By C.D. Moriarty
The SECURE Act ostensibly will make it easier to save for retirement. One big change creates a boon for annuity sellers. As a financial planner, I am not sold yet, especially when it comes to using annuities as a one-size fits all solution. You need to be cautious too.
Annuities create a consistent life-long base of income, but that is what Social Security offers participants in retirement. Whenever a perplexed potential annuity purchaser came into my office for a second opinion, I would ask, “What else did this financial advisor recommend?” Often, the answer was, “This was the only investment.” I explained they must sell annuities and most likely only insurance products, as this was an insurance product.
Over the years, as a fee-only financial planner, I never sold or made money from annuities. However, I saw many people get sold annuities that were not to their benefit, including an 80-year-old who was sold an annuity illegally. Yet, someone did benefit: the person who received the commission.
I came to highlight the main reasons you do not need to buy an annuity as follows:
• The commissions are high.
• The surrender fees if you cancel a policy lock you in for six to seven years.
• Especially today, interest rates are low, which means the cost of buying that guaranteed income is particularly high. You have a long time to live. Interest rates will change and you may be locked in to that annuity structure.
• There are other options including actual bonds, cash and a mix of investments also generate a steady income stream.
Annuity is a term to cover several individual products backed by an insurance company. Just consider the type of annuity products out there: Single premium annuities, variable annuities, fixed-indexed annuities, immediate annuities and deferred annuities. Then there are different terms for each company product.
Confusing? Yes. This legislation adds another layer of complexity that may sway people toward what seems like a simple product rather than solutions to save for a healthier retirement.
Now, individuals will have the option to invest money within their current defined-contribution (401(k), 403(b), etc) plans into annuities. Yet the trustees of the retirement plans will not have the same fiduciary duty in choosing the annuity for their participants. They do have fiduciary duty of care for choosing carefully the mutual-funds in their plan. This legislation only requires them to collect the insurance company information, not evaluate it.
Despite this attention-getting legislation, people could always invest their retirement monies in an annuity with IRA funds. In fact, an investment company always seemed to put their clients’ IRA money into an annuity. This is redundant, as an IRA grows tax-free and an annuity grows tax-free. Both are used as way to shelter for retirement.
When does an annuity make sense?
There are two or three times I did recommend an annuity purchase in the retirement plan options. They were typically to individuals who had received a large payout that they did not need right away. I know other financial professionals who sell annuities at the right time to the right folks, along with making other recommendations to a well-devised plan. Annuities make a great retirement base. Annuities are terrific way for high-net-worth and or high-income people to shelter some money and let it grow tax-free until they need it.
The biggest misconception about annuities? Income taxes. Annuities are tax-deferred but that does not mean they avoid taxes altogether. Whether they are bought with qualified or non-qualified money, you will pay taxes . Tax rates change, each state has its own tax code and the withdrawals format all determine how much money you will pay in taxes.
Investors prefer paying taxes on capital gains rather than earned income because capital-gains rates are typically lower. In 2020 the capital gains tax rates range between 0% and 20% for assets held for more than a year. Yet, annuities can be taxed at your ordinary income rate (10-35%). How taxes are determined depends on many factors including whether the funds came from qualified or non-qualified monies.
Insurance and investment people typically do not have the qualifications or know enough about your full financial situation let alone the complicated rules associated with your annuity. More importantly, the buyer does not understand this tax issue. For this reason, you should consult a tax professional before buying an annuity and certainly before considering withdrawing annuity monies.
Thinking of an annuity anyway? Proceed with prudence and slowly. Get advice for the 401(k) from an independent financial professional who does not sell product. Then you will know what is best for your needs rather than taking the advice of investment folks who stand to gain by your decision.
Retirement planning is changing because of the SECURE Act. Now that President Trump has signed this legislation, you best put “scheduling a meeting” with a fee-only planner on your list in 2020. This legislation kicks quickly, on Jan. 1, 2020. Best to be fully informed on your financial situation.
C.D. Moriarty, CFPR is a Vermont-based financial speaker, writer and coach who wants to create financial peace of mind for others. She can be reached through her website at www.MoneyPeace.com.
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