Tax-Sheltered Retirement Plans by gabyion


Two different animals!
Deferred or Immediate
        What is an annuity?
• “An annuity is a contract in which an
  insurance company makes a series of
  income payments at regular intervals in
  return for a premium or premiums you
  have paid. Annuities are most often
  bought for future retirement income, and
  can pay an income that can be guaranteed
  to last as long as you live.”

       Objectives (be able to)
• Understand the BASICS of annuities
• Distinguish between
  – using annuities to invest tax-deferred for
    retirement &
  – using annuities to provide income during
    retirement that you will never outlive
• Describe how to shop for an annuity
• Know who should NOT buy deferred
 Annuity: Insurance company
contract with 2 distinct phases
• Accumulation phase
  – Invest tax-deferred during earning years
• Pay-out phase
  – Pay regular income for life or for specified
  – Payments cease when annuitant (recipient)

 Annuity plans offered through
– 403(b) or 401(k) plans
– Limits on yearly contributions
– Today our focus is on individually purchased
  annuities, NOT employer plans
– Similar concepts
– No sales commissions when participating in
  employer plan

       Fixed or Variable?
• Guaranteed       • No guarantee
  rate of return   • Return varies
• Guaranteed         – Based on
  payout               investment
• Insurance            options you
  product              choose
  – Regulated by   • Securities
    states           regulated by SEC
Annuities b/4 & after Retirement
• Deferred               • Immediate
  – Investment or          – Pay out phase in
    accumulation phase       retirement
  – Tax deferred           – Income for life

Annuities: Common Features
• Contracts backed by insurance company
  – Death benefit to heirs if you die prematurely
• No limit on amount you can invest
• High Commissions & Fees
  – If purchased from salesperson
• No Load or Sales Commissions
  – If purchased directly from insurance arm of No-
    Load MF company
     • Vanguard, Fidelity, TIAA-CREF, etc.
• Surrender charges (always) in first 6-10 years
  – on withdrawals of >10% of accumulation value/year

      Accumulation Phase
• Purchased during working years
• Money is invested in contracts backed by
  insurance companies
• Fixed or variable rates of return
• Penalties & fees for withdrawals b/4 59.5

• Purchased with
  – Single premium (SPDA), or
  – multiple payments over a period of years
• Contributions MAY be tax-sheltered
  – If part of 401(k) or 403(b) plan
• Most annuities purchased with after-tax $
• Earnings are tax-sheltered, until withdrawn

   Types of Deferred Annuities
• Fixed Annuity: your money earns interest at
  rates set by the insurance company.
• Variable Annuity: the insurance company
  invests your money in stocks, bonds or other
  investments you choose.
• Equity-Indexed Annuity: the interest rate is
  based on an outside index, such as a stock
  market index. The annuity pays a base return,
  but it may be higher if the index increases

  Fixed Annuities might be for:
• Individual who
  – wants guaranteed interest rate (like a CD)
    • One co.‟s rate as of 03/15/2007 is 4.25%
    • 5 year lock in so buy when interest rates are high
  – wants tax-deferred earnings (CDs don't offer)
  – has significant assets to set aside for
    retirement, and
  – does not need to access their assets for at
    least five years
          Variable Annuities
• An investment in an insurance wrapper
  – Stocks, bonds, money market investments
• Principal & return are not guaranteed
  – you may lose some or all of your investment
  – Trade off security for chance for more gain
• More features & higher fees than fixed ann.
• Regulated as securities by the Securities
  and Exchange Commission (SEC)
      Equity Indexed Annuities
• Complicated investment for sophisticated
• Minimum guaranteed return
• Rate of return on your investment is based on an
  underlying index such as the S&P 500
  – One of the most confusing features of an EIA is the
    method used to calculate the gain in the index to
    which the annuity is linked.
• difficult to compare one EIA to another

         Don‟t cash out early!
• Penalties for cashing out early
  – 10% Early withdrawal penalty imposed by IRS
     • Before age 59 ½
     • Withdrawals taxed as ordinary income
• Surrender charges imposed by ins. co.
  – If funds withdrawn before 5-7 years
  – Surrender charges (6-7%) decrease over time
• Watch out for salespeople who advise you to
  switch annuities (churning)
  – Fees & penalties
Consider a Deferred Annuity IF
• You contribute the maximum to your
  employer‟s retirement plan
• You fully fund your IRA
  – $4,000/year or $5,000 if 50+
• If self-employed:
  – Start a SEP-IRA or SIMPLE plan

 Alternative to Deferred Annuity
• “Tax-managed” mutual fund
  – no-load, low expense
  – Managed to reduce yearly taxes
     • Manager buys and sells underlying assets strategically to
       yearly minimize taxes
     • Most taxes are long-term capital gains (max. 15%) vs.
       ordinary income (max. rate = 35%)
  – Often require $10,000 minimum
• Exchange-Traded Funds (ETFs)
  – For lump sum investment
  – Very low expense ratio

Summary- Deferred Annuities for investing
   for retirement during earning years
• Be absolutely sure an annuity is right for
  you before you buy!
• Do your homework! Read!
• Don‟t buy from a salesperson who
  contacts you
• Don‟t pay commissions to salesperson
• Shop the internet

 Questions on Deferred Annuities?
• Investing for retirement by purchasing an
  annuity (generally with regular payments)

             Part 2

How to Avoid Running out of
   Money in Retirement
  Everything you always wanted to
 know about Immediate Annuities!
        The “payout” phase
 Afraid of Outliving Your $?
• Babyboomers are at risk of living long
  lives and outliving their assets
• Want to spend your last $ the day you
  die? (or close to it)

    Buy a Lifetime Income
• Immediate annuity
  – Monthly payments until you die
  – Fixed $ amount (inflation reduces
    purchasing power)
• Generally, you cannot change or stop
  your payment option once the annuity
  payments have begun.

   Should you annuitize?
How long are you likely to live?
• Living to 100 Life Expectancy
• Calculate your longevity (Module 1b):

Safe Retirement Withdrawal Rate
• Withdraw from nest egg no more than 4-
  5% yearly ($4,000 payout from $100,000)
• What happens if the value of your
  investments dives (as did stocks in
  – $1 million in Jan. 2000 = $.5 million in 2003
• Expect irregular, unpredictable
  investment returns from stocks
• Risk outliving your money
           No Pension ?
• No Problem!
• Create your own “synthetic pension”
  with an immediate fixed annuity
• Purchase a lifetime stream of income for
  a lump-sum payment @ retirement
• Provides income security for persons
  with only defined contribution plans such
  as a 401(k)
      Immediate Annuity
  Guaranteed Income Annuity
• Purchase a guaranteed income stream
  for life with single payment
  – From IRA, 401(k), etc.
  – Tax-Free Rollover to immediate annuity
• Plain vanilla: Regular payments begin at
  once and last for life
  – Annual, semi-annual, quarterly, monthly
• If you die early: No benefits to heirs
• If you live long: you (& children) win!
        Payment Options
• Straight annuity
  – Lifetime income for annuitant only
• Installment-certain
  – For life or at least X years (10-20 years)
• Joint & Survivor
  – Pay spouses (or other 2 people for as long as
    either lives)

  $100,000 SPIA Examples
• Straight annuity (until you die)
  – $790/month
• Installment-certain (10 years minimum)
  – Heirs receive payments if you die b/4 10 yrs
  – $680/month
• Joint & Survivor (lasts as long as 2nd to die)
  – $640/month

     Lifetime Annuity Income
• Pros                  • Cons
• Can‟t outlive your    • No inflation protection
  income                  w/ most immediate
• Complement to risky     fixed annuities
  stock investments     • No $ for heirs
                        • Payments depend on
                          prevailing interest
                          rates @ purchase
                           – 2001-2002 was a bad
                             time to buy

Using Fixed Immediate Annuities in
• TIAA-CREF research study (2000)
  – 65 year old retiree
  – Conservative portfolio
  – 4.5% withdrawal rate
  – Only 33% chance of lasting 30 years
• Purchase annuity with 25% of assets
  – 53% chance of lasting 30 years

        Laddering Strategy
• At retirement, purchase immediate fixed
  annuity with 25% of assets & invest
  remainder moderately aggressively in
  growth investments
• After 10 years, purchase second annuity
  with 25% of assets & continue to invest
  remaining assets
• After another 10 years, repeat process
      Is an Annuity right for you?
     From the Federal Citizen Information Center
                Answer Yes or No to the following
1.    Saving for retirement is one of my main goals.
2.    I do not want to touch my principal or interest until I
      am at least 59½ years old.
3.    I contribute the maximum deductible amount to my
      IRA, 401(k) or 403(b).
4.    I need an investment that will earn tax-deferred
      interest for many years.
5.    I am retired or very near retirement now.
6.    I have a lump sum of money and I want to begin
      drawing an income from it.
7.    I want immediate return from my investment.
8.    I want to receive a steady monthly check for the rest
      of my life.
               Quiz Results
• If you answered yes to questions 1 through 4, a
  deferred annuity may be appropriate for you.
• If you answered yes to questions 5 through 8,
  an immediate annuity may be suitable.
• A trusted financial advisor can help you decide
  if an annuity is appropriate for you.
  – Salesperson will earn a commission if you buy.
  – Read & educate yourself before you talk with

         Tips from the SEC
• Before buying any variable annuity do
  your homework and compare; evaluate
  insurance company
• Request a prospectus from the insurance
  company or from your financial
  professional, and read it carefully.
• The annuity contract contains: fees and
  charges, investment options, death
  benefits, and annuity payout options.
• Compare it to other annuities and other
  types of investments like mutual funds.
          Escape Clause:
How to Dump a Bad (deferred variable
     or equity indexed) Annuity
• Strategy depends on:
  – How long you‟ve owned the annuity & amount
    of surrender charge
      • Wait until surrender period expires
      • Withdraw 10%/year w/o charge
  – Tax consequences of cashing out
      • If owned inside a retirement account, cash out and
        reinvest w/o paying taxes
      • If owned outside a ret. acct. you owe taxes on gain

 Kiplinger‟s January 2007 @               35
  Annuities and Senior Citizens
• Senior Citizens Should Be Aware Of Deceptive Sales
  Practices When Purchasing Annuities
• “Annuity sales to seniors have significantly increased in
  recent years. However, as annuity sales have risen, so
  has a sense of confusion among consumers. This is due,
  in part, to questionable or deceptive sales practices
  employed by companies and agents looking to take
  advantage of uninformed consumers. It is extremely
  important, when considering whether or not to buy an
  annuity, to take the necessary precautions in order to
  make an informed decision that is best for you.”

  Annuity sales pitches to sellers:
       Who can you trust?*
• “Not all annuities are created equal. Some
  pay MUCH higher commissions while
  providing GREAT benefits to your clients.
  Introducing… a 13% commission equity
  indexed annuity.”
• Info that puts “clients and customers at
  your marketing mercy” using “maximum
              *Probably not the sales person
         “Annuity University”
• “Spend 2 days with me and I will turn you
  into a premium machine or suggest that
  you get into a different type of work.”
• Books:
  – 11 Amazing secrets of outrageously
    successful insurance agents
  – Kick your „But‟: 18 steps to removing the
    obstacles to sales success
  – Red-hot cold call selling: Prospecting
    techniques that pay off
Dinner Seminar Marketing Concept
• „has helped thousands of advisors across
  the country generate the highest
  commissions and see more prospects in
  one month than most advisors see in a
• Double your Fun: Sell enough annuities to
  qualify for both a 5 night stay in Cancun
  and a 7-night Caribbean cruise.
      Thanks to Wall Street Journal writer Jonathan Clements
      Annuity Seller Websites
• Find out the sales pitches to be wary of
• Life Insurance Selling

     “Baby boomers aren‟t driving the economy; they are
     the economy!
     Discover how to have better, deeper relationships
     with aging boomers and older clients!”
    Reporting Unethical Sales
• Blow the Whistle
  – Contact state insurance & securities
    • Utah Division of Securities
    • UT Insurance Dept.
  – Regulators may pressure insurer to allow
    withdrawal w/o penalty
  – Help protect other consumers

• Annuities come in two basic types
  – Deferred- for investing for retirement
  – Immediate- for a retirement income you won‟t
  – Many different “flavors” with lots of variety
• Guarantees only as good as the insurance
  company selling the annuity
  – Caveat emptor!

        Annuity Resources
• Morningstar & Lipper- var. annuities


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