What you need to know about year-end dues
How to pay your final contributions and ensure optimal investment of your independent pension assets.
Contributing to a Standard IRA or Roth IRA by April 15 is your opportunity to reduce 2021 income taxes with a Standard IRA or achieve tax-free growth with a Roth, assuming you are eligible.
Now is also a great time to review how you invest all of your IRA funds to see if there are better options available. Review your asset allocation and consider rebalancing if you are too focused on equities.
By broadening your horizons, you can develop an investment strategy that will provide you with greater growth without exposing you to unacceptable risk.
I won’t cover well-known strategies, such as domestic and foreign stocks, bonds, CDs, and commodity ETFs. All of these can play a valuable role in a diversified portfolio to stay ahead of inflation. I’ll stick to my expertise, annuities, and explain why they can be a valuable addition to your IRA plan and asset allocation.
Annuities cannot all be grouped into one category. Some annuities allow you to invest your assets in equity funds. Some behave like certificates of deposit. Some offer a guaranteed stream of lifetime income. Some combine growth potential without bear market risk. I will not cover variable annuities because I believe they are not optimal for IRAs.
Unlike variable annuities, fixed annuities all guarantee principal or income. Backed by life insurers, they have one thing in common: you won’t lose money due to market declines. This is because the issuing insurance company bears all the investment risk. None of them can give you the kind of eye-popping returns you might get from growth stocks, but you eliminate the downsides.
Fixed-index annuity: upside potential without downside
It is the only financial product that offers market-based growth potential while securing your capital. Fixed-index annuities are a separate asset class because they share some of the characteristics of stocks and fixed-income investments.
They pay a share of the gain as an annual interest credit when the stock market goes up. In exchange for the guarantee that you will never lose money, you can only get a portion of the market’s annual gain as measured by an index such as the Dow Jones Industrial Average or the S&P 500.
If the market index is negative for the year, you generally won’t get any interest.
Experts expect the product to deliver higher long-term returns than bonds or fixed-rate annuities while tracking equity returns, but without market risk or volatility. You must be prepared to withstand some interest rate uncertainty.
Optional guaranteed lifetime income and/or withdrawal benefit riders are generally available for an additional fee.
Indexed annuities have a lot of positives and sales have exploded. A “have your cake and eat it too” approach is appealing.
A disadvantage is the complexity. It takes work to understand them and identify which one might be the best deal for you. Plus, they’re designed to work for the long term, not short-term needs, and that’s one of the reasons they can work well in IRAs.
The other downside is that you won’t get the full benefits when the markets explode. These annuities have various caps and participation rates that limit the upside. Some insurers offer better deals than others, and it’s hard to make apples-to-apples comparisons. More information can be found here.
The deferred income annuity (DIA) can provide a guarantee lifetime income
A DIA defers income payments to a future date that you choose. It can provide guaranteed lifetime income after an initial holding period ranging from two to 40 years.
The main disadvantage of income annuities is that you no longer own the cash value. You give it up in exchange for a promise of future income.
You can choose an income annuity with a limited payout period, such as 15 years, but most people choose the lifetime option. This option gives you longevity insurance. Income payments can also be guaranteed in conjunction with your spouse’s life.
A DIA can work well as an IRA, but make sure your income payments start no later than age 72 to comply with the required minimum distribution (RMD) rules. If you want to defer income payments beyond this age, consider a qualified longevity annuity contract (QLAC).
QLAC defers RMDs for greater future revenue
The QLAC is an IRA DIA designed to meet IRS requirements. You do not need to take the required minimum distributions on the assets of a QLAC. This is the only way to legally delay RMDs for a portion of your standard IRA funds and thus keep more money in your IRA longer.
You can invest up to 25% ($135,000 maximum) of your IRA money in a QLAC. You can delay taking RMDs on the QLAC until age 85, instead of having to take them from age 72 as you would with a standard IRA.
Since you are relying on the insurer to pay crucial future earnings, choose a financially strong company.
Immediate Income Annuity Can Fulfill RMDs
If you are over 72, an immediate annuity can help you with your RMDs. You can choose a guaranteed lifetime income or a limited term so as not to exceed your life expectancy.
An immediate annuity effectively converts an asset into income, but in return you have little or no ability to alter the income stream once it has begun.
Some retirees don’t like the idea of illiquidity. But it’s very difficult to get the same level of guaranteed lifetime income otherwise if you need immediate income.
Fixed rate annuities can outperform bank CDs and bond funds
The fixed rate annuity is sometimes referred to as the CD type annuity. Its official name is the multi-year guaranteed annuity, orMYGA—a tongue twister of a name for a simple product.
Like a bank certificate of deposit, it guarantees a fixed interest rate for two to ten years. MYGAs generally pay significantly higher rates than CDs of comparable length. For current rates, see this table
These annuities offer great benefits for the fixed income portion of your portfolio, especially if you need to rebalance. They offer higher current yields than most bond funds or ETFs. And you can’t lose market value with them like you can with a bond fund or an ETF. The downside is less liquidity.
You can renew a MYGA for an additional warranty period at the end of each term. Or you can optionally choose to make it an annuity: convert it into a guaranteed income stream for a certain number of years or your lifetime.
As with CDs, you will be penalized if you make excessive withdrawals before the end of the term. Unlike CDs, these annuities are not guaranteed by federal deposit insurance, so it is wise to choose a financially strong insurer. State Guarantee Associations, however, offer a good level of relief protection to annuitant holders up to certain limits.
Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed rate, indexed and lifetime income annuities. He is a nationally recognized annuity expert and author. A free rate comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.