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-March 2016 -
by Kirk A. Hoffman
A three legged stool analogy is often used for planning and saving for retirement. The three legs represent personal savings, employer provided benefits, and government benefits. For public school employees, 403(b) plans are used for individual savings. School districts pay into 403(b) plans and/or the state pension program to provide an employer benefit. Social Security provides the government benefit.
One of many tools available for the personal savings portion of a goal focused financial plan is an annuity. Annuities have two phases, the accumulation phase and the pay-out phase. Annuities can be part of a 403(b) plan to accept and accumulate contributions. The accumulation phase is pretty straight forward. Contributions go in on a tax deferred basis and taxes on earnings are deferred. More questions arise once a plan participant reaches retirement and the pay-out phase begins.
There are several options available at the pay-out phase:
Under this option, the participant withdraws only the interest and earnings on the account. The principal balance is not accessed. This can be done on a monthly, quarterly, semi-annual, or annual basis. Taxation on the principal is deferred until death. (Required minimum distributions at age 70 ½ may require some principal distribution).
Systematic withdrawal based on a percentage or dollar amount.
Under this option, the participant establishes a regular withdrawal percentage or dollar amount. The plan participant could outlive the withdrawals depending on the withdrawal rate and earnings.
Guaranteed life income.
The real power of an annuity is that it can provide guaranteed life income. Under this option, the annuity is set up to pay out, like the participant’s pension and social security, monthly income for life. Just like with the pension, there are various guarantees that can be selected:
Life only – payments cease at death
Life with a period certain (5, 10, 20 years) – payments for the longer of life or the
guaranteed number of years.
Joint and Survivor – based on two lives, payments cease at the second death
Joint and Survivor with period certain (5, 10, 20 years) – payments for the longer of
life of the two individuals or the guaranteed number of years.
The monthly payout is affected by the selected guarantees. The more guarantees, the lower the monthly payment.
There is no better tool to create another guaranteed income stream to go along with a pension and Social Security than an annuity. It works well if you are in good health and you have a history of longevity. You cannot outlive the income. It removes you from the markets so you are not subject to volatility which provides peace of mind for risk adverse individuals.
Every investment tool has positives and negatives. Some negatives of annuitizing are that you give up access to the principal and potential higher earnings that could be realized from other investments. These are significant factors to consider.
A professional advisor can assist in determining if creating another guaranteed income stream with an annuity is a good fit for your particular situation and if it will contribute to accomplishing the goals defined in you financial plan.