BY JOE BRISBEN
Last month, I started a two-part series about annuities forbaby boomers, those who will turn 65 sometime between 2011 and 2027. Thereare 12 pitfalls that they should look out for in buying an annuity. I revealed6 in the last issue. Here are the rest:
• Trading in your annuity for one with a higherrate. Watch out! Yourpresent annuity may call for penalties for withdrawal during the first sevenyears. You may be getting into one that has limited liquidity. Figure out yourliquidity needs, and make certain you don’t paint yourself into a cornerwhere you might need funds and cannot access them easily from your annuity.
• Funding your annuity with the right kind of money. Annuities are long-termsavings and accumulation instruments. They are not the source of funds youneed for groceries and rent. They are also not funds you can take out on amoment’s notice to satisfy some craving like a hot stock offering ora recreational toy.
Annuities are used to build nest eggs, to help you transfer funds upon yourdeath, and, of course, to save for retirement. Even if some annuities comewith checkbooks, they are not money market accounts.
You also need to understand the cost implications—for example, capitalgains taxes and surrender charges—when you are liquidating resourcesto fund an annuity.
• Exploring the “split-funded annuity” concept. You mightwant to use a combination of an immediate annuity for income and one or moredeferred annuities for safety of principal and tax-deferred accumulation.
That way you can have both an income security blanket and, if you will, “anincome security quilt.” You will have the guaranteed income you need,often with income tax advantages (the exclusion ratio), while retaining mostof your principal for growth and additional free withdrawals, if needed.
For many retirees, financial security is all about income security for therest of their lives. Using this technique can help achieve it.
• Failing to transfer 1035 exchange funds directlyfrom carrier to carrier. Some people assume that, when they change jobs, their old employer just signsa check from its pension fund to the new employer’s pension fund.
The requirements for tax-free exchanges under the law are clear: the employeesmust request the transfers. Then the funds will transfer directly from onecarrier to another. The same is true for partial 1035 exchanges.
If you are transferring funds from a pension plan to an annuity, avoid havingthe check made out and sent to you. Have the check made out to the annuityfor your benefit and include the annuity’s account number if it is available.
If the check comes to you in your name, it will trigger a 1099 report, andyou will have to report the check to the IRS as income. Moreover, you willhave to show that the funds were transferred to another tax shelter. Otherwise,you pay income tax on the transfer.
• Not using 1035 partial tax-free exchanges. Some retired clients havean “underwater” variable annuity policy. One of the unique rehabilitationtechniques possible is the partial exchange of these assets to a fixed annuityor an indexed product that preserves principal.
You can do a partial exchange of 90 percent or more of the variable annuityand keep the minimum necessary in the variable annuity to satisfy the deathbenefit guarantees.
This simultaneously preserves the remaining assets in the fixed or indexedannuity, and it preserves the additional death benefit of the variable annuity.Partial 1035 exchanges are also useful where cumulative free withdrawals aresubstantial in amount.
• Purchasing annuities without professional adviceand failing to review annuity contracts annually. Many clients do their own shopping for annuities,often on the Internet. They may buy something based on the first-year rateor bonus. These clients can easily fail to evaluate other planning considerationssuch as liquidity.
Moreover, after they make their purchase(s), they may not make the effortto stay current on rates of return, liquidity options, and new products thatmay better satisfy their needs.
Well, there they are, the 12 pitfalls involved in annuities. If you want tomake certain you avoid them, see your friendly neighborhood financial advisor.