Need a Better Yield? Try Fixed Annuities
JP Morgan once said that it is not necessarily about a return on your capital but the return of capital. Think about that. As he implies, sometimes you've got to buck down and focus on preserving assets. Say you've got 50,000 wrapped up in A CD or money market account that is no longer generating competitive yields--how about something a bit more aggresive but also "smart?" I got your answer: an annuity. If you've taken a lump sum distribution from a pension plan recently, you're a prime candidate--here's why.An annuity contract is purchased from an insurance company. Most often, it is used as a vehicle for saving for retirement or to guarantee an income for life. Deferred annuities are the most popular. They allow people to accumulate money without paying current income tax on their earnings. This means that the amount can grow faster, due to the tremendous power of compound interest (a la IRAS). Fixed annuities are viewed as secure investments by many people, since the insurance company that offers the annuity guarantees the current cash value plus a future guaranteed interest rate. Today, they often offer interest rates that are comparable to (or higher than) CDs, along with the added benefit of deferring taxes on the earnings until they are withdrawn.
For example, if you have $10,000 to invest in a deferred annuity that is earning 5% a year, at the end of the first year your annuity will be worth $10,500. That full amount will be available to earn interest the following year. If, instead, you invest in a currently taxable investment that is also earning 5%, and your marginal tax rate is 28%, at the end of the year only $10,360 will be available for reinvestment. The remaining $140 will be paid to the government for income tax on the $500 you earn. This may seem like a small sum of money, but if this continues for ten years, the difference between the values of the tax-deferred annuity and the currently taxable investment will be $2,046...
When deciding between a CD and a fixed deferred annuity, your investment horizon should be a key factor. Your investment horizon is the amount of time you need to save for a specific goal. For short-term goals, such as a down payment on a home, a new car or a vacation, a CD may prove to be a better choice for you. On the other hand, a fixed deferred annuity is generally the product of choice for the long haul. Fixed deferred annuities are designed to help accumulate money for retirement or to protect funds already saved up once you've reached retirement.When a CD reaches its maturity, you can take the CD's lump sum value in cash, renew the CD for the same or different maturity period. In a fixed deferred annuity you may elect to withdraw your money in a lump sum or you may want to select a lifetime income option, which will provide you with a consistent flow of income that you cannot outlive. Or, you can simply elect to let your funds accumulate until a need arises.
CDs offer a guaranteed rate of return for a specified period of time. Interest rates will vary depending on current market conditions and the length of time to maturity. Generally, the shorter the period of time to maturity, the lower the rate. There is no guaranteed minimum for renewal rates. Earnings on CDs are taxable in the year the interest is earned even if you don't take the money out. With fixed deferred annuities, on the other hand, earnings accumulate free of current taxation. Earnings inside an annuity are not treated as taxable income until they are withdrawn. This allows more of your money to work harder towards achieving your long-term goals...
Fixed deferred annuities may also help reduce or eliminate the taxes on your Social Security benefits. By leaving your money in a fixed deferred annuity you can reduce your taxable income, keeping it below the level where you would begin to owe taxes on your Social Security benefits. But with CDs, your interest earnings count in the calculation to determine how much of your Social Security benefits will be taxed — even if you don't withdraw the earnings. As much as 85% of your Social Security benefits could end up subject to taxation. At death, the annuity's account value will be paid directly to your named beneficiary(ies), avoiding the costs and delays associated with the probate process. This is not the case with a CD, which may be subject to probate.
Since it's technically an insurance product, there's the guaranteed death benefit, too. But ultimately, you'd be looking at a fixed annuity as an alternative to watching your retirement savngs wither in the dangerous stock market. And of course your risk tolerance, time horizon, and capital outlay will play a large role.
<< Home