Blog Layout
Annuities and the Retirement Income Process
Keith Fevurly, Esq., CFP® Investment Advisor Integra Financial, Inc • September 18, 2020
Unlike life insurance, which provides financial protection against dying a premature death, an annuity provides protection against living too long. Thus, an annuity is insurance designed to provide for the possibility of an individual or retiree outliving his or her income, known in insurance language as the risk of “superannuation”. An annuity product’s inclusion as a payment option in an employer-sponsored retirement plan has been encouraged by recent legislation. Essentially, any employer plan must include an illustration of what an annuity payout would look like if the participant chose to “annuitize” his or her retirement income distribution.
Annuitization is the process of converting an accumulated capital sum, usually at the date of retirement, into a level and regular stream of annual payments. The process is designed to eliminate what is known as “longevity risk” or the “risk of superannuation”, the possibility of outliving one’s money and not dying until after one’s projected life expectancy. An annuity to begin payment after the date of retirement is an “immediate annuity” used in the process of “immediate annuitization”. Often, an employer-sponsor of a retirement plan, particularly a pension plan, will purchase a commercial annuity with the accrued benefits of the plan, thereby transferring the risk of future retiree payments to an insurance company. The default risk associated with non-payment is, as a result, transferred from the balance sheet of an employer to the balance sheet of the insurance company.
Despite the obvious advantage of the immediate annuity in the elimination of longevity risk, most Americans have traditionally not favored the annuity product and process of immediate annuitization. Why? The primary reason for rejecting the form of payment is the loss of control over the retirement assets. Specifically, the “annuitant” (person entitled to the annuity payments) may require a considerable sum of retirement funds to pay for a medical emergency. Whereas annuities often provide for a “guaranteed lifetime withdrawal benefit” (GLWB) of a percentage of funds (for example, five percent of the income base) as an alternative to annuitization, this may not be adequate to meet the financial needs of the annuitant. Annuities sold-in-the-past specified the forfeiture of the capital sum (the “principal”) of the annuity if the annuitant died before collecting the total sum. This has now been remedied by present-day annuities where a death benefit is offered to a named beneficiary. Indeed, a special form of annuity payment option, a “qualified joint and survivor annuity” (QJSA), must be offered to some married participants of an employer-sponsored plan. If a plan requires a QJSA, a married participant opting for a single-life payout of the retirement assets at the time of distribution, must get the written consent of a named beneficiary to waive the joint form of payout.
Other perceived problems with the immediate annuity form include:1) if fixed in amounts payable (as is usually the case), such payments are not adjusted for inflation; and 2) low interest rates (as is currently the case) will lower the amount of payment. Still, the immediate fixed annuity form is often purchased to protect against the possibility of a “bear market” in stocks; that is, such annuity purchased by the retiree will typically cover his or her basic living expenses so that stocks do not need to be sold at a potential loss and reduce the growth of the retiree’s portfolio. For this reason, as well as to implement portfolio diversification, most financial advisors recommend that no more than half, usually less, of a retiree’s investment portfolio consist of an immediate (or variable) annuity.
Annuities may be categorized in several ways, but most investment advisors differentiate annuities by the time and method of payment: an immediate fixed or deferred variable annuity. An immediate fixed annuity makes payments immediately, or within one month from the purchase date of the annuity, and in a fixed or pre-determined amount. Such an annuity is often used by a retiree as an alternative to a reverse mortgage and tends to be “qualified” for tax purposes, meaning all annuity payments are currently taxable (since the annuity was purchased with “before-tax dollars”, either by an employer-sponsor of a retirement plan, or from a rollover IRA established by the annuitant). In contrast, a deferred variable annuity is purchased by a pre-retiree to provide variable payments at the time of the individual’s retirement date. As such, the pre-retiree may increase payments over time through the growth of the annuity’s account value in mutual fund sub-accounts. The variable form of annuity, for tax purposes, may be payable either from qualified funds (such as a rollover IRA) or non-qualified funds, where the “after-tax dollars” expended to purchase the annuity are recovered tax-free by the annuitant during the time of retirement. Both types of annuities provide for a death benefit to the heirs of the annuitant, a feature that is common to insurance products generally. But, unlike a traditional life insurance policy, the death benefit payable from an annuity is income-taxable!
Historically, annuities, particularly deferred variable annuities, have not been recommended by investment advisors because of the high cost of the annuity. The argument goes that a variable annuity is nothing more than a “mutual fund wrapped in a life insurance shell”! Thus, if wanting to invest in mutual funds, a retiree, particularly one that does not need life insurance protection, should merely invest in the mutual fund without the death benefit protection and cost. There are also additional costs incurred with the purchase of “riders” associated with most annuities. However, a major advantage of a deferred variable annuity is that the pre-retiree is permitted to save a large amount of cash and not pay taxes on either the cash or the income generated thereon until a much later date. The annuity can then be used as a supplement to Social Security and personal savings in generating needed retirement income. Moreover, to encourage the inclusion of an annuity as a source of retirement income, the SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 made it easier for an employer to offer an annuity in a retirement plan without fear of employer liability for possible underperformance.
A final, and increasing-in-popularity, form of annuity is a deferred income annuity, a type of which was introduced by the Obama administration: the QLAC or qualified longevity annuity contract. A deferred income annuity is a type of insurance contract whereby, in exchange for a lump sum payment, the insurance company promises to make a monthly payment to an individual beginning at some future point of time. In such manner, the individual (known as “the annuitant”) is insured (guaranteed) against running out of money during his or her lifetime. The annuity payment can begin at any point in the annuitant’s future, including in his or her early 80’s when many long-term care payments are initially needed. Moreover, the assumed interest rate used to calculate the amount of deferred annuity income is generally higher than prevailing bank certificate-of-deposit (CD) or Treasury Bill rates.
A “qualified longevity annuity contract” (or “QLAC”) is a type of deferred income annuity funded with proceeds from a tax qualified retirement plan, such as a 401(k) plan or IRA. Under current law, an individual must begin “required minimum distributions” (or “RMDs”) no later than April 1st of the following the year in which he or she attains the age of 72. A QLAC is a retirement strategy whereby a portion of the RMD for the annuitant is deferred until a certain age (currently, the maximum is age 85). The main benefit of the QLAC is a deferral of taxes that is otherwise due on the RMD. The maximum age of 85, which may be chosen by the annuitant, also corresponds nicely to when the annuitant may need the RMD for the payment of long-term care expenses. Under current rules, an individual can expend the lesser of 25% or $135,000 of their employer-sponsored retirement plan or IRA to purchase a QLAC.
If you are interested in using an annuity as a source of retirement income in your portfolio, please contact either Willis or Nick of our office.
Happy New Year! We hope you had a wonderful holiday season and wish you prosperity, good friends, and good health for 2025 and beyond. We are pleased to report that the broad Morningstar index increased by 24.09% for the year and 2.57% in the fourth quarter. The "growth" segment of the market, particularly companies like Apple, Microsoft, NVIDIA, Amazon, Alphabet, Meta, and Tesla, has been a major contributor to this performance. Together, these seven companies are valued at approximately $17.92 trillion, which represents around 44.80% of the S&P 500. Their performance remains a significant driver of broader market trends. Several key events have recently influenced the financial landscape: The post-election “Trump Rally.” Bitcoin's significant rise, recently reaching around $100,000. Potential tariffs and their uncertain effects. Government debt interest payments surpassing defense spending, ~$1 trillion vs ~800 billion respectively. A notable increase in government employment in 2023, with 709,000 jobs added, a jump from 299,000 in 2022 and 392,000 in 2021 (source: www.bls.gov). The establishment of the Department of Government Efficiency (DOGE). The full impact of these events is still unfolding, but potential risks to market stability include tariffs, government debt, and the new DOGE department. While tariffs could have far-reaching effects, it is important to recognize that the policies discussed during campaigns may not align with actual implementation. Government debt may not pose an immediate concern, but over time, the bond market may react to the growing debt load, leading to necessary spending cuts. Though such measures could be painful in the short term, they may be necessary for long-term economic stability. The potential impact of the Department of Government Efficiency remains unclear. Elon Musk’s restructuring of Twitter (now X), which resulted in the elimination of thousands of jobs, has been seen as an effort to increase efficiency. Historically, the closure of government departments has been rare; the only significant example occurred during the Carter administration, when Alfred Kahn successfully dismantled the Civil Aeronautics Board (CAB), leading to lower airline prices and more travel options. Overall, we expect the companies we monitor and invest in to remain profitable. Despite potential disruptions, 2025 is likely to be another positive year for the market, though some volatility or "jolts" along the way should be anticipated. Enclosed is our annual privacy notice (mailed letters). Additionally, if you would like a copy of our ADV, it is available on our website or can be sent upon request. Lastly, I want to express my gratitude to Kathy, Nick, Keith, and Alison for their excellent work. Please feel free to contact us with any questions or concerns. We remain committed to providing the best financial advice to support your well-being. Sincerely, Willis Ashby, President Integra Financial, Inc. 5105 DTC Parkway, Suite 316 Greenwood Village, CO 80111 303-220-5525 / 303-689-0973 FAX Bureau of Labor Statics, Wall Street Journal, 1 st Trust, Morningstar, Zacks Research, Co-pilot &/or ChatGPT
I hope you had a wonderful summer and are enjoying weather similar to what we have in Colorado. The Morningstar broad index rose by 3.59% this quarter and is up 19.65% for the year. In a long-anticipated shift, value stocks—such as Costco, Comcast, and Home Depot—have outperformed growth stocks like Google and Amazon. The growth sector, which has led the market for so long, is now seeing stretched valuations and limits to growth, making the value side increasingly appealing for investment. As we focus more on value investing, it’s rewarding to maintain a diversified portfolio that includes both value and growth stocks. Reflecting on the past year and beyond, I’ve been reminded that “the market climbs a wall of worry.” It can be challenging to invest when headline news seems discouraging, but I’ve witnessed this pattern often enough to firmly believe that the best strategy is to enter the market and stay invested. Many of you who have been with us for a decade or more can attest to the benefits of this approach. Viewing investments through a long-term lens—thinking in decades rather than years—helps manage the inevitable market fluctuations. I don’t want to come across as overly optimistic, but there are positive signs: inflation is declining, incomes are rising, and personal savings rates are up. Gross Domestic Product (GDP) is also on the rise, with many corporations exceeding their earnings expectations. Historically, during periods of high inflation, like the Carter years, the stock market has proven to be an effective hedge against rising costs. As expenses—wages, goods, and taxes—increase, the value of stocks tends to follow suit, as corporations pass these costs onto consumers while striving to maintain their profit margins. Nick, Keith, Alison, and I are closely monitoring various factors that could impact the market and your portfolios. As always, we’re keeping an eye on the overall economy, particularly monthly employment numbers. Currently, over 60% of new jobs are in government or government-related sectors, which is less favorable than if the majority were in the private sector. The Federal Reserve has recently lowered the Fed Funds Rate by half a percent, a move prompted by falling inflation that appears to be trending toward the target rate of 2%. This reduction has been celebrated on Wall Street, as it lowers the cost of borrowing, benefiting both businesses and the government. Another trend we’re addressing is the stock-to-bond ratio in your portfolios. The stock side has grown much faster than bonds, for example, an initial 50/50 allocation is now closer to 60% stocks and 40% bonds. To rebalance your portfolio, we will sell some stocks and buy bonds to return to the desired ratio that best suits your investment strategy. In closing, I want to emphasize the importance of being vigilant with your online activities. The number of malicious actors attempting to hack personal information is increasing daily, so please take precautions. If you have any questions or if your financial situation changes, don’t hesitate to reach out. Alison, Keith, Nick, Kathy, and I appreciate your trust and are here to support you. Willis Willis Ashby, President Integra Financial, Inc. 5105 DTC Parkway, Suite 316 Greenwood Village, CO 80111 303-220-5525 / 303-689-0973 FAX
Salary-reduction-type retirement plans have, for some time, permitted so-called “hardship distributions” or “hardship withdrawals” prior to a participant’s retirement date. Salary-reduction-type plans include Section 401(k) plans available to for-profit employees, 403(b) plans for not-for-profit employees, and 457(b) plans for State and local government employees. Generally, such distributions are includible in a participant’s income and are subject to an “early distribution 10 percent penalty”, unless an exception applies.
Inheriting Traditional or Roth IRA Proceeds:
Some points to consider: 1) Likely the biggest distribution question that a 401(k) participant asks is: should I rollover the proceeds to an IRA or retain it within the 401(k), assuming the plan sponsor allows that? There is no certain answer to this question, although in the majority of situations, it is preferable to roll the proceeds because of participant control of the account. See Willis, Nick, or Keith to begin the paperwork for a Rollover IRA.
Greetings! We hope this letter finds you well. As you head into the heart of summer, we hope you're ready to make the most of the season. Whether you're planning a relaxing vacation, enjoying outdoor activities, or simply basking in the summer sun, we wish you a season filled with joy and memorable moments. Let's dive into the latest updates from the financial world.
As usual I hope this finds you well. As we welcome spring and having just finished the first quarter, things look good. The broad Morningstar index was up 10.24% through 03-31-24. The large cap companies led the way up 11.08% and the small caps up 5.69%. The S&P 500 experienced 22 “all-time highs” with less than 2% drops in-between. Amazing!
I hope you had a safe and enjoyable holiday season. For the first time since COVID we were able to have our entire family together, including the Australians, it was very nice. I hope yours was as enjoyable. The top news stories of the year were the rapid rise of interest rates effectively slowing inflation without crashing the economy:
After the bruising market in 2022 where the broad index was down 19.43%, we are in a better place. Year to date the Morningstar broad index is up 12.81% but down 3.19% for the quarter. That said, we have a lot to keep our eyes on. On the positive side, consumer spending is remaining robust, and the Biden administration passed their TRILLION-dollar spending bill, corporate profits are slowing but still positive, unemployment is a low 3.6% and the Fed again passed on raising interest rates.
I hope you had a wonderful 4th of July celebration. We have a reading of the Declaration at our gatherings, it is always amazing to me to hear how many people under 30 saying they didn’t understand what was declared and to whom it was sent. After the declaration we (our founders) wrote our Constitution taking the best from the Magna Carta of 1215 and the English Parliament’s Bill of Rights of 1689. We have a lot of issues in our country but when you look at our beginning, it is amazing!