As a financial industry professional and contributor to several publications, Tyler J. Coia discusses how to maximize retirement income with a strategic approach to split annuities in the article below.
During the tail end of 2022, the S&P 500 lost 19.4% of its value and accompanied by the highest inflation rates in 40 years. If the stock market looks dire, risk-averse investors turn to options that are less volatile.
One such option are annuities, offering a safe haven away from the ups and downs of Wall Street.
Annuities are referred to as the only financial vehicle in existence that guarantees regular income within a definite period of time.
Annuities are Slow and Steady
Annuities are contractual agreements designed to be used as retirement vehicles. These agreements with insurance companies can be bought with a lump sum or through regular contributions. In return, the company provides regular payments depending on the terms of the annuity.
Among the many advantages of annuities is the tax-deferred growth of the principal used to enter the agreement. Annuities also do not have contribution limits, and their flexibility allows them to be used strategically.
One such strategy is the Split, utilizing immediate annuities and single premium tax-deferred annuities (SPDA).
The Split
By using these two kinds of annuities, the principal is preserved while still generating a steady source of money. The strategy is broken down to understand its mechanics:
Simultaneous Purchase
The investor takes a double-pronged approach by utilizing an immediate annuity and SPDA simultaneously.
Dividing Capital
The capital for the investment is then divided among the two, with the objective to balance both the short-term and long-term advantages of the two annuity types. As the immediate annuity generates tax-advantaged monthly income, the SPDA will gradually rebuild the principal during the same time frame.
Tax Consideration
When employing the Split, the investor must take into account that premature withdrawals are considered ordinary income. It is not tax-advantaged.
Renewal and Repetition
Once the time period for the immediate annuity concludes, the strategy can be repeated using the money gained through the SPDA. This method allows the investor to generate income while preserving capital, setting the foundation for a stable financial future.
However, annuities are not guaranteed by the Federal Deposit Insurance Corporation or any other government agency, and hinge on the insurance company’s ability to pay, so due diligence is required when choosing annuity providers. If the Split is exercised with care, investors can benefit from both the instant and delayed gratification of financial security.
The process is demonstrated in the example below:
Meet Justin the Retiree
Justin is newly retired, and to replace his monthly paychecks he has decided to invest in annuities.
With $300,000 as his capital, he divides it between an SPDA lasting 10 years, promising a 5% return, and an immediate annuity also lasting 10 years but with a 3% return. After some number crunching, Justin allots $182,148 to the SPDA, and the immediate annuity gets the remaining $117,852.
During the term period of 10 years, the immediate annuity generated a reliable monthly income of $1,117. Consequently, the untouched SPDA has rebuilt most of Justin’s capital, now valued at $296,700.
By employing the Split, Justin secured himself money for monthly expenses, while preserving the majority of his initial $300,000.
It’s Not All Sunshine and Rainbows
While the Split is attractive, it’s vital to remember that annuities also come with its respective fees. Furthermore, investor’s money can become tied-up in an annuity due to surrender charges, making it challenging to withdraw the principal in case of emergencies.
Annuities can be structured in many ways and it’s best to consult a financial adviser when considering investing in this financial vehicle.
The Bottom Line
Annuities are not a one-size-fits-all financial vehicle, though they could be a good fit for retired or nearing-retirement investors, due to its ability to replace the accustomed paychecks..
With due diligence and careful consideration, the Split can be effective in achieving a regular source of income and preserving capital, but investors must take the time to understand their specific contract terms.
“The biggest advice I can give to someone who is thinking about whether an annuity is right for them is to ask questions,” says Ron Tallou, founder and owner of Tallou Financial Services in Troy, Michigan.