How to Customize Annuities

Higher interest rates are making annuities more popular than ever, but misun- derstandings keep many people from taking advan- tage of annuities.

Insurers have been dealing with waves of applications as yields on multi- year guaranteed annuities (MYGAs) leapt to 3%, 4% and then above 5%. Let’s look at the misunderstandings that keep people from the benefits of annuities and look at ways annuities can be customized.

There are several types of annu- ities. In this article, I focus on the more conservative, low-cost an- nuities that should be considered instead of bonds in many retirement and pre-retirement portfolios.

In a MYGA, the consumer depos- its a lump sum with an insurer for a fixed period. The insurer guarantees the principal value won’t fluctuate and the account will earn a fixed rate of interest.

MYGAs are like bank CDs, except MYGAs of three years and longer usually pay higher yields than CDs and taxes on annuity interest in- come are deferred until the interest is distributed.

For example, the top-yielding three- year MYGA recently had a yield of 5.30% for the first year, according to www.stantheannuityman.com. Some MYGAs guarantee the yield each year for the full term while others adjust the interest rate each year with market conditions. You decide to either lock in a yield when buying the annuity or have it fluctuate annually with the market.

Some people don’t buy MYGAs because they don’t want their money locked up for the annuity term. They have options. Many MYGAs allow you to receive or withdraw the interest as it is earned or when you want without a penalty. Your principal stays in the MYGA to earn more interest.

Most MYGAs also allow you to withdraw some of your principal pen- alty-free after one year. The rest of the principal stays in the account to earn interest. Typically, the maximum pen- alty-free annual principal withdrawal after the first year is 5% or 10%. MYGAs don’t have extra fees or commissions. The insurance agent’s commission is built in the yield the ac- count earns. The insurer pays the agent, so the full amount you deposit is in the account earning the guaranteed yield.

Another type of annuity to consid- er is the single-premium immediate annuity (SPIA), the classic annuity that guarantees a fixed periodic income for life no matter how long you live. You deposit money with an insurer and decide when you want the guaranteed payments to begin. The insurer tells you how much those payments will be.

There’s a lot more flexibility in SPIAs than many people realize. A concern for some people is they might not live to life expectancy. If that happens, the insurer keeps the deposit, and the annuity owner’s heirs receive nothing. In that scenario, the insurer “wins.”

There are solutions if that’s your concern. Some annuities let you select income that lasts for the longer of either a term of years or for life. Suppose you select an income period of 10 years or life.

If you die within 10 years after the annuity payments begin, the payments will continue to your beneficiary until income was paid to you and your ben- eficiary for a total of 10 years. An alternative is known generally as return of premium. There are many variations, but in general if you die be- fore life expectancy a prorated portion of your initial deposit is paid to your beneficiary.

Or you can elect payments to be made for the joint life of you and a beneficiary. Payments don’t stop until both you and the beneficiary have passed away. This is a good choice for many married people. An insurer might offer other options and variations. The point is you shouldn’t forego the guaranteed lifetime income of a SPIA out of fear you might not live long enough.

Keep in mind, though, that each of these options reduces the monthly guaranteed lifetime income. Also, I don’t recommend putting all your retirement funds in a SPIA. Let a SPIA plus Social Security pay your basic living expenses. The remainder of your assets can be invested and left to heirs.

Another criticism of the standard SPIA is that the regular income pay- ment is fixed for life. It loses purchas- ing power to inflation over time. One way to protect purchasing pow- er is with assets outside the annuity. Invest those for growth so they can be used to supplement the SPIA income.

Some SPIAs also offer inflation pro- tection known generally as an income growth factor. No insurer in the United States offers true inflation protection in which the income payment increases each year with the change in the Con- sumer Price Index. But many SPIAs allow you to select a percentage, usually from 1% to 5%, by which the income payment will automatically increase each year. The cost of the income growth factor in your first-year income payment is reduced.

The reduction varies between insurers but tends to be from 20% to 33% of the first-year payment of a SPIA without the growth factor. You can use a spreadsheet to estimate how long it would take you to receive more from a SPIA with the income growth factor than from one without it.

Another concern about SPIAs is the annuity owner receives only the fixed pe- riodic payments. That’s not helpful when a large, unexpected expense arises. Some insurers respond to this con- cern by offering an option allowing an additional withdrawal after the first year.

Typically, up to 10% of the initial deposit can be withdrawn during a year. Electing this provision usually means the initial income payments are reduced. In addition, if the option is exercised by withdrawing some of the deposit, future income payments usually are reduced accordingly. The better strategy usually is to put only a portion of your nest egg into SPIAs and have other funds available for unexpected spending.

Annuities are more flexible than many people realize. The standard an- nuity, whether it is a MYGA or SPIA, can be customized to satisfy many goals and concerns. For many people, the best plan is to deposit a portion of your assets in the appropriate annuity and look to the rest of your assets to meet other goals such as inflation protection, unexpect- ed expenses and benefits to heirs.

Another reason people give for avoiding both MYGAs and SPIAs is interest rates. They don’t want to lock in current interest rates and will recon- sider annuities when rates are higher. This reason was more valid before 2022. Now, it isn’t a good reason to avoid having some MYGAs in your holdings. You can lock in the highest yields in a long time, and those yields often are higher than those on compa- rable CDs and treasury bonds. If you anticipate rates will go higher, then consider dollar-cost averaging into MYGAs over time.

Or you can establish an annuity ladder, deposit- ing equal amounts in annuities that mature over, say, five years. After the one-year annuity matures, roll over the balance to a new five-year annuity. With SPIAs, the wait for higher rates never made much sense. SPIAs are long-term contracts, and insurers don’t give primary weight to current short- term rates when setting the income payments. They focus more on your age and life expectancy. To the extent the insurers consider interest rates, they look at the earnings they expect from their investment port- folios over the rest of your life expectan- cy instead of current interest rates. Don’t take a do-it-yourself approach to annuities. Work with a consum- er-friendly expert.

I recommend Todd Phillips and Stan Haithcock. You can reach Todd at Phillips Financial Services at 1-888-892-1102 or visit https://epmez.com/annuity-analysis. Stan also is known as Stan the An- nuity Man. Review his annuity cal- culators and other materials at www. stantheannuityman.com. Then, book a call with him.