Fixed Annuities for Different Retirement Income Needs
With more than 10,000 baby boomers crossing the retirement threshold each day, an increasing number of retirees and pre-retirees are turning to fixed annuities for greater predictability and security in their retirement income. Fixed annuities—known for safety of principal, competitive yields, tax-deferred earnings, and guaranteed income—have been a mainstay of retirement planners for decades. They are also one of the only types of investment vehicles that can manage longevity risk with a guaranteed lifetime income stream.
Over the years, annuity providers have expanded the reach and appeal of fixed annuities by creating products that address the various preferences and needs of today’s retirees. Here is an overview of four of the more popular fixed annuity products available.
Multi-Year Guaranteed Annuity
Also referred to as a “fixed rate annuity,” Multi-Year Guaranteed Annuities (MYGAs) are like traditional fixed annuities in every way except for their multi-year rate guarantees. Traditional fixed annuities typically offer a one-year rate guarantee, after which the rate is set by the insurer based on the performance of its general account portfolio. With a MYGA, you can lock in a rate for a specific number of years, starting at two years and for as long as 10 years.
In exchange for a multi-year commitment, contract holders can lock in a higher rate—the longer the commitment, the higher the rate lock—than they would receive from a traditional fixed annuity. MYGAs are often presented as a certificate of deposit alternative for people who seek a higher rate and have a long-term time horizon for their money.
Like CDs and traditional fixed annuities, MYGAs have a surrender period during which early withdrawals are penalized (surrender charge). However, like most types of deferred annuities, most MYGAs allow up to 10 percent of the surrender value to be withdrawn each year without penalty.
Single Premium Immediate Annuity
Single Premium Immediate Annuities (SPIA) are the vehicle of choice for investors who covet predictability and security throughout their retirement years.
In exchange for a lump sum premium payment, a SPIA provides a fixed monthly payout for the lifetime of the annuitant. The payout amount is based on the current age and life expectancy of the annuitant, so the older you are when you start a SPIA, the higher your monthly payout. Although you cannot access your principal once you start a SPIA, your principal is paid out over your lifetime as part of the monthly payout. Payouts can be based on a single life, joint life, or a period certain.
When included as a part of an overall investment portfolio, an SPIA provides the foundation of an income strategy upon which a range of investments can be layered to create capital growth and increasing income.
Deferred Income Annuities
Deferred Income Annuities (DIAs) are a more recent innovation capturing the attention of financial planners and retirees who want to maximize future income while protecting against extended longevity. DIAs can be especially effective for retirees who have no need for an immediate income stream, but who anticipate a bigger need for income in the future.
A DIA is sometimes referred to as “longevity insurance” because it can be set up to turn on an income stream at a much later age. The advantage of a DIA over Single Premium Immediate Annuity is that the same amount of monthly payout can be purchased with less capital because of the time that passes between the premium deposit and the payout.
Using current interest rate and actuarial assumptions, the amount of future payout can be substantially higher than current monthly payouts because the insurance company assumes a shorter period for monthly payments later in life. The amount of future payout is also affected by the continued accumulation of capital that occurs prior to the commencement of the payout.
Investors may purchase an option upfront that provides for a death benefit to be paid to a beneficiary if the investor dies before receiving any of the payout.
Qualified Longevity Annuity Contract
Like a DIA, Qualified Longevity Annuity Contracts (QLACs) were created for the specific purpose of addressing the risk of longevity (outliving your income). A QLAC provides a guaranteed lifetime income in exchange for an upfront investment, except that, instead of paying the income out currently, it is deferred for a period of time, usually about 20 years but no later than age 85.
The primary difference between a QLAC and a DIA is that a QLAC can be purchased inside a qualified retirement plan. This is significant for investors facing potential, unwanted Required Minimum Distributions (RMDs). When a QLAC is purchased inside a 401(k) or a Traditional IRA using retirement funds, the year-end balance is reduced by the amount invested in the QLAC. The yearly RMD calculation is then based on the lower fund balance. The amount that can be invested in a QLAC is limited to 25 percent of the fund’s balance or $125,000 (adjusted each year for inflation), whichever is less.
As with DIAs, QLACs do not have cash surrender value. Once your money is invested, it cannot be accessed except through future income payments. However, it can be purchased with an option for a single-sum death benefit or a return-of-premium option that can be paid before or after the annuity start date.
The Breakdown
- Traditionally, fixed annuities have been an attractive investment vehicle for investors seeking safety of principal, competitive yields, tax deferred earnings, and guaranteed income.
- Over the years, variations of the fixed annuity have emerged to address the different preferences and needs of retirees.
- A Multi-Year Guarantee Annuity is attractive for investors with a longer-term time horizon seeking a higher yield.
- For an immediate income need, a Single Premium Immediate Annuity creates lifetime income sufficiency through a guaranteed monthly payout.
- If there is no need for immediate income, a Deferred Income Annuity can create a larger income stream later in life to protect against the risk of longevity.
- A Qualified Longevity Annuity Contract also protects against longevity risk, but it can be purchased inside a qualified retirement plan which has the effect of reducing unwanted Required Minimum Distributions.
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