs” of an annuity are low-risk and a guaranteed, tax-deferred revenue stream, the “nays” include its high expense, compared to direct investment in mutual funds, money markets, stocks and bonds. Essentially annuity investors are paying for insurance on their investments, since risk shifts from investor to the insurance carrier.
New Jersey’s Difficult Approval Process
In New Jersey – versus all other states, except New York – another downside of an annuity is the difficulty involved in getting it approved, states Bradley Bofford, a Certified Financial Planner™ (CFP®) with Financial Principles in Fairfield. “New Jersey is one of the toughest states for insurance companies to issue an annuity,” Bofford explains. “Each state has its own insurance commissioner, and almost all approve a national carrier’s various products. But New Jersey quite often requires a separate contract for insurance products – including annuities, riders and various optional benefits – even from national carriers.
For example, if a carrier is rolling out a new product available to most of the US as of December or January, in New Jersey that product may not come online until February, March or later, if at all. And/or, if the product offers a five percent deferral rate, New Jersey may approve just four percent.
“Eventually, most big insurance companies gain approvals in New Jersey, but more slowly and/or with watered-down benefits,” Bofford says.
Annuities vs. the 401(k) and IRA
The common denominator between an annuity and other retirement products such as a 401(k) and IRA is tax-deferred growth. And for all three, investors typically face penalties for withdrawal prior to age 59½.
From there, things change: Annuities are taxed on their gains, while a 401(k)and IRA are taxed on total distribution.
For example, Bofford explains that if a $100,000 annuity gains $50,000 over the years, and the investor age 59½ or older makes a withdrawal, he or she pays taxes only on the money earned – the $50,000 gain – not on the original investment. But investors of the same age making withdrawals to a 401(k) or IRA are taxed on the total investment to date, including growth.
In addition, for the latter two products, the government imposes a required minimum distribution at age 70½, but most annuity carriers allow investors to defer payment past that age.
Non-Traditional Annuity Products
The financial industry continues to develop new and innovative solutions that meet a wide range of investor needs. For example, “those seeking a higher level of guaranteed income either now or in the future than what a traditional annuity offers can consider a variable annuity, which features predictable growth without stock market exposure,” states Rodney Allain, senior vice president and head of sales for Prudential Annuities®.
For investors seeking income growth and protection, Prudential also offers a “Highest Daily” variable annuity benefit. “This product provides a solid starting baseline of guaranteed income, equity upside potential and downside market protection, along with the ability to lock in gains every time they happen to increase investors’ guaranteed retirement income,” Allain says.
And for those saving non-qualified dollars for retirement, Prudential offers tax-deferred solutions to help manage the impact of taxes associated with portfolio rebalancing and year-end portfolio distribution.
A wide range of educational platforms, including interactive websites, videos and calculators, help Americans better understand today’s retirement landscape, and the options available to them.
“As with any investment, we encourage people not only to educate themselves, but to work with a trusted financial advisor,” Allain states.
Allain adds that an advisor can help with annuity decisions as well as everything from the ins and outs of Social Security; the growing complexity of healthcare in retirement; the tax implications of where and when one retires; and the financial strategies for successfully funding a retirement.