AnnuitiesTwo different animals!

Deferred or Immediate

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What is an annuity?

• “An annuity is a contract in which an insurance company makes a series of income payments at regular intervals in return for a premium or premiums you have paid. Annuities are most often bought for future retirement income, and can pay an income that can be guaranteed to last as long as you live.”

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Objectives (be able to)

• Understand the BASICS of annuities• Distinguish between

– using annuities to invest tax-deferred for retirement &

– using annuities to provide income during retirement that you will never outlive

• Describe how to shop for an annuity• Know who should NOT buy deferred

annuities

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Annuity: Insurance company contract with 2 distinct phases

• Accumulation phase– Invest tax-deferred during earning years

• Pay-out phase– Pay regular income for life or for specified

period– Payments cease when annuitant (recipient)

dies

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Annuity plans offered through Employers

– 403(b) or 401(k) plans– Limits on yearly contributions– Today our focus is on individually purchased

annuities, NOT employer plans– Similar concepts– No sales commissions when participating in

employer plan

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Fixed or Variable?

• Guaranteed rate of return

• Guaranteed payout

• Insurance product– Regulated by

states

• No guarantee• Return varies

– Based on investment options you choose

• Securities regulated by SEC

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Annuities b/4 & after Retirement

• Deferred– Investment or

accumulation phase– Tax deferred

accumulation

• Immediate– Pay out phase in

retirement– Income for life

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Annuities: Common Features • Contracts backed by insurance company

– Death benefit to heirs if you die prematurely

• No limit on amount you can invest• High Commissions & Fees

– If purchased from salesperson

• No Load or Sales Commissions – If purchased directly from insurance arm of No-

Load MF company• Vanguard, Fidelity, TIAA-CREF, etc.

• Surrender charges (always) in first 6-10 years– on withdrawals of >10% of accumulation value/year

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Accumulation Phase

• Purchased during working years

• Money is invested in contracts backed by insurance companies

• Fixed or variable rates of return

• Penalties & fees for withdrawals b/4 59.5

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Deferred• Purchased with

– Single premium (SPDA), or – multiple payments over a period of years

• Contributions MAY be tax-sheltered– If part of 401(k) or 403(b) plan

• Most annuities purchased with after-tax $

• Earnings are tax-sheltered, until withdrawn

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Types of Deferred Annuities

• Fixed Annuity: your money earns interest at rates set by the insurance company.

• Variable Annuity: the insurance company invests your money in stocks, bonds or other investments you choose.

• Equity-Indexed Annuity: the interest rate is based on an outside index, such as a stock market index. The annuity pays a base return, but it may be higher if the index increases

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Fixed Annuities might be for:

• Individual who – wants guaranteed interest rate (like a CD)

• One co.’s rate as of 03/15/2007 is 4.25% • 5 year lock in so buy when interest rates are high

– wants tax-deferred earnings (CDs don't offer) – has significant assets to set aside for

retirement, and – does not need to access their assets for at

least five years

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Variable Annuities

• An investment in an insurance wrapper– Stocks, bonds, money market investments

• Principal & return are not guaranteed– you may lose some or all of your investment– Trade off security for chance for more gain

• More features & higher fees than fixed ann.

• Regulated as securities by the Securities and Exchange Commission (SEC)

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Equity Indexed Annuities

• Complicated investment for sophisticated investors

• Minimum guaranteed return• Rate of return on your investment is based on an

underlying index such as the S&P 500– One of the most confusing features of an EIA is the

method used to calculate the gain in the index to which the annuity is linked.

• difficult to compare one EIA to another

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Don’t cash out early!

• Penalties for cashing out early– 10% Early withdrawal penalty imposed by IRS

• Before age 59 ½• Withdrawals taxed as ordinary income

• Surrender charges imposed by ins. co.– If funds withdrawn before 5-7 years– Surrender charges (6-7%) decrease over time

• Watch out for salespeople who advise you to switch annuities (churning)– Fees & penalties

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Consider a Deferred Annuity IF

• You contribute the maximum to your employer’s retirement plan

• You fully fund your IRA– $4,000/year or $5,000 if 50+

• If self-employed:– Start a SEP-IRA or SIMPLE plan

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Alternative to Deferred Annuity• “Tax-managed” mutual fund

– no-load, low expense– Managed to reduce yearly taxes

• Manager buys and sells underlying assets strategically to yearly minimize taxes

• Most taxes are long-term capital gains (max. 15%) vs. ordinary income (max. rate = 35%)

– Often require $10,000 minimum

• Exchange-Traded Funds (ETFs)– For lump sum investment– Very low expense ratio

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Summary- Deferred Annuities for investing for retirement during earning years

• Be absolutely sure an annuity is right for you before you buy!

• Do your homework! Read!

• Don’t buy from a salesperson who contacts you

• Don’t pay commissions to salesperson

• Shop the internet

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Questions on Deferred Annuities?

• Investing for retirement by purchasing an annuity (generally with regular payments)

How to Avoid Running out of Money in Retirement

Everything you always wanted to know about Immediate Annuities!

The “payout” phase

Part 2

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Afraid of Outliving Your $?

• Babyboomers are at risk of living long lives and outliving their assets

• Want to spend your last $ the day you die? (or close to it)

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Buy a Lifetime Income

• Immediate annuity – Monthly payments until you die– Fixed $ amount (inflation reduces

purchasing power)

• Generally, you cannot change or stop your payment option once the annuity payments have begun.

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Should you annuitize? How long are you likely to live?

• Living to 100 Life Expectancy Calculator– http://www.livingto100.com/

• Calculate your longevity (Module 1b):– http://www.ces.purdue.edu/retirement/

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Safe Retirement Withdrawal Rate

• Withdraw from nest egg no more than 4-5% yearly ($4,000 payout from $100,000)

• What happens if the value of your investments dives (as did stocks in 2000-2002)?– $1 million in Jan. 2000 = $.5 million in 2003

• Expect irregular, unpredictable investment returns from stocks

• Risk outliving your money

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No Pension ?

• No Problem!

• Create your own “synthetic pension” with an immediate fixed annuity

• Purchase a lifetime stream of income for a lump-sum payment @ retirement

• Provides income security for persons with only defined contribution plans such as a 401(k)

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Immediate AnnuityGuaranteed Income Annuity

• Purchase a guaranteed income stream for life with single payment– From IRA, 401(k), etc. – Tax-Free Rollover to immediate annuity

• Plain vanilla: Regular payments begin at once and last for life– Annual, semi-annual, quarterly, monthly

• If you die early: No benefits to heirs• If you live long: you (& children) win!

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Payment Options

• Straight annuity– Lifetime income for annuitant only

• Installment-certain– For life or at least X years (10-20 years)

• Joint & Survivor– Pay spouses (or other 2 people for as long as

either lives)

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$100,000 SPIA Examples

• Straight annuity (until you die)– $790/month

• Installment-certain (10 years minimum)– Heirs receive payments if you die b/4 10 yrs– $680/month

• Joint & Survivor (lasts as long as 2nd to die)

– $640/month

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Lifetime Annuity Income

• Pros• Can’t outlive your

income• Complement to risky

stock investments

• Cons• No inflation protection

w/ most immediate fixed annuities

• No $ for heirs• Payments depend on

prevailing interest rates @ purchase– 2001-2002 was a bad

time to buy

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Using Fixed Immediate Annuities in Retirement

• TIAA-CREF research study (2000)– 65 year old retiree– Conservative portfolio– 4.5% withdrawal rate– Only 33% chance of lasting 30 years

• Purchase annuity with 25% of assets– 53% chance of lasting 30 years

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Laddering Strategy

• At retirement, purchase immediate fixed annuity with 25% of assets & invest remainder moderately aggressively in growth investments

• After 10 years, purchase second annuity with 25% of assets & continue to invest remaining assets

• After another 10 years, repeat process

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Is an Annuity right for you? From the Federal Citizen Information Center

Answer Yes or No to the following1. Saving for retirement is one of my main goals.2. I do not want to touch my principal or interest until I

am at least 59½ years old. 3. I contribute the maximum deductible amount to my

IRA, 401(k) or 403(b).4. I need an investment that will earn tax-deferred

interest for many years.5. I am retired or very near retirement now. 6. I have a lump sum of money and I want to begin

drawing an income from it. 7. I want immediate return from my investment.8. I want to receive a steady monthly check for the rest

of my life.

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Quiz Results

• If you answered yes to questions 1 through 4, a deferred annuity may be appropriate for you.

• If you answered yes to questions 5 through 8, an immediate annuity may be suitable.

• A trusted financial advisor can help you decide if an annuity is appropriate for you. – Salesperson will earn a commission if you buy. – Read & educate yourself before you talk with

salesperson!

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Tips from the SEC

• Before buying any variable annuity do your homework and compare; evaluate insurance company

• Request a prospectus from the insurance company or from your financial professional, and read it carefully.

• The annuity contract contains: fees and charges, investment options, death benefits, and annuity payout options.

• Compare it to other annuities and other types of investments like mutual funds.

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Escape Clause: How to Dump a Bad (deferred variable

or equity indexed) Annuity• Strategy depends on:

– How long you’ve owned the annuity & amount of surrender charge

• Wait until surrender period expires• Withdraw 10%/year w/o charge

– Tax consequences of cashing out• If owned inside a retirement account, cash out and

reinvest w/o paying taxes• If owned outside a ret. acct. you owe taxes on gain

Kiplinger’s January 2007 @ kiplingers.com

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Annuities and Senior Citizens

• http://www.insurance.utah.gov/Annuities_alert.htm• Senior Citizens Should Be Aware Of Deceptive Sales

Practices When Purchasing Annuities• “Annuity sales to seniors have significantly increased in

recent years. However, as annuity sales have risen, so has a sense of confusion among consumers. This is due, in part, to questionable or deceptive sales practices employed by companies and agents looking to take advantage of uninformed consumers. It is extremely important, when considering whether or not to buy an annuity, to take the necessary precautions in order to make an informed decision that is best for you.”

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Annuity sales pitches to sellers: Who can you trust?*

• “Not all annuities are created equal. Some pay MUCH higher commissions while providing GREAT benefits to your clients. Introducing… a 13% commission equity indexed annuity.”

• Info that puts “clients and customers at your marketing mercy” using “maximum persuasion”

*Probably not the sales person

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“Annuity University”

• “Spend 2 days with me and I will turn you into a premium machine or suggest that you get into a different type of work.”

• Books:– 11 Amazing secrets of outrageously

successful insurance agents– Kick your ‘But’: 18 steps to removing the

obstacles to sales success– Red-hot cold call selling: Prospecting

techniques that pay off

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Dinner Seminar Marketing Concept

• ‘has helped thousands of advisors across the country generate the highest commissions and see more prospects in one month than most advisors see in a year’

• Double your Fun: Sell enough annuities to qualify for both a 5 night stay in Cancun and a 7-night Caribbean cruise.

Thanks to Wall Street Journal writer Jonathan Clements

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Annuity Seller Websites

• Find out the sales pitches to be wary of

• ProducersWeb.com http://www.producersweb.com

• Life Insurance Selling http://www.lifeinsuranceselling.com/

“Baby boomers aren’t driving the economy; they are the economy!Discover how to have better, deeper relationships with aging boomers and older clients!”

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Reporting Unethical Sales

• Blow the Whistle– Contact state insurance & securities

regulators• Utah Division of Securities • UT Insurance Dept. http://www.insurance.utah.gov/

– Regulators may pressure insurer to allow withdrawal w/o penalty

– Help protect other consumers

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Summary

• Annuities come in two basic types– Deferred- for investing for retirement– Immediate- for a retirement income you won’t

outlive– Many different “flavors” with lots of variety

• Guarantees only as good as the insurance company selling the annuity– Caveat emptor!

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Annuity Resources• Morningstar & Lipper- var. annuities

• http://www.immediateannuities.com/• http://www.sec.gov/investor/pubs/varannty

.htm

• http://www.pueblo.gsa.gov/cic_text/money/annuity/annuities.htm

• http://invest-faq.com/articles/ins-annuities.html

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Questions?