By Beau Henderson – Strategic Retirement
For a retiree, the only thing worse than dying is outliving your money. The average 65-year-old man today can expect to be retired for a minimum of 19 years — up from 13 years in 1940.
A longer retirement means more time without a paycheck — and more years of expenses You’d better hope your Social Security checks… personal savings… and other sources of income are up to the challenge.
Of course, the best way to do that is to plan your retirement strategy NOW
The sooner you figure out how to maximize those pools of cash, the less stress and worry you’ll have in the future. And there’s one tool that could help you secure a worry-free retirement — annuities.
The right kind of annuity for your specific situation can help you create income that will last you for the rest of your life.
The right annuity can not only protect and grow your wealth now, but it could also protect your loved ones after you’re gone. Here’s what you need to know…
Why Annuities Are So Safe
An annuity is a private contract between you (known as the annuitant) and an insurance company. At its most basic, you give the insurance company money and it turns that pot into payouts that will last for the rest of your life.
It’s the only financial vehicle we know of that will provide a guaranteed lifetime of income.
You can choose to annuitize your money immediately — receiving your first income checks in as little as 30 days.
Or you can choose to defer annuitization, letting your account grow for several years until you need the money in retirement. If you choose a fixed deferred annuity, your money is guaranteed to grow at a steady rate.
It doesn’t matter what banks are doing with interest rates… how the stock market is performing… or even how the world economy is faring. With a fixed deferred annuity, your account will only ever gain value.
The safety of these kinds of annuity is unparalleled. In the history of our country, no one (who hasn’t taken their money out early) has ever lost a single penny in a fixed tax-deferred annuity.
There are a few reasons why fixed deferred annuities can offer these kinds of promises. For one thing, the insurance company has an obligation to protect the premiums it’s been paid. It does that by holding a legal reserve — meaning it must have enough cash on hand to equal the withdrawal value of every annuity account on its books.
In other words, if all of an insurance company’s annuity clients decided to reclaim their premiums at once, the insurance company must be able to oblige them. (Compare that with banks’ fractional reserve system, where a bank only needs to keep a portion of its customers’ cash on hand.)
And to keep clients’ money as safe as possible, insurance companies stick to conservative, long-term investments. I’m talking about things like U.S. Treasury securities, other instruments backed by the U.S. government and investment-grade corporate bonds.
These are some of the safest instruments available, ensuring your pool of cash is in good hands.
And that’s not the only kind of safety annuities provide.
Depending on what state you live in, annuities can also offer special protection from creditors, lawsuits, bankruptcies, etc. Laws vary by state, however, so make sure you understand your state’s laws before you decide to buy the annuity.
Just don’t think you can buy an annuity at the last minute when you’re facing financial hot water. The court could take action if you simply buy an annuity for creditor protection. But the longer you own an annuity, the more likely the court will consider it protected from your creditors.
That’s several solid layers of protection right there. But perhaps the biggest benefit of a fixed deferred annuity is how it protects you from taxes.
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Taxes Deferred Are Taxes Diminished
Annuities enjoy tax-favored treatment under current law. In fact, the interest that a fixed annuity earns isn’t immediately taxable. It’s much like the money you make in your 401(k) or individual retirement account (IRA).
Technically speaking, this is because the income isn’t “constructively received.” That is, you can’t access the money without substantial limitations or restrictions. Annuities charge fees for early withdrawals, and there may be tax penalties on top.
Since you don’t have easy access to the money, its growth isn’t immediately taxed. That makes tax-deferred accounts an incredibly valuable vehicle for tax-efficient retirement saving.
Typically, tax-deferred investments are made during a person’s working years, when earnings and taxes are more often higher than earnings and taxes during retirement. Of course, I use the term “tax-deferred” for a reason. Uncle Sam always gets his due in the end.
The interest you earn is credited and compounded untaxed until regular payouts begin or the annuity is surrendered. But the taxes you will owe are based on the amount of money you choose to distribute to yourself.
Ideally, that will be when you start retirement. Since you won’t have a regular salary, you may be in a lower tax bracket. Even if your tax bracket does not decline in retirement, you are still likely to benefit from a tax-deferred account. That’s because it’s better to pay taxes in the future rather than every year until then.
In fact, tax deferral produces a triple-compounding effect, which can have a significant impact on the growth of your money:
- You earn interest on your principal.
- You earn interest on the interest you earn.
- You earn interest on the money you would normally pay to Uncle Sam in the form of taxes.
Finally, a deferred annuity can also help eliminate taxes you pay on your Social Security benefits. Earnings in a deferred annuity are not reported as income on your 1040 tax form. So you’ll payless taxes and have more discretionary income.
Even better, annuity earnings are not included in the calculation of how much Social Security benefits will be taxed. Finally, annuities can offer your family some protection after you’re gone.
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Annuities Protect Your Family
You’ve probably heard the old saying, “You can’t take it with you.” When you leave this world, you leave behind all of your money. But you also leave your debts. Most of who gets what is decided through probate. CDs and most other savings vehicles must pass through probate, making this information open to the public.
That means those assets can be contested by another party. Put another way, someone can say they are owed a particular asset. If the probate court agrees, it’s less money for your family or other beneficiaries.
And even if it does go to your family, there is still a fee involved. But an annuity spares your family any of that. When you set up an annuity, you typically designate a person to serve as the beneficiary of the account.
The specific method of naming a beneficiary depends on the forms provided by the company selling the annuity. It’s typically as simple as writing the name of your beneficiary in a designated place. (If your beneficiary dies before you, you must name another beneficiary to avoid probate.)
In the event of your death, the beneficiary will receive some of the remaining. The type and amount of funds will vary according to the type of annuity. The transaction is made in private with no public record and can never be contested.
This is generally true no matter what stage your annuity is in. That is, if you’ve deferred receiving payments to let your annuity grow — or are even adding money to it — the life insurance company guarantees to pay a certain sum directly to the designated beneficiary.
If your account has been annuitized, the insurance company will still pay your designated beneficiary. Depending on the terms of your annuity, the beneficiary may receive a limited number of payments or payments for his lifetime.
In all cases — assuming your named beneficiary is still alive when you pass on — the annuity bypasses probate. In other words, an annuity can get your cash into your beneficiaries’ hands with as little hassle as possible.
Remember, though, that even with all the safety that fixed deferred annuities provide — both for you and your loved ones — they should still just be part of your full retirement plan.
Beau Henderson is a financial advisor, syndicated radio host and bestselling author. He writes and speaks internationally helping people create success with both money and life. Through Beau’s numerous degrees and certifications, he has helped more than 3,000 families to discover their true relationship with money and equipped them to live a healthy, wealthy, fulfilled life.