Annuities Put You in Control of Your Retirement Income Stream

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Dynamic energy of success.  A stream of money falls from the sky.
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Since the early 1980s, 401(k)s and individual retirement accounts have become the dominant way that workers save for retirement. Yet many workers long for the days of traditional pensions when you could set your watch by how much income you could count on every month after your retired. Many people like that the pension fund (if it did as promised) would pay them and their spouses for the rest of their lives. To be fair, those old-style pensions had some serious flaws:
  • It was difficult and sometimes impossible to port with you when you left the company. Depending on the program and how it was administered, you could be left without a pension and without the money in the pension fund if you left the company before a certain number of years.
  • You didn't control the asset base that created the income. After you and your spouse pass away, the income stream from the pension fund stops, and your estate gets no cash from the fund. This was even if both spouses passed away early and collected very little of the pension.
  • It was difficult to impossible to access any of the cash inside of the pension prior to actual retirement.
With the 401(k) and most other qualified plans, the flaws of the pension were in large part put to bed.
Now you have the full right to withdraw or roll over your portion of your 401(k) when you leave the company. You control the asset base, so when you and your spouse die, any remaining balance left inside of your qualified plan will go to your estate. It is easier to access your account via loans -- assuming you abide by terms laid down by your plan administrator and your employer.

As is often the case when you fix a flaw in something, that repair caused a new set of flaws to emerge. With 401(k)s and IRAs, the burden of guaranteeing income and performance is shifted to the employee. This means that if you are invested in the market, then in good markets you could win, and bad markets you could lose.

Wouldn't it be great if you could combine the benefits of pensions, 401(k)s and IRAs? Consider annuities. Annuities are offered through insurance carriers to take in big chunks of money and guarantee a payout over a certain period, based on that sum used to purchase the annuity. There are two types of income structure:
  • In the immediate annuity, income is started from the lump sum immediately after the annuity purchase.
  • In the deferred annuity, your lump sum can grow before you activate the annuitization phase. This structure will result in more monthly income from the extra growth and the number of years the insurance company will have to pay out on the contract.
Once you decide on what kind of payout you want, then you have three basic choices:
  • The fixed annuity will guarantee your principle never loses money in the market and guarantee modest growth during the growth phase. That rate might be 2 to 3 percent, so this is for the extremely conservative investor who believes in the old saying "I am more concerned about the return of my money than the return on my money."
  • The variable annuity will go up and down based on the movements of the chosen market (usually the stock market). This product is more for the market player who believes we are in for a bull market during the annuity contract years.
  • The fixed indexed annuity will guarantee your principle is not lost, but your growth is not guaranteed. The growth will depend on which market index or indexes your annuity follows, such as the Standard & Poor's 500 index (^GPSC).
With many annuities, you can add riders. The most common is the lifetime income rider, which for an annual fee will guarantee your future retirement income will increase every year regardless of the market's rise or fall. As the name implies the insurance company will also guarantee your annual income for the rest of yours and your spouse's life. This income will be guaranteed even if the underlying funds in the annuity are drawn down to zero.

Your 401(k) and IRA can be used to purchase an annuity with no taxes or penalties. Annuities do have potential pitfalls.
  • They are not very liquid. There can be substantial penalties if you withdraw the original purchase price from the contract during a certain period. This penalty will usually graduate downward to zero. This penalty will be determined by the carrier and the product, and it will vary by state.
  • Potential annual fees are inherent. Many fees can be reasonable and bring value (such as the lifetime income rider), but some fees buy you very little value and get prohibitive. Fees are generally higher with variable annuities due to their active money management. Make sure you are comfortable with the fees and know what you receive in return.
Do your research and don't be rushed by a sales pitch.

John Jamieson is the best-selling author of "The Perpetual Wealth System." Check out this week's featured video.

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13 Comments

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drmike15

"With 401(k)s and IRAs, the burden of guaranteeing income and performance is shifted to the employee."

Caveat emptor is neither a logical nor just way to care for an ever growing population of seniors. Pensions as I recall had enormous corruption (even organized crime) issues but the solution wasn't to destroy pensions, it was more open, transparent, and democratically controlled pensions. I won't even mention how many jobs now have no 401K plan (much less an employer match) to speak of. If you are on the wrong end of this class divide you're living paycheck to paycheck, amassing more and more debt, and have little hope.

April 22 2014 at 3:24 PM Report abuse rate up rate down Reply
bobktmfs

Like all investment types, these do come with some risks that every person needs to consider. Sure there are pros and cons for all of them. Just keep your eye on them. You can learn even more about this type of investment at http://www.mutualfundstore.com/annuity/annuities-good-investment-option. This doesn't have to be the only option you pursue, but it can be one.

April 15 2014 at 10:09 PM Report abuse rate up rate down Reply
chelsea.fox1

I think this article was just meant to sell annuities. Saving in your 401K and getting a company match (free money) always makes sense. Annuities are also very expensive. I am all for the cheapest financial products that get the job done. For instance Vanguard has excellent performing mutual funds with the lowest fees in the industry. Why throw your money away on anything else unless you are an expert...

You can also save way more for retirement if you save money on other financial products. For instance my husband and I just got two term policies for about $30 a piece a month, now we know our kids are safe and we can sleep at night, AND we can save more to our retirement accounts. I am not paying higher fees for the lower return of an annuity.

March 20 2014 at 10:26 PM Report abuse +1 rate up rate down Reply
Robert Cook

As a senior 79 AARP has an annunity that pays 8.4% fixed return on $100,000 fixed for life through New York Life you have to pay $1345. interest tax per year on a fixed payment of $701.00 per mo. what's left after your passing goes to who ever you pick in your will. who cares what the fees if any are as long you have a fixed income for life, that's better than 0.10% at the banks.

March 20 2014 at 5:15 PM Report abuse +1 rate up rate down Reply
kolblh

I have fixed annuities for the last twenty years at three percent and sleep well at night. I was also in blue chip stocks, Enron, etc., and lost heavyly from late ninties to 2008 when I got out in the nick of time. I'm in my eighties, living well, and haven't needed to draw any money from the annuities so far. Include your age in planning your investments and never gamble your retirement money. The rules are simple, avoid greed.

March 20 2014 at 4:55 PM Report abuse +1 rate up rate down Reply
1 reply to kolblh's comment
classof68gto

I have invested in the stock market since 1980 and have done extremely well. There are bumps along the way but the stocks always come back.

March 20 2014 at 11:17 PM Report abuse rate up rate down Reply
Artie

Annuities, which are sold by insurance companies, as noted above, can be part of an overall retirement plan. Generally, you are looking to exchange a lump sum for a fixed payment over some extended period of time like your lifetime or some period like 10, 15, or 20 years. Or, you may also be looking to accumulate extra money for retirement on a tax deferred basis not unlike a 401K or IRA except you generally won't get a tax deduction for this. An annuity might be useful if you come into some extra cash that you want to put away for retirment and you already maxed out on your retirement plan contributions to your 401K and IRA's, for example. There are some decent annuities, however, they vary widely as do their provisions.. Regardless, they tend to be relatively complex, come with a lot of hidden fees that can rob you of investment returns had you just invested wisely on your own. They have all have insurance costs and management fees.Then there are early withdrawl penalties, tax considerations and surrender charges that decline in the early years of ownership. The amount of surrender charge can vary depending on which company you bought the annuity from and the type of annuity (e.g. fixed or variable). . Anything that provides a guarantee of your prinicipal or provides a guaranteed rate of interest has an addtional cost of insurance. This is why their yields tend to be less than other investments. You are paying for this insurance. They can offer some people a reasonable rate of return and some piece of mind. However, there is no ONE perfect investment instrument out there.

March 20 2014 at 4:27 PM Report abuse +1 rate up rate down Reply
evd10

1. What is the commission being paid at inception?...What difference does it make?

2. What happens if I want all my investment back in less than 5 years?...You'll take a beating,so don't buy an annuity unless you can leave the money alone until the early withdrawl penalty period expires.

They're not a scam, but you've got to know what you're buying. A defined benefit pension is nothing more than an annuity.

March 20 2014 at 1:29 PM Report abuse rate up rate down Reply
SPQR

annuities can be great but interest rates are so low you can't even keep up with inflation. Retirees are being screwed so badly they will all end up out on the streets. A good pension was the answer...but they are gone :( unless you work for the feds or the state but they too will be gone

March 20 2014 at 11:24 AM Report abuse rate up rate down Reply
sadvokat

Study after study concludes that pensions were a better deal for employees than 401(k)s. Even the financial community is coming around to that conclusion. Pity the author of this light look at annuities didn't dig a little deeper.

March 20 2014 at 8:25 AM Report abuse rate up rate down Reply
Oyster

Before in invest in an annuity, ask 2 questions-

1. What is the commission being paid at inception?
2. What happens if I want all my investment back in less than 5 years?
That should end your interest in these scams.

March 20 2014 at 8:16 AM Report abuse +1 rate up rate down Reply
1 reply to Oyster's comment
mewinsplnr

The commission is a 1 time cost/payment that is paid by the insurance company, yes the insurance company recoups that cost over time, but you are not charged. However, when you pay for a fee for service (a new type of annuity) the fees always add to more than a 1 time commission.

March 20 2014 at 6:05 PM Report abuse rate up rate down Reply