While you research annuities on the internet as part of your investigation of retirement options, you will see a long list of ads and columns from financial advisors warning you about the pitfalls of investing in a product that provides guaranteed income for life.
The writers will discuss taxes, the complexity of annuities, the supposed difficulty of transferring money to heirs, and the threat of high fees.
They imagine retirees as gluttonous consumers who gorge themselves on a feast of annuities to the exclusion of all other options – and who woozily regret their decisions the morning after.
These commentators don’t distinguish between types of annuities – and they are using the wrong analogy.
Create your own retirement
Planning your retirement diet should be like creating the perfect ice cream sundae. You build a combination of flavors based on your own preferences. You might like vanilla ice cream, a dollop of whipped cream, and a tablespoon of crumbled peanuts. If you are like me, you will make sure a hefty helping of hot fudge is poured over the whole thing.
That’s how retirement planning should be: A mix of elements that fit your lifestyle over the course of what we hope is a long retirement. You wouldn’t plan to hold 100% cash and expect it last you for the next 30 years, and if everything is in stocks and bonds you stand a chance of losing a large portion of the holdings when you need it most.
No reasonable person would advocate putting all of your retirement savings into annuities, either. But if they account for, say, 30% of the calories — just like that sundae — you will enjoy the result.
Six reasons to consider income annuities
Here are the reasons I put forth for making income annuities part of your retirement mix.
- Distributions (either required or voluntary) that you make from an IRA or a 401(k) are taxed as ordinary income at your highest tax rate. So dividends and capital gains that might otherwise enjoy favorable rates in your personal investment account are taxed at double the rates. So when you are in a distribution phase, you might as well invest your IRA/401(k) savings in financial instruments that give you the highest secure cash flow – and that’s an income annuity.
- Everyone should plan to spend down their rollover IRAs or 401(k) accounts because, when left to heirs, they are taxed as ordinary income. Use money from those accounts to buy income annuities and leave heirs your personal investment accounts of stocks and bonds, which escape income tax at your passing.
- Retirees looking for safer investments will find dramatically higher cash flow from income annuities than from bond funds. That higher cash flow will free up your savings from risky withdrawals, and enable you to take a longer view on your returns.
- Deferred income annuities can be bought at a significant discount before or early in retirement to pay for late-in-retirement expenses like health care. The cash infusion late in retirement can help you stay in your home and preserve your assets for your heirs.
- A deferred income annuity called a Qualifying Longevity Annuity Contract, or QLAC, can be purchased with savings from your 401(k) or rollover IRA, which eliminates taxable required minimum distributions on the amount of the purchase. The income later in life can pay for deductible medical or long-term care expenses.
- When you need long-term care for one member of a couple, investment in income annuities can provide income for the partner who continues to live at home – while the ill spouse qualifies for Medicaid.
So next time your research turns up all the arguments against income annuities, analyze the retirement menu the critics are trying to feed you. The alternative — a portfolio of stocks and bonds, topped off with income annuities — is a diet anyone can consider.
If you have questions about annuities and how they might help meet your retirement objectives, write to me at Ask Jerry.
Or if you’d prefer to do more research on your own, take a look at the useful tools and information we offer in our Current Income Learning Center.