Annuity Income: What is the best strategy?
The Annuity Man
There’s a good chance that if you are an adult with some money put away, some agent or advisor is going to try and sell you some type of annuity. Before you buy that dream sales pitch and try and fit that agent’s favorite annuity into your retirement plan, you might want to make sure an annuity of any type is right for you.
Annuities are primarily used for retirement income needs, so you need to be aware of the different types of annuities that can provide those contractually guaranteed payments.
Annuities have a monopoly when it comes to lifetime income. No other financial product can provide payments that you can’t outlive. That’s a fact and a surprise to most “annuity haters.” By the way, your Social Security payment is an annuity structure, and I’m sure you don’t hate that Social Security money when it hits your bank account.
There is not just one type of annuity. There are many annuity products, and they all have unique benefits and limitations. In addition, all annuity types are issued and backed by life insurance companies.
Annuity lifetime income guarantees are transfer of risk strategies. You are transferring the risk of lifetime payments to the annuity company...regardless of how long you live. In other words, there’s no ROI (Return on Investment) calculation until you die. The same is true for pension payments and your Social Security income guarantees.
To find out the right type of annuity for your specific income situation, you only have to ask and answer two questions.
- What do you want the money to CONTRACTUALLY do?
- When do you want those CONTRACTUAL guarantees to start?
From those two answers, then you can choose the right annuity type to provide the highest contractual guarantees.
If you answered those questions with “I need income” and “I need it to start soon,” then you are looking for an Income Now strategy. For income starting within 30 days up to a 1 year deferred start date, a Single Premium Immediate Annuity (SPIA) is the best product choice. A SPIA is an annuity contract and a fixed annuity insurance product issued by a life insurance company.
SPIAs policies can be customized and structured for the income payments to pay for life, or a specific period of time….or a combination of both. For lifetime income guarantees, the primary pricing mechanism is your life expectancy at the time you start the payments. Interest rates play a secondary pricing role.
SPIAs can be used in Traditional IRAs, Roth IRAs, and non-IRAs (i.e. non-qualified accounts). They also can be structured to cover one life or two lives.
If you answered the 2 questions with “I need income” but “I don’t need it to start for a couple of years or more in the future,” then you need to take a look at Income Later strategies.
Income Later annuity types provide a lifetime income stream that can be turned on at a future date that you choose. If that income start date is a minimum of 13 months away and up to 10 or more years in the future, there are 3 different Income Later types (all fixed annuities) to consider.
Deferred Income Annuities (DIAs) - DIAs are the exact same simplistic structure as a Single Premium Immediate Annuity (SPIA), but just deferred for at least 13 months and up to 20 years or more with some carriers. DIAs have no moving part and no annual fees, and are a pure transfer or risk income strategy.
Qualified Longevity Annuity Contracts (QLACs) - This product is a DIA structure, but can only be used in a qualified account like a Traditional IRA or select employer sponsored plans (i.e. 401ks, etc.). Currently, the 2020 funding rules for QLACs is 25% of your total IRA assets or $135,000...whichever is less. Even though you are using your personal IRA type funds, you can structure the QLAC for joint lifetime income with your spouse/partner.
Income Riders - A Rider is an attached benefit to a deferred annuity like Variable Annuities (VAs) and Fixed Index Annuities (FIAs). Even though VAs have internal mutual funds (i.e. separate accounts) as the investment engine looking for stock market returns, the attached Income Rider benefit is a separate calculation and can only be used to calculate the first lifetime income payment. The same applies for FIAs with Income Riders. The index option accumulation value part of the contract is a separate calculation from the Income Rider. Both VAs and FIAs with Income Riders will most likely have a long term surrender charge schedule, but you should be making the buying decision solely on the contractual guarantees that the Income Rider provides. There are a few Income Riders that also provide a death benefit as well.
DIAs, QLACs, and Income Riders can be set up single or joint life. DIAs and Income Riders can be used in all account types (Traditional IRA, Roth IRA, non-IRA). QLACs can only be used in qualified (IRA type) accounts. The contractual guarantees are the same, the only difference is the taxation of the income depending on the account type used.
Rip The Knob or Keep The Knob
Annuity income guarantees are either structured using “annuitization” or “withdrawal” as the contractual way the payments are distributed from the annuity income base.
Annuitization is like ripping the knob off of a water faucet. The water is going to flow. The same goes for annuitization, which is creating an irrevocable income stream. Once you annuitize, those payments are coming. Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), and Qualified Longevity Annuity Contracts (QLACs) are all annuitized structures. Some Income Riders can only be annuitized, but most fall under the “withdrawal” category.
Withdrawal means subtraction in my world. That annuity income stream is withdrawn (i.e. subtracted) from the annuity total. The main benefit of a withdrawal type Income Rider is that it provides more flexibility than annuitization. That doesn’t mean it’s better, but if you aren’t sure you need future income but want to lock in that guarantee anyway...then a withdrawal type Income Rider might make more sense.
With all annuity income types and strategies, you should always shop for the highest contractual guarantees available for your specific situation. That should always be the first filter.
Regardless of How Long You Live
So what is the best strategy for annuity income? In the annuity world, there are no perfect answers, just bad sales pitches! The best buying strategy is to pick the life insurance company that provides the highest number for your income goals, and has the claims paying ability to back up those payment promises.
It’s very important to find and use an objective annuity income calculator or immediate annuity calculator that shops all carriers. Buying annuity income guarantees should be like buying a plane ticket. You punch in your specific parameters in order to find the best deal.
When it comes to contractually guaranteed annuity income, that is the best strategy.