When it comes to annuities investors planning for retirement steer clear of them. They are seen as confusing, expensive and come with their own complicated tax rules.
Craig Hawley, Head of Nationwide Advisory Solutions, believes that now is the time to dispel those stereotypes and myths. Hawley discussed with Fox Business how annuities help protect your investment gains from taxes, secure your financial future in retirement, and transfer wealth to the next generation. Here is what you need to know.
Boomer: Is it true when markets are up, annuities restrict my gains?
Hawley: There are many types of annuities. And it is true that certain types of annuities, such as indexed annuities or annuities with income guarantees, may limit upside potential in exchange for downside protection. But it is not true of all annuities. For example, an investment-only variable annuity (IOVA) offers a wide range of underlying funds, from the most aggressive to the most conservative, as well as non-correlated assets and even liquid alternatives. Using an IOVA, investors can create fully diversified portfolios, then trade and rebalance as needed, to capture more upside and enhance performance potential. And because annuities such as IOVAs are tax-deferred vehicles, with virtually no contribution limits, they help investors take full advantage of the compounding power of tax deferral to maximize accumulation and grow more wealth.
Boomer: Once I invest in an annuity, am I stuck with that choice?
Hawley: Annuities are long term investments and should be considered carefully because there can be tax penalties on withdrawals made before age 59½. But even though a certain type of annuity may have been a good fit when it was originally sold to the investor, over time needs can change. Section 1035 of the IRS code allows investors to transition tax-free from an annuity that no longer meets their needs to one that is a better fit. Before switching, investors should work with their advisors to evaluate the loss of any benefits or guarantees.
Also, be aware that many traditional annuities can lock-in investors for an extended period of five years or more, by charging a high surrender fee to investors who choose to switch too soon. In some cases, it may be beneficial to wait until the surrender period is over before making an exchange. In other cases, when exchanging from a high cost traditional annuity to a new lower cost annuity, the cost savings may help absorb the expense of these surrender fees. Going forward those savings can grow tax-deferred and compound faster over time. To help maximize accumulation, look for annuities with the lowest costs, and for the greatest flexibility, look for annuities with no surrender fees.
Boomer: Are annuities a good option for legacy planning?
Hawley: Investors often want to leave a legacy for their spouse, children and grandchildren, and annuities can offer many good options. Annuities can come with a range of optional death benefits, from a lump sum payment to a guaranteed income stream for heirs. Typically, these proceeds receive favorable tax treatment, and can be transferred to heirs without the hassle of probate and legal fees. For investors who want to protect the value of their hard-earned wealth for the next generation, some annuities offer an optional Return of Premium rider (ROP) to act as an insurance policy for their legacy and guarantee that their initial investment will never be lost, no matter how the market performs.
For investors who want to control distributions to heirs and minimize the tax burden of a large inheritance by spreading it out over their beneficiaries' lifetimes, some annuities offer a Restricted Stretch provision. For many clients, especially the high net worth, trusts are a go-to option for estate planning. But distributions from trusts over $12,500 are taxed at the highest rate, severely impacting the investment. Working with an advisor to fund a trust inside a low-cost IOVA, those distributions can be re-invested, without the tax-drag that may hinder NIMCRUTs, Charitable Remainder Trusts, and other trust structures, to compound and grow more wealth for heirs.
Boomer: Do annuities limit my charitable giving?
Hawley: Not at all. Annuities can be a valuable solution for charitable giving. In addition to funding a NIMCRUT or Charitable Remainder Trust with an IOVA, another solution is to invest assets ear-marked for charities directly in a low-cost IOVA. This allows those assets to accumulate and grow tax-free, maximizing the impact of charitable giving and leaving a lasting legacy. And if tax-exempt charities are named as beneficiaries in the IOVA contract, those assets are transferred tax-free, without the hassle of probate and legal fees.