In developing an allocation strategy for your investment assets, the first question to consider is: how willing are you to take investment risks in your retirement portfolio? If you are unwilling to take any risks whatsoever, then your investment allocations should be in ultra-safe investments, such as laddered CDs, conservative bond funds, money market accounts, treasury instruments or fixed annuities. Even if your risk tolerance is moderate (meaning you are willing to assume some investment risk), more than likely a portion of your portfolio should be in fixed dollar investments.

Fixed annuities have long been popular with middle-aged investors. An annuity is a type of contract that is issued by an insurance company. Annuities come in different varieties, such as fixed, variable and equity-indexed. With a fixed annuity, the money that you contribute to the contract is your premium payment, and that payment may be made in a single sum, or paid over time. Single-sum fixed annuities are referred to as single premium deferred fixed annuities, and once your premium has been paid, the insurance company should offer some sort of interest guarantee on your money.

I was taught to honor my father and mother, and you should honor and base all of your annuity buying and ownership decisions on the contractual guarantees from the issuing company. Annuities should be regarded as non-correlated assets within your retirement portfolio, which means that their value does not rise and fall like your other investments may do. Annuities that are providing lifetime income transfer the risk of your living too long away from your portfolio to the life insurance company.

Annuities that are not in a qualified plan offer two very important income tax advantages: first, the interest earnings that are credited to your premiums are not reportable as income to you during the accumulation phase of the contract. This is the phase of the contract in which your premiums are earnings interest and growing in value. The other tax advantage of fixed annuities that are not in qualified plans is the manner in which periodic withdrawals are taxed. If the contract is annuitized, which means the accumulated value in the contract is withdrawn, generally, over your remaining life expectancy, a portion of the income is non-taxable, and a portion is taxable. The portion that represents a return of your principle is non-taxable, while the interest portion is taxable. Annuity income can also come with additional guarantees so that you can pass along values to beneficiaries in the event of your premature death while in the annuity payout phase.

Far too many annuity sales people hype the fact that, since annuity taxation during the accumulation phase is deferred, annuity earnings in the contract do not count as earned income, thereby perhaps reducing the taxable portion of your social security benefits. Buying an annuity solely for this reason is a mistake.

If you simply utilize the annuity as an accumulation vehicle, and subsequently terminate or surrender the policy after a period of time, the gain in the contract is taxable to you, and capital gain treatment is not available.

There are certain considerations that you should be aware of in considering a fixed annuity: First, the financial ratings of the issuing company are very important, and the primary insurance rating agencies are: A.M. Best, Moody’s, S&P and Fitch. Don’t be distracted by over promises from agents representing companies with poor ratings.

The interest guarantee – usually these guarantees are higher than current CD rates. Remember that the guarantees are what you should be focusing on, not the illustrated rates in the proposals. If it sounds too be good to be true, it usually is.

The surrender penalty period – this refers to the period of time that your money must remainder in the annuity contract before you can terminate the entire contract without the insurance company charging you a termination fee. Here, a shorter period is better, but often, higher rates of guaranteed interest are made available if you are willing to forego dipping into your annuity values until the surrender period expires. Most annuity contracts allow you to withdraw up to 10 percent of your current value each year, but these withdrawals are taxable, if your annuity has generated any gains before you withdraw any monies.

Finally, it will pay you to shop around for the best rates from the best companies.

Fixed Annuities are long term insurance contacts and there is a surrender charge imposed generally during the first 5 to 7 years that you own the annuity contract. Withdrawals prior to age 59-1/2 may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the financial strength of the underlying insurance company.

Author: Greg Roberts

Source: Aiken Standard

Retrieved from: www.aikenstandard.com

FINRA Compliance Reviewed by Red Oak: 487151