Kerry Pechter

Cheat Sheet / Updated 07-03-2023

Assess your personal situation and follow some basic guidelines for determining if an annuity is right for you. After you decide to buy an annuity, figure out how to shop for annuity contracts and how to use one to make your retirement years financially safer.

Article / Updated 06-27-2016

The single-year guarantee fixed annuity is like an adjustable rate mortgage in reverse. With this annuity, the insurance company promises to pay you a certain rate of interest for one year. But each year until the contract expires, the insurance company can raise or (more commonly) reduce that interest rate. The new rates are called renewal rates. At the end of the surrender period, the contract expires. You have to buy a new contract or roll over to it. Be sure you understand your actual rate; an agent or broker may throw a lot of different terms at you, including all or most of the following: The base rate: The interest rate the company pays you the first year The bonus rate: The bonus the company adds to the interest rate in the first year The current rate: The base rate plus the bonus rate The current yield: The interest rate your money will earn over the entire term of the contract if the company does not lower its base rate The guaranteed yield: The lowest possible interest rate you can earn Renewal rates: The rates after the first year A table of renewal rates can tell you whether the company has a history of raising, lowering, or maintaining the base interest rates of its single-year guarantee contracts after the first year. Ask your agent or broker for a renewal rate table, or look up the contract’s interest rate history online. The following figure shows a sample rate table from the Annuity Advantage Web site. (Rate histories are routinely provided to annuity salesmen, but not necessarily to customers.) A table of fixed annuity rates from the Annuity Advantage Web site.

Article / Updated 06-27-2016

Fixed deferred annuities offer safe, but low, returns and tax deferral. Risk-averse investors buy them when they offer higher interest rates than CDs, when the stock market is declining or appears headed for a fall, and when they’ve already parked as much money as possible into other savings vehicles, like employer-sponsored retirement plans. Here are some of the reasons why people buy fixed annuities: Safety: Buying a fixed annuity with a multi-year guarantee (MYG) fixed annuity and holding it for the entire term is a safe, conservative way to grow your money. It’s even safer than a bond or shares in a bond fund because a bond’s price or the share prices of a bond fund can fall in response to rising interest rates. Tax deferral: Annuities, like IRAs and 401(k) plans, grow tax-deferred. You earn interest each year, but you don’t pay taxes on it. The advantage? Your savings grow faster than they would if your gains were taxed every year. The longer you defer taxes, the better — especially if you expect to be in a lower tax bracket in retirement. Stable rates: When you buy an MYG fixed annuity, you know its annual interest rate and the exact worth of your investment at the end of the term. As long as you don’t make withdrawals, the result is entirely predictable. Higher returns when bond-yield curve is steep: A steep bond-yield curve occurs when bonds of longer maturities (like a ten-year Treasury bond) pay higher rates of interest than bonds of shorter maturities (like a three-month Treasury bill). At such times, fixed annuities often pay higher interest rates than CDs. If the owner dies, the assets avoid probate: It’s hard to get excited about a benefit triggered by your own demise, but annuities are famous for them. If you die while owning a fixed annuity, your money goes straight to the beneficiaries on your contract. Because the money doesn’t become part of your estate, it doesn’t go through probate (the legal process), where creditors and relatives can lay claim to it. The option to annuitize: Like all annuity contracts, a fixed annuity can be converted to a retirement income stream. Although this option is the defining feature of annuities, few people know about it or care about it and even fewer use it.

Article / Updated 06-27-2016

Although fixed deferred annuities are a relatively safe investment, there are also reasons why people tend to shy away from them. They include the following: Low liquidity: Generally, if you take more than 10 percent of your money out of your fixed annuity during any single year of the surrender period, you pay a charge. You can avoid charges by buying a fixed annuity with a short surrender period or by using other sources of cash for emergencies. Contracts with longer surrender periods typically pay higher rates, but don’t be lured into tying up your money for longer than you can afford to. Uncertain returns: With single-year guarantee fixed annuities, you don’t know the exact interest rate after the first year. Based on past renewal-rate histories, the rates on these contracts either stay the same or decline gradually after the first year. Rates are especially likely to fall if the annuity offers a first-year bonus. Lower returns when bond-yield curve is flat: When the yield curve is flat — that is, when long-term interest rates are the same or lower than short-term rates, as they were during the mid-2000s — you may get a better rate from a CD. (You can find an illustration of the yield curve in the business section of the Sunday New York Times.) Federal penalty for early withdrawal: If you withdraw money from a fixed annuity before age 59½, you may have to pay a penalty (10 percent of the amount withdrawn) to the IRS. Under certain circumstances such as illness, you can withdraw money from an annuity before this age without a penalty. You may also be able to withdraw the money penalty free by taking Substantially Equal Period Payments, or SEPPs, over a minimum of five years. The penalty is Uncle Sam’s way of discouraging Americans from using annuities and other tax-deferred investments for anything but saving for retirement.

Article / Updated 06-27-2016

A fixed deferred annuity is the insurance industry’s version of a savings account. The annuity helps you earn a modest rate of interest safely, and allows you to postpone the payment of income taxes on your earnings for as long as you want. When you buy a fixed deferred annuity, you’re indirectly lending money — without taking the risk that the borrower won’t pay you back. The process is fairly simple. In most cases, you hand a check to an agent, who sends it on to an insurance company. The insurer promises that your money will earn a certain rate of interest for at least the first year. When it receives your money, the insurance company adds it to its general account (where it pools most of its incoming premiums). It invests that money as it sees fit — usually in safe government securities or high-quality corporate bonds that pay a slightly higher rate of interest than the insurance company pays you. The difference between the rate the carrier earns and what it pays you is known as the spread. The wider the spread, the more money the carrier makes. If one of the carrier’s creditors defaults on its bonds, that’s the carrier’s problem, not yours. The carrier has to pay you back. It gave you a guarantee. The carrier pays you compound interest on your premium, which means that In the first year, you earn interest on your investment. In the second year, you earn interest on your investment plus your first year’s interest. In the third year, you earn interest on your investment plus your first year’s interest and your second year’s interest, and so on. It’s a snowball effect that’s often described as the magic of compound interest. At the end of the term (for example, one, three, five, seven, or ten years), you take your money out.

Article / Updated 06-27-2016

Although insurance companies usually assume your interest-rate risk when you buy a fixed annuity, that’s not always the case. With a market value-adjusted (MVA) fixed annuity, you assume the interest-rate risk. In return, the insurance company can afford to pay you a slightly higher interest rate than it pays on non-MVA annuities (book value annuities). If MVA annuities pay a higher rate, why buy anything else? Because, if interest rates go up and you decide to break an MVA contract to take advantage of a fixed annuity that offers the new rate, you’ll pay a bigger penalty than if you broke a book value contract. The MVA triggers two penalties when you withdraw too much money (over 10 percent, in most cases) from your annuity during the surrender period. Typically: You have to pay a surrender charge (for example, equal to the number of years left in the surrender period) Your account value is adjusted Downward if interest rates have risen since you bought your annuity Upward if rates have declined Keep in mind the effects of interest-rate risk. Suppose you buy a $10,000 bond that pays 5-percent interest per year. Your bond has a face value of $10,000 and a yield (rate of return) of 5 percent. But then calamity occurs. The Federal Reserve’s Board of Governors raises interest rates to 6 percent. Immediately, the market price of your bond drops. Why does your bond lose value when rates rise? Because no one wants to pay $10,000 for a bond with a 5-percent yield when he can buy a $10,000 bond with a 6-percent interest rate! Your 5-percent bond will fetch about $9,260 on the open market when 6-percent bonds are selling for $10,000. The important principle to remember is this: When interest rates rise, the market prices of existing bonds fall.

Article / Updated 03-26-2016

Would you buy an insurance policy today that would cost you about one-fifth of your savings and pay you a guaranteed lifetime income starting at age 80 or so? If you died before age 80, you'd lose your original premium, but if you lived to age 85 or 90, you'd eventually get back much more than you paid up front. What is described above is an advanced life deferred annuity, or ALDA. On the surface, this might seem like a bad investment, but it's not really an investment at all. Instead, it's insurance against the risk that you'll live longer than you can afford to. Indeed, actuaries and economists call it longevity insurance. You've probably never heard of ALDAs. So far, only a few insurance companies sell them. But they're worth considering. In addition to removing your fear of running out of money in retirement, they can make retirement planning easier. They can even make spending money in retirement more fun. How ALDAs work In an unadulterated ALDA, you give a portion of your retirement savings — 10 to 25 percent — to an insurance company in return for a guaranteed specific monthly income starting at whatever age you choose — 75, 80, or 85 years. The earlier you pay for the contract, the better, because your premium will have time to earn in the carrier's coffers and buy you more income later. The later you start receiving payments, the more income you'll get each year, simply because you'll collect your benefits for fewer years. How ALDAs save you money What ALDAs lack in cash value, they make up for in insurance value. You can guarantee yourself much more income at age 80 or 85 by buying an ALDA than by self-insuring — that is, by under-spending or setting up a rainy-day fund that you can use "just in case" you live longer than you expect. Here's a comparison of the two strategies: With self-insuring, you might set aside your own personal old age fund at age 60. For instance, if you put $23,700 in reserve at age 60 and invested it in bonds paying 5 percent per year, you'd have about $80,000 by age 85. You could then buy an annuity that paid $1,000 a month for life. If you died before age 85, your heirs would get the entire reserve. With an ALDA, you'd pay only about $16,000 (according to one company's quote) at age 60 for a lifetime income of $1,000 starting at age 85. That's a savings of $7,700. Why is the ALDA cheaper than self-insuring? For the same reason that homeowner's insurance is cheaper than paying for damage to your home: because most homeowners never file a claim, and their premiums are used to reimburse the few who do. Similarly, the premiums of the ALDA owners who don't reach age 85 — and never file a "claim" — go to pay for the ones who do.

Article / Updated 03-26-2016

A fixed deferred annuity is the insurance industry's version of a savings account. It helps you earn a modest rate of interest safely and allows you to postpone the payment of income taxes on your earnings for as long as you want. Fixed annuities sometimes offer higher interest rates than competing investments, such as CDs (certificates of deposit), because the insurance carrier puts your money in longer-term bonds, which typically offer better returns than short-term bonds. Whenever fixed annuities pay higher rates than other safe investments, they're worth considering. Don't confuse these fixed annuities with immediate fixed annuities, where you pay a lump sum for a fixed monthly payment that can last the rest of your life, a specific number of years, or as long as you or your spouse is living. Characteristics of fixed annuities include: Guaranteed principal: You can't lose your money unless the insurance company fails, which is unlikely if it has a strong financial rating. Guaranteed minimum interest rate: Your money never earns less than this rate, even if the insurance company reserves the right to reduce the rate it gave you in the first year. Annual withdrawals: Most contracts let you withdraw up to 10 percent of the value of the annuity every year with no penalty. If you're younger than age 59-1/2, however, you may owe an IRS penalty. Surrender period and surrender charges: This is the waiting period (one to ten years in most cases) during which you can't withdraw more than 10 percent of your money per year without a penalty or adjustment. Death benefits: If you die while owning the annuity, your money (including the interest you've earned up to your death) goes to your beneficiaries. If you want, you can change the beneficiary after you buy the contract. Income option: You can convert the value of the fixed annuity to a guaranteed income stream (regular payments to you) for a specific number of years or for as long as you (or you and your spouse) are living. Premium requirements: The minimum initial investment for a fixed annuity ranges from $2,000 to $100,000. You can purchase a single-premium contract with one payment or a flexible-premium contract with ongoing payments. If you send in more than one premium, each premium may require the purchase of a separate contract. Fixed annuities have their pitfalls. For example, you may find yourself trapped for years in an investment that pays you less and less interest every year if you get bad advice or don't read the fine print. But, when handled with care, fixed annuities can be valuable because: Your money is safe. You can delay paying taxes on the interest you earn. You have virtually no upper limit on contributions. They often offer higher interest rates than competing investments. They can reduce the overall risk of your investment portfolio.

Article / Updated 03-26-2016

As baby boomers enter retirement age, estate planning and sound investing loom large as they plan for a happy retirement and for leaving their children a legacy. Annuities offer a way to invest your money without the fear of losing it all to the whims of market forces. What is an annuity? Put simply, annuities are investments with money-back guarantees. Imagine a typical investment in stocks or bonds; then imagine that same investment with a guarantee that you'll get your money back with interest after (or over) a certain time period. That's an annuity. Of course, annuities aren't quite that simple. Most annuity brochures and prospectuses contain enough disclaimers, footnotes, and contingencies to keep a dozen lawyers busy. But it's useful, at least at first, to ignore the complexities of annuities and take a high-level snapshot of what they are and how they work. Many people confidently walk the financial high wire of life without a safety net. Others, especially those approaching retirement, feel more secure with a net there to catch them — just in case the tightrope snaps. An annuity is both a tightrope and safety net; it's an investment and insurance against the loss of that investment. Annuities aren't always as exciting as the investment alone (like a tightrope walker without a net), but they're not as risky. Should you get an annuity? This is a not a simple question. The only sensible answer is that certain annuities are right for certain people. If you recognize yourself in any of the following categories, then you should definitely explore annuities further: People in high tax brackets often like deferred annuities because they can contribute virtually any amount of money to the plan and still defer taxes on the gains for as long as they like. Middle-class couples in their 50s who are earning $100,000 or less and have a savings of $250,000 or more but no pension should like income annuities. They have a 50 percent chance that one of them will live to age 90. Financial advisers sometimes put their wealthy clients' money in variable annuity subaccounts (mutual funds) instead of conventional (taxable) mutual fund accounts so that they can defer taxes on any gains they realize when buying and selling fund shares. Pessimists who believe that the gigantic, highly leveraged house of cards (the United States' financial system) may collapse at any time, should like the guarantees that annuities provide. Women are much more likely to need annuities than men. It's true. Women live significantly longer and are therefore at greater risk of running out of savings. Single or widowed women are more likely to be poor in old age than single or widowed men. Many people expect that, in the future, as birth rates in developed countries (the United States, Japan, and much of Europe) fall, and the number of elderly citizens rises, a retirement financing crisis will occur. Women will probably bear the brunt of that crisis.

Article / Updated 03-26-2016

Technically, every annuity has two phases: accumulation and income. During the accumulation phase, you put money in the annuity account (paying all at once or making a series of payments), and it grows tax-deferred. During retirement, you initiate the income stage by converting it to an irrevocable income stream. In practice, it usually doesn't work that way. Most people who buy deferred annuities never formally convert them to income; they just take withdrawals during retirement. And a handful of people buy immediate annuities after age 59-1/2 and start receiving income right away. The purchase stage described below isn't an "official" contract stage. It's added to the beginning of the cycle to articulate the initial steps in acquiring an annuity. 1. The purchase stage (typically starting at age 45 or so): Meet with a trusted agent/broker/adviser to explain your needs; give her time to research the annuity products available in your state. Study the various prospectuses or brochures your broker obtains from the wholesaler, broker-dealer, or carrier; choose the best product. Fill out the contract application; if it's a deferred variable annuity, choose the subaccounts (mutual funds), riders (options), and services you want. Wait while your application is submitted to the insurance company for approval. Sign the approved application and provide a check for the purchase premium. 2. The accumulation stage (lasting from purchase until after age 59-1/2): Manage your subaccounts. If it's a deferred variable annuity, make periodic contributions; if it's a fixed annuity, wait until the term ends and, if you want, roll it into a new contract. Take withdrawals if necessary, knowing that withdrawals may be subject to a surrender charge, income tax, and a 10-percent federal penalty tax if you are under age 59-1/2. If you purchased a "guaranteed accumulation benefit," watch to see whether your account value surpasses or falls short of it. If your account balance falls short, you can exercise your option to take the guaranteed amount. 3. The income or distribution stage (starts at age 59-1/2 and lasts indefinitely). Do only one of the following: Take withdrawals from your contract as needed without converting the assets to a guaranteed irrevocable income stream. Exercise your guaranteed withdrawal benefit, if you purchased one, to receive a guaranteed income for life while maintaining access to your money. Convert your annuity assets to a fixed or variable guaranteed income stream for one of the following: life; either of two lives; or a certain period. Transfer the assets of your deferred fixed or variable annuity to an immediate income annuity and receive guaranteed income for one of the following: life; either of two lives; or a certain period.