How Annuity Can Help

How an Annuity Can Help You

The economy is all about cycles: stock market indices rise and fall as if on a roller coaster ride, interest rates cycle in an unpredictable fashion, new industries emerge and old ones die, inflation is always present but constantly waxing and waning, and individual stock prices cycle in response to an incomprehensible number of variables. The only certainty is more change. What’s the average investor and saver to do? Economists and financial pundits are constantly making guesses that are mostly wrong, and brokers are touting the latest hot investment in hopes of generating another commission. Going it alone is even more dangerous. How can you know what is right?

First of all, take only the risk you can afford by asking yourself: “what will I do if the worst case happens?” If you don’t like the answer, then you’ll need to rethink the risk. If you’re speculating in the market with retirement money that has to last you for the next 25 years, you’re in danger of running out of money before your last breath. Ironically, sometimes unsuitable risks yield unaffordable losses which raise stress levels that can shorten your retirement – permanently. Risks sometime lead to good gains and that’s the temptation!

Secondly, acknowledge that no one knows the future direction of markets, interest rates, inflation or any other economic/financial variable, because there are simply too many imponderables that drive them. For instance, what do you suppose would happen to the financial markets if a major American city suffered a catastrophic terrorist attack? Or, if foreign oil supply were shut off? Or, what if China, Europe and/or Asia stopped holding their reserves in US dollars? All of these developments, and others just as severe, are possible at any moment. What can you do to protect your hard earned retirement dollars?

If you currently have money in stocks, bonds, mutual funds, variable annuities and other assets whose value is determined by the “market”, you probably have done well over the past few years. The Dow Jones Industrial Average (“DJIA”) hit its last low point of 7,592 just past mid-year in 2002, and beginning in early 2003 it has been steadily marching upward. Today the index is resting at roughly 12,500. Will it now turn south and give up some or all of the gain of the last four years, or will it continue north to even higher records? You can make an argument for either because, as is always the case, there are positives and negatives. The fact is that no one knows the future direction of the market, and if you have money there that will be needed for your retirement, you’re at risk. If you’re young or wealthy this should not be a major concern, because in the long-term you’ll probably do just fine; however, if you’ll need your money before the “long-term”, there could be problems. So, what should you do?

One solution would be to start moving your money into safer places – at least move that money which you anticipate using in the first 15 years of your retirement. This does two things: first, it immunizes you from market losses that you probably can’t afford; and second, it allows you to lock in gains that were a gift from a rising market. The gains were due to luck not skill – don’t think otherwise! What are the safe places? There aren’t many – the mattress and money market funds are not going to shelter you from inflation. If you need to lower your taxes, try fixed annuities: safe, good rates of return, some liquidity and tax deferral. If you want absolute safety, there are bank CDs: safe but taxable with so-so returns. If you can tolerate the hassle and are willing to take some interest rate risk, investigate US Government savings bonds. Notice, US Government bonds are not included, because you can suffer losses if interest rates rise after you purchase them and then you need to sell before maturity. If making the transition from risky places to safe places is a hassle for you, call your financial advisor for professional help. Be sure and stress that you don’t want the risk of loss; demand a market rate of interest or a risk-free opportunity to earn above market rates; and lower taxes would be nice as well. Can you do it without a financial advisor? Probably, but that’s a risk you’d be well advised to avoid. In fact, one of the biggest risks you can take is “do-it-yourself” retirement planning.

Most people, even married couples, mistakenly think they’re the only ones that will be using their retirement money. Not true because coming to your retirement party as uninvited guests will be inflation and taxes. Potential market loss can come only if you extend the invitation. Give some thought to the market risk exposure of your retirement money and plot a course to safety while the market is still hot. Tomorrow could be too late!

The Accumulation Phase


During the accumulation phase, the fund grows tax deferred, it does not grow tax free. If the annuity was not purchased as part of a qualified retirement program such as an IRA, 401(k), TSA, or 457 plan, income taxes are paid on the earnings when money is ultimately paid out. If the annuity is part of a qualified plan the entire fund is subject to income taxes as it is withdrawn.

  • Surrender charges for early withdrawals. Most offer partial withdrawals free of surrender charges.
  • If you withdraw money from your annuity before age 59 ½ it is called a “premature distribution” and is subject to an additional 10% IRS penalty.
  • If a premature death should occur, the accumulated funds within the annuity are transferred to the named beneficiary, avoiding probate costs.
  • Annuities can vary by payment mode and are available as “single premium” (purchased with one-time payment) or “flexible premium” (purchased with recurring periodic payments). They also vary by timing of the annuity income and may be available as a “deferred annuity” (which means that annuity income payments are deferred until later) or as an “immediate annuity” (which means that annuity income starts immediately).
  • For fixed and equity indexed annuities there is safety of principal and earnings.


  • Fixed annuities
  • Equity Indexed annuities

Fixed Annuities

In a fixed annuity, the insurance carrier:

  • Declares a current rate of interest for a specified time period. Once the time expires the company will set a new rate which may be higher or lower than the original rate.
  • Guarantees a minimum interest rate of return which is specified in the contract, and at no time may the current or renewal interest rate fall below it.
  • Guarantees the principal.

* Equity Indexed Annuities

An Equity-Indexed Annuity (EIA) has interest rates that are linked to growth in the equity market as measured by an index such as the S&P 500. The EIA owner enjoys the upside potential of equities but is not exposed to downside risk. Subject to fixed minimum guarantees, the value of an EIA can only increase due to market growth – it will never decline due to market movement. There are many variations in product design. No two of the EIAs are exactly alike, and some are very different from each other. However, all the various types fall into three general categories: annual high-water mark with look-back. The following is a simple definition of each. Please call us if you would like to know more.

Annual Reset – Also known as the annual ratchet design, the annual reset design resets the starting index point annually. It also credits index increases (interest) annually and compounds annually.

Point-to-Point – The point-to-point design measures the change in the index from the start of the term to the end of the term.

Annual High-Water Mark with Look-Back – The annual high-water mark with look-back can be viewed as a variation on the point-to-point design, except that it measures the index from the start of the term to the highest anniversary value over the term.

* Some annuities allow the insurance company to change participation rates, cap rates or spead/asset/margin fees either annual or at the start of the next contract term. If an insurance company subsequently lowers the participation rate or cap rate or increases the fees, this could adversely affect an investor’s return. Therefore, a prospective investor must carefully review his or her contract in order to examine these issues.


Withdrawals may be made at any time. However, the withdrawal may be subject surrender charges and if done before age 59 ½ there will be a 10% IRS penalty. Some contracts allow an annual 10% withdrawal free of surrender charges. The owner may pre-authorize a systematic periodic withdrawal plan. The owner of the contract instructs the company to withdraw a percentage or a level dollar amount from the contract on a monthly, quarterly, semiannual, or annual basis.

The Distribution Phase

As part of the distribution phase, the owner has two options, he or she can withdraw money (either in a lump sum or elect a systematic withdrawal plan) or annuitize (purchase an annuity pay out plan).


When the owner annuitizes the funds he or she purchases an annuity pay out plan. In a Fixed and in an Equity Indexed Annuity the owner purchases a monthly income that will be paid to him or her until death. It is a guaranteed income that will not change.

Annuity Pay Out Plans

Life Only – Periodic monthly payments to an annuitant for the duration of his or her lifetime and then ceases. It is for a lifetime, the annuitant cannot outlive the payments. The payments are determined at the time of purchase and are based on age and sex.

Life with 10 years certain – Payments will be made for at least ten years, regardless if the annuitant lives for the entire ten years. If the annuitant dies during the ten-year period the remainder of the ten-year payments will be made to a beneficiary. If the annuitant lives longer than ten years he or she will continue to receive payments for his or her lifetime. The guaranteed monthly payments will be less than “life only.”

Life with 20 years certain – Payments will be made for at least twenty years, regardless if the annuitant lives for the entire twenty years. If the annuitant dies during the twenty-year period the remainder of the twenty-year payments will be made to a beneficiary. If the annuitant lives longer than twenty years he or she will continue to receive payments for his or her lifetime. The guaranteed monthly payments will be less than “life only”, and “Life with 10 years certain.”