Five Times When An Annuity Makes Sense


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

My recent blog posts,  as well as on this platform, discussed the advantages of arranging assets early – ten years or more before retirement – to lay the groundwork for an income-tax free retirement.  Many experts believe it’s time to dump the stock-market-based approach in favor of an insured retirement solution – see Time To Rethink the 401(k).

Planning for an income tax-free retirement is very doable for many people, though not everyone, to be sure.  I’ve even posted a recorded webinar on this subject (Note:  It’s about an hour long; so get some coffee and get comfortable).

Then there’s the Obama administration’s Green Book, which I discussed last week, detailing budget and tax proposals for the coming year.  It leaves little doubt, if there was ever any, that the government will be looking at all types of retirement vehicles (401(k)s, IRAs, Roth IRAs, etc.) – vehicles the government created, regulates, and is therefore in a position to write the rules.  You can see that post here.

Of course, there are other insured solutions, designed to address the issue of longevity risk – we do seem to be living longer; and, some are worried that their money won’t last as long as they will.

Last week, Rich Lane of  Magellan Financial outlined five reasons annuities can make sense, especially for financially conservative investors who want to build and protect their assets.   He was talking about fixed annuities (which is good – I must admit I am  not a great fan of variable annuities; but, that’s another story.

6a017c332c5ecb970b01a3fd41160b970b-320wiThose who remember losing money back in the economic downturn are often  interested in a vehicle that has a guaranteed minimum rate of return – something few alternatives offer; and that’s one of the reasons why the fixed annuities industry is seeing strong sales growth.

Fixed deferred annuities can provide a predictable future with flexible payout options that offer a guaranteed income stream, and those earnings aren’t taxed until the funds are withdrawn.  In effect, they are treated as a source of income, just like a pension.  So you can think of it as your own “pension” that you fund yourself.

A deferred indexed annuity – a fixed annuity with an interest crediting rate that’s linked to an outside market index of some type – can be “turned on” before or after retirement to create a liquid stream of income.    When you think about it, how many investments do you know of — other than a fixed annuity — that can provide a predictable and guaranteed stream of income?

Banks?  Maybe.  But, during the Great Depression, banks across the country closed.  Insurance companies thrived (risk management is their business).   Bonds?  Maybe.  But, governments seem to habitually spend beyond their means and you face interest rate risk when it’s time to reinvest at maturity.  Bond ladders can reduce this risk; but, few people in their second decade of retirement want to spend their time tracking the bond markets.

Here are Rich Lane’s five reasons an annuity might make sense for you:

  1. Safety: Fixed annuities can ensure that if anything should happen to you, your surviving spouse has a source of continued income in place.  This can help in case of a catastrophic illness or if there should ever be a need to enter a nursing home.
  2. Liquidity: Today’s challenging economy has heightened interest in liquidity.   Many hesitate to make long-term financial commitments without flexibility and access to funds – even if it means creating an income stream should they need it.
  3. Tax deferral: The tax benefits of fixed annuities are important to many.  Because earnings will not be taxed until withdrawals are made or regular distributions start, annuity owners can benefit from triple compounding: earning interest on principal, interest on interest, and interest on tax savings.
  4. Control: Another appealing aspect of fixed annuities is the ability to choose a predictable income stream.  Lifetime income options provide clients with the control of selecting payments that are guaranteed to continue for life.
  5. Wealth transfer: Financially-conscious investors tend to be keenly focused on what happens to their money after they pass away.  Annuities can bypass a lot of red-tape and provide greater control over outcomes.

It’s worth remembering that no investment, vehicle, or strategy will be right for everyone; and no investment or vehicle should be regarded as “the answer” to all your needs.  Creating a retirement strategy is more like assembling a puzzle.  There are always trade-offs.  The key is not to get blinded by single issues; it’s really about finding the mix of solutions that create a master strategy for accomplishing your prioritized goals.
Do you know how much risk is embedded in your current investment and retirement portfolio?  If you’d like to find out your risk number, you can begin here.


Are YOU a Target in the Green Book?

Last week we heard from many experts who believe it may be time to dump the 401(k).

Two weeks ago we discovered that many experts, like retirement guru and CPA, Ed Slott and former US Comptroller General David M. Walker, believe income taxes are going up – I even conducted my first-ever webinar on how you might be able to plan for an income tax-free retirement.

(You can access a recorded version here.  Be aware: There’s a lot of information, so it lasts about an hour).

This week, I want to tell you about the Green Book.   The Green Book is what the administration releases every year, detailing budget and tax proposals for the coming year.   The Obama Administration released their latest version in February, detailing their proposals for the fiscal year beginning this October.

Surprise:  Many of the Green Book retirement planning proposals are aimed at limiting taxpayer use of tax-advantaged qualified retirement plans and IRAs.

Maybe you’d like to view that recorded webinar, after all.

This proposal should cause some concern because many who have contributed to retirement plans throughout their working lifetime and hit the proposed “retirement savings cap” will lose the ability to make future contributions and lose matching contributions provided by an employer.

By the way, under the Green Book proposals, after-tax contributions to an IRA could not be converted to a Roth IRA.

As many experts recommended in the second video featured in last week’s post, the current system might be better replaced with an insured solution, taking market-risk off the table and potentially removing much of the legislative risk, as well.

What the Green Book proposals would do.

According to David Cordell, PhD, CFP®, CFA, CLU®, and Thomas Langdon, J.D., LL.M., CFA, writing for the Journal of Financial Planning, these are some of the key proposals:

  • Raise the capital gains rate from 20% to 28%
  • Treating gifts of appreciated property (this would include your investments) as realized gain, requiring the payment of capital gains tax
  • Reducing the estate and generation-skipping transfer tax exemptions from their current level of $5.43 million to $3.5 million with (ready?) no inflation indexing
  • Reducing the lifetime gift tax annual exclusion from $5.43 million to $1 million. Eliminating the IRC Sec. 1014 “step-to” basis provision and replacing it with a $100,000 per person exclusion at death – the “steps” can be down, as well as up.

How this might impact your planning:

The “insured solution” may be where much planning is headed.  The Green Book proposals might make life insurance policies designed for cash accumulation even more attractive than they already are, for both individuals and businesses.

The most significant changes in the Green Book include:

  • Eliminating “stretch” IRAs by requiring non-spouses to distribute inherited IRA funds within five years.
  • Depriving individuals with more than a specified amount in their retirement accounts from making contributions to retirement accounts – they’re currently projecting this figure to be about $3.4 million, which could be expected to produce an annual income of $119,000 before taxes with a comfortable margin of safety using a 3.5% withdrawal rate while allowing for inflation adjustments. The figure, however, could vary – the government will let you know.
  • Repealing the special exclusion for net unrealized appreciation for lump-sum distributions of employer securities from employer plans.
  • Requiring plans to expand eligibility requirements to include part-time employees who worked at least 500 hours per year in three consecutive years, and
  • Limiting Roth conversions to pre-tax dollars

[Source:  Journal of Financial Planning, May 2015]

If you missed my webinar, you might want to take a look now.  Grab a cup of coffee, a pad and pen – you’ll be taking notes – and see what you might be able to do to secure your future and remove, as much as possible, government intervention from the picture you have of your 30+ year retirement.


Did You Think Trusts Were Only for the Wealthy?

Jim Lorenzen, CFP®, AIF®

6a017c332c5ecb970b01a5116fb332970c-320wiWhen most people think about estate planning, they think about protecting assets from estate taxation.  But, most people aren’t worried about that liability.

You may be surprised to learn that the upper middle class, defined as clients with between $500,000 and $5 million in investable assets can also benefit from estate planning.    There are other issues, many never think about.

If you are concerned with any of the issues on this checklist below you may need an estate plan:

See if any of these are of concern to you:

  •        Do you have concerns about family members or beneficiaries that cannot manage their financial affairs?  In this case the estate plan can contain a trust to prevent these beneficiaries from squandering their inheritance, protect them from creditors, predators, lawsuits, and divorces.
  •        Are you recently divorced, or your spouse has recently died?
  •        Are you in a second (or later) marriage and/or have a blended family?
  •        Do you have a disabled child or beneficiary?  In this case the plan needs to be carefully structured to be sure that your disabled child or beneficiary continues to receive their crucial governmental benefits, because even a modest inheritance can cause loss of important benefits such as health care and housing.
  •        Do you have  a family or closely held business or hold  an interest in such a business?
  •        Do you want  to minimize the costs of administration of your estate (financial affairs) if you should become disabled or pass away unexpectedly?
  •        Do you want to leave money and things of value to people you care about?
  •        Are you looking to benefit charities or causes that matter to you?

It is possible to create an estate plan using trusts affordable for middle class families dealing with the issues mentioned above.  If these issues are of interest and you don’t have a written plan in place, I may be able to provide you some guidance and assistance.  Just call my office at 802-265-5416, extension #1.

Does Time REALLY Reduce Risk? Don’t bet on it.

You’ve seen this chart.  Advisors have been using it – or something like it – with clients and prospective clients for years.   It’s supposed to educate you.

It doesn’t.

Image_Rolling Period Returns_001

The chart is designed to address the issue of risk by showing that it’s time, not timing, that reduces risk for the investor.  After all, as you can see, a 50-50 stock and bond portfolio might go down 15% if held over one year; but, should expect a ‘downside’ risk of +5% if held twenty years.

While it may be true that the volatility of long-term outcomes may be reduced, it actually means little in the real world.

Patrick Kelly, in his book The Retirement Miracle, talks about the story of Tom who had been contributing to his 401(k) plan for years, riding the market ups and downs, and finally feeling good about the $2.5 million he’d accumulated in November, 2007 on his 64th birthday as he looked forward to retiring the following year.

On the day he planned to retire in November 2008, he walked into the office finding a lot of commotion.   During the next three days his $2.5 million was at $2.2 million.  By October 7th, it was down to $1.5 million – down about $1 million in 12 months.  His dreams of traveling with his wife had gone up in smoke.

The chart above didn’t let him know that when you’re one year away from retirement, you aren’t looking at the 20-year data anymore; it’s the one-year data that may be more relevant.

Now, obviously, the 2008 market meltdown was an extremely rare occurrence, and one arguably caused as much by (and that’s being generous) elected officials as anything Wall Street did; but, the lesson is no less worth learning:  Managing the downside becomes critical as time passes and we get closer to the time we begin to draw-down on assets.

‘Nuff said.


You can begin your planning here!   Let me know if I can help.