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Incorporating Annuities Into Your Retirement Income Strategy

If you’re nearing retirement, deciding when to officially exit the workforce can be a difficult, yet important, decision. Assuming you are able to retire on your own terms, rather than being forced to retire, there are two primary questions you should answer in advance:1) what will your annual spending be in retirement, and 2) will your investments perform well enough to minimize longevity risk (the risk of potentially outliving assets)?

After zeroing in on a retirement date, it is important to determine your potential annual spending. Your Stifel Financial Advisor has tools available to assist in determining your spending goals by considering all potential expenses you may incur. Once you’ve determined your annual spending goal and other typically guaranteed retirement income streams are factored in, such as pensions and Social Security, you may wish to consider using a portion of your savings to purchase an annuity. Annuities are one of the few investments that can guarantee an income for life.

Let’s look at a hypothetical example to explain the concept. We will assume a 60-year-old female client wanting to retire in five years needs to guarantee $750 a month for life to cover necessary expenses.

Maximize Income With Lower Investment

Given today’s rates, a 60-year-old female would need to invest approximately $130,000 of non-qualified funds into a deferred income annuity with a cash refund option to generate $750 a month for life starting at age 65. With this option, she gives up control of the asset in exchange for a monthly income she cannot outlive. However, if she passes away before the annuity returns, the entire $130,000 she initially invested, the income stream will stop and the principal yet to be paid out will be distributed to her beneficiary in a lump sum. Also, this will be tax-advantaged income, as each payment over her life expectancy is partly non-taxable return of principal and partly taxable earnings. This option is worthy of consideration for those facing Medicare premium surcharges, as it serves to minimize taxable income.

Maximize Potential With Higher Investment

Many annuities have living benefit riders available at an additional cost that increase the income benefit base by a set percentage every year until the first withdrawal, regardless of market performance. Assuming a 5% compound growth rate on the benefit base, and a lifetime withdrawal rate of 5%, our hypothetical retiree would need to invest approximately $142,000 today to guarantee at least $750 a month for life five years from now. In this case, our retiree does not give up control of the asset and can choose whether to turn on the income stream in the future.

Annuities are long-term investments that contain surrender periods that typically run from five to eight years with surrender charges up to approximately 8%. Withdrawals reduce the cash surrender value. All taxable withdrawals are subject to ordinary income tax rates and may be subject to a 10% tax penalty if made prior to age 59 ½. In addition to the features and benefits of annuities, it is important to understand all fees and expenses, such as mortality and expense charges, along with any additional charges for income riders that you may incur.

Ages, values, and percentages are hypothetical for illustrative purposes only and do not represent actual performance for any particular investment. Please consult your Stifel Financial Advisor for current rates, quotes, and illustrations. Guarantees are based on the claims-paying ability of the insurance company. Annuities are not insured by the FDIC or any government agency and involve market risk, including the possible loss of principal.

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