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Conservative Annuity Buyers Turning To Split Annuity Strategy


Annuity buyers, by and large, we have found, are a conservative bunch. And the most conservative of the conservative – call them the investment world’s equivalent of the Tea Party wing of the Republican Party — tend to favor fixed deferred annuities. Those don’t pay much today – 2.5 percent annually to a maximum of 3.4 percent – but they are super-protected and grow tax-deferred. When the earnings are withdrawn they are taxed.

A growing number of our fixed deferred annuity buying clients, however, feel battered by our ultra-low interest rate environment. So some are taking a good peek at the numbers and deciding to tweak their retirement income strategy. After all, even a 10-year fixed deferred annuity buys you no more than $34,000 supplemental income a year on a $1 million premium, which may be a challenging sum to live on even with Social Security benefits.

Specifically, what our fixed deferred annuity fans are increasingly doing is buying two annuities instead of one – a fixed deferred annuity and a fixed immediate annuity – and often substantially improving their cash flow.

By pursuing this split annuity strategy, you might say these annuity buyers are re-polishing the allure of annuities. Even when the stock market does its volatility dance, owners of conservative annuities don’t have to be concerned – their income stream is guaranteed.* But let’s face it — the income stream should be respectable. Otherwise, it falls short of the goal of providing the foundation for a more financially confident retirement.

Consider a hypothetical case of a 65-year-old man who buys a $500,000 five-year fixed deferred annuity today and a $500,000 single premium fixed immediate annuity. With some products, he could receive around $3,700 a month, compared to $2,000 if he put $1 million premium entirely into the five-year fixed deferred annuity. With the split annuity strategy, his income is still guaranteed,* and, in addition, he gets a tax break until he withdraws the interest earned.

This is not a panacea. The catch is that the $500,000 premium for the immediate annuity is locked in and the annuity-owner can’t change his or her mind. Also, to make sense, immediate annuity buyers must have a reasonable expectation of living a normal lifespan. Otherwise, they are getting nowhere near their money’s worth.

Still, this may be good tradeoff for many folks amid today’s near record-low interest rates, especially since immediate annuity buyers can purchase a cash refund death benefit option guaranteeing that any unpaid principal is returned to a beneficiary. The cost may be around $200 a month out of the cash value. This benefit rider may not be available with all fixed immediate annuities and may not be available in all states.

Many fixed deferred annuity buyers do not pursue this split annuity strategy because they don’t know it exists. Somerset Wealth Strategies and other firms are informing clients about it and at Somerset, according to our source, about half of fixed deferred annuity buyers are adopting it. It is especially popular among people in higher income tax brackets.

Each monthly payment blends the principal and the interest that was earned on that principal, and the principal is exempted from taxation because it was after-tax money.

A key advantage of a fixed deferred annuity – the ability to surrender it and receive the principal plus interest five, seven or 10 years later (after the surrender penalty period ends), and purchase a new annuity, when interest rates presumably will be higher – remains intact with the split annuity strategy. At that time, our 65-year-old man will again have $500,000 with which to purchase a new annuity because he paid no fees on the fixed deferred annuity. (The insurance company is able to pay interest on the $500,000 because it can make more money by investing the amount of the annuity premium in higher-yielding bonds.)
Our 65-year-old man’s five year fixed deferred annuity matures in 2020. Let’s assume annuity rates by then have risen to 4 percent and he takes a lump sum distribution and then purchases another five year fixed deferred annuity. That means his monthly income increases more than $600 to approximately $4,300.

What if interest rates don’t budge? He’s still collecting $1,600 more a month than if he had all his money in the five-year annuity (or approximately $1,400 more if he purchased the cash refund benefit rider). That, as they say, should equal more spendable income – and that is a good feeling.

* Annuity guarantees rely on the financial strength and claims-paying ability of the issuing insurer.

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Document Reference: #1500288-4

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