Why Fixed Annuities Are Suitable For Safe Money Needs

There is a persistent misunderstanding on the suitability of fixed deferred annuities. Fixed deferred annuities offer life time guarantees and other benefits that set it apart from other financial products. The tax treatment of deferred annuities is different. If you understand these differences, you will see how these features are attractive to seniors, and more importantly, why fixed deferred annuities can be a suitable part of a senior's financial plan.

Some of the features and benefits include:

1. The ability to elect an income that cannot be outlived at guaranteed rates sometime in the distant future. This is a feature unique to annuities for those who require certainty in the income portion of their portfolio. Insurance companies are stepping up to the plate to fill a need, given their unique capability for insuring longevity risk. Moreover, in addition to specified guaranteed rates, the carriers also generally offer to turn the deferred annuity into an income stream at the customer’s discretion guaranteed for a specific time frame, even life, based on current factors that generally even more favorable than the guaranteed rates.

2. The guarantees of fixed annuities are the primary appeal to an older population, a dynamic that has been universally recognized across the financial services industry. Given their ability to safeguard and insure principal and previously credited returns, insurance companies are again in a unique position to meet the needs of seniors who are concerned about having their principal exposed to market risk. It is the convergence of this age group’s need and the unique ability of insurance carriers that has created the substantial interest in fixed annuity products among seniors.

3. A secondary benefit of annuities is their tax-deferred nature. Accumulating and holding retirement funds in tax-deferred vehicles allows the asset to grow more quickly than would otherwise be the case in a similar, but taxable, vehicle. Due to this significant advantage, Congress has imposed a 10% penalty for taxable amounts withdrawn before age 59 ½ in recognition of the public good of holding these products into retirement years. The tax treatment of deferred annuities lead to a significant proportion of owners over age 59 ½. Insurance companies have designed products in conformity with the tax laws and in response to the market demand for the product by those who have the most to gain from the benefits of these products.
While some casual observers may indicate that already-tax-favored funds such as IRA money and pension funds should not be held in an annuity because they are already tax favored and, therefore, there is no benefit to the use of annuity, they forget that it is the guarantees and longevity insurance that drive the use of the annuity in these situations.

4. Penalties for early withdrawal are common among financial products and annuities are no different. Still, most annuities include a variety of withdrawal provisions, some of which provide substantial withdrawal rights without penalty…and without exposure to loss of principal through market risk. Among the circumstances that commonly allow for early withdrawal of the entire proceeds without penalty are death, terminal illness, nursing home confinement, Required Minimum Distributions and unemployment. Furthermore, most fixed annuities also allow for a specified annual withdrawal amount without penalty. Most common is a 10%-of-accumulated-value penalty-free annual withdrawal, but other options may include interest (often cumulative) or a specified annual percentage amount that accumulates annually. No other accumulation vehicle allows the owner to make withdrawals prior to the end of the penalty period without penalty fees or market risk to the asset. Surrender penalties are clearly spelled out in the contract.

5. The maturity date of the contract is also commonly misunderstood. A maturity date is a term of the contract required by state law and it is often the last date by which the funds must be dispersed. This legal requirement also ensures that the annuity complies with federal tax laws. Generally surrender charges will be over before the maturity date is reached—in many cases long before the maturity date is reached. As indicated earlier, in most cases there is liquidity each year and in many cases the client is able to convert the proceeds to a stream of income before the maturity date without penalty.

6. In addition to tax-deferral, there is another significant tax benefit to recipients of Social Security benefits that causes the annuity to be particularly beneficial to older individuals. Social Security benefits can be taxed on up to 85% of the benefit amount at the client’s marginal tax rate if their income is above a certain provisional level. This is true even if the income is left to accumulate in a vehicle such as a CD or is generally considered to be tax-free as with municipal bond interest. Not only do returns left to accumulate in a deferred annuity escape current taxation, they do not count in determining whether, and to what level, Social Security provisional benefits will be taxed. This is a significant benefit to customers, and especially middle-class retirees who derive a significant percentage of their income from Social Security, not currently consuming all of their assets for living expenses.

7. Finally, because an annuity is a contract it generally passes to heirs through beneficiary provisions rather than through the probate process. For those without a will, this is one way in which assets can be passed to a named beneficiary not subject to the intestacy provisions of the state and without the delays and costs associated with state probate. Since the cost of probating assets for a decedent can be significant, again, especially for middle-class retirees, this is another benefit to a senior wise enough to have some of his or her assets in a fixed deferred annuity.

In the end the two most important maxims for suitability are:
1. Target safe money needs, not age or demographic.
2. Diversify products as well as risk by putting savings or investments into more than one financial product.