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A podcast designed to help retirees and those nearing retirement navigate finances and life planning with expert insights from financial advisor Trevor Lawson. Tune in for practical strategies and inspiring ideas to ensure your retirement years are purposeful, fulfilling, and truly your best chapter yet.
*Securities and investment advisory services offered through Osaic Wealth, Inc. member FINRA/SIPC. Osaic Wealth is separately owned and other entities and/or marketing names, products or services referenced here are independent of Osaic Wealth. Branch phone: 919-546-0400.
Today's episode will kick off a two, maybe three part series on a commonly misdefined. Oftentimes, um, carrying a lot of negative connotations, word annuities. So annuities are. HA. Or a financial instrument, a financial vehicle that had been around for many moons and have served a lot of different purposes for investors in [00:01:00] retirement.
But in some cases, the investor d need that annuity as part of their retirement picture and perhaps, uh, entered a contract that. It wasn't appropriate for their situation. And another situations an investor shied away from an annuity because of misunderstandings and just poor definitions around what annuity did and therefore.
Didn't benefit from what would've been a very valuable tool. Tool as part of their retirement. So over the next episode or two, my hope is to really provide education around what annuities are, who they're right for, and help you the client make better informed decisions on whether or not an annuity could be a tool that makes sense to be a part of your retirement toolkit.
So. To kick things off, I'm going to be talking today about what you need to know about annuities, and the source of inspiration for this episode is a [00:02:00] Morningstar article and, and video, which we'll link to in the the show notes by Christine Benz and Margaret Giles. And it's all about what you need to know about annuities.
So why don't we kick things off by talking about what actually is an annuity? So. You hear, you hear this word from, from friends, peers. You read about it online, but in, in essence, annuity, and I'm quoting Ms. Bins here. An annuity is a contract with an insurance company. So in the most basic annuity type, you give the insurance company a pool of your money and they send it back to you as a stream of income over your lifetime.
That is the most simple annuity type. And of course there are a lot of different variations on that, but that's the basic, basic kind of idea. So you're giving an insurance company your money and they're paying you back. And income from your money over the course of your lifetime. [00:03:00] That's an income annuity.
Um, and the most simple type of annuity. How do income annuities work? Well, we just kind of talked about it, but again, the insurance company that you've given your money to, they send it back to you as a stream of income. And the reason that retirement researchers in particular are so excited about these types of products is that they give you a lot more income than you could potentially earn on your own.
Annuities are also really starting to gain a lot of favor in the retirement research world because pensions are becoming a thing of the past, and many retirees are looking for the peace of mind that a pension used to provide. You've, you've got, you know, income coming in every month regardless of what's happening in the market, in the economy.
Those that have pensions know that. My paycheck is coming every month, and it takes a lot of of [00:04:00] worry about, you know, the, the market off the table. You've got a, when you've got a guaranteed source of income coming through the door. So annuities can provide that, and that's the reason why we're starting to see retirement researchers really promote them as a considerable or, or something worth considering as part of, of, of the common retirees investment plan.
So how, how annuities can help with retirement planning and, uh, Ms. Bins gives an example, but I'll, I'll provide my own. So the way that they can, they can work, and I'm, I'm talking specifically here just about a, a basic income annuity is, let's say you, the retiree, you know, through your retirement preparations have determined that your basic living expenses, so what you typically spend on, you know, housing, healthcare.
Food. Just your what, what you generally will spend on your basic living expenses ends up being 50,000 a year. And that's the [00:05:00] amount that you know, like you know you're gonna need coming in every year to meet your, your living needs. And let's say that your social security is going to provide. 30,000 of that 50,000.
So that, that certainly helps, you know, take the pressure off of the amount that your investments are gonna provide when social security is gonna cover a large portion of, of your. Living needs, but some folks will turn to an income annuity to bridge that gap between what Social Security is gonna provide and what their living expenses actually cost.
So in this example, living expenses are 50,000. Social Security is providing 30,000 of that an income annuity. It could potentially bridge that gap and provide the additional 20,000. Taking a lot of pressure again off of, off of the market and how your investments are are performing, and give you that peace of mind knowing you've [00:06:00] got that guaranteed amount of income coming in every year to meet your basic living needs.
What are the different types of deferred annuities? Ms. Giles asked Ms. Benz, so I'll quote Ms. Bins here. The most familiar one, I think for many viewers will be a variable annuity, where if you buy such a product, you're in control of the investment allocations for better and for worse. Then there are also what are in increasingly popular called fixed indexed annuities, where you're also obtaining some market exposure.
There are caps on your gains. There are also caps on your losses in such a product. Those products have become quite popular recently. Then registered indexed linked annuities fall between the two products. In terms of the risk spectrum, so the last two types that I mentioned, fixed indexed annuities and registered indexed linked annuities have become increasingly popular [00:07:00] because both of those will provide some protection.
Own your monies, uh, from, from a downturn in the market. But they oftentimes will provide much more growth potential than, say, a traditional CD or, or treasury. So they're, they're. They can be a good blend between, you know, a fixed income investment, like a CD or treasury, and a, a pure stock investment. These fixed index and registered index linked annuities can, can give you a blend of protection and performance.
What investors should know before investing in deferred annuities, and let me just define deferred annuities. Deferred annuities are essentially annuities where you're, you're. Giving your money to the insurance company and your, your payout or the money you're gonna receive is, is going to be deferred.
It's not something you're gonna turn around and start collecting benefits from right away. It's gonna grow in a [00:08:00] tax deferred manner, and you're gonna collect income or the payout later. That's all that deferred means in this case. Uh, but the, what investors should know is typically these products will carry really long contracts with lots of fine print about how they work.
So the best thing an individual can do to, to evaluate these contracts and determine whether or not a particular annuity is right for you is to consult with a fiduciary, someone who you know, works with, with retirees, works with this, this, this tool and annuity, and really helps you better understand the annuity you may be considering.
Goes through the contract with a fine tooth comb and helps you make an informed decision on whether or not it's right for your retirement situation. Tax implications of annuities, so this is sometimes a big draw for investors because annuities are tax deferred. So when you invest in annuity, [00:09:00] all the gains are tax deferred.
Unlike a brokerage account where, you know, you, you, you put in the money and every year you're likely to get a 10 99 on, on the interest earned annuities are tax deferred, so you don't have to worry about taxes until you start taking money out. However. That being said, when you do start taking money out of an annuity, you're taxed at ordinary income tax rates.
So that's a key difference between an annuity and say a traditional brokerage account is annuities are taxed at ordinary income tax rates. Brokerage accounts, oftentimes capital gains tax rates and the amount of taxes that you'll pay on, the money that you take out of the annuity will be determined by the source of monies that were used to initially fund the annuity contract.
So let's say you were initially using pre-tax money from an [00:10:00] IRA or 401k to fund the annuity. Well, it's gonna continue to be pre-tax money. So when you do take it out of that annuity, you're gonna pay ordinary income tax rates, just like you would have if it had stayed in the 401k or IRA. Where it gets a little tricky is if you fund the annuity initially with after tax money.
The common term for that is a non-qualified annuity. So if you fund. The annuity initially with after tax money, there's what's called an exclusion rate. Exclusion ratio that comes into play, meaning you're only gonna pay taxes on the monies that have on the earnings. In that case, the money that you've, you've already paid taxes on, you're are gonna be excluded from taxes.
But the money that you are still having to pay tax on is taxed at ordinary income tax rates. So tax implications are something worth, uh, making sure you understand and just know. In general, annuities [00:11:00] are taxed at ordinary income tax rates, which are oftentimes much less favorable than capital gains tax rates.
Um, lastly, they, they note how investors can a, evaluate their annuity insurers financial strength. So, Ms. Ben's notes, uh, financial strength ratings are available from rating agencies that look at the financial wherewithal of the insurance company. You certainly wanna do your homework on this and just make sure that the insurance company that you are considering has a very high, uh, rating.
Uh, am best is a common rating agency, uh, for these. These annuity companies and insurance companies, but just make sure that you're, you're, you're dealing with, you know, a, a very reputable, highly rated company because ultimately you want to know that they have the financial strength to be able to pay you out over the course of your lifetime, which is what certainly income annuities are designed to do.
So. I [00:12:00] mentioned a couple different types of annuities there. The three being income annuities, which are designed to pay you income for life. Fixed indexed and registered index linked annuities, which are more on the investment side designed for protection, but also growth potential. But those are some key things just to to keep in mind, you know.
What is an annuity? Who is it right for? How can it benefit one's retirement plan? How are the taxes involved and how to, how to evaluate the financial strength of the insurance company offering the annuity. Next time we will talk more about the type of individual that annuities may be right for. But I hope, hope you found this initial initial episode on annuities very educational.
I hope you enjoyed this episode. Stay tuned for part two where we'll dive a bit deeper into this concept and I will look forward to being with you then. Take care.