Kerry Peabody, Long Term Care Insurance Specialist at Clark Insurance
We’re talking about “deferred annuities” this week, in a three part series. Here’s Part III: Fixed, Deferred Annuities. You can also read Part II: Immediate Annuities, or Part I: Indexed Annuities.
We’ve talked about “immediate annuities,” or “income annuities.” These are used to create a lifetime stream of income. But what if you’re not ready for that? What if, instead, you have some money that you’d like to see grow, but you don’t want to leave it in the stock market. You could keep it in a CD, but CD rates are abysmally low right now, and what you do earn in a CD is taxable. A safe alternative to a CD is a fixed, deferred annuity.
This is a growth and savings tool. You agree to let the insurance company hold your money for a certain time period, usually 3-10 years. In return, they guarantee you a specific return on your money. And, while the money is in the annuity, it grows tax-deferred. This means that, not only will you get, in most cases, a better rate of return, but you’re not going to be taxed on it until you take the money out at some point in the future. So, your money grows faster due to the higher guaranteed returns and the tax deferral inside the contract.
Here’s an example. Jane is 72. She’ has $100,000 in CDs that she’s not using for income, and she’s making 2% in the CD she’s in. She can move that $100,000 to a fixed, deferred annuity with a 6 year annuity period, and get a guaranteed return of 3.15% (using interest rates offered today.) That’s a significant difference, one that will add up over time. After 6 years, the annuity is going to be worth roughly $11,000 more than the CD! At that point, she can keep her money in the annuity and let it continue to grow, she could convert it to income, using an immediate annuity, or she could move it to a new annuity. Or, she could simply take the money and run!
You may have heard horror stories about people being charged to take money out of their annuity. This is because of something called a “surrender charge.” Remember, the company promises to pay you a certain interest rate on your money. In return, you agreed to leave the money with them for the annuity period. If you break that agreement, then you pay a hefty penalty. This is all laid out in the contract. A typical surrender charge is calculated as a percentage of the annuity value, and it decreases over time. For instance, the 6 year annuity I’ve used in this example has a surrender schedule of:
Year 1, 8.5%; Year 2, 7.5%, Year 3, 7%; Year 4, 6%, Year 5, 5%, Year 6, 4.5%, and 0% thereafter.
So, if you take your money out earlier than you agreed to, you pay a penalty. So, you wouldn’t put money into a deferred annuity unless you were sure that you wouldn’t need it. But, also keep in mind, that most good annuities will let you take a portion of your money out –sometimes as much as 10% per year – with no penalty. Many will waive the surrender charges if you’re terminally ill and need your cash, or if you’re confined to a nursing home. Again, this is all laid out in the contract, so do your homework.
Just like any insurance product, you should only buy annuities from a financially stable carrier with a good reputation. Do your homework, and make sure your agent is comparing several companies for you. Not all annuities are created equally, and you don’t want to base your purchase just on the guaranteed rate of return. Look for the surrender schedules, waivers, etc. And don’t hesitate to call me if I can answer questions.