The Immediate Annuity: Living at the Next Level

In his book Living at the Next Level: Insight for Reaching Your Dreams, John Maxwell wrote, “Every time you discover something new, ask yourself three questions:  ‘Where can I use this?’ ‘When can I use this?’ and ‘Who needs to know it?’”

This truth also applies in life and finances. Very few financial products are inherently bad. It’s just that sometimes they are not the right fit for a client’s particular needs. Applying John Maxwell’s three questions before investing will help ensure that the product you are considering meets your personal goals.

To Annuitize or Not To Annuitize

Hi FedNav,

I am a 79-year-old widower. In the 1970’s, I put away money in stock market investments and a tax-deferred annuity, and have been quite lucky. As a result of my income from those investments, a small pension, and my Social Security paychecks, I have more than enough funds to live on. I recently went to an estate attorney to set up a will. I mentioned that I live on my stock dividends but feel that I will never need the annuity, which is now worth a good amount. It has a steady lifetime interest rate for me, but the attorney said I should annuitize and buy a life insurance policy instead. I’m not sure I’m comfortable with that suggestion. What should I do?

Uncomfortable, Gaithersburg, MD

Dear Uncomfortable,

The reason your attorney suggested a life insurance policy instead of a tax-deferred annuity is probably due to the difference in taxation at death:

1. The growth on a tax-deferred annuity is taxed to your heirs as ordinary income, unlike stocks or real estate. This can be a big tax burden to your heirs.

2. A life insurance policy, assuming your estate is under the Federal estate tax limit of $5.43 million, is a non-taxable event to your heirs, hence the attorney’s recommendation. However, there are two catches your attorney may not have considered:

a. When you annuitize the annuity (turn your principal into income) for life, part of that income is taxable to you.

b. Your annuity is paying a certain rate, which, depending on your exact rate, could be better than the other products that are available. But remember, the guarantees are based on the claims-paying ability of the issuer, and they do not adjust for inflation.

Should You Move to an Annuity?

To decide whether you should make this move, take a couple of things into consideration:

-First, calculate the annuity’s growth using the interest rate according to your life expectancy.

-Then, go ahead and subtract the tax amount that the annuity will be subject to (remember it would be taxed as regular income) to determine the net amount that would go to your heirs.

-If this number is greater than the death benefit you could buy with your annuitized amount, you may want to go for the life insurance. If not, the annuity may be a better deal.

In your case, depending on how high the annuity’s lifetime rate is, transferring it to an insurance policy may not be the best choice. If the rate is really high, it may be a good option to just leave it in the annuity and go from there: if it ain’t broke, no need to fix it! But if the rate isn’t that impressive, an insurance policy could be a possibility.

Of course, the best thing to do would be to set up an appointment with a financial planner to talk it over, just to make sure the right direction is being taken with your money. You have options, and it’s important to make sure you’re taking the right one.