By Norman A. Pappas
July 1, 2008
What if there was a retirement savings vehicle that gave you access to the upside potential of the stock market but protected you from the downside risk, let you lock in gains but defer taxation on them, and guaranteed a lifetime income for you and your spouse that you could never outlive?
Would that be worth having? Would it make you set for life?
All of these features are available to anyone with even a relatively modest amount to invest. It can be used for general retirement savings, but works especially well for pension or profit sharing plans, or for traditional IRAs and 401(k) rollovers.
There are many variations available, but generally they work like this:
-¢ Your principal is guaranteed, usually in the form of income.
-¢ Increases in account value can be locked in. For example, if the portfolio goes up 10 percent, so does the guaranteed value.
-¢ Some minimum annual growth rate is guaranteed (e.g., 5 to 7 percent) for some number of years (5 to 10). So even if the stock market crashes, your guaranteed account increases - and you get to sleep at night.
-¢ Your guaranteed account value is usually returned to you in the form of an annual income, which can span the lifetimes of both spouses, and continue even after you’ve used up your guaranteed value. In some cases, you can even continue to increase your guaranteed base while taking income.
-¢ You can choose from a variety of investment funds, including many “brand name” fund managers. Other features include automatic rebalancing, and diversified model portfolios that automatically put you in several funds based on your desired level of risk.
There are many other features, but these are the five that significantly distinguish this vehicle from traditional investment choices.
So now you may be thinking: “What’s the catch?” Why wouldn’t everyone use this magical vehicle? There are, indeed, some catches that you need to be aware of before deciding if this is the right vehicle for you.
-¢ Costs: The guarantees are not free. There are costs associated with guaranteeing your principal, a minimum return and lifetime income. There are other charges as well, so get those defined before buying, to avoid surprises.
-¢ Taxes: There is no income tax on gains while you keep the money in the contract, but there is when you take it out. When withdrawn, gains are taxed as ordinary income. This can be minimized with careful planning.
-¢ Surrender charges: In most cases, a charge is assessed for early surrender. While these usually burn off in a few years, understand how long you will be “locked in” to whatever contract you select.
So what is this vehicle that offers principal and lifetime income guarantees? It is known as a Tax Deferred Annuity. A familiar name, but as you have seen, this is not your father’s tax deferred annuity. You must do your homework on companies and features. If you do, you will be on your way to being set for life.