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Convert some of your retirement savings into a lifetime annuity and you could snag a big tax break, if a new bill recently introduced in the House sees the light of day.
The rationale behind the Retirement Security Needs Lifetime Pay Act (H.R. 2748) is that we are going to screw up withdrawals from our retirement accounts and run out of money way too soon. Indeed, more than 40% of respondents to a MetLife survey said a 10% annual drawdown of their retirement savings seemed on target. But that aggressive pace would deplete your retirement funds in under 10 years; given longer life expectancies, it's prudent to aim for a retirement income stream running for at least 20 years, and preferably 30. (In fact, the universally accepted initial annual withdrawal rate to ensure your money will last as long as you, is 4%.)
So that brings us to the new legislation introduced by Reps. Earl Pomeroy (D-N.D.) and Ginny Brown-Waite (R-Fla.) that holds out a nice tax carrot to get us to convert some of our lump sums into annuities that will provide a lifetime income stream. The idea is to get us to create our own old-fashioned pension plans that deliver steady payouts. Key provisions of the bill include:
•   You will be allowed to exclude 50% of annual annuity payouts from a non-qualified plan (one you invested after-tax dollars in) from taxable income. The annual maximum exclusion would be $10,000.
•   You will be allowed to exclude 25% of annual annuity payouts from a qualified plan (401(k), IRA and other tax-deferred accounts) from taxable income.
The bill also creates a tax incentive to purchase longevity insurance, an annuity usually structured so it doesn't start paying out until you're in your eighties. (In return for that delay of gratification, you get higher annual payments than you would from annuities that start paying earlier.)
In 2005 Pomeroy floated a similar idea (the more catchily-named Lifetime Pension Annuity for You Act) that never made it out of committee. But that was long before retirement security was threatened by a severe bear market and the bursting of the real estate bubble. And according to academics who studied the 2005 version, the tax breaks would help to reduce the cost of annuities (by getting more folks to buy ‘em) and wouldn’t be a huge hit for Treasury’s coffers. Then again, back when the study was conducted we didn’t have massive deficits to pay for, so any hit to future tax revenue may be a tough sell in Congress today.
And what about you? Would a tax break entice you to consider converting some of your retirement savings into an fixed annuity?
Are these the product of our current environment? Absolutely. Much like any product or service, innovation is driven from current state of the nation, both political and financial. You must remember that personal financial planning is both an art and a science. Rarely will you find someone that does exactly what they should be doing in accordance to mathematic planning towards their financial goals (ie. Retirement, Legacy or otherwise). Instead people do something that is almost financial prudent, while saying inside their comfort zone.
So is this financial planning concept a sign of the times- yes, it is.
@Roger, you raise many good points (though Karen's right, you won't win friends with the word "ignorant"!). However, you may have missed my point in raising the example of reverse mortgages.
Obviously, as market conditions change, the concept of a reverse mortgage may look better or worse. That is a relative issue…assuming you get one, when is the best time?
My point was focused not on timing (the relative benefits of a reverse mortgage), but that the very concept itself emerged in the last 2 years, i.e., at the peak of the real estate market. While some owners might find it their best option, my impression is that reverse mortgages were aggressively marketed as a great way to sell your house and still live in it. The tricky part, as I understand it, is not in how the monthly payments are computed, but in how sale/liquidation of the house occurs, if and when the occupants die. It would be nice if the bank said, "well, the survivors legally own X% of the home, so we will liquidate and split the proceeds accordingly." However, my ignorant impression is that it doesn't happen quite so easily (e.g., the bank can dictate the terms of sale, and also various fees).
My argument is admittedly a bit of hand-waving, but my concern is not with the product itself, but rather the market conditions that lead to the product's creation, and the various fees and costs that are associated with administering it. In the same vein, I wonder if the annuities being discussed here are more a product of our current economic environment, than economic good-sense.
This sounds like a logical bill, for our current situation. I have a deferred annunity, with direct deposit, and my fees are waived; great deal. The American dream is no longer in America, I plan on retiring to Central America and my expenses will be reduced by 40% to 50 %.
This would make sense for me. I have a variable annuity funded with Traditional IRA funds. When taken out, it is to be all taxable. If this could save me 25% on the tax bite, great. Is this available to those who have already purchases the annuity or only those that sign up after the bill?
It is ignorant people, such as the ones that have responded to this column, that make people untrustworthy of financial professions.
First, Dean (from PA) says that annuities are know to be quite expensive with low yields. Please do your research before posting any rumors that you obviously know very little about. Immediate (and Fixed) annuities, unlike Variable Annuities, do NOT have expenses associated with them. You merely receive an interest rate, much like you would with a savings account or a CD at the bank– would you consider CD's expensive? Also note that most immediate annuities are paying 3-6% right NOW. I dont know about you, but to get 3-6% without market risk is pretty nice, wouldn't you agree?
Peter, you biggest flaw is not recognizing that reverse mortgages 2 years ago would have actually been the BEST thing you could have done. Dont you make money when you buy low, sell high?
Bart, you ask who wants to trust their life savings to an insurance company? Do you have health insurance? House insurance? Life Insurance? Car insurance… Enough said, I think.
All, most of the payout from annuities are nontaxable? Not true. Research shows that over 41% of all non qualified annuity payouts are taxable. How does this work? If you deposit $300/month into a variable annuity and earn a mere 5% (net of fee's) for 20 years, you would have invested 72,000 and would have over 147,000. Now take that 147k and annuitize over the next 20 years (and an assumed 5%), guaranteed, you would receive $961 a month. That math is you would receive over 230k for those 20 years.
However, that 961 payment would be about 30% principle and 70% taxable- at ordinary tax rates.
Are immediate annuities right for all? No. No investment program is. Furthermore, in reviewing insurance companies you should always look at the rating companies. There are 4 major ratings and then an index called comdex. With wise decisions you will can make good decisions. My suggestion, get professional, trusted advice.
Why is it either/or. I annuitized part of my 401K when I retired. The rest is in taxable funds and some remained in the 401K. I receive guaranteed return on my original annuity investment plus 5% annually for each of the first five years I don't make a withdrawal. This has turned out to be fortunate given what's happened this year. I would "just say no" to an annuity. Look at all the possibilities.
Much of the payout from an intermediate annuity is a Return of Capital, not taxable income. Will the Government guarantee that the annuity payments will continue if the insurance company fails to pay according to the contract. And annuities are known to be quite expensive with low yields!!
What is an annuity? If I am an insurance company, an "annuity" means "you pay me now in lump sum and I give it back to you little by little". Of course, when this works for the annuitant, the payback is in full, plus interest. The idea is that–instead of investing in risky stocks–you get a guaranteed amount paid to you every month.
But there are lots and lots of catches, in the real world: (1) what if you die before the lump sum is returned, (2) what is the effective rate of return on the payments, after service charges and fees, (3) what if the company you paid goes under (not an incredible question, these days)?
There are several other hidden catches, that generally make annuities too good to be true. In general, they are a GREAT product for insurance and investment firms, and TERRIBLE products for the annuitant (depending on the risk level, of course).
My feeling about this proposal is that it is industry-fueled, and specifically worded to feed on our current fears of stock-market crashes. Remember how tempting "reverse mortgages" sounded 2 years ago? I think this is more of the same.
Despite some of the negative comments, this could really make some retiree sleep better at night. There are some great insurance companies that I think would make this work.
In 25 years (if not sooner), we're going to see a new generation of "destitute elderly" as boomers hit their 80's and run out of money. It will be kind of like seeing the Madoff victims – feeling a little sorry for thier situation, but knowing it was largely their own d*m fault…
Agreed. Who wants to trust their life savings to a slimy insurance company that's not even FDIC insured. I'll do the math myself.
That's nonsense. Much of an annuities payout is not taxable anyway since it's a return of your own capital.
Second, annuity payouts are based on US Treasury yields. Extremely low right now compared to historical values. Thus, buying an annuity now is locking in low payouts forever. Not something we should encourage through a tax policy that sounds good but isn't.
This is an interesting idea. An immediate annuity makes sense in many retirement situations. A common strategy is to annuitize enough of your accumulated savings to yield a payment amount equal to Social Security payments, retaining the rest as investable assets. If you do not have large enough savings, you should probably annuitize it all anyway. I'd use a firm like TIAA-CREF, solid and smart.
I feel like the whole system is broken and my trust is gone. I could not even consider trusting an insurance company with any of my retirement money. The rating agenies were crooked, the advisors were clueless, stocks oversold, houses oversold, my long term care company is broke, Ponzi schemes, gee it just doesn't end.
A better idea is to pay off everything and thus need less money to live. Then you don't have to take any risk.
I can live on my small pension and SS and don't need to live off of my CD savings. A much better idea. No risk.
The tax credit should only apply to annuities offered by solid and reliable, well-run insurance companies, such as AIG.
Yeah, I want a plan that will start paying me when I reach my Eighties, right!