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Itâ€™s tempting to overinvest in stocks today, but everyone still needs some safe footing from other places. For part of your safe-money portion, fixed annuities offer guarantees, higher rates, and tax deferrals.
Making sure you can cast a wide net for your eventual retirement is the safe, and smart, option.
An asset allocation plan means that you set the percentages you put in equities (stocks or stock funds) and fixed income, which includes savings accounts, money markets, CDs, bonds and fixed annuities. Your asset allocation should not change in the short term, but it will change over the years.
As you approach and enter retirement, you’ll normally decrease the percentage in stocks and boost your share in safe investments. Once you’re retired and begin withdrawing your savings, you’ll likely want to become even more conservative. Sticking to your asset allocation also offers many benefits, such as, decreasing excessive risk and preventing you from buying high and selling low.
If and when the stock market falls, you’ll be less tempted to sell everything because you’ll also have a solid cushion of fixed assets that doesn’t fluctuate with the market. Many people without a plan panic and sell their stock funds at exactly the wrong time, when the market is at a low point.
You’ll also be able to resist overinvesting in the stock market when it’s reaching new all-time highs, as it’s been doing this year. When there’s a bull market, it’s easy to get too excited and forget that what goes up will come down eventually.
The right asset allocation is ultimately up to the individual. Besides your age and expected income in retirement, your psychology is important. Some people are very risk-averse, while others don’t mind the ups and downs of the stock market too much.
Most people’s financial lives fall into two distinct phases: accumulation and distribution, sometimes called decumulation. When you’re working, you’re in the accumulation phase saving for future needs such as a first home, education for your kids, and retirement.
It’s hard for many people to put aside much in the early years of their working life, but once education and other needs are met, and as you advance in your career, you can ramp up your savings especially by your 50s and early 60s.
Stocks, savings accounts, money markets, CDs, and bonds can all play a valuable role as part of your asset allocation during the accumulation phase. Their characteristics are well known, whereas, the advantages of fixed annuities are less well known.
A deferred fixed annuity is suited for the accumulation phase because you don’t need current income. It defers payments and thus taxes until the distribution phase when you do. Without the drag of taxes all your earnings can be reinvested and grow faster.
One of the most popular products is the multi-year guaranteed annuity, also called a CD-type annuity. You make a single deposit and then the annuity pays a guaranteed interest rate for a set period of time, usually 3 to 10 years.
There’s no sales charge. Every dollar you deposit goes to work for you immediately.
Fixed-annuity advantages also include:
Multi-year guarantee annuities often pay substantially more than a comparable bank CD. For example, the highest-paying five-year CD was recently yielding 3.25%, versus 4.00% for the top five-year annuity—a 23.1% advantage over the CD. The top rate for a three-year annuity was 3.10%.
All CDs interest is subject to federal and state income tax annually, even when it’s reinvested in the CD. Similarly, interest from bonds and money markets is also taxable unless held in a qualified plan such as an IRA. Municipal bonds pay tax-free interest, but municipal rates are lower than other types of bonds.
With a deferred annuity you won’t receive a 1099 and you won’t owe tax on the interest until you withdraw it. At the end of the annuity’s initial guarantee period you may renew it for another term or roll it over into another annuity.
You can continue to defer taxes as long as you like, until you need the money for retirement or another purpose and withdraw it.
Your principal is guaranteed by the issuing life insurance company. Life insurers are strictly regulated by the states to ensure solvency. An additional layer of protection is provided by state guaranty associations up to certain limits that vary by your state of residence.
Bond mutual funds are also used in asset allocation to reduce risk. However, bond-fund share prices vary. You can lose money in a bond fund, especially in long-term funds.
Once you’re retired, you’ll need income from your savings. This is the distribution phase of life. Annuities offer unique advantages here.
If you have an existing annuity, you may choose to annuitize it. That is, you’ll convert the cash into a stream of income guaranteed for whatever period of time you choose, such as 20 years or your lifetime—the most popular option.
Lifetime income helps assure you won’t run out of money even if you live past 100, it’s longevity insurance without many strings attached.
For more personal finance insight, read on here!
Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. It provides a free quote comparison service. launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities.
More information, including updated interest rates from dozens of insurers, is available at https://www.annuityadvantage.com or (800) 239-0356.