Creating Secure Income
In Your Retirement

By: Ginine Castillo
Special to the Oahu Island News

If you are like most people planning for retirement, you want secure income once you are no longer working. Fixed and variable-rate annuities to maintain your standard of living in the face of inflation are one approach.

The Annuity Misconception
Annuities are one of the most popular investments. Most investors think of annuities as supercharged certificates of deposit (CDs) or mutual funds that help your money compound, free of taxes, until you eventually dip into your stash. But that is just part of the story. Annuities are more than just an accumulation vehicle — they are also a way to convert assets into steady income that will last as long as you live. This process is known as “annuitizing” or “annuitization”.

Annuities that provide a steady income stream, or a “payout,” are similar to life insurance policies. With life insurance, you pay regular premiums to an insurer that makes a lump-sum payment upon your death. However, with an annuity, the insurer converts a lump sum of cash into payments.

Fixed Payout
If you choose a fixed payout amount, the size of your payout will depend on many factors, including the amount you invest, your life expectancy and how much the insurer feels he or she can earn from your money over time. For example, based on current rates, a 65-year old man who annuitizes $100,000 might receive a guaranteed annual payment of about $7,400 for as long as he lives. This amount is based on a man’s life only. If he lives past his life expectancy, he will earn more than he could by putting the same amount into safe, fixed-income investments.

Variable Payout
As with a fixed payout, if you choose a variable payout, the amount you receive will depend partly on your life expectancy. However, unlike a fixed payout, the amount you receive each month will fluctuate according to how the underlying investments perform. You choose an assumed interest rate, which determines the size of your initial payment. (Some insurers allow you to pick your own rate, while others assign one.) Rates are typically in the range of 3-6 percent.

Then you decide how to invest your contribution among a variety of mutual fund-like portfolios called “subaccounts.” If your subaccount portfolio generates a return higher than the interest rate, your variable annuity payments increase. If your portfolio earns less than the rate, your payments drop — and this can make budgeting in retirement tricky.

Tax Implications
Keep in mind that withdrawals made from an annuity before age 59 1/2 are taxed as ordinary income and may be subject to a 10 percent federal penalty. Also be aware that annuities have a tax disadvantage: All gains are taxed as ordinary income.

Rest assured, however, that annuities generally offer a tax benefit when you invest taxable dollars: A portion of each payment you receive is considered a return of your capital and therefore is not taxed.

Combining the Best of Both Worlds
It is clear that owning an annuity, in addition to a conventional portfolio of stocks or mutual funds, can substantially reduce the odds that you’ll run short of money. Here are six tips to help you maximize the value of your annuities:

• Shop around for low fees.

• Choose an annuity that offers a wide variety of investment options (“sub-accounts”).

• Consider investing the same amount of money at regular interval.

• Keep your investments diversified.

• Spread your money around to different investment types.

• Use annuities to pass money along to heirs quickly.

Don’t Put All Your Eggs in One Basket

Annuities are just one tool you can use as part of your long-term financial plan. Remember not to put all your money in annuities. Make sure you have emergency reserves and other accessible assets to draw upon in case you have an immediate need.

Using annuities for retirement and estate planning can be quite complicated. A qualified financial advisor can help you sort through the products, potential risks and timing and determine what strategy fits best within your personal economy.

Ginine Castillo is a Financial Advisor at American Express Financial Advisors Inc. She can be reached at 952-1188 or by email: ginine.h.castillo@aexp.com. The information provided in this article is for informational purposes only. It is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. The views expressed may not be suitable for every situation.