Over the next 20 years, an estimated 77 million Americans – the baby boomers — will transition from work life to retirement. Without pensions to fall back on and with Social Security’s future in doubt, it’s no wonder many near-retirees and retirees alike are searching high and low for sources of income.
For many, the search begins and ends with a fixed-rate annuity. Not only are these insurance contracts are locked into a fixed rate of income, they can be costly, complex, and require handing off control of your assets. What’s more, most won’t keep pace with inflation.
An annuity is a contract sold by an insurance company designed to provide payments to the holder at specified intervals, usually after retirement. The holder is taxed only when they start taking distributions or if they withdraw funds from the account. All annuities are tax-deferred, meaning that any earnings from investments in these accounts are tax-deferred until withdrawal. Annuity earnings are also tax-deferred so they cannot be withdrawn without penalty, until a certain specified age (usually 59.5). Fixed annuities guarantee a certain payment amount, while other types of annuities do not, but do have the potential for greater returns. Relatively conservative yields on annuities are not geared to be high yielding investments. An annuity offers a death benefit equivalent to the higher of the current value of the annuity or the amount the buyer has paid into it.
If you want to retain more control of your assets or just potentially build in some inflation protection, there are some alternatives to the traditional fixed annuity route. But most require increased diligence and may involve increased exposure to various investment and market risks. Before undertaking any financial decisions, be sure to consult with your financial professional.
Market Value Adjusted (MVA) Annuities1 – This is a type of fixed annuity that lets an investor lock in a fixed interest rate for a term that can range from one to 10 years. At the end of each term, the annuity company offers the investor a new interest rate. If the investor approves of the rate, the MVA annuity is renewed. If the investor doesn’t want to renew, the principal can be withdrawn without surrender charges. The investor bears a number of risks, including the risk that rates may rise while their principal is locked in at a lower rate. Additionally, if the investor wishes to withdraw from the contract prior to its expiration, surrender charges will apply.
Equity-Indexed Annuities (EIAs)2 – EIAs have characteristics of both fixed and variable annuities. The opportunity for a higher return exists when compared to a fixed annuity, but not as much as a variable annuity. EIAs are designed to give more potential return (but greater risk) than a fixed annuity, coupled with less potential return (and less risk) than a variable annuity. EIAs offer a minimum guaranteed interest rate combined with an interest rate linked to a market index (such as the S&P 500). Because of their guaranteed interest rate, EIAs have less market risk than variable annuities and also have the potential to earn better returns than traditional fixed annuities when the stock market rises but up to a stated maximum participation rate, which means your return will be ‘capped’ at a return when compare to the index it’s tracking.
Mutual Funds2 –Retirement income funds, which operate like target-date funds for those already retired, are the latest new product in the mutual fund space. The funds are invested in an allocation of stocks, bonds and cash that evolves over time. Some pay dividends monthly – investors have the option to withdraw the income or reinvest it. These funds come in two varieties: perpetuity and non-perpetuity. Perpetuity funds attempt to balance capital preservation with income generation for as long as possible, while non-perpetuity funds pay distributions only for a specified amount of time. Note that these products are still very new and fees and returns can vary widely. As with all mutual fund investments, it is possible to lose principal. Because the market value of the fund fluctuates with changes in market conditions and the value of the underlying securities, your shares may be worth more or less than their original price when sold. Retirement income funds are subject to unique risks including, but not all-inclusive of, the risks of its underlying holdings and the markets they are invested in; volatility, interest rate, asset allocation and underperformance risk. Retirement income funds are not guaranteed at any time, including on or after the holders retirement date.
Fixed-Income Unit Investment Trusts (UITs)2 – The goal of a fixed-income UIT is to generate a relatively predictable and stable stream of income over the life of the trust. These securities operate similar to closed-end mutual funds and are not actively managed. They are typically portfolios comprised separately of municipal bonds, corporate bonds, international bonds, and government-backed or mortgage-backed securities and provide income on a monthly, quarterly, or annual basis. Because the market value of the trust units fluctuates with changes in market conditions and the value of the underlying securities, shares of the UIT may be worth more or less than their original price when sold. Unit Investment Trusts (UITS) are a fixed portfolio of securities with a set term. Strategies are long-term; therefore investors should consider their ability to pursue investing in successive trusts and the tax consequences.
1Investors should carefully consider the investment objectives and risks as well as charges and expenses of an annuity before investing. The prospectus contains this and other information. Read it carefully before you invest.
2Investing in EIAs, mutual funds, variable annuities and UITs involve risk, including loss of principal. All of these products are offered and sold by prospectus only. You can obtain a prospectus from the investment company or your financial representative. You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. The prospectus contains this and other information. Read it carefully before you invest.