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Investment Services, Annuities & Income

Reimagining Retirement with a Variable Annuity

Planning for retirement has changed greatly in the last forty years. The Revenue Act of 1978 was passed by Congress and included IRS Section 401(k), which granted employees the ability to defer compensation tax-free from stock options and bonuses. Companies started moving their retirement plans from pensions into this new investment vehicle. Most companies could no longer afford to be paying out pensions when year after year people were living longer. It was no longer feasible for their bottom line. Living longer coupled with pensions going away means people need to plan even more diligently for their retirement.

There are multiple strategies investors can use to generate income for retirement, but many of them aren’t a guarantee. However, by learning about products that are predictable and provide a steady form of income, it’s possible to feel secure about retirement.

Variable Annuities Can Provide Stability

A variable annuity is a long term, tax-deferred investment. It creates a steady retirement income for life. It’s part investment and part insurance policy that allows for tax-deferred growth. It’s also managed professionally, has a death benefit, and offers flexible withdrawal options. The income is guaranteed by the ability of the issuer to pay claims, and they’re only sold by prospectus.

Variable annuities offer a unique advantage over other investments. They allow participants to invest in equity markets via a feature called ‘living benefits.’ This feature is optional and can offer lifetime payments, return on principal, or both. They can be set up to start immediately or at a future date.

How Does a Variable Annuity Work?

You pay money into an investment portfolio allocated for the annuity. When setting up the annuity, you can choose a specific time frame you want to receive payments (up until your death), have the money target your investment objectives, and align it to your level of risk tolerance. The amount of income you get will go up or down, depending on how good the investment is doing.

Most variable annuities guarantee a return of premium, which means the initial money you invested won’t go down. If the investment doesn’t do well, you won’t earn any money on growth. If the investment does well, there is the potential for gain. Depending on the variable annuity you choose, the amount invested can be spread out into a range of funds or other investments. In some cases, you might be able to change where your money is invested for a small fee.

The Popular Guaranteed Lifetime Withdrawal Benefit

Many investors in variable annuities choose the guaranteed lifetime withdrawal benefit (GLWB). Depending on the issuing insurance company, rates for this feature can run anywhere from 0.40% up to 1.62%. There’s often a connection between the guarantee and the cost of living benefit. Before choosing this option, it’s important to figure out just how much protection you want.

The main reason investors choose GLWB is because the income is secure for life, as long as the withdrawals stay within the parameters of the feature. This type of policy also allows for participation in equity markets.

As an example of how the annuity works for immediate income, let’s say an investor is 60 years old and invests $100,000 into their annuity and they have chosen to have a GLWB. If they are able to take out $5,000 each year, that policy would last 20 years. If the investment was wisely managed, that money would last much longer. If the investment wasn’t managed well or the markets were down, the insurer would still be liable to pay $5,000 each year until the death of the policy owner.

There are other ways to benefit from GLWBs. If there is a ‘step-up’ added to the policy it means that if the investor’s account grows in value on the anniversary of the policy, those additional funds would increase the value of the policy, and an even greater amount could be pulled out yearly.

Is a Variable Annuity Right for You?

There are some things you can do to figure out if a variable annuity is right for you. It’s best to start with a good overall view of your current finances and what you’re looking for from the annuity. A steady income stream? Security? How much do you already have saved? What do you want your retirement to look like?

Start by writing down your estimated expenses and how much income you’ll need to cover those costs. For now, this should be your needs over your wants. Then determine how much you’ll have covered by your current investments and any Social Security you’ll receive. The gap, called shortfall, is what you might want to make up with a variable annuity.

It’s important to contact a financial professional to help determine the best way to cover any shortfall. Many retirees like the security a variable annuity can provide with a guaranteed income stream. When you work with your financial professional, they can help you to choose from all the options to get the most out of your policy. They can also help you to judge the underlying insurance company. This is a crucial step to make sure the company you choose to do business with is solid and has a low chance of insolvency, since your money is guaranteed based on their claims paying ability.

Benefits vs. Risks

Benefits

  • A professionally managed policy with a range of investment options.
  • The ability to reallocate investment choices without worrying about creating a taxable event.
  • The choice of GLWBs which provide secure income even if the contract value diminishes.
  • Beneficiaries receive death benefits from the account value or a return of the investment after being adjusted for proportional withdrawals.
  • Earnings grow tax-deferred until you start making withdrawals.

Risks

  • The IRS penalizes 10% of withdrawals before the age of 59½, in addition to possible surrender charges.
  • Investments that have tax-deferred gains are taxed the same as regular income when they’re withdrawn.
  • The value of the annuity could be worth more or less than the original value if the sub-account portfolios fluctuate and may have impact if the annuity is redeemed.
  • If a withdrawal is taken over the maximum amount under the GLWB feature, it could negatively affect the benefit base level, therefore having you pay for a feature you aren’t using. To offset this issue, consider having another source of funds for emergencies and staying within the parameters of the GLWB.
  • Insolvency of the issuing insurance company. Know your state’s coverage for annuities by contacting the insurance-guarantee association where you live.
  • Should the company become insolvent, you could lose a portion or all of your future guarantees.


To learn more about Variable Annuities, contact one of our knowledgeable Financial Advisors who can help review your options.

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The financial advisors of Orange County's Retirement & Investment Services are registered with and offer securities and advisory services through LPL Financial (LPL), a registered investment advisor and broker/dealer (member FINRA/ SIPC). Insurance products are offered through LPL or its licensed affiliates. Orange County's Credit Union and Orange County's Retirement & Investment Services are not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using Orange County's Retirement & Investment Services, and may also be employees of Orange County's Credit Union. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, Orange County's Credit Union or Orange County's Retirement & Investment Services. Securities and insurance offered through LPL or its affiliates are:

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