When you are running a fact finder on a young couple and the discussion of retirement comes up, keep in mind the power of compounding coupled with tax-deferral. In other words, talk about flexible premium deferred annuities (FPDA).
Annuities are not well-understood by young people. (They often aren’t well understood by agents and financial advisors, either!) Basically, an annuity is an insurance contract into which the policy owner makes payments (premium) and the account value grows at interest with no reportable income tax on the gains. The principal (sum of all premiums made) is guaranteed by the financial security of the insurance company. A fixed annuity (conventional or indexed) may be in your client’s best interest as the foundation of their retirement plan. The keys to making this a successful and worthy consideration are:
- The choice of a financially strong and well-capitalized insurance company
- The right kind of annuity for your client’s level of aversion to risk
- Regular, bank-drafted contributions
- Avoiding withdrawals of any kind. Contributions to the annuity should be looked at as a “fixed expense” and the money as “untouchable”.
- Unscheduled “drop in” money. Unlike IRAs, an FPDA has no annual limit on funding. That $10,000 inheritance check – whole or in part – should be dropped into the annuity. (In some states, there might be an inheritance tax that would have to be paid first and the inheritance may be subject to income- or capital-gains tax, as well. A qualified tax advisor should always be consulted before moving any large amounts of money into long-term savings).
Getting 1%-3% on a retirement savings plan isn’t very exciting. However, the current interest rate environment is not likely to last forever. But, even if it did, that’s not the primary point. The truly remarkable things about an annuity is that a) the principal is guaranteed, b) any gains do not have to reported to the IRS as long as they are left to accrue in the contract (tax-deferral).
Agents don’t often introduce annuities to clients until they are much older. A recent survey* indicates that the average age of indexed annuity purchasers, for instance, today is 65. In the aftermath of the market crash of 2008 and the impact that had (and is still having) on market-based retirement plans, the federal government is now encouraging everyone of all ages to take another look at this long-standing insurance contract for safety and security.
So, what would a young couple do in later years with this annuity cash account that they have been so diligently contributing to? USE IT! (An annuity is not something that you want to consider transferring to the next generation.)
Distributions can be configured in a number of different ways. In fact, you can design the payouts so that you can’t outlive them. That’s security that young people might not appreciate now, but they will find that running out of income during retirement is one of the major fears among the elderly.
If a lifetime payout is chosen, only the gains within the payout will be taxed. This is referred to technically as “the exclusion factor”. It is based on the favorable tax treatment of the annuity by the IRS. Gains are income-taxable, but return of premium (deposits) is not. For example, a lifetime payout may have an exclusion factor of, say, 37%, meaning that only 37% of the payment received is subject to income tax (gains). The rest is income-tax free because it represents a return of premium (deposits).
Get your clients to start early. Even a 5%- of-net-income payment automatically deposited monthly into a deferred annuity beginning at age 30 or 40 could produce a significant amount of retirement funds due to the miracle of compounding and tax-deferral. What a great feeling of security for your clients to know that in addition to their investments and social security, they have another source of income for those unpredictable retirement years.
*AnnuitySpecs.com’s Indexed Sales & Market Report , 4th qtr, 2011