Walter Pardo, CWS, CEO of Wealth Financial Partners and WFP Tax Partners, Liberty Corner, New Jersey. WealthFinancialPartners.com
Annuities—insurance products that provide guaranteed regular income in exchange for a lump-sum payment upfront—are booming in popularity. Total sales hit a record-breaking $183 billion in the first half of 2023, a 27% jump from the same period one year earlier. One reason: Retired baby boomers now realize that generating steady income from their own portfolios for decades can be daunting.
But annuities aren’t right for every retiree—they can charge high fees and are complicated to understand…and you lose a lot of financial liquidity when you purchase one.
Here are two scenarios where annuities make sense for retirees…
You are worried about a big tax hit from required minimum distributions (RMDs), especially since the IRS makes you take a higher and higher percentage from most tax-deferred accounts as you get older.
Example: A 79-year-old client had $500,000 in traditional IRAs. Even though he didn’t need the money, he was required at his age to withdraw about 4.74% of his IRA assets (an RMD totaling $23,697). The RMD also would put him in a higher tax bracket as well as increase the Social Security income taxation—because RMDs count as provisional income.
Annuity solution: He invested in a Qualified Longevity Annuity Contract (QLAC), a deferred annuity that lets you delay payouts until you reach the advanced age of 85 and that reduces the amount of assets subject to RMDs. His $200,000 QLAC—the maximum amount allowed by law in 2023 (after which the limit will be adjusted for inflation)—will provide a $28,000 guaranteed annual payout for life, starting at age 85. In the next few years, he will roll the rest of his IRA money into a Roth IRA so that the assets can eventually be withdrawn tax-free by him and his heirs. For more on QLACs, see BottomLineInc.com/money/retirement-planning/an-annuity-gains-appeal.
Your current guaranteed income (e.g., Social Security benefits) isn’t enough to cover essential expenses. Many retirees are willing to cut back on annual discretionary expenses if the stock market performs poorly and their portfolios drop in value. But they never want to worry about being unable to cover their costs for housing, insurance premiums and utilities.
Example: An 86-year-old widow retired with basic monthly expenses of about $5,000. Her Social Security benefits covered only half that amount. She had a portfolio totaling $1.4 million—$300,000 in an IRA, $700,000 in a Roth IRA and $400,000 in a money-market fund—to see her through the rest of her life, but she didn’t want to risk putting all that money in the stock market where it could grow.
Annuity solution: She took $300,000 from her money-market fund and purchased a 10-year Single-Premium Immediate Annuity (SPIA), which (according to recent rates) started paying her guaranteed checks of $2,834 a month immediately. That’s $34,008 per year for 10 years, with about $27,000 excluded from taxation because only the interest portion of payments are taxable.
That not only covered the rest of her essential living expenses but also gave her the security to invest her Roth IRA money in a balanced long-term portfolio of stocks because she would not have to touch those assets for at least a decade. Helpful resource: ImmediateAnnuities.com.