How to Make Annuities Work If You Keep Working

How do you take advantage of annuities when you aren't retiring and won't need the boost in income they provide?

Well, you have a few options.

Annuities can help retirees maintain a steady stream of income after they've left work, but that isn't the only way annuities can work for you. Unfortunately, you kind of have to reach that retirement decision before you pull the trigger on an annuity.

"If I have an annuitized distribution, but I'm not retiring… that annuitized distribution is going to keep coming in anyway," says Ken Nuss, founder and CEO of AnnuityAdvantage in Medford, Ore. "It seems to me the annuitization was a past event assumed in the question. If that's the case, not sure what you can do. You're going to have taxable income."

Though that doesn't necessarily have to be the case. Eric Meermann, a certified financial planner, enrolled agent and vice president at Palisades Hudson Financial Group in Stamford, Conn., says that a Section 1035 Exchange allows a cash-free like-to-like transfer between different types of insurance products.

"If you have a cash value built up in a variable annuity or a whole-life insurance plan, you can roll it up and do a 1035 exchange to a different type of product," Meermann says. "For people who have expensive variable annuities, we'll go to Vanguard or Fidelity and get them a very low-cost annuity and roll it into that."

If you're continuing to work into retirement age and have plenty of funds, a whole-life insurance plan may be more expensive than you need. In that situation, Meermann advises using a 1035 exchange to transfer the cash value of that plan into a Vanguard variable annuity -- an annuity he typically isn't a big fan of. That move will allow you to invest in equity market and earn a higher rate of return than what they're getting from the insurance company. Just be careful, as some insurance companies have surrender charges that go into effect if you such an exchange.

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"There's no tax consequence, but that doesn't mean there's no fee," he says, noting that those fees often diminish over time. "If you had another year to go until you avoid the fee, you might want to hold off."

However, if you haven't yet annuitized a contract, you're in luck. For one, you can continue to hold onto it as a deferred annuity. That will continue tax deferral while maintaining the flexibility to annuitize at a later date or withdraw to supplement income or for emergency needs. By remaining with fixed deferred annuities, you can access some funds monthly or annually if needed.

"You can annuitize only if or when you want increased cash flow," Nuss says. "Most importantly, you remain in control of your principal with a deferred annuity, which makes them ideal for maximizing principal protection and minimizing taxes until you want income."

There's also the possibility of entering a Qualified Longevity Annuity Contract (QLAC). That option is available as an annuity, and allows postponement of distributions (including required minimum distributions) on either 25% of your IRA or $125,000, whichever is less. By postponing distributions, you reduce your taxable income in each year of deferral and increase your lifetime income whenever you opt to set a start date, which can be as late as age 85. Without a QLAC, you'd have to start taking required minimum distributions from your IRA, 401(k), SEP or other retirement account at age 70.5.

"If you don't need the income, distributions cause two problems: they erode the value of your retirement accounts and increase your taxable income," Nuss says. "A QLAC works for people who want to keep more of their retirement plan intact and tax-deferred."

The QLAC's deferred income annuity is designed to meet specific IRS requirements that qualify it, and the money in the QLAC is excluded from assets on which future distributionss are calculated. For instance, at age 75, $125,000 in a QLAC avoids $5,459 in distributionss you'd otherwise have to accept. At age 80, you'd be exempt from $6,684 in distributions. The downside is that, as with any deferred income annuity, you're no longer in control of the principal with a QLAC. The upside? You can choose an individual or a joint lifetime payout, with the latter paying out income until the second spouse dies. There's also a cash-refund option, in which beneficiaries can get a lump-sum payout for any of the initial deposit premium not yet paid out at the death of the the person who started the annuity.

Also, the $125,000/25% limit is per person, Nuss points out. For example, if one spouse has $600,000 in an IRA, up to $125,000 can go into a QLAC. If the other spouse has $350,000 in and IRA, $87,500, or 25%, could go into a QLAC.

Lastly, you could simply move money to a deferred income annuity (DIA) that isn't a QLAC. That guarantees future income at whatever age you'd like, creates no taxable income between the purchase date and starting age and doesn't confine you to a starting date. Even if you don't want to take distributions at age 85, you won't have to.

"Consider deferred annuities with guaranteed lifetime income benefit riders," Nuss says. "These typically are more flexible than a DIA regarding the ability to choose your income activation date, but they do come at a cost to actual underlying policy performance."

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