Alternative Income Streams: The Role Of Annuities In Retirement

Alternative Income Streams: The Role Of Annuities In Retirement

What is an Annuity?

An annuity is a contract between the annuitant (that’s you) and an insurance company. The annuitant makes a payment (a premium) to an insurance company that, in turn, promises to make regular income payments that over time could exceed the amount of premium paid. Some annuity contracts with lifetime income riders—an option that may have an additional cost—even promise payments for the life of an annuitant and/or a spouse. The promise to make payments is backed by the claims-paying ability of the insurance company issuing the contract, much as the ability to make lifelong Social Security payments is backed by the good faith and credit of the U.S. government.

Annuities are not for everyone. But for people looking for alternative sources for sustainable income streams, annuities are a consideration worth making as part of a well-rounded retirement income plan. Let’s take a brief look at three basic types of annuities.

Four Types of Annuities

• Fixed annuity: These offer a fixed interest rate that is typically higher than the rate you might get on a bank product.*
• Variable annuity (VA): The contract value of a VA rises and falls daily depending on the market performance of the “sub accounts” the annuitant chooses as investment options, and you can lose money since your money is subject to the market.**
• Fixed index annuity (FIA): Though not directly invested in the market, the FIA offers the potential for growth through credited interest generated by a rise in whatever market index the contract is linked to. The annuity value is locked in each year on the annuity’s anniversary date and cannot be lost to future market drops. Conversely, should the index level fall below the reset value in any given contract year, the contract value remains at its previous level. The contract, in effect, has a floor of $0 in losses, although the cost of any additional riders purchased will continue to be deducted every policy anniversary. This means that, in a worst-case scenario—such as when the S&P 500*** fell by more than 38 percent in 2008, then experienced a similar free fall during February and March of 2020—the value of an FIA doesn’t lose a dime due to the market. Because FIAs are insurance products that offer guarantees to your money, they also have limits on how much interest you can earn, however, and the interest you earn will generally not equal the full gains of the market index.****

The FIA’s potential to 1) offer guaranteed income through 2) index-based interest coupled with 3) a protection against loss of principal due to market volatility makes this an attractive choice for many consumers to provide added stability to an income plan.

Provisions of the SECURE Act that took effect on January 1, 2020, allowed for the first time the inclusion of annuities as part of a 401(k) plan. This presents an option that could work well for some people. President Brett Shunkwiler’s opinion, however, is that a person interested in an annuity should also consider the options available in the open market and not limit themselves to the often-limited options available within a company’s 401(k) plan.

Questions about Annuities? Set up a complimentary 15-min consultation with one of our retirement professionals to discuss annuity rates and practices.

*Fixed annuities are long term insurance contacts and there is a surrender charge imposed generally during the first five to seven years that you own the annuity contract. Withdrawals prior to age fifty-nine-and-one-half may result in a 10 percent IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the financial strength of the underlying insurance company.

** Consider the investment objectives, risks, charges, and expenses carefully before investing in variable annuities. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from the insurance company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest. The investment return and principal value of the variable annuity investment options are not guaranteed. Variable annuity subaccounts fluctuate with changes in market conditions. The principal may be worth more or less than the original amount invested when the annuity is surrendered.

***Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred.  Returns do not include reinvested dividends.

The Standard & Poor’s 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general.  It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

****Indexed annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company. Surrender charges apply if not held to the end of the term. Withdrawals are taxed as ordinary income and, if taken prior to fifty-nine-and-one-half, a 10 percent federal tax penalty. Investors are cautioned to carefully review an indexed annuity for its features, costs, risks, and how the variables are calculated.