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Annuities For Dummies [2 ed.]
 1394168586, 9781394168583, 9781394168590, 9781394168606

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Table of contents :
Title Page
Copyright Page
Table of Contents
About This Book
Foolish Assumptions
Icons Used in This Book
Beyond the Book
Where to Go from Here
Part 1 Making Sense of Annuities
Chapter 1 The ABCs of Annuities
Getting Acquainted with Annuities
Part investment, part insurance
Deferring taxes
Recognizing the Most Popular Annuities
“Savings account” annuities
Pension-like annuities
Options-based fixed indexed annuities
Registered index-linked annuities
Traditional variable annuities
Deferred income annuities
Age-in-place annuities (also known as reverse mortgages)
Reasons for Exploring Annuities
The Life Cycle of All Annuities
The purchase stage
The accumulation stage
The income or distribution stage
Chapter 2 Taming the Big Retirement Risks
Countering the Main Risks of Retirement
Longevity-related risks
The risk of outliving your savings
The risk of losing a spouse
Health risk
Long-term-care risk
Investment risks
Market risk
Sequence-of-returns risk
Inflation risk
Tax risk
Policy risk
Planning risks
Having no income plan at all
Helping out family members
Facing a decline in cognitive ability
Using Annuities to Buffer Retirement Risks
Annuities for longevity risks
Annuities for investment risks
Annuities for planning risks
Chapter 3 Diving into Annuity Documents
Exploring the Annuity Application and Contract
Signing an annuity contract
Designating the key players
The owner
The annuitant
The beneficiaries
The issuer
Other standard elements of annuity contracts
Free-look periods
Death benefits
Surrender periods
Single versus flexible premium
Qualified versus nonqualified
Annuitization options
New or replacement annuity
Distinguishing between Variable, Fixed, and Fixed Indexed Annuity Contracts
Variable annuity contracts
Fixed annuity contracts
Fixed indexed annuity contracts
Ensuring Suitability and “Best Interest”
Chapter 4 Weighing Annuity Pros and Cons
Evaluating Annuity Advantages
Punting income taxes to the future
Contributing as much as you want
Reducing investment risk
Protecting beneficiaries
Assuring income in retirement
Capturing “survivorship credits”
Obtaining peace of mind
Replacing your old paycheck
Confronting Annuity Drawbacks
Duplicating Social Security
Higher expenses than mutual funds
Reduced liquidity
Annuity earnings are taxed as ordinary income
Low transparency, high complexity in some cases
Adverse selection
Comparing Annuities with Their Competition
Deferred fixed annuities versus CDs
Deferred variable annuities versus mutual funds
Income annuities versus systematic withdrawals
Chapter 5 Deciding Whether an Annuity Is Right for You
Identifying Candidates for Annuities
Boomer couples with 401(k) or 403(b) accounts
The middle class and the affluent
Retirees who don’t have a defined benefit pension plan
People with rugged genes
Market bears and other pessimists
Neither the very young nor the extremely old
People who want to turn a tax bite into bite-size pieces
Those seeking less-expensive long-term-care insurance
People without beneficiaries
Part 2 Identifying the Major Annuities
Chapter 6 Earning Interest with Fixed Annuities
Understanding How Fixed Annuities Work
What’s fixed about a fixed annuity?
Protection from two kinds of risks
Examining the Main Types of Fixed Annuities
Single-year guarantee fixed annuities
Multiyear guaranteed annuities
Weighing the Pros and Cons of Fixed Annuities
Buying a Fixed Annuity
Chapter 7 Creating Retirement Paychecks with Income Annuities
Understanding Income Annuities
Customizing Your Income Annuity
Deciding who will receive income
Deciding how long payments will last
Accessing your money after you buy the contract
Deciding whether to add an inflation-protection rider
Deciding whether to add a cash refund or installment refund
Deciding when to buy your annuity
Buying and Paying for an Income Annuity
Deciding how to pay for your annuity
After-tax money
Pretax money
Comparing an income annuity to a variable annuity with a guaranteed lifetime withdrawal benefit
Choosing fixed or variable income payments
Comparing quotes
Catching Up on Single Premium Immediate Annuity Innovations
Medically underwritten income annuities
Easing into retirement with a bridge annuity
Accelerating your income payments
Dividend-paying “mutual” income annuities
Income annuities that let you take all your money out
Medicaid-compliant or restricted annuities
Chapter 8 Gambling on Fixed Indexed Annuities
Defining Fixed Indexed Annuities
Searching for the Right Fixed Indexed Annuity
Step 1: Finding an FIA-savvy agent
Step 2: Finding a strong life insurer
Step 3: Choosing and customizing an FIA
Choosing a term length
Setting a reset interval
Choosing a market index
Volatility-controlled indexes
Choosing a crediting formula
Other choices and decisions
Lifetime income riders
Enhanced performance (“strategy”) fees
Surrender charges and market-value adjustments
Tracking Index Annuity Performance
Weighing the Pros and Cons of Fixed Indexed Annuities
Chapter 9 Aiming Higher with Registered Index-Linked Annuities
Understanding Registered Index-Linked Annuities
Customizing Your Registered Index-Linked Annuity
Choosing terms or segments
Choosing indexes
Choosing buffers and floors
Adding a lifetime income guarantee
Choosing which “cap” to wear
Seeing How RILAs Work
Finding Out Who Buys or Sells Registered Index-Linked Annuities
Regulating RILAs
State insurance commissioners
Considering Recent RILA-like Savings Products
Chapter 10 Tapping Variable Annuities for Tax Breaks and Income
Understanding Variable Annuities
Investment-Only Variable Annuities
Variable Annuities with Income Riders
How best to use a variable annuity with a guaranteed lifetime withdrawal benefit
What to do with old variable annuities with guaranteed lifetime withdrawal benefits
Lifetime income versus annuitization
Weighing the Pros and Cons of Variable Annuities
The pros
The cons
Chapter 11 Aging Gracefully with Deferred Income Annuities and Qualified Longevity Annuity Contracts
Understanding Deferred Income Annuities
Hedging longevity risk with deferred income annuities
Weighing the pros and cons of deferred income annuities
The pros
The cons
Postponing Required Minimum Distributions with a Qualified Longevity Annuity Contract
Shopping for a Deferred Income Annuity or Qualified Longevity Annuity Contract
Chapter 12 Tapping the Liquidity in Your Home
Defining Reverse Mortgages
Releasing Your Home Equity
Changing your mind
Deciding what to do with the money
Abiding by the rules
Determining your loan amount
Accepting your property as collateral
Weighing the Pros and Cons of Reverse Mortgages
Setting Up a Standby Line of Credit
Finding an HECM Counselor
Part 3 Shopping in the Annuity Marketplace
Chapter 13 Issuing Annuities: It’s What Life Insurers Do
Measuring a Life Insurer’s Strength
Classifying the Life Insurers
Mutual life insurers
The meaning of “on your side”
Specializing in simple annuities
Stock life insurers
Conflicting interests
Selling variable annuities
Private equity-linked life insurers
Selling fixed indexed and fixed-rate annuities
Distributing through insurance agents
Other types of life insurers
Keeping the Life/Annuity Industry Honest
Chapter 14 Meeting the Annuity Salespeople
Surveying the Annuity Sales Landscape
Meeting the distributors
Meeting the agents and advisers
Insurance agents
Advisers at banks
Brokerage advisers
Financial planners
Asking Smart Questions
Do I need a product or do I need advice?
Who serves people at my level of wealth?
What conflicts of interest do advisers have?
Which hat does my adviser wear today?
Which designations are meaningful?
Am I getting customized advice?
Expecting Service in Your “Best Interest”
The suitability standard
The fiduciary standard
The best interest standard
Chapter 15 Site-Seeing in the Annuity Web World
Shopping for Fixed Annuities Online
The Annuity Man
Blueprint Income/AARP
Fidelity and Schwab
Income Solutions
Annuity Straight Talk
Working with Robo-Advisers
Income Strategy
Retirement Researcher
Retirement Optimizer
Calculating Your Financial Future
Landing on the Annuity Issuers’ Sites
Chapter 16 Adding Annuities to 401(k)s
Fixing the Flaw in 401(k)s
Telling 401(k) Annuities Apart
Income annuities versus annuities with guaranteed lifetime withdrawal benefits
In-plan versus out-of-plan annuities
Annuities in TDFs or managed accounts
Deferred contracts, immediate contracts, and qualified lifetime annuity contracts
Browsing the 401(k) Annuity Shelf
BlackRock LifePath Paycheck
Prudential Income Flex
Nationwide Lifetime Income Builder
Principal Pension Builder
MetLife Guaranteed Income Plan: Income Now or Income Later
GuidedChoice Retirement Income Planning
TIAA Secure Income Account
State Street Global Advisors IncomeWise
Deciding Whether to Buy an Annuity with 401(k) Savings
Part 4 Getting the Most out of Your Annuity
Chapter 17 Building Safe Retirement Income
Weaving Annuities into an Income Plan
Topping up Social Security with an annuity
Bucketing your retirement savings
Leapfrogging your annuities
Pairing home equity with an annuity
Creating an Income Plan without Single-Premium Immediate Annuities
Using a Nobel Laureate’s method
Turning required minimum distributions from foe to friend
Flexing your deferred annuity muscles
Chapter 18 The Taxing Side of Annuities
Understanding Annuity Tax Rules
Qualified annuities
Purchases of qualified annuities
Withdrawals from qualified annuities
Nonqualified deferred annuities
Purchases of nonqualified annuities
Withdrawals from nonqualified annuities
Special withdrawal cases
Withdrawals taken as guaranteed lifetime withdrawal benefits
Withdrawals from qualified longevity annuity contracts
Withdrawals from contingent deferred annuities
Weighing the Benefits of Tax Deferral
Weighing the Pros and Cons of Nonqualified Annuity Taxation
Remembering Miscellaneous Annuity Tax Issues
Paying state premium taxes
No tax on 1035 exchanges
Taxes and annuity beneficiaries
Chapter 19 Recognizing Annuity Exit Ramps
Knowing Where Your Contract’s Exits Are
Taking free withdrawals during the surrender period
Using nursing-home waivers
Using the period certain of an income annuity
Choosing a lifetime benefit over annuitization
Eluding the federal penalty — legally
Swapping Annuities: 1035 Exchanges
Converting an Annuity to Life Insurance
Chapter 20 Structuring Your Annuity Correctly
Naming Owners and Annuitants
Naming Beneficiaries
Choosing a Death Benefit
Chapter 21 Avoiding Annuity Pitfalls
Watching Out for Common Annuity Missteps
Forgetting about fees
Surrendering to a long surrender period
Mis-structuring your contract
Heading Off Income Annuity Errors
Trying to “time” an income annuity purchase
Ignoring the period-certain and refund options
Getting only one or two quotes
Choosing the Wrong Assumed Interest Rate
Deflecting Deferred Variable Annuity Problems
Tripping over step-up fees
Confusing the account value with the benefit base
Preventing Silly Mistakes
Buying an indexed annuity that you don’t understand
Falling for an annuity postcard come-on
Underestimating your own (or your spouse’s) longevity
Ignoring the impact of inflation
Avoiding annuities entirely
Part 5 The Part of Tens
Chapter 22 Ten Great Books about Annuities
The Annuity Stanifesto, by Stan G. Haithcock
Are You a Stock or a Bond?: Identify Your Own Human Capital for a Secure Financial Future, by Moshe Milevsky
Don’t Go Broke in Retirement: A Simple Plan to Build Lifetime Retirement Income, by Steve Vernon
Income Strategies: How to Create a Tax-Efficient Withdrawal Strategy to Generate Retirement Income, by William Reichenstein
Lifetime Income to Retire with Strength, by Bruno Caron
Retirement Income Redesigned: Master Plans for Distribution, by Harold Evensky and Deena B. Katz
Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success, by Wade Pfau
Risk Less and Prosper: Your Guide to Safer Investing, by Zvi Bodie and Rachelle Taqqu
Unveiling the Retirement Myth: Advanced Retirement Planning Based on Market History, by Jim Otar
Another Day in Paradise: The Handbook of Retirement Income, by Jeff Dellinger
Chapter 23 Ten Questions to Ask Before You Sign a Contract
How Will This Annuity Reduce My Risks?
What Are My Risk Tolerance and Risk Capacity?
How Much of My Assets Should I Put into an Annuity?
What Are the Strength and Integrity of the Issuer?
What Are the Fees?
What’s My Upside Potential?
How Do I Get My Money Out?
Where Can I Get More Information about This Annuity?
Am I Better Off Exchanging My Annuity for Another One?
What Are the Tax Implications?
Chapter 24 Ten Annuity Checkpoints on the Information Highway
Moshe A. Milevsky
Center for Retirement Research at Boston College
Society of Actuaries (
Financial Industry Regulatory Authority
Securities and Exchange Commission
National Association of Insurance Commissioners
National Organization of Life & Health Insurance Guaranty Associations
Alliance for Lifetime Income
Insured Retirement Institute
American Council of Life Insurers
Part 6 Appendixes
Appendix A Glossary
Appendix B State Guaranty Associations

Citation preview


Annuities 2nd Edition

by Kerry Pechter

Annuities For Dummies®, 2nd Edition Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, Copyright © 2023 by John Wiley & Sons, Inc., Hoboken, New Jersey Media and software compilation copyright © 2023 by John Wiley & Sons, Inc. All rights reserved. Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at Trademarks: Wiley, For Dummies, the Dummies Man logo,, Making Everything Easier, and related trade dress are trademarks or registered trademarks of John Wiley & Sons, Inc. and may not be used without written permission. All other trademarks are the property of their respective owners. John Wiley & Sons, Inc. is not associated with any product or vendor mentioned in this book.


For general information on our other products and services, please contact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002. For technical support, please visit Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at For more information about Wiley products, visit Library of Congress Control Number: 2023939003 ISBN 978-1-394-16858-3 (pbk); ISBN 978-1-394-16859-0 (ebk); ISBN 978-1-394-16860-6 (ebk)

Contents at a Glance Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Part 1: Making Sense of Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 CHAPTER 1: CHAPTER 2: CHAPTER 3: CHAPTER 4: CHAPTER 5:

The ABCs of Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Taming the Big Retirement Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Diving into Annuity Documents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Weighing Annuity Pros and Cons. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Deciding Whether an Annuity Is Right for You. . . . . . . . . . . . . . . . . . . . . . . 59

Part 2: Identifying the Major Annuities. . . . . . . . . . . . . . . . . . . . . . . . 73 CHAPTER 6:

Earning Interest with Fixed Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 CHAPTER 7: Creating Retirement Paychecks with Income Annuities. . . . . . . . . . . . . . 91 CHAPTER 8: Gambling on Fixed Indexed Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 CHAPTER 9: Aiming Higher with Registered Index-Linked Annuities. . . . . . . . . . . . . 129 CHAPTER 10: Tapping Variable Annuities for Tax Breaks and Income . . . . . . . . . . . . 143 CHAPTER 11: Aging Gracefully with Deferred Income Annuities and Qualified Longevity Annuity Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . 161 CHAPTER 12: Tapping

the Liquidity in Your Home. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

Part 3: Shopping in the Annuity Marketplace . . . . . . . . . . . . . .


CHAPTER 13: Issuing

Annuities: It’s What Life Insurers Do . . . . . . . . . . . . . . . . . . . . . . 191 the Annuity Salespeople . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 CHAPTER 15: Site-Seeing in the Annuity Web World. . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 CHAPTER 14: Meeting

CHAPTER 16: Adding

Annuities to 401(k)s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

Part 4: Getting the Most out of Your Annuity . . . . . . . . . . . . . . CHAPTER 17: Building


Safe Retirement Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245 CHAPTER 18: The Taxing Side of Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259 CHAPTER 19: Recognizing Annuity Exit Ramps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269 CHAPTER 20: Structuring Your Annuity Correctly. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277 CHAPTER 21: Avoiding Annuity Pitfalls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285

Part 5: The Part of Tens. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



Great Books about Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 CHAPTER 23: Ten Questions to Ask Before You Sign a Contract . . . . . . . . . . . . . . . . . 303 CHAPTER 24: Ten Annuity Checkpoints on the Information Highway. . . . . . . . . . . . . 311

Part 6: Appendixes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . APPENDIX A: Glossary . APPENDIX B: State


. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319

Guaranty Associations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


Table of Contents INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 About This Book. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foolish Assumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Icons Used in This Book. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Beyond the Book. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Where to Go from Here . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2 3 4 4 4

PART 1: MAKING SENSE OF ANNUITIES. . . . . . . . . . . . . . . . . . . . . . . . 5 CHAPTER 1:

The ABCs of Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Getting Acquainted with Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Part investment, part insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Deferring taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Recognizing the Most Popular Annuities. . . . . . . . . . . . . . . . . . . . . . . . . 10 “Savings account” annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Pension-like annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Options-based fixed indexed annuities. . . . . . . . . . . . . . . . . . . . . . . 12 Registered index-linked annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Traditional variable annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Deferred income annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Age-in-place annuities (also known as reverse mortgages) . . . . . . 13 Reasons for Exploring Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 The Life Cycle of All Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 The purchase stage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 The accumulation stage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 The income or distribution stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18


Taming the Big Retirement Risks. . . . . . . . . . . . . . . . . . . . . . 21 Countering the Main Risks of Retirement . . . . . . . . . . . . . . . . . . . . . . . . 22 Longevity-related risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Investment risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25 Planning risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Using Annuities to Buffer Retirement Risks. . . . . . . . . . . . . . . . . . . . . . .29 Annuities for longevity risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Annuities for investment risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Annuities for planning risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Table of Contents



Diving into Annuity Documents . . . . . . . . . . . . . . . . . . . . . . . 33 Exploring the Annuity Application and Contract. . . . . . . . . . . . . . . . . . . Signing an annuity contract. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Designating the key players. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other standard elements of annuity contracts. . . . . . . . . . . . . . . . . Distinguishing between Variable, Fixed, and Fixed Indexed Annuity Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variable annuity contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed annuity contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed indexed annuity contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ensuring Suitability and “Best Interest” . . . . . . . . . . . . . . . . . . . . . . . . . .


40 41 42 43 45

Weighing Annuity Pros and Cons. . . . . . . . . . . . . . . . . . . . . . 47 Evaluating Annuity Advantages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Punting income taxes to the future . . . . . . . . . . . . . . . . . . . . . . . . . . Contributing as much as you want. . . . . . . . . . . . . . . . . . . . . . . . . . . Reducing investment risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Protecting beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assuring income in retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Confronting Annuity Drawbacks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duplicating Social Security. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Higher expenses than mutual funds . . . . . . . . . . . . . . . . . . . . . . . . . Reduced liquidity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity earnings are taxed as ordinary income. . . . . . . . . . . . . . . . Low transparency, high complexity in some cases . . . . . . . . . . . . . Adverse selection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comparing Annuities with Their Competition. . . . . . . . . . . . . . . . . . . . . Deferred fixed annuities versus CDs . . . . . . . . . . . . . . . . . . . . . . . . . Deferred variable annuities versus mutual funds . . . . . . . . . . . . . . Income annuities versus systematic withdrawals . . . . . . . . . . . . . .


34 34 34 37

48 48 49 49 49 50 52 52 53 53 53 54 54 55 55 56 57

Deciding Whether an Annuity Is Right for You. . . . . . 59 Identifying Candidates for Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Boomer couples with 401(k) or 403(b) accounts. . . . . . . . . . . . . . . .60 Women. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 The middle class and the affluent. . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Retirees who don’t have a defined benefit pension plan . . . . . . . . 65 People with rugged genes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 Market bears and other pessimists . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Neither the very young nor the extremely old . . . . . . . . . . . . . . . . . 68 People who want to turn a tax bite into bite-size pieces. . . . . . . . . 70 Those seeking less-expensive long-term-care insurance . . . . . . . . 70 People without beneficiaries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70


Annuities For Dummies

PART 2: IDENTIFYING THE MAJOR ANNUITIES . . . . . . . . . . . . . . 73 CHAPTER 6:

Earning Interest with Fixed Annuities . . . . . . . . . . . . . . . . 75 Understanding How Fixed Annuities Work . . . . . . . . . . . . . . . . . . . . . . . What’s fixed about a fixed annuity? . . . . . . . . . . . . . . . . . . . . . . . . . . Protection from two kinds of risks . . . . . . . . . . . . . . . . . . . . . . . . . . . Examining the Main Types of Fixed Annuities. . . . . . . . . . . . . . . . . . . . . Single-year guarantee fixed annuities . . . . . . . . . . . . . . . . . . . . . . . . Multiyear guaranteed annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighing the Pros and Cons of Fixed Annuities. . . . . . . . . . . . . . . . . . . Buying a Fixed Annuity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


76 77 78 79 81 82 84 87

Creating Retirement Paychecks with Income Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Understanding Income Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 Customizing Your Income Annuity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Deciding who will receive income. . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Deciding how long payments will last . . . . . . . . . . . . . . . . . . . . . . . . 97 Accessing your money after you buy the contract. . . . . . . . . . . . . . 97 Deciding whether to add an inflation-protection rider . . . . . . . . . . 97 Deciding whether to add a cash refund or installment refund. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Deciding when to buy your annuity . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Buying and Paying for an Income Annuity. . . . . . . . . . . . . . . . . . . . . . . 101 Deciding how to pay for your annuity . . . . . . . . . . . . . . . . . . . . . . . 101 Comparing an income annuity to a variable annuity with a guaranteed lifetime withdrawal benefit. . . . . . . . . . . . . . . . 103 Choosing fixed or variable income payments. . . . . . . . . . . . . . . . . 103 Comparing quotes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 Catching Up on Single Premium Immediate Annuity Innovations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 Medically underwritten income annuities. . . . . . . . . . . . . . . . . . . . 106 Easing into retirement with a bridge annuity . . . . . . . . . . . . . . . . . 106 Accelerating your income payments . . . . . . . . . . . . . . . . . . . . . . . . 106 Dividend-paying “mutual” income annuities. . . . . . . . . . . . . . . . . . 107 Income annuities that let you take all your money out. . . . . . . . . 107 Medicaid-compliant or restricted annuities . . . . . . . . . . . . . . . . . . 108


Gambling on Fixed Indexed Annuities. . . . . . . . . . . . . .


Defining Fixed Indexed Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Searching for the Right Fixed Indexed Annuity. . . . . . . . . . . . . . . . . . . Step 1: Finding an FIA-savvy agent . . . . . . . . . . . . . . . . . . . . . . . . . . Step 2: Finding a strong life insurer . . . . . . . . . . . . . . . . . . . . . . . . .

112 113 113 114

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Step 3: Choosing and customizing an FIA . . . . . . . . . . . . . . . . . . . . Other choices and decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tracking Index Annuity Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . Weighing the Pros and Cons of Fixed Indexed Annuities . . . . . . . . . . CHAPTER 9:

Aiming Higher with Registered Index-Linked Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Understanding Registered Index-Linked Annuities . . . . . . . . . . . . . . . Customizing Your Registered Index-Linked Annuity . . . . . . . . . . . . . . Choosing terms or segments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Choosing indexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Choosing buffers and floors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adding a lifetime income guarantee. . . . . . . . . . . . . . . . . . . . . . . . . Choosing which “cap” to wear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seeing How RILAs Work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Finding Out Who Buys or Sells Registered Index-Linked Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regulating RILAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SEC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FINRA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State insurance commissioners . . . . . . . . . . . . . . . . . . . . . . . . . . . . Considering Recent RILA-like Savings Products . . . . . . . . . . . . . . . . . .


Tapping Variable Annuities for Tax Breaks  and Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


114 119 125 126

129 130 131 131 132 132 133 133 135 137 139 139 139 140 140


Understanding Variable Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment-Only Variable Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . Variable Annuities with Income Riders. . . . . . . . . . . . . . . . . . . . . . . . . . How best to use a variable annuity with a guaranteed lifetime withdrawal benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What to do with old variable annuities with guaranteed lifetime withdrawal benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lifetime income versus annuitization . . . . . . . . . . . . . . . . . . . . . . . Weighing the Pros and Cons of Variable Annuities . . . . . . . . . . . . . . . The pros . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The cons. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

144 148 149

152 152 156 156 157

Aging Gracefully with Deferred Income Annuities and Qualified Longevity Annuity Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



Understanding Deferred Income Annuities . . . . . . . . . . . . . . . . . . . . . 162 Hedging longevity risk with deferred income annuities . . . . . . . . 163 Weighing the pros and cons of deferred income annuities . . . . . 164


Annuities For Dummies

Postponing Required Minimum Distributions with a Qualified Longevity Annuity Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 Shopping for a Deferred Income Annuity or Qualified Longevity Annuity Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

Tapping the Liquidity in Your Home . . . . . . . . . . . . . . . .


Defining Reverse Mortgages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Releasing Your Home Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changing your mind . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deciding what to do with the money. . . . . . . . . . . . . . . . . . . . . . . . Abiding by the rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Determining your loan amount. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accepting your property as collateral. . . . . . . . . . . . . . . . . . . . . . . . Weighing the Pros and Cons of Reverse Mortgages . . . . . . . . . . . . . . Pros. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cons. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Setting Up a Standby Line of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . Finding an HECM Counselor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

176 177 178 178 179 180 181 182 183 184 185 187






Issuing Annuities: It’s What Life Insurers Do . . . . . .


Measuring a Life Insurer’s Strength . . . . . . . . . . . . . . . . . . . . . . . . . . . . Classifying the Life Insurers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mutual life insurers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock life insurers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Private equity-linked life insurers. . . . . . . . . . . . . . . . . . . . . . . . . . . Other types of life insurers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Keeping the Life/Annuity Industry Honest. . . . . . . . . . . . . . . . . . . . . . .

192 195 196 198 200 202 203

Meeting the Annuity Salespeople . . . . . . . . . . . . . . . . . . .


Surveying the Annuity Sales Landscape. . . . . . . . . . . . . . . . . . . . . . . . . Meeting the distributors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Meeting the agents and advisers . . . . . . . . . . . . . . . . . . . . . . . . . . . Asking Smart Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Do I need a product or do I need advice? . . . . . . . . . . . . . . . . . . . . Who serves people at my level of wealth?. . . . . . . . . . . . . . . . . . . . What conflicts of interest do advisers have?. . . . . . . . . . . . . . . . . . Which hat does my adviser wear today? . . . . . . . . . . . . . . . . . . . . . Which designations are meaningful?. . . . . . . . . . . . . . . . . . . . . . . . Am I getting customized advice?. . . . . . . . . . . . . . . . . . . . . . . . . . . . Expecting Service in Your “Best Interest”. . . . . . . . . . . . . . . . . . . . . . . . The suitability standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The fiduciary standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The best interest standard. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

206 206 207 213 214 214 214 215 215 215 216 216 217 217

Table of Contents




Site-Seeing in the Annuity Web World. . . . . . . . . . . . . .


Shopping for Fixed Annuities Online . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Annuity Man. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Blueprint Income/AARP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fidelity and Schwab. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Solutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity Straight Talk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Working with Robo-Advisers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NewRetirement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IncomeConductor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement Researcher. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement Optimizer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Calculating Your Financial Future. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Landing on the Annuity Issuers’ Sites. . . . . . . . . . . . . . . . . . . . . . . . . . .

220 220 220 221 221 222 222 223 224 224 224 225 225 225 227

Adding Annuities to 401(k)s. . . . . . . . . . . . . . . . . . . . . . . . . . .


Fixing the Flaw in 401(k)s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Telling 401(k) Annuities Apart . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income annuities versus annuities with guaranteed lifetime withdrawal benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . In-plan versus out-of-plan annuities. . . . . . . . . . . . . . . . . . . . . . . . . Annuities in TDFs or managed accounts . . . . . . . . . . . . . . . . . . . . . Deferred contracts, immediate contracts, and qualified lifetime annuity contracts . . . . . . . . . . . . . . . . . . . . . . . . . Browsing the 401(k) Annuity Shelf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BlackRock LifePath Paycheck. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prudential Income Flex. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nationwide Lifetime Income Builder . . . . . . . . . . . . . . . . . . . . . . . . Principal Pension Builder. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . MetLife Guaranteed Income Plan: Income Now or Income Later. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . GuidedChoice Retirement Income Planning. . . . . . . . . . . . . . . . . . TIAA Secure Income Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State Street Global Advisors IncomeWise . . . . . . . . . . . . . . . . . . . . Deciding Whether to Buy an Annuity with 401(k) Savings. . . . . . . . . .

230 232 233 234 234 234 235 235 236 236 237 237 237 238 238 239



Building Safe Retirement Income . . . . . . . . . . . . . . . . . . .



Weaving Annuities into an Income Plan. . . . . . . . . . . . . . . . . . . . . . . . . 247 Topping up Social Security with an annuity. . . . . . . . . . . . . . . . . . . 247 Bucketing your retirement savings. . . . . . . . . . . . . . . . . . . . . . . . . . 248


Annuities For Dummies

Leapfrogging your annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pairing home equity with an annuity . . . . . . . . . . . . . . . . . . . . . . . . Creating an Income Plan without Single-Premium Immediate Annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Using a Nobel Laureate’s method. . . . . . . . . . . . . . . . . . . . . . . . . . . Turning required minimum distributions from foe to friend. . . . Flexing your deferred annuity muscles . . . . . . . . . . . . . . . . . . . . . . CHAPTER 18:



250 250 252 252 255 255

The Taxing Side of Annuities. . . . . . . . . . . . . . . . . . . . . . . . . .


Understanding Annuity Tax Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Qualified annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nonqualified deferred annuities. . . . . . . . . . . . . . . . . . . . . . . . . . . . Special withdrawal cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighing the Benefits of Tax Deferral. . . . . . . . . . . . . . . . . . . . . . . . . . Weighing the Pros and Cons of Nonqualified Annuity Taxation . . . . Remembering Miscellaneous Annuity Tax Issues. . . . . . . . . . . . . . . . . Paying state premium taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . No tax on 1035 exchanges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes and annuity beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . .

260 260 261 263 264 266 267 267 268 268

Recognizing Annuity Exit Ramps. . . . . . . . . . . . . . . . . . . . .


Knowing Where Your Contract’s Exits Are. . . . . . . . . . . . . . . . . . . . . . . Taking free withdrawals during the surrender period. . . . . . . . . . Using nursing-home waivers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Using the period certain of an income annuity. . . . . . . . . . . . . . . . Choosing a lifetime benefit over annuitization. . . . . . . . . . . . . . . . Eluding the federal penalty — legally. . . . . . . . . . . . . . . . . . . . . . . . Swapping Annuities: 1035 Exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . Converting an Annuity to Life Insurance . . . . . . . . . . . . . . . . . . . . . . . .

270 270 270 271 271 272 273 275

Structuring Your Annuity Correctly. . . . . . . . . . . . . . . . .


Naming Owners and Annuitants. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278 Naming Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280 Choosing a Death Benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282 CHAPTER 21:

Avoiding Annuity Pitfalls. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


Watching Out for Common Annuity Missteps. . . . . . . . . . . . . . . . . . . . 286 Forgetting about fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286 Surrendering to a long surrender period. . . . . . . . . . . . . . . . . . . . .286 Mis-structuring your contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286 Heading Off Income Annuity Errors. . . . . . . . . . . . . . . . . . . . . . . . . . . . 287 Trying to “time” an income annuity purchase. . . . . . . . . . . . . . . . . 287 Ignoring the period-certain and refund options. . . . . . . . . . . . . . . 288 Getting only one or two quotes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288

Table of Contents


Choosing the Wrong Assumed Interest Rate . . . . . . . . . . . . . . . . . . . . Deflecting Deferred Variable Annuity Problems. . . . . . . . . . . . . . . . . . Tripping over step-up fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Confusing the account value with the benefit base. . . . . . . . . . . . Preventing Silly Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buying an indexed annuity that you don’t understand. . . . . . . . . Falling for an annuity postcard come-on. . . . . . . . . . . . . . . . . . . . . Underestimating your own (or your spouse’s) longevity. . . . . . . . Ignoring the impact of inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Avoiding annuities entirely. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

289 290 290 291 292 292 293 293 294 294

PART 5: THE PART OF TENS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .





Ten Great Books about Annuities . . . . . . . . . . . . . . . . . . .


The Annuity Stanifesto, by Stan G. Haithcock. . . . . . . . . . . . . . . . . . . . Are You a Stock or a Bond?: Identify Your Own Human Capital for a Secure Financial Future, by Moshe Milevsky . . . . . . . . . . . . . . . . Don’t Go Broke in Retirement: A Simple Plan to Build Lifetime Retirement Income, by Steve Vernon. . . . . . . . . . . . . . . . . . . . . . . . . . . Income Strategies: How to Create a Tax-Efficient Withdrawal Strategy to Generate Retirement Income, by William Reichenstein. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lifetime Income to Retire with Strength, by Bruno Caron . . . . . . . . . Retirement Income Redesigned: Master Plans for Distribution, by Harold Evensky and Deena B. Katz . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success, by Wade Pfau. . . . . . . . . . . . . . . . . Risk Less and Prosper: Your Guide to Safer Investing, by Zvi Bodie and Rachelle Taqqu. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unveiling the Retirement Myth: Advanced Retirement Planning Based on Market History, by Jim Otar . . . . . . . . . . . . . . . . . . Another Day in Paradise: The Handbook of Retirement Income, by Jeff Dellinger. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

297 298 298 298 299 299 299 300 300 300

Ten Questions to Ask Before You Sign a Contract. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


How Will This Annuity Reduce My Risks?. . . . . . . . . . . . . . . . . . . . . . . . What Are My Risk Tolerance and Risk Capacity?. . . . . . . . . . . . . . . . . . How Much of My Assets Should I Put into an Annuity?. . . . . . . . . . . . What Are the Strength and Integrity of the Issuer? . . . . . . . . . . . . . . . What Are the Fees?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What’s My Upside Potential? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . How Do I Get My Money Out?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Where Can I Get More Information about This Annuity? . . . . . . . . . . Am I Better Off Exchanging My Annuity for Another One?. . . . . . . . . What Are the Tax Implications?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

303 304 305 305 306 306 307 308 308 309

Annuities For Dummies


Ten Annuity Checkpoints on the Information Highway. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


Moshe A. Milevsky. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312 Center for Retirement Research at Boston College. . . . . . . . . . . . . . . 312 Society of Actuaries ( . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .312 Financial Industry Regulatory Authority. . . . . . . . . . . . . . . . . . . . . . . . . 313 Securities and Exchange Commission . . . . . . . . . . . . . . . . . . . . . . . . . . 313 National Association of Insurance Commissioners . . . . . . . . . . . . . . . 314 National Organization of Life & Health Insurance Guaranty Associations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 Alliance for Lifetime Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 Insured Retirement Institute. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316 American Council of Life Insurers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316

PART 6: APPENDIXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . APPENDIX A: Glossary . APPENDIX B: State


. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319

Guaranty Associations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Table of Contents





f you’re trying to figure out how to finance your own retirement and how to make your retirement savings last at least for the rest of your life, you’ve come to the right place. This book is about annuities. And annuities are about retirement income planning. A lot has changed in the world of money, insurance, and retirement since the first edition of Annuities For Dummies appeared in 2008. But two things have not changed: Most people don’t understand annuities well, and middle-class retirees can’t afford not to understand them. Annuities are inherently complex, and they’re rarely explained well. Most books on annuities say that annuities are contracts between you and a life insurer, with an accumulation stage where you put money in and let it grow, followed by a ­payout stage where you receive an income for life. That definition is a bit misleading. Annuities have evolved into a dozen or so ­complex, specialized products that, in practice, bear little resemblance to one another. Different annuities are sold for different purposes by different kinds of agents or advisers to investors or retirees with different needs. In this book, I devote a full chapter to each major type of annuity. You can decide for yourself which of them, if any, can solve the particular financial challenge or risk that you’re facing. Everyone who wants to reduce their financial risk should learn about annuities. My approach to this topic is as unbiased as it can be, but I do have a point of view. My opinions are based on a quarter-century’s experience in Vanguard’s Retirement Resource Center, at Annuity Market News, and as owner and publisher of Retirement Income Journal. I believe that annuities are best used for safe income, as a supplement to Social Security.



About This Book If ever a candid, consumer-driven book about annuities has been needed, the time is now. Millions of Americans are reaching retirement with their 401(k) or 403(b) plan savings, their home equity, and their monthly Social Security benefits as primary sources of income in retirement. Aside from teachers, firefighters, and other ­public-sector workers, not many are covered by adequate “defined benefit” pensions. Long shelves of books have been published on saving and investing for retirement. Many have been written about annuities. Fewer have been written about­ combining investments and annuities in creative and efficient ways to replace the pensions most Americans no longer have. As I write this book in 2023, the annuity industry has reached a turning point. After the 2008 financial crisis, the Federal Reserve lowered U.S. interest rates to near zero and kept them low until 2022. Low rates favor the stock market and real estate market but can be toxic for the popularity of annuities. The bumpy ride of the “life and annuity” industry over those 14 years deserves a business book of its own. In this updated edition of Annuities For Dummies, I ­concentrate on the new annuity products and the new life insurers that emerged during that period. Annuities For Dummies is written and designed for the intelligent nonexpert. Like all For Dummies books, you can read the contents in any order. Its bold headings and icons direct your attention to the essentials. You shouldn’t have to dig very far to find the specific information you need. Throughout this book, I emphasize that annuities are more readily understood when you recognize their three distinct benefits:

»» Tax deferral: When you want to defer income taxes on more savings than the government lets you contribute to a 401(k) plan or individual retirement account (IRA), you can put those excess savings in almost any annuity.

»» Protected growth: When you want to invest for growth while receiving

guarantees against losses, you can buy one of several flavors of deferred annuities.


Annuities For Dummies

»» Income for life: When you want to create income during retirement, either

right away or in the future, you can purchase immediate or deferred income annuities or deferred variable or fixed indexed annuities with guaranteed lifetime withdrawal benefit (GLWB) riders.

Note: The tax breaks and insurance guarantees associated with annuities tend to complicate matters because they have all sorts of conditions and restrictions. But in this book, I try to keep the bigger picture firmly in view. Within this book, you may note that some web addresses break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy — just click the web address to be taken directly to the web page.

Foolish Assumptions When an author sits down to write a book, they try to envision the people — or sometimes a single person  — to whom they’re speaking. In the process, they make certain assumptions about that audience. In writing this book, I’ve made a few assumptions that may apply to you:

»» You’re looking ahead toward your retirement years, and you’d like to make them more financially secure.

»» You know a fair amount about saving and investing for retirement (perhaps through your employer-sponsored retirement plan), but you know little or nothing about annuities.

»» You want to participate in the financial decisions that affect you. Even if you

leave the details to a financial adviser, broker, or insurance agent, you still want to understand what’s going on and whether your adviser is taking you in the right direction.

»» You’re a bit skeptical. You’ve heard or read some negative media about

annuities, including lawsuits against salespeople or companies that allegedly prey on retirees.

»» You tend to be a risk-averse investor. You understand that the stock market

isn’t just a roller-coaster ride for thrill seekers but also a place where prudent people can take steps to protect themselves against its volatility.



Icons Used in This Book Throughout this book, you find icons that alert you to especially useful tidbits of information. Here’s a guide to what the icons mean: When you see this icon, look for useful advice that can probably save you time or money or both!

I try to make each chapter as independent as possible. But occasionally I need to remind you of a fact from another part of the book. You see this icon whenever something bears repeating. The world of annuities can be like a golf course — full of rough patches, water hazards, and sand traps just waiting to add strokes to your score. This icon points them out. You can skip this stuff if you want to. I put it here for engineering-minded folks who can’t relax until they can account for every nut and bolt.

Beyond the Book In addition to what you’re reading right now, this book comes with a free ­access-anywhere Cheat Sheet that includes tips for deciding on an annuity, being annuities-savvy, and shopping for an annuity. To get this Cheat Sheet, simply go to and type Annuities For Dummies Cheat Sheet in the Search box.

Where to Go from Here Feel free to dive into this book wherever the headings catch your interest or wherever the table of contents directs you. If you don’t know anything about annuities yet, definitely read Part 1. If you’re already well versed in annuities, but you want to know more about the people selling them to you, skip to Part 3. Part 4 is the capstone section  — it tells you how to combine annuities and investments to maximize a safe retirement income.


Annuities For Dummies


Making Sense of Annuities


Define annuities and find out why older Americans spend hundreds of billions of dollars on them every year. Identify the financial risks that don’t appear until we retire. Preview the applications, contracts, and suitability forms you’ll need to fill out. Weigh the pros and cons of the various types of annuities. Decide if you’ll be a “green zone,” “yellow zone,” or “red zone” retiree.


»» Understanding annuities »» Learning the major types of annuities »» Noting the reasons why people buy annuities »» Recognizing the life cycle of all annuities



The ABCs of Annuities


ike millions of Americans, you’ve probably purchased stocks, bonds, or mutual funds. All those investments involve risks. You may be less familiar with a type of product that can reduce those financial risks, especially for people in or near retirement. Those risk-reducing products are called annuities.

Of course, annuities aren’t quite that simple. Most annuity brochures and prospectuses contain enough disclaimers, footnotes, and contingencies to keep a dozen lawyers busy. And the tax features of annuities keep a lot of accountants busy, too. But it’s useful, at least at first, to set aside the complexities of annuities and take a high-level snapshot of what they are and how they work. If investing is like walking a tightrope and insurance is like a safety net, annuities are both the tightrope and the safety net. They involve risk and guarantees at the same time. Annuities won’t return as much as pure investments can, all else being equal — but they’re not as risky either. If you’re in or near retirement, you may find such a trade-off appealing.

CHAPTER 1 The ABCs of Annuities


In this chapter, I provide an overview of what annuities are, what they do, how they work, who should buy them, and so on. In later chapters, I dig down into the details. Throughout the book, I also share my own opinions about annuities, based on my experience in writing about the products and the industry that produces and sells them.

Getting Acquainted with Annuities To a list of life’s mysteries — the curvature of space-time, for instance — I would add annuities. Hardly anyone understands them. That’s a shame, because ­annuities can bring stability to our financial lives during retirement, which is arguably when we need it most.

Part investment, part insurance Annuities differ from other financial tools in several important ways. With ­investments, you may buy stocks, bonds, or mutual funds through a broker. You hope that in the near or distant future you can sell them for a profit. The risk that you may lose money is on you. With annuities, you’re buying a type of insurance policy or contract. You transfer money from one of your existing accounts (or from another annuity) to a life/ annuity company. The life insurer invests the money and assumes certain risks on your behalf. Some contracts offer a guaranteed or minimum gain over a certain number of years. Other contracts help your money grow until you retire, with an option to convert your savings to income at some point. Still others help you turn savings into income right away. In this book, you see references to life/annuity companies, life insurance companies, and life insurers or carriers. These are all the same kind of entity. This book focuses on the annuity businesses of life insurers.

Deferring taxes Investments and annuities differ in the way the federal government taxes them. When you buy mutual funds and hold them in a traditional brokerage account, the fund distributes or reinvests capital gains, dividends, or interest on which you owe income tax each year.


PART 1 Making Sense of Annuities

When you buy an annuity, you pay no taxes on the annual gains until you take the money out (after age 59½, there’s no 10 percent IRS penalty tax on withdrawals). More money stays in your account, so it can grow faster. In that respect, an ­annuity is a bit like an individual retirement account (IRA). I delve into the tax benefits of annuities in Chapter 18. The types of annuities that most people buy today are usually long-term ­tax-deferred investments with protections against loss. Relatively few people buy annuities solely for monthly income in retirement, and only a minority converts investment-style annuities to retirement income. The different types of annuities are so different from each other (despite several similarities) that I recommend approaching them as distinct products. Different types of annuities are sold by different kinds of agents or advisers to different kinds of clients for different purposes. Annuities are often sloppily described in the media. The media typically defines them as ways for people to create guaranteed retirement income that starts right away (immediate annuities) or after an “accumulation period” (in the case of deferred annuities) and in the form of either steady or fluctuating payments. This definition makes it sound as if every annuity ends up as guaranteed income in retirement. That’s like saying that all eggs grow into chickens, instead of getting fried, hard-boiled, poached, or added to cakes long before then. Most annuity owners use them for the benefit of tax deferral and to protect their savings from loss due to market volatility.

WAIT, DID SOMEONE SAY “CONTRACT”? Yes, buying an annuity means filling out an application, which, if approved, is followed by the signing of a contract. Like those endless software contracts online, annuity contracts can be long, hard to understand, and printed in a font size that strains the naked eye. The application will acquaint you with the terms of your annuity. It will also require you to make certain decisions about how you’ll fund the annuity, how you want your money invested, and when you want your money back. Hundreds of thousands of dollars are typically transferred in annuity transactions. Signing your name to the application and/or contract can be scary. But the thought of losing a chunk of your retirement nest egg in a market crash can be scarier. That, along with the tax deferral, is why people buy annuities.

CHAPTER 1 The ABCs of Annuities


THREE ANNUITIES IN ACTION Let’s bring this discussion of annuities down to earth with a few concrete examples. Consider these common financial situations: Imagine that you’ll need exactly $50,000 in five years, and you can’t afford to lose any of it between now and then. You can take $43,000 or so from savings, buy a five-year contract, and receive a guarantee that it will compound by 3 percent or 4 percent each year for the next five years (depending on current interest rates) with no taxes on the annual gains during that period. After five years, you’d have $50,000. Guaranteed. That’s an investment-oriented, fixed deferred annuity. Or imagine that you’re 70 years old and you’ve saved enough money to cover your essential expenses for the next 15 years but not for 20 years or longer. You can buy an annuity that pays you an income starting next month and lasting as long as you live. Alternatively, you can, with a much smaller premium, buy an annuity whose payments start only if and when you reach age 85. That’s a single premium immediate annuity (SPIA) and a deferred income annuity (DIA), respectively. Or imagine that you’ve contributed the maximum amount to your defined contribution plan or IRA, but you’d like to save more every year for retirement in a tax-deferred account whose value may fluctuate (upward, you hope) over time. You can put that money in an annuity and let it compound tax-deferred indefinitely. That’s a deferred variable annuity or a structured variable annuity.

Recognizing the Most Popular Annuities Many books and articles describe annuities as having two stages. In the first stage — the accumulation stage — you contributed to the contract, as you would to a bank account. In the second stage — the income stage — you converted your contributions to a monthly income in retirement. Long ago, these two stages became decoupled and evolved into two distinct types of annuities:

»» Deferred annuities, which are contracts that stay in the accumulation stage indefinitely, with the assets growing tax-deferred

»» Immediate annuities, which are contracts that skip the accumulation stage and start paying out monthly or quarterly income shortly after the owner makes a large, lump-sum investment


PART 1 Making Sense of Annuities

Each of these two types evolved further. Depending on the type of deferred annuity you bought, your money can accumulate at

»» A fixed rate (if the insurance company invested your money in bonds) »» A variable rate (if it was invested in the insurance versions of mutual funds, often called subaccounts)

»» An indexed rate (if returns were linked to a market index) If you bought an immediate annuity, on the other hand, the level of monthly or quarterly income can be

»» Fixed (if the money was invested in the insurance company’s bonds) »» Variable (if the money was invested in subaccounts) Over the years, certain types of annuities have become more popular than others. Deferred variable annuities were the most widely sold from the 1990s up until about 2010. Since then, sales of index-linked annuities have become more prevalent. In the following sections, you find thumbnail portraits of the annuities most commonly purchased. In Part 2 of this book, I devote a chapter to each.

“Savings account” annuities When people simply need a safe place to grow a large sum of money for a few years, or if they’re saving for a specific need — a planned wedding, a down payment on a house or car — they may buy a certificate of deposit (CD) at a bank. Some annuity contracts outyield CDs because life insurers typically invest in longterm corporate bonds that may offer higher returns. These annuities are called fixed annuities, fixed-rate annuities, multiyear guaranteed annuities (MYGAs), or even “plain vanilla” annuities. Your money can grow for terms of up to ten years. You can find out more about these types of annuities in Chapter 6.

Pension-like annuities If you don’t have a company-paid annuity (a traditional defined benefit pension) to rest your weary head upon in retirement, you can buy a pension-like stream of income from a life/annuity company. The most common names for this type of annuity are: an income annuity, an immediate annuity, or (if you’re into “the whole brevity thing,” as the Big Lebowski said in the Coen brothers’ film) a SPIA.

CHAPTER 1 The ABCs of Annuities


Options-based fixed indexed annuities The first fixed indexed annuities (FIAs) appeared in the mid-1990s. These contracts generate earnings for their owners when an equity stock index such as the S&P 500 Price Index rises in value. Their original name, equity indexed annuity, was changed to fixed indexed annuity in 2007 to clarify their identity as an insurance product, not a security. As I discuss in Chapter 8, FIAs rely for growth on the purchase of options rather than on bond yields or on increases in the value of equity shares. In 2021, the first fixed index-linked annuity (FILA) appeared on the market. It offers investors a chance for higher gains than they might receive from an FIA. Investors can lose gains that their accounts have already achieved, but their principal remains protected from loss.

Registered index-linked annuities In 2011, a new kind of annuity was born. Variously called registered index-linked annuities (RILAs), structured variable annuities, or index-linked variable annuities (ILVAs), these contracts bear a resemblance to FIAs. Both rely on the purchase of options on equity (or blended-asset) indexes. A big difference: You can lose principal when you buy a RILA. Because of that risk, sales of RILAs are regulated by the U.S.  Securities and Exchange Commission rather than by state insurance commissioners. More an investment than an annuity, a RILA typically offers higher potential gains than an FIA while also using “floors” and “buffers” for partial protection from loss. You can find details on RILAs in Chapter 9.

Traditional variable annuities At the peak of the 2010–2020 bull market, Americans had $2.5 trillion invested in mutual fund–like subaccounts in deferred variable annuities. When you contribute to a variable annuity, your money goes into a separate account with your name on it, rather than into the insurance company’s general fund. Starting decades ago, wealthy investors bought vast amounts of variable annuities, where their after-tax savings can grow untaxed until withdrawn. Between 2005 and 2015, older investors bought mountains of variable annuities with guaranteed lifetime withdrawal benefit (GLWB) riders. These riders enabled retirees to lock in a minimum level of retirement income without locking themselves out of access to their own money. You can find out more about the benefits of these types of annuities in Chapter 10.


PART 1 Making Sense of Annuities

Deferred income annuities DIAs are sometimes called “longevity insurance.” They’re intended to provide income that doesn’t start until mid- or late-retirement — at age 75, 80, or (at the latest) 85 — rather than at the beginning. Compared with income annuities that pay income starting at age 65 or 70, these late-life annuities cost much less but still address your risk of outliving your savings. DIAs have a close cousin called qualified lifetime annuity contracts (QLACs) that have important tax features. Chapter 11 has more details on both.

Age-in-place annuities (also known as reverse mortgages) Many Americans say they would like to live in their own home throughout retirement. But many elderly people feel pressure to sell their homes to generate cash to live on. A reverse mortgage lets you borrow against your home equity and stay in your home. You can take that loan as a lump-sum payment, as an annuity that delivers income for as long as you live, or as a home equity line of credit for cash during emergencies. The reverse mortgage helps you maintain your home and pay your property taxes. The loan isn’t repaid until you pass away or sell the home. I explain reverse mortgages in Chapter 12.

THE “ALPHA” OF ANNUITIES When you buy an annuity for lifetime income, you throw your money into a pool with money from thousands of other annuity owners your age. This is longevity risk pooling. Social Security and corporate defined benefit pensions are based on the same principle. With these annuities, an insurance company puts the money into its own interestbearing account. All owners then take an annual income from that pool for as long as they live. This insures them against the risk of living long enough to run low on money in retirement. Your income from this type of annuity will come from a combination of three sources:

• Your contribution to the pool • Interest earned on your contribution to the pool (continued)

CHAPTER 1 The ABCs of Annuities



• Money left in the pool by fellow annuity owners who have died (also known as the survivorship credit or mortality credit)

In purchasing this type of contract, you agree that

• If you die early, you may not receive as much as you put in. • If you live exactly to your life expectancy, you’ll get back about what you put in. • If you live well past your life expectancy, you’ll get back much more than you put in. In buying a life annuity of this type, you’ve purchased income for life at the price that a person who lives to the average life span (average for annuity buyers of your age and gender, but not necessarily for the general public) would pay. You can customize your income to last for a minimum number of years, or to last as long as either of two people are living, or to provide your beneficiaries a refund if you die before getting back all of your initial premium. In Chapter 7, I go into greater detail. Fewer people buy this type of contract than buy deferred annuities, for a variety of reasons. But I give priority to income annuities in this book because they’re the only true annuities. Only life-contingent income annuities offer survivorship credits. They can help boost your income in retirement.

Reasons for Exploring Annuities A book about annuities is, by nature, a book about financial planning for retirement. If you’re in your 50s, 60s, or 70s, annuities can help you

»» Save for retirement with less risk of loss »» Enter retirement with less exposure to a market crash »» Live in retirement with less fear of running low on money Here are the main reasons why people buy annuities, roughly in order of importance (for more on this topic, see Chapter 4):

»» Retirement income: Annuities were built to provide income, especially

income that lasts for as long as you live. Life/annuity companies are good at calculating the average life expectancies of large groups of people. This helps them forecast death rates and to set fair prices for life insurance and annuities. Several kinds of annuities can provide retirement income.


PART 1 Making Sense of Annuities

»» Tax deferral: Money compounds faster when gains aren’t subject to end-

of-year taxation. Over many years, the difference in growth rates between money in taxable and tax-deferred accounts can be substantial. People in high tax brackets often buy deferred annuities because they can contribute virtually any amount of nonqualified money (money on which they’ve already paid taxes) to the contract and defer taxes on the gains until they take withdrawals. For more on taxation of deferred annuities, see Chapter 18.

»» Protected growth: Certain investment-style annuities offer opportunities

for growth along with protection against loss. One type of fixed deferred annuity offers guaranteed rates of return and a guarantee against loss. Indexed annuities offer a chance for growth and either partial or complete protection against loss. That makes them popular as savings tools for people — especially those nearing retirement — who don’t feel that they can afford to take a loss.

»» A desire to age in place: Reverse mortgages convert home equity to income that’s based on the life expectancies of the borrowers. Two groups of people should take an interest in reverse mortgages:

• Middle-class retirees without much savings but with substantial home equity

• Affluent people who can use the advantages that reverse-mortgage home

equity lines of credit may have over conventional home equity lines of credit

See Chapter 12 for more details on reverse mortgages.

»» Future medical expenses: Many annuities come with special clauses or

riders that enable the owner to access, or to accelerate their access, to their money if they’re disabled or confined to a nursing home. Certain fixed deferred annuities are designed to let the owners buy high-deductible, low-cost long-term-care insurance.

»» Charitable giving: Certain annuities allow you to combine your wish to leave

a bequest to a charity, receive a tax deduction for the gift, and provide monthly retirement income for yourself. For instance, you can give money to a charity (and get a tax break) and then receive an income from the charity until you die. Or, you can buy an annuity for yourself that, at your death, pays any money left unpaid to a charity.

»» Womanhood: Although their mortality rates have been converging, American

women still live longer than American men on average. Visit any nursing home, and you’ll see that women far outnumber men. Because those who live longest benefit most from income annuities (as they do from Social Security), women in general are good candidates for annuities.

CHAPTER 1 The ABCs of Annuities


ASKING YOUR FINANCIAL ADVISER ABOUT ANNUITIES You may wonder, “Why doesn’t the author just tell us to visit our investment adviser or insurance agent and ask them which annuity to buy?” The short answer is that every adviser or agent may recommend a different annuity or none at all. Not every intermediary (adviser or agent) will know much about annuities. Most intermediaries specialize in either investments or annuities, not both. Few are “ambidextrous advisers,” as I put it. So, it’s wise to know a bit about annuities before you consult a professional.

Your annuity’s safety depends on the life/annuity company’s financial strength. The company’s strength is its ability to pay you back, as measured by the depth of its reserves and surplus. Every insurance company receives ratings for financial strength from the major rating agencies (AM Best, Fitch Ratings, Standard & Poor’s, and Moody’s). Each company also has a Comdex rating, which combines the agencies’ ratings into an overall score on a scale of 1 to 100.

The Life Cycle of All Annuities Every annuity has two potential phases: accumulation and income. During the accumulation phase, you put money in the account (paying all at one time or making a series of payments), and it grows tax-deferred. During retirement, you initiate the income stage by converting it to an irrevocable income stream. In practice, as I mention earlier in this chapter, it usually doesn’t work that way. Most people who buy deferred annuities never formally convert them to income; they just take withdrawals during retirement or leave the money to their beneficiaries. Others buy immediate annuities after age 59½ and start receiving income right away. The following sections describe an overview of the life cycle of most annuities (I’ve added a purchase stage to show the initial steps in acquiring an annuity).

The purchase stage When you begin to make concrete plans for your retirement, you may


Meet with a trusted agent/broker/adviser to explain your needs. Give them time to research the annuity products available in your state.


PART 1 Making Sense of Annuities

2. 3. 4. 5. 6.

Study the various prospectuses or brochures your broker obtains from the wholesaler, broker-dealer, or life insurer, and then choose the product that best suits you. Decide whether to use after-tax savings or IRA savings to pay for your annuity. Fill out an application. If it’s a deferred variable annuity, choose the subaccounts (similar to mutual funds), riders (options), and services you want. If it’s a DIA, set an income start date. Wait while your application is submitted to the insurance company for approval. If approved, you’ll get a contract.

7. 8.

Sign the contract and provide a check for the initial purchase premium. Use the “free look” period to review and confirm or reverse your purchase.

The internet has made it easier to learn about and buy annuities. The law still requires you to work with someone who has a license to sell insurance products in your state, and you’ll still need to sign a contract (with either a handwritten or e-signature). But you can educate yourself before you talk to an agent or adviser. Some annuity websites ask for your name, email address, phone number, and perhaps your age and household wealth before sending you information. If you comply, expect a call from an insurance agent. Chapters  15 and  24 have more information about the internet and annuities.

The accumulation stage This stage lasts from the time you buy a deferred annuity until the time you cancel the contract or convert it to retirement income.

»» If it’s a deferred variable annuity, you can make periodic contributions and change your investment mix.

»» If it’s an FIA, you may be able to adjust your crediting rates or index choices at the end of each crediting interval.

»» If it’s a savings-style fixed annuity, you receive a yield that the life/annuity

company can change each year. If it’s a MYGA, the rate stays the same for the entire term.

CHAPTER 1 The ABCs of Annuities


If you take withdrawals during this period, they may be subject to a surrender charge, a market-value adjustment, income tax, and a 10 percent federal penalty tax if you’re under age 59½.

The income or distribution stage This stage starts after age 59½, when you retire. You may

»» Take withdrawals from your deferred annuity as needed without converting the assets to a guaranteed irrevocable income stream.

»» Exercise your GLWB rider, if you purchased one, to receive a guaranteed income for life while maintaining access to your money.

»» Begin taking monthly, quarterly, or annual income from your income annuity, if you have one.

RECOGNIZING LIFE/ANNUITY COMPANY DIFFERENCES Not all annuity issuers are alike. Different insurers specialize in different types of annuities. They sell their contracts through a variety of agents, brokers, or advisers. Life/ annuity companies vary in size, financial strength, and quality of customer service. Some life/annuity companies are stock companies (owned by shareholders) and some are mutual companies (owned by policyholders). Some are subsidiaries of giant holding companies. Others are affiliated with investment companies that deal in “private equity,” “private credit,” or “alternative assets”. Years ago, many life insurance companies employed armies of career agents to represent their products. Although some mutual life insurers still employ these “captive forces,” more insurers now reach the public through insurance marketing organizations, broker-dealers, and banks. Independent agents and advisers can recommend any annuity they believe will be suitable for you and in your best interest. In practice, they may steer you toward their list of preferred products or carriers or to products that pay them a higher commission. (See Chapter 14 for more on working with intermediaries and Chapter 23 for questions to ask before you sign anything.)


PART 1 Making Sense of Annuities

Putting money into an annuity is relatively easy. Getting money out may be ­conditional. Annuities are more “sticky” than pure investments for several reasons. Life insurers need long-term commitments from you in order to give you long-term guarantees — like a fixed interest rate for a specific number of years or a certain income for the rest of your life. Annuities are insurance-and-investment hybrids. They can provide tax ­advantages, protected investment growth, and guaranteed lifetime income. Nearretirees and retirees can use annuities to bring certainty to one or more aspects of their financial lives.

SOLVING AN AGE-OLD OLD-AGE PROBLEM Because none of us knows how long we’ll live, we don’t know exactly how much money we’ll need to support ourselves after we retire and are no longer working. The history of annuities is the search for a solution to that problem. Annuities have existed since ancient times. In the Roman Empire, contracts called annua promised a stream of payments in return for an up-front payment. Speculators who sold insurance for Mediterranean shipping ventures sometimes offered these insurance contracts to the public. Wealthy Romans sometimes willed their heirs or friends incomes for life. To estimate the value of such gifts, tax collectors needed to know how long those heirs or friends were likely to live. In AD 225, a Roman judge named Ulpian produced the first known “mortality tables.” By his reckoning, a 30-year-old Roman man would live until age 60, on average. Any man over age 30, he concluded, had an average life expectancy of 60 years minus his current age. William Shakespeare is said to have invested a large part of his wealth near the end of his career in an “annuity-like arrangement.” In pre-Renaissance Europe, both the Catholic Church and governments sold annuities to raise funds and refinance debt. As early as 1540, the Dutch government sold annuities to finance wars and public works, just as modern governments sell interest-bearing bonds. In the 1600s, special annuity pools called tontines operated in France. In return for an up-front payment, purchasers of tontines received a lifetime income. As purchasers died over time, their income was divided among the survivors. The last living purchaser collected the remaining money. Tontines were eventually banned — partly because the last few survivors had a strong motive to kill each other! (continued)

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The first annuities in the United States were issued in 1759, when the Corporation for the Relief of Poor and Distressed Presbyterian Ministers and of the Poor and Distressed Widows and Children of Presbyterian Ministers was chartered in Pennsylvania. In 1812, the Pennsylvania Company for Insurances on Lives and Granting Annuities was founded. After the stock market crash of 1929, many people turned to annuities as safe places for their retirement savings. The modern era of annuities began in 1952, when TIAA-CREF (the educators’ retirement fund, now TIAA) offered the first group variable deferred annuity — a precursor of other employer-sponsored retirement savings plans. Sales of annuities to individuals flourished after the tax reforms of 1986, which left deferred annuities as one of the few remaining havens from taxes on investment gains. As of 2022, Americans have saved about $2 trillion in annuities, up from $1.6 trillion in 2010. By contrast, they hold a total of more than $30 trillion in all tax-favored retirement accounts. Today, many economists and finance professors (not to mention life/annuity companies) hope that American retirees will rediscover the original purpose of annuities and use them to turn their savings into guaranteed lifetime income.


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»» Countering the main risks of retirement »» Using annuities to buffer retirement risks



Taming the Big Retirement Risks


e’ve all heard or read about “tipping points” — watershed moments, subtle or dramatic, personal or social, where new modes of living or thinking replace older ways. Shakespeare defined the “seven ages of man.” In the 1970s, these inflection points were called “passages” in a bestseller of the same name. The transition from the paycheck years to the Social Security years constitutes one of those predictable passages. You may cross that boundary suddenly, gradually, or in several intermediate steps. You may be able to control the timing of your retirement, but often, an injury or illness takes people “out of the game.” Retirement will change your financial life. When you’re young, someone once said, your goal is to turn a small amount of savings into a large amount. When you’re old, however, your goal is to prevent a large pot of savings from becoming a small one. Tax deferral is a tailwind when you’re young, and investment risk is your path to reward. In retirement, tax deferral is a headwind, and market risk becomes more of a threat. This chapter describes the financial risks that commonly vex people over age 55, as well as the annuities that can help hedge, mitigate (reduce), or eliminate those

CHAPTER 2 Taming the Big Retirement Risks


risks. Your job is to decide which risks you’re willing to take without insurance and which ones you’d rather insure against. Yes, insurance costs money, but sometimes it’s cheaper than the alternative.

Countering the Main Risks of Retirement The most common retirement risks tend to fall into three main areas:

»» Longevity risks: The hazards of aging »» Investment risks: The uncertainty of the financial markets »» Planning risks: The chance that people will make mistakes with their money In the following sections, I talk about each type of risk.

Longevity-related risks Modern humans have walked the Earth for some 200,000 years. On average, life spans at birth and at age 65 have gotten longer. But people never know exactly how long they’re going to live or how much it could cost if they have to pay for a life that’s longer than they expected. Actuaries have a fancy name for that uncertainty: longevity risk. That’s the risk that your healthy diet and exercise classes will pay off, and that you’ll live five or ten years longer than your savings are certain to carry you. If so, you may need much more savings for living expenses. When you’re 80, you may no longer be able to earn money from working. Your family members, if available, may not be able to help you. In my own family, I’ve seen once-prosperous people reduced to asking relatives for alms after reaching age 80. If you’re reading this book, you’re likely to live longer than you expect.

The risk of outliving your savings In 2022, a 65-year-old American man could expect to live another 17.3 years on average. An American woman could expect to live another 19.83 years. In 1940, when Social Security started, average life expectancy at age 65 was 12 years for men and 13.5 years for women. (Fewer Americans reached age 65 in 1940 than in 2022, but it’s a myth that almost no one lived past age 65 in 1940.)


PART 1 Making Sense of Annuities

Those are average life expectancies; about a quarter of people will live longer than average. Married couples, white Americans, wealthier Americans, and even poor Americans who live in wealthy areas all tend to live longer than average. Statistically, the higher your income, the greater your life expectancy at any given age, according to a 2016 report in the Journal of the American Medical Association. Marriage has a positive effect on longevity. For both men and women age 65, life expectancies for married people are about two years longer than for single people, according to a December 2020 report in SSM – Population Health. For couples age 65, there’s a 47 percent chance that one spouse will live to age 90 and a 20 percent chance that one will live to age 95, according to the Social Security Administration. If anything, Americans tend to underestimate their longevity potential. According to the Center for Retirement Research at Boston College, 58 percent of men and 64 percent of women ages 65 to 69 expect to reach age 80. But life expectancy tables suggest that 66 percent of men and 75 percent of women aged 65 should live to age 80. Financially speaking, extreme longevity is a mixed blessing. If you planned on living to age 85 but you live to age 90, how will you pay for five extra years of expenses? Should you save more? Spend less during retirement? Invest more aggressively? Buy a life-contingent annuity?

The risk of losing a spouse This event carries such a catastrophic emotional cost that we can easily underestimate or forget the financial cost. When one spouse dies, up to half of the family’s Social Security income may disappear. In addition, the surviving spouse may be left without a caregiver, and hiring an outside caregiver is expensive. Most surviving spouses are women. Women live an average of two years longer than men, and 46 percent of women over age 65 are widows. In contrast, only 14 percent of men over 65 are widowers, according to LIMRA, the life insurance research organization. As the last to die, women are much more likely to experience the effects of longevity risk than men.

Health risk Medical costs will likely be one of your largest expenses in retirement. Medicare, Medicare Advantage plans, and Medigap insurance policies can protect you from some of the larger costs of care. But they’re not free, and they don’t cover every service or procedure that you may need or want. Medicaid covers nursing-home expenses for some people, but you must demonstrate poverty to qualify for it.

CHAPTER 2 Taming the Big Retirement Risks


The average, healthy, 65-year-old couple will spend between $156,000 and $1 million out of their own pockets on health care during retirement, according to Healthview Services, Inc. That amount may appear staggering, but it accounts for the costs incurred by two people for up to 30 years, so it averages out to about $10,000 per person per year and includes the cost of all health insurance premiums. Medicare enrollees pay premiums for Parts B and D and any supplemental coverage; contribute a portion of the cost of Medicare-covered services they receive through copayments and deductibles; and face the full cost of dental and vision services, which are not covered by Medicare. For about 5 percent of households, these out-of-pocket expenses can eat up over half of their total income, according to one estimate. A 2020 report from the Bureau of Labor Statistics showed that Americans over age 75 spend almost 18 percent of their pretax income on health care. Your health costs in retirement will depend in part on whether you choose a ­Medicare Advantage plan or a Medigap policy to cover medical expenses that Medicare doesn’t. Because of their low or even zero monthly premiums, and aggressive marketing campaigns on their behalf, Medicare Advantage plans are very popular. They may have co-pays, high deductibles, and restrictions on your choice of doctor. Medigap plans typically require a monthly premium of about $150, and premiums will slowly increase as you age. In order to be accepted into a Medigap plan without suffering a penalty for a preexisting condition, you must enroll during the year after you reach age 65. Vision and dental coverage generally are not included, though policies may be available from the same insurer.

Long-term-care risk Today’s retirees know that if they live long enough, they’ll probably need either in-home care or nursing-home care. One provider of long-term-care insurance estimated that in 2021 the median monthly cost for a private nursing-home room was $9,034, and the cost for a one-bedroom unit in assisted living was $4,500. A home health aide costs $5,148 per month. You’re likely to incur some form of expense for short-term or long-term care in your home or in a facility. According to the U.S. Department of Health & Human Services, almost 70 percent of people who reach age 65 will eventually need some type of paid assistance.


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Men will need nursing-home care for an average of 2.2 years, and women will need it for an average of 3.7 years. Forty-two percent of those who reach age 65 will need some form of paid in-home care for an average of one year. Thirtyseven percent will need an average of one year’s care in a nursing home or assisted living center. But the results of studies and surveys differ, and averages are always misleading. A 2019 report from the Center for Retirement Research cited evidence that about half of people approaching retirement today will never need nursing-home care, even in old age.

Investment risks Every investor experiences investment risk. The value of your investments can go up or down. When you’re young, you can (and should) ignore the ups and downs of the securities markets. But as you age, the various types of investment risks can become more pronounced.

Market risk Compared with younger people, retirees tend to have more to lose when the securities markets crash. Having saved for a lifetime, their retirement portfolios are probably at an all-time high. And although stocks tend to grow in value over the long run, you don’t have as long a “long run” when you’re older. Time isn’t necessarily on your side. Retirees used to play it safe by putting their money in bonds or bond funds. Does an aging turtle beat an aging hare? It’s hard to say. From 2008 to 2020, new bonds didn’t pay much interest, but the prices of old bonds kept going up. In 2022, the Federal Reserve raised rates, lifting the yield on new bonds but reducing the prices of old bonds. So, bonds carry a degree of investment risk.

Sequence-of-returns risk Here’s a risk you may never had heard of, yet it can sink your retirement if you’re not careful. Sequence-of-returns risk (also known as sequence risk or timing risk) is the risk that a financial market crash may occur either a few years before or a few years after your retirement date. If you haven’t retired yet, the crash may force you to postpone retirement until market values recover. It could also force you to work longer in order to recover lost savings. If you’ve already retired, and you’re selling assets to cover your monthly expenses, you could find yourself having to sell depressed assets.

CHAPTER 2 Taming the Big Retirement Risks


This trap, known as negative dollar-cost averaging, can, for example, force you to choose between selling more mutual funds shares than usual (and keeping your income the same) and selling the same number of shares as usual (and spending less for a while). A market crash during early retirement can be especially damaging, because these are the “go-go” years of retirement, when retirees tend to spend a lot on travel or home renovations. This sort of disruption can shrink your portfolio and increase the risk that you’ll run short of money before you die, according to Moshe A. Milevsky, a finance professor at York University in Toronto. The five years immediately before and after you retire are the most vulnerable years for your savings. One insurance company called this period the retirement red zone. A serious bear market during that time can put you in a financial hole that you don’t have time to earn your way out of.

Inflation risk Since 1946, when the first baby boomer was born, America’s worst bout of inflation occurred during the 1970s. In 1973, the cost of living in the United States, as measured by the Consumer Price Index (CPI), was 44.4. By 1981, the CPI was 90.9. In the space of eight years, the average family needed twice as much money to cover the average budget for groceries, gasoline, and rent. During the period from 1981 to 2021, inflation was often described as mild or even “tamed.” Yet, over those 40 years, the cpi tripled, from 90.9 to 270.1. In 2022, the CPI was predicted to rise by 8.6 percent from the year before.

Tax risk When you were working and saving, you probably benefited from the tax breaks on your contributions to individual retirement accounts (IRAs) and employersponsored saving plans, as well as from the deferral of taxes on gains that build up inside your annuities. But in retirement, taxes become a headwind. Whatever money you take out of qualified accounts, and whatever gains you withdraw from annuities, will be taxed as ordinary income. Because your annual income tax burden in retirement may depend on your pattern of withdrawals from these accounts, you’ll face the risk of paying more taxes than you absolutely need to. Strategies for minimizing taxes in retirement are beyond the scope of this book, but you’ll find more information on taxes and annuities in Chapter 18.


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Policy risk This is the risk, for example, that a future president, Congress, or court may decide to eliminate the Social Security program or reduce the generosity of its benefits formula, which includes inflation indexing, the 50 percent minimum benefit for spouses of primary earners, and the retention of a couple’s highest benefit to the surviving spouse. Congress has to act on Social Security soon, because the program’s expenses (benefits) are expected to exceed its revenue (from payroll taxes and liquidation of trust fund bonds) sometime in the mid-2030s. This doesn’t mean the program has failed; it just means that its rules will require adjustment. Polls show that many Americans, especially younger Americans, don’t believe that they’ll ever receive Social Security benefits. But they still pay their payroll taxes as if they did. One insurance company has started selling insurance that pays off if a person’s Social Security benefits are cut because of legislative changes. Other people believe that politicians won’t touch the lethal “third rail of American politics” (a reference to the electricity-bearing rail that powers subway trains).

Planning risks Economists used to assume the existence of Homo economicus: the “economic man.” In trying to predict human behavior in financial matters, they assumed that people were “rational” and financially literate. But over the past 20 years, conversations between economists and psychologists have led to the “discovery” that most of us — present company excluded — are either irrational or “rationally irrational” about money, and that most people don’t understand basic principles of finance, like compound interest. Forget about asking the average person to define the time value of money or the future value of an annuity. Of course, people with higher-than-average savings hire financial advisers to know these things for them. But that doesn’t stop them from making a lot of mistakes on their own. Retirement planning also entails a number of difficult choices and trade-offs. At times, you may have choose the lesser of two evils.

Having no income plan at all Few employer-sponsored retirement plans offer advice or options for converting savings into retirement income. Many people will leave their plans with a lot of money but no strategy for investing it, protecting it from taxes, or making it last for 20 years or more.

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Without a strategy, a 401(k) participant who retires may withdraw their money in one lump sum, forget to roll it into an IRA, and lose a big chunk of it to taxes in the first year. Obviously, the absence of an income plan raises the risk of running out of savings during retirement.

Overspending A vast amount of research shows that if you spend more than 4 percent to 5 percent of your savings every year during retirement, you run a pretty high risk of running out of money. But 5 percent of, say, $300,000 (which, in 2022, is more savings than most Americans will accumulate by the time they retire) is only $15,000. The temptation will be great to spend at a much higher rate, especially during the first years of retirement.

Hoarding Conversely, many people run the risk of spending too little of their savings out of fear that they may live to age 100. By rationing too conservatively, people deprive themselves of pleasures that, in retrospect, they could’ve afforded. Some behavioral economists believe that baby boomers are so conditioned to save that they’ll be reluctant to spend during retirement.

Helping out family members Because retirees tend to have a lot of savings, their children and grandchildren not infrequently come to them for financial help. The Health and Retirement Study, which the University of Michigan has conducted since 1992, shows that roughly one-third of households age 65+ make family transfers over any given two-year period, mainly by giving money to children. Children may need money for living expenses, a down payment on a home, a stint of unemployment, or substance abuse rehabilitation.

Facing a decline in cognitive ability “Senior moments” are part of growing older. You may forget to pay an electric bill. Or, eventually, you may even forget your way home. As the executor of my father’s estate, I sorted through his mail, his bills, and his credit card statements. I saw evidence, after he died at age 83, that he had almost completely neglected his finances. Our financial skill tends to deteriorate after age 70. The deterioration makes many older people especially vulnerable to fraud. Over the phone, con artists may lie and tell them that they’re under investigation by the government. Email “phishing” campaigns may target their passwords or Social Security numbers. According to the Center for Retirement Research, the elderly are more likely than younger


PART 1 Making Sense of Annuities

people to be solicited for fraudulent investment schemes. One survey showed that nearly one in six older people had lost money in a “senior scam.” My purpose here isn’t to alarm you. You already know that life can throw ­knuckleballs and sliders at you. Instead, I urge you to think more about your ­liabilities. Pre-retirees and their investment advisers tend to focus on their ­retirement assets. But it’s just as important to anticipate your retirement ­liabilities  — your predictable and potential costs  — when creating a retirement income plan. You shouldn’t buy an annuity without first examining what some have called your “household balance sheet.” (See Chapter 17 for more on that.)

Using Annuities to Buffer Retirement Risks Annuities are designed to insure you, partially or completely, against the retirement risks that I describe in this chapter. Later in this book, I describe each of the major types of annuities. For the moment, however, let me briefly illuminate the connections between specific risks and specific annuities.

Annuities for longevity risks Income annuities are intended specifically to address the biggest financial problem in retirement, which is uncertainty about how long you’ll live, how much you can afford to spend, and how much you have to save for retirement. The common type of income annuity is the single premium immediate annuity (SPIA; see Chapter 7). Indirectly, SPIAs can help protect against any of the risks that come with living a long time, including the risk of losing a spouse, health risk, and long-term-care risk. Deferred income annuities (see Chapter 11), where income doesn’t start until you reach mid- or late-retirement, also protect against longevity risks. But even the annuities that people use primarily for guaranteed growth or for tax deferral can be used as longevity risk insurance. Fixed and deferred variable annuities often offer optional riders that provide income for life. So-called “longterm-care” fixed annuities can offer protection against long-term-care risk. Every deferred annuity must, by definition, give you the right to convert the cash value of the contract to a guaranteed income stream, even if you have no intention of using it for that purpose. All annuities potentially have both an investment phase and an income phase, but most annuities are used for investing or for income, not both.

CHAPTER 2 Taming the Big Retirement Risks


Annuities for investment risks The most widely sold annuities, by far, are the deferred annuities that Americans use for what the annuity industry calls protected growth. These include fixed-rate deferred annuities, multiyear guaranteed annuities (MYGAs), fixed indexed annuities, and registered index-linked annuities (RILAs). As later chapters show, fixed-rate annuities and MYGAs offer guaranteed rates of return, either for one year or for several years. Fixed indexed annuities offer the potential for gain with guarantees against loss of principal, and RILAs offer returns with limits on both gains and losses. These annuities can protect against market risk and sequence-of-returns risk. Deferred annuities offer tax benefits, but they don’t necessarily protect against tax risk. Low-cost investment-only variable annuities offer some protection against inflation.

Annuities for planning risks Income annuities offer a lot of protection against overspending and underspending in retirement, which are two of the most common planning risks. They’re a much more precise planning tool than the “4 percent rule,” which many retirees use to decide how much of their savings they can afford to spend each year in retirement. When you’re very old and your personal financial planning skills aren’t as sharp as they used to be, reliable income from an annuity can simplify your finances and make you feel more secure. It may be hard to appreciate the vulnerabilities of extreme old age when you’re young, but it’s important to recognize them and plan for them. “Risk budgeting” is a concept that near-retirees may want to think more about. We all face many risks during our lifetimes, and not many of us can afford to, or would be inclined to, buy insurance against all of them. (I was once offered termite insurance; my house has a solid, poured-concrete foundation, so I turned it down.) You have to decide for yourself which risks you can handle without insurance, which ones you’d rather buy insurance for, which to hedge (by diversifying your strategies or betting on and against the same strategy), and which to self-insure against (by keeping emergency cash on hand). For instance, if you arrange to have one of your children care for you in your old age, you’re hedging your risk of needing nursing-home care.


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When you eliminate one risk, you create room in your risk “budget” for a different risk. Insurance may be expensive, but it can pay for itself by creating new opportunities for risk taking. That’s the purpose of insurance: to allow you to do things you wouldn’t otherwise be able to do. Without parachutes, there would be no skydiving. If you know that your basic expenses in retirement will be met by guaranteed income sources (like Social Security, a pension, or an income annuity), you can afford to invest your remaining money in stocks without the temptation to panic during a crash. Similarly, you can afford to spend more freely in the early years of retirement if you’re insured against running out of money later on. Insurance isn’t necessarily a deadweight loss, even if you never file a claim.

YOU PROBABLY UNDERESTIMATE YOUR RETIREMENT RISKS There’s ample research that most people have difficulty estimating the chance that they will live to age 90. That implies that they have difficulty knowing how much to save for retirement and how much they can afford to spend each year in retirement. Most people also underestimate the amount of money they’ll need for health care in retirement. “Retirees do not have an accurate understanding of their true retirement risks,” according to a research paper published by the Center for Retirement Research at Boston College in 2022. The paper emphasized the importance of guaranteed sources of income like Social Security and annuities, especially for people who have undersaved for retirement.

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»» Exploring your application and contract »» Seeing how paperwork differs between types of contracts »» Ensuring suitability and best interest



Diving into Annuity Documents


f you buy an annuity, you’ll have to fill out and sign an application and then a contract. Signing contracts is scary. We’ve all clicked the I Agree button on software or app contracts without reading what we signed. But those contracts don’t entail agreements to fork over, say, $100,000 or more. Annuity contracts do. Ideally, your trusted adviser will nod in your direction if they believe it’s safe for you to sign. Current regulations require agents, brokers, and advisers to act in your best interest when selling you an annuity. But you should read the application carefully before signing so nothing surprises you down the road. This chapter acquaints you with the elements you’ll encounter if you buy an annuity. There’s a lot of jargon in annuity contracts. Specialized attorneys write them in legalese that sometimes makes sense only to them.

CHAPTER 3 Diving into Annuity Documents


Exploring the Annuity Application and Contract There are many more steps involved in purchasing an annuity than in buying, say, a mutual fund or shares of stock. You must read and sign a lengthy, binding contract; name the people who will be paying or receiving money; and learn about your rights and limitations under the terms of the contract.

Signing an annuity contract The annuity purchase process typically includes these steps:

1. 2. 3. 4. 5.

You meet with the agent or broker to discuss your finances and choose a suitable product. You complete an application and the agent or broker submits it to the life insurer that issued the annuity contract for approval, along with a check or instructions for payment. In some cases, you lock in an interest rate, just as you’d lock in a mortgage rate if you were buying a house. If the life insurer finds your application “in good order,” suitable for you, and “in your best interest,” it sends you and your agent or broker a final contract. You have a “free look” period of up to 30 days to review the contract, sign it, and send it back. The carrier pays the licensed agent or broker a commission for making the sale. The cost of the commission may already have been incorporated into the annuity’s yield or payout rate. You put the contract in a safe place. Shoeboxes, filing cabinets, desk drawers, and safe-deposit boxes are among the preferred destinations (but not necessarily in that order!).

Designating the key players Every annuity contract has an owner, an annuitant, and beneficiaries. If you put someone’s name in the wrong place in the contract, you could create big headaches for yourself.


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The owner The owner of an annuity is just that — the owner. This person

»» Pays the premiums »» Signs the application and contract »» Agrees to abide by the terms of the contract »» Decides who the other parties of the contract will be »» Can withdraw money or even sell the annuity (depending on the type of contract or the stage it’s in)

»» Is liable for any taxes that are due The owner should be a person, but it can also be a trust that represents the interest of a person. Married couples can and often do own annuity contracts jointly, while also serving as each other’s beneficiary. If one of them dies, the other, like a copilot, can take over the controls. (It’s never a great idea to have two unrelated owners with different beneficiaries.) Depending on the contract, the owner may be able to change a designated annuitant (see the following section) after buying the annuity. The owner can pass ownership of an existing annuity over to someone else, but a taxable event (where the owner ponies up the income taxes on the contract’s gains) may result.

The annuitant The annuitant is the person whose age is used to calculate annuity payments if the contract is used as a source of lifetime income in retirement. Owners and annuitants are often the same person or people. But if they aren’t, you must be careful not to mix them up on your contract. You don’t hear much about annuitants because it’s rare for anyone who buys an investment-style (“deferred”) annuity to “annuitize” it. That is, to convert it to an irreversible retirement income stream that stops at death. (I return to the subject of annuitants later in this chapter.) As I remind you several times throughout this book, most annuities are not used for income. People buy them as long-term but temporary investments to obtain tax deferral and guarantees against loss of principal (in a fixed annuity) or loss of purchasing power (in a variable annuity with an income rider).

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Imagine that the sole owner of the annuity contract is a 68-year-old man. He names his 65-year-old wife as the sole annuitant. If the contract’s value is converted to guaranteed monthly or quarterly payments, the wife will receive the payments. The insurance company will calculate the value of each payment based on her life expectancy, not his. At age 65, a woman’s life expectancy is about 19 years. If the man were the annuitant, his payments would be higher because his life expectancy, at age 68, may only be about 15 years. There can be two annuitants. Often a husband and a wife are named joint annuitants. A non-spouse can be a contingent annuitant. If the contract is converted to an income stream, the two annuitants receive the payments jointly. If there are joint annuitants, the monthly or quarterly payment will be based on the age of the annuitant with the greater life expectancy. At the same age, women have longer average life expectancies than men. In most annuity contracts, however, the owner and the annuitant are the same person. In fact, if they aren’t the same person and one of them dies, trouble can result. This leads us into the complicated area of annuity “structure,” which I cover in detail in Chapter 20. If the owner of an investment-style deferred, nonqualified annuity dies, their beneficiary can choose to receive the death benefit as a lump sum, as payments over a period of up to five years, or over their life expectancies. If the annuitant dies, and the owner is not the annuitant, one of two things will happen:

»» If the annuitant is currently receiving income payments, the annuitant’s

beneficiary will receive a death benefit equal to any payments that were still due to the annuitant.

»» If the deferred contract hasn’t begun paying the annuitant an income and the annuitant dies, the owner can appoint a new annuitant, but only if the contract is “owner-driven.” Most annuities are “owner-driven” and, to prevent complications, owners and annuitants should be the same people.

The beneficiaries A beneficiary is the person designated to receive assets upon someone else’s death. When filling out an annuity contract application, the owner names their own beneficiary and also the annuitant’s beneficiary (if the owner and beneficiary are not the same person). The owner and the annuitant can be each other’s beneficiary (which simplifies matters for couples). No one can be their own beneficiary, however.


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The issuer The life insurance company that issues the contract and guarantees the safety of your money is the issuer. (Note: I use life/annuity company, life insurer, annuity issuer, insurer, and occasionally carrier as synonyms for life insurance company in this book.) All five have the same meaning. Every life insurer publishes its own annuity application and contract forms. In fact, it publishes many different versions of its application, because each state in the United States imposes its own requirements and restrictions on the contents or wording of the contract. Always look for an issuer that’s rated Excellent, Superior, or Very Good by the rating agencies, such as AM Best, Standard & Poor’s, or Fitch Ratings. A high rating means that the rating agency believes that the finances of the life insurer are strong and that the company will be able to meet all its foreseeable obligations. Insurers also have Comdex ratings, which are numerical composites of the agencies’ ratings.

Other standard elements of annuity contracts All annuities have a free-look period, a death benefit, and annuitization options. If a life/annuity company pays a commission to your agent or adviser, your annuity will most likely have a surrender period. Deferred variable annuities have accumulated unit values (AUVs), which correspond to the net asset values (NAVs) of mutual funds.

Free-look periods When you buy an annuity, you have between 10 and 30 days to cancel the contract after you receive it in the mail, depending on the state you live in. This free-look period gives you a final chance to change your mind and opt out of the purchase. This period is designed to protect retirees who feel they were rushed into buying an annuity. Some immediate annuity contracts let you cancel your contract within the first six months, and some fixed deferred annuity contracts let you opt out during a brief window at the beginning of each contract year. For more information, see Chapter 6. Your initial application may or may not alert you to your right to a free-look period. All contracts should carry the alert.

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Death benefits If the owner of the contract dies (or, in some contracts, if the annuitant dies), their beneficiary receives a death benefit. Depending on the death benefit option the owner chose when they bought the contract, the death benefit may be equal to

»» The value of the investments in the contract when the owner or annuitant dies »» The amount of the original investment, if it’s higher than the value of the investments when the owner or annuitant dies

»» The highest value of the contract on any contract anniversary, if it’s higher

than the original investment or the value of the investments when the owner or annuitant dies

Life/annuity companies measure time by contract anniversary years, not by calendar years. So, if you buy your contract on June 17, that’s your contract anniversary. The date is important because some contracts allow you to make favorable changes in your account on the anniversary. For instance, if you own a variable annuity contract with a guaranteed minimum withdrawal benefit rider and the cash value of your contract reaches a higher-than-ever level, You may be able to lock in a richer benefit that can translate into more income. (For details, see Chapter 10.)

Surrender periods Most, but not all, annuities have surrender periods, a span of time when the issuer may levy a contingent deferred sales charge (CDSC) if the owner withdraws too much money too soon. If there’s a surrender period on the contract, it generally means that the life insurer has paid your agent or broker a sales commission. CDSCs are a necessary evil; they discourage withdrawals. If investors can cancel their contract at any time, the carrier won’t be able to recover the expense of the commission back from the contract owner through an annual fee. You can pay the commission yourself at the time of sale, but few people choose that option. Surrender periods are not the impenetrable firewalls between you and your money that the popular press makes them out to be. There is generally no surrender charge on

»» Withdrawals of 10 percent or less of a deferred annuity’s value every year.

(Note: Some life/annuity companies reduced or eliminated this perk during the low-interest rate period from 2009 to 2022.)

»» Withdrawals taken to satisfy your required minimum distribution (RMD). These are the withdrawals Uncle Sam requires you to take from your


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tax-deductible retirement accounts, such as traditional individual retirement accounts (IRAs) and employer-sponsored retirement plans, after you reach age 73 (for those who reach 72 in 2023 or later). (See Chapter 18 for more on RMDs.)

»» Withdrawals taken to pay for nursing-home care. Single versus flexible premium Immediate and deferred income annuities are typically purchased with one big payment and start producing income either within 13 months after purchase (for immediate annuities) or several years later (for deferred income annuities). If you want to increase your income, you must buy a second contract. You can usually make multiple or “flexible” contributions to a single deferred variable annuity contract over many years.

Qualified versus nonqualified An individual qualified annuity is a contract that you purchase with the savings in your tax-deductible traditional IRA or with money from an employer-sponsored retirement plan. (You must rollover 401(k) money to an IRA first, and then buy an annuity in the IRA.  The annuity issuer can do this for you in one transaction.) A nonqualified annuity is purchased with savings that you have paid income taxes on. There have long been group annuities available to workers within employersponsored retirement plans. Workers can deduct their contributions to such annuities from their taxes. In 2019, Congress passed the SECURE Act, which will make it easier for employers to offer flexible-premium individual annuities to participants in 401(k) plans if they want to (see Chapter 16 for details). The tax treatment of qualified and nonqualified annuities differs significantly:

»» With a qualified annuity, at age 72, you must take out RMDs (which equal

the value of your account divided by your life expectancy). All your withdrawals become part of your taxable income the year that you withdraw them. (See the earlier section, “Surrender periods,” in this chapter for more on RMDs.)

»» With a nonqualified annuity, you don’t have to take RMDs; you only owe income tax on a portion of your withdrawals. (See Chapter 18 for more information.)

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Annuitization options To annuitize a deferred annuity means to convert the value of the investments in the contract to a guaranteed income stream for

»» A specific number of years »» The rest of your life »» As long as you or your spouse is living All investment-style deferred annuities give you the right to annuitize your contract. Every application will ask you to indicate how you’d like to receive your income payments. Even though annuities are, in a sense, made for annuitization, very few deferred annuity owners annuitize. Annuitization puts limits on their ability to withdraw lump sums from their contracts. Many people don’t know they can annuitize until they see this section of the application. They may believe that only deferred annuities with “guaranteed minimum withdrawal benefits” allow them to convert their assets to a pension-like income. I discuss annuitization in Chapter 7.

New or replacement annuity The application will also require you to indicate whether you’re buying a new annuity or swapping an annuity that you already own for a new annuity. That “swap” is called a tax-free 1035 exchange when the transaction involves nonqualified annuities and a trustee-to-trustee transfer when it involves annuities in traditional IRAs. (For more on this topic, see Chapter 19.) Regulators require agents, brokers, and advisers to demonstrate that they’re not steering you from an annuity that’s valuable into a new annuity that offers no meaningful advantage over the old one. What might motivate such a bum steer? The agent or adviser earns a new commission from the life insurer.

Distinguishing between Variable, Fixed, and Fixed Indexed Annuity Contracts The applications and contracts of traditional variable annuities and fixed indexed annuities differ substantially. For that reason, I discuss them in different sections.


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Variable annuity contracts When you buy a variable annuity, you’re investing in a type of tax-deferred mutual fund. Your account can lose market value when the stock market drops. Because you can lose money in variable annuities, they’re securities under U.S. law and regulated by the Securities and Exchange Commission, a branch of the U.S. ­Department of the Treasury. To sell you a variable annuity, an adviser has to be licensed to sell securities and licensed to sell insurance in your state (or must work in tandem with someone who has an insurance license). For your own protection, the SEC requires that the annuity issuer send you a ­prospectus for the variable annuity that you’re buying, in addition to your ­application. Full-blown prospectuses can run 250 pages or more in length. ­Summary prospectuses are a recent (and refreshing) phenomenon; they may be only 50 pages long. Ask for a summary prospectus when buying a variable annuity. Why are variable annuity prospectuses so long? The full prospectus has to explain the details of all the investments that the product offers you. Sometimes there are more than 100 investment options. Your adviser will probably recommend a combination of investments for you. There are services that help advisers analyze, evaluate, and compare different annuity prospectuses. You’ll probably never read an entire prospectus; neither will your adviser. When I study a prospectus, I use the table of contents to locate the most important information — like fees, for instance. Near the beginning of every variable annuity prospectus, you’ll find a declaration of contract fees. You’ve probably heard or read that variable annuities have lots of fees. Some do and some don’t. There are stripped-down variable annuities, often preferred by the clients of registered investment advisers and their clients, that charge only about $25 a month, not counting the advisory fee that your adviser charges. These products are used mainly to defer taxes on investment gains. There are also variable annuities that contain a selection of optional lifetime income guarantees, each with its own fee. The application form or contract will probably not tell you what the various fees are or how they may change in the future. It won’t tell you the payout rates from lifetime income riders, the investment management fees, or the contract-related fees. You need the prospectus for that. A full prospectus or summary prospectus for a particular product can usually be found on the website of the life insurance company that issues it, along with product brochures. The brochures often contain illustrations (hypothetical examples of how an annuity might perform in hypothetical scenarios).

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Let’s glance at the fee schedule in the summary prospectus of one of the topselling variable annuities of recent years. It includes most of the common fee categories and fees. In Chapter 10, I zoom in on the features and fees of variable annuities.

»» Contract fees: This variable annuity contract has a contract fee of 1.31 percent per year, or $1,310 per year per $100,000.

»» Investment fees: The annual fees and expenses for the investment options in this variable annuity range from 0.52 percent to 2.01 percent.

»» Surrender charge schedule: In this case, you pay an 8.5 percent penalty if

you withdraw all your money in the first year. That penalty drops gradually to zero over a period of seven years.

»» Optional living benefit fees: There are several “living benefits” or “income

riders” in this contract. The most expensive one costs 1.75 percent per year. These options allow you to turn your investments into an income that lasts for the rest of your life, even if your account balance drops to zero, while allowing you to make withdrawals from your account.

»» Optional death benefit fees: The death benefit is the amount your beneficiary receives if you die while owning an investment-style annuity that you haven’t converted to a guaranteed income stream (what I consider a “true” annuity). It can range from zero to 2 percent per year.

»» Other rider fees: In this particular annuity, you can pay an extra 0.4 percent

per year just to shorten the surrender charge period to four years from seven years.

To help you translate the individual fees into the total amount of fees you’ll incur in a year, the variable annuity prospectus may provide a separate fees and expenses table. It shows you what your overall fees may be in the first year you own this product. If you invested $100,000  in this particular product, for instance, your annual expenses would range from a low of $1,692 to a high of $5,010, depending on how many bonuses or guarantees you ordered.

Fixed annuity contracts Unlike variable annuities, fixed annuities are not considered securities. That’s because they offer you guarantees against loss of principal. Like all insurance products in the U.S., they’re regulated by the insurance commissions in the states where the annuity issuers are headquartered in office towers full of cubicles and computer terminals, or on grassy corporate campuses.


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The most widely sold types of fixed annuities are

»» Fixed-rate annuities, whose yields can change from year to year while you own it

»» Multiyear guaranteed annuities (MYGAs), whose yields don’t change from year to year

»» Fixed indexed annuities (FIAs), whose yields are tied to the movement of market indexes

»» Fixed immediate annuities, which provide fixed (usually monthly) income payments in retirement

When filling out a fixed annuity application, you’ll need to choose the term length. That’s the number of years you’d like to let your money grow before you get it back or renew it. Fixed annuities are sometimes advertised as having “no fees.” You won’t find much mention of fees in the application or even in many product brochures, unless the fees apply to bonuses or income riders. The contract’s surrender fees will be visible on the application, but, generally, you won’t pay a surrender charge unless you withdraw more money from the contract during the surrender period than the contract allows. The fees associated with creating, selling, managing, and distributing a fixed annuity are not visible. That’s not a crime. The expenses associated with putting a can of soup or bar of soap on the grocery shelf are equally hidden. With soup or soap, the manufacturer’s expenses help determine the price. With fixed annuities, the life insurer’s expenses help determine the rates of return that a fixed annuity contract promises. I return to this subject in Chapter 6.

Fixed indexed annuity contracts Most FIAs do not have explicit fees. In the past, they were often marketed as having “no fees.” Some are still marketed that way, while others have added riders and bonuses for which they do charge explicit fees. Unlike a fixed-rate annuity, an FIA application will require you to choose how you want to split your premium among various index options and crediting formulas. I discuss those terms in detail in Chapter 8.

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WHERE DO YOUR EXPENSE DOLLARS GO? Insurance companies use your fees to pay their bills. These fees are deducted from your account. Your benefits — the money you eventually get back — come from the growth of the pool of funds that your money went into. Here’s where some of your expense dollars go:

• Compliance: Insurance is a highly regulated industry. It’s overseen by state and

federal watchdogs that require a constant stream of reporting to demonstrate that the company is compliant with the law.

• Customer service: Any large financial service company employs thousands of people who work at computer terminals, answer telephones, respond to policyholder questions and complaints, resolve problems, and execute routine transactions.

• Financial reporting: If the insurer is publicly owned, it must continuously report its financial activities to its shareholders and to the Securities and Exchange Commission.

• Information systems: Insurance companies have terabytes of policy information that have to be stored and managed by mainframe computers and computer networks.

• Marketing: The carrier may buy millions of dollars’ worth of advertising on television and radio and in magazines and newspapers each year.

• Research and development: The biggest insurance companies employ squads of

actuaries and product developers to invent new kinds of annuities and other insurance products.

• Risk management: To protect themselves from market volatility, annuity issuers employ sophisticated hedging strategies that involve the continuous buying and selling of options.

• Training: Because the world is constantly changing, financial services companies

continually retrain their employees to use new types of technology, represent new types of products, or employ new ways to market to the public.

• Wholesaling: Besides paying commissions to those who sell their contracts (independent agents, brokers, and financial advisers), insurers must maintain small armies of wholesalers to promote their products to agents and advisers.


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Ensuring Suitability and “Best Interest” About halfway through your annuity application, or on a separate form, you’ll be asked to read certain disclosures and acknowledge that you understand them. You’ll also be asked for answers about your personal finances. This fact-finding process furnishes you, the agent, and the life insurer that issues your annuity with evidence  — should regulators ever ask to see it  — that the annuity suits your needs and that all three parties agree that the purchase will benefit you. The application or suitability form may require

»» Your household income »» Your net worth »» Your liquid net worth »» Your risk tolerance »» Your debt »» Your intended use of the annuity »» Your financial time horizon »» Your ability to pay for emergencies after you buy the annuity »» Your level of financial experience or literacy The agent or broker may be required by regulators to pledge that they informed you regarding any or all of the following:

»» Surrender period and surrender charge »» Index features (on an index-linked annuity) »» Availability of cash value of the annuity »» Potential tax implications associated with various transactions »» Death benefit(s)

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»» Fees, such as mortality and expense fees, cost of insurance fees, and investment advisory fees

»» Non-guaranteed elements, including variability in premium, cash value, death benefit, or fees

»» Product restrictions or exclusions »» Potential charges for and features of riders »» Limitations on interest returns »» Guaranteed interest rate »» Insurance and investment components »» Any applicable market risk »» The manner in which the producer is compensated Some life insurers ask many detailed questions about your personal finances in order to determine whether the annuity sale is suitable for you or in your best interest. You may even be asked for permission to market other products to you. If so, you may be able to opt out of solicitations.


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»» Checking out the positives »» Taking a close look at the negatives »» Making choices between annuities and their competition



Weighing Annuity Pros and Cons


efore you buy an annuity, you should consider all their advantages and disadvantages. Distinguishing between an annuity’s pros and cons isn’t always easy, however, because in many cases the pros are the cons, and vice versa.

To complicate matters, different annuities  — deferred and immediate, variable and fixed — have different pluses and minuses. Ironically, the best feature that annuities offer — the survivorship credit — is the aspect that’s most commonly neglected. But don’t lose sight of the bigger picture: Annuities are effective tools for achieving a financially secure retirement. The question you may ask yourself is whether, in your particular situation, they can deliver that benefit more conveniently and efficiently than competing tools. Annuities don’t exist in a vacuum. You always have to compare them with alternative or competing products, and you have to factor in your own needs and preferences. Even when annuities are good, they may or may not be right for you. My goal for this chapter is to identify the pros and cons of annuities in general and of specific types of annuities in particular. I also show you how annuities measure up against their closest competitors. (For more about each type of annuity, see Part 2.)

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Evaluating Annuity Advantages People buy annuities to deal with tax issues, investment risk, and the need for retirement income. Investment-style or deferred annuities help with taxes and investments. Income or immediate annuities provide income. A few annuities ­provide a combination of benefits.

Punting income taxes to the future When you buy an investment-style or deferred annuity with money that you’ve already paid taxes on.

»» You can let the annuity grow indefinitely without paying annual taxes on the

appreciation, as you would on the appreciation of a mutual fund in a taxable — non–individual retirement account (IRA) or 401(k) — account.

»» You don’t have to start withdrawing money from a deferred annuity at age 73, as you must from traditional IRAs and accounts. Generally, the longer you allow your savings to grow without touching them, the more you benefit from deferring taxes on the gains.

»» If your income tax rate during retirement is lower than your tax rate while

you’re still working, you may ultimately pay less in taxes by deferring them. (See ­Chapter 18 for more on the taxing side of annuities.)

Before seeking tax deferral in a deferred annuity, contribute as much as you can to your tax-deductible retirement savings accounts, such as traditional IRAs or employer-sponsored retirement plans. Factors that make tax deferral more effective include the following:

»» Large contributions »» High income-tax bracket while working »» Maximum benefit from tax deferral »» Ten years or more of accumulation »» Low fees »» Continuing contributions »» Low income-tax bracket in retirement


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Contributing as much as you want You can contribute virtually as much as you want to a deferred annuity. That’s a unique advantage of annuities. Most insurance companies reserve the right to review contributions over $1 million in advance (perhaps to screen out money launderers).

Reducing investment risk As I will remind you throughout this book, annuities combine features of investments and of insurance. That mixture can be confusing, because pure investments differs from insurance in at least two ways:

»» Investments involve risk. When you buy stocks, for example, you face the

chance that the prices of your stock or of all stocks will rise or fall. When you buy bonds, you face the risk that interest rates may rise and reduce the sale price of your bonds. In fact, investors actively seek investment risks in order to get rewards.

»» Insurance contracts involve the transfer of risk from you to another

party. When people buy annuities, they pay for guarantees that transfer their risk of losing money to an insurance company. Annuity buyers actively seek to limit investment risk.

Annuities permit financial risk and reduce it at the same time. Owning an annuity is a little like applying the gas and the brakes at the same time while driving. (This, I believe, greatly adds to the public confusion about annuities.) But that’s precisely why people buy annuity contracts: as tools to control risk rather than avoid it altogether. For instance, when you buy a deferred variable annuity contract, you usually put most of your money in so-called subaccounts that are essentially mutual funds with special tax treatment. That’s risky. But the contract might offer a guarantee that if you contributed $100,000 to your annuity at, say, age 55, you’ll receive an income of at least $10,000 a year for life starting at age 65 — even if the stock market crashes in the meantime. That reduces your risk. (For more on variable annuities, see Chapter 10.)

Protecting beneficiaries When you buy a deferred annuity, you pay a small annual fee for a death benefit that ensures your beneficiaries a certain minimum if you die while the contract is

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in force. The more you pay for the death benefit (you may have up to three or four options), the richer the benefit. As a side note, I’ve never seen market research proving that consumers choose annuity contracts based on the death benefit.

Assuring income in retirement Modern humans have walked the Earth for some 200,000 years. On average, life spans at birth and at age 65 have gotten longer. But one thing hasn’t changed: We don’t know exactly how long we’re going to live. Actuaries have a fancy name for that uncertainty: longevity risk. It’s the risk that your healthy diet and exercise classes will pay off, and that you’ll live five or ten years longer than the average. If you do, you may need proportionately more savings for living expenses. Annuities are the only retail financial product that you can use to convert savings to an income that can last for the rest of your life, no matter how long you live. In effect, they allow you to save as if you knew you would live the average life span (the average for healthy annuity buyers, not the national average) and not worry that you may live ten years longer. You can use different types of annuities to accomplish this goal. You can

»» Contribute regularly throughout your life to a deferred fixed or variable

annuity, then reverse the stream and convert your savings to a guaranteed retirement income.

»» Take money from another source (for example, the sale of conventional

investments, the sale of a business, the savings in a rollover IRA), plop it into a new fixed or variable income annuity (also called an immediate annuity), and start drawing your fixed or variable retirement income from it within a year.

»» Contribute money (gradually or all at once) to a deferred variable annuity with a guaranteed lifetime withdrawal benefit (GLWB); this entitles you to lifelong income that’s usually a percentage of your account value or a specific guaranteed minimum account value.

»» Purchase longevity insurance (either deferred income annuities or qualified

longevity annuity contracts [QLACs]). These are relatively inexpensive annuities that begin paying out a guaranteed lifetime income late in retirement, such as at age 80.


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The benefits of income annuities are similar to the benefits of Social Security or a corporate pension. They help you create do-it-yourself pensions and can maximize income during retirement while ensuring that monthly checks will arrive as long as you (either one person or a couple) are living. In sum, they deliver financial peace of mind in retirement.

Capturing “survivorship credits” I’ll pivot here to the advantages of immediate income annuities, which resemble personal pensions. The single biggest benefit of an income annuity is the extra retirement income you get from pooling your longevity risk — the risk of living much longer than you saved for — with other people of the same age and gender as you. This bonus is called a mortality credit or, more palatably, a survivorship credit. What does it mean to “pool your longevity risk”? It means that if you die before recouping all your original premium in the form of retirement income, leftover savings will be shared by your fellow annuity owners. If you live longer than the other annuity purchasers, you’ll inherit some of their money. Assuming that the life insurance company anticipates the rate of shrinkage of your pool and prorates the survivorship credit across all the income payments, including the first one, you may receive other annuity owners’ money before they die.

Obtaining peace of mind Retirees who own income annuities say they like the peace of mind that comes from receiving a regular paycheck. It’s like the peace of mind that Social Security provides, and that traditional company pensions used to provide. You can’t prevent the disappearance of company pensions. But an income annuity can help you achieve a similar sense of financial serenity.

Replacing your old paycheck Are you one of the millions of Americans who have compiled six-figure nest eggs in their employers’ retirement plans but don’t know how to convert them to income? An income annuity that pays out a blend of principal, earnings, and ­survivorship credits somewhat evenly over your entire future may be the most efficient way to turn your savings into income.

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THE NATURE OF INSURANCE UTILITY As you ponder the pros and cons of annuities, remember that they’re a form of insurance, and like all insurance, they can help you use your scarce financial resources more effectively. For instance, if you rely on a car to commute to work, you can’t afford to be without it. To offset the risk that an accident may deprive you of your car, you have a choice. You can put $30,000 in escrow so you can buy a new car right away. (That’s called self-insuring.) Or you can buy insurance for $3,000 a year. The insurance, in effect, frees up $27,000 for other purposes and limits your potential cost to only $3,000. An income annuity also frees up money and limits your potential cost. Suppose you’re worried about living to age 90, because longevity runs in your family. You can self-insure by saving more, which is like putting money in escrow for a new car. Or, with far less money, you can buy a life annuity that pays out as long as you live. That’s like buying car insurance. Annuity analysts have calculated that, all else being equal, an annuity can cost about 40 percent less than the amount you’d need to save in order to cover the cost of living to age 90.

Confronting Annuity Drawbacks Every benefit of annuities has a corresponding drawback. On the one hand, they provide tax deferral. On the other hand, their gains are eventually taxed at the ordinary income tax rate. They offer guaranteed returns and income, but in return you often have to give up complete control of your money. Annuities involve trade-offs. To enjoy their benefits, you may have to accept one or more of their drawbacks.

Duplicating Social Security Academics have long wondered if sales of immediate income annuities in the U.S. are low because so many American retirees already own one  — in the form of Social Security. Anyone who works and pays payroll taxes in the United States for enough years earns Social Security disability and retirement benefits. Social ­Security is a life-contingent deferred income annuity. Some say Social Security crowds out the sale of private income annuities. Others contend that Social Security benefits replace only a fraction of the average ­American’s pre-retirement income. This means that they’ll likely experience an income shortfall in retirement that private annuities can make up. In Chapters 7 and 17, I show you why it makes sense to buy enough annuity income so that, when you combine it with your Social Security benefits, you’ll have enough


PART 1 Making Sense of Annuities

guaranteed income in retirement to cover all or most of your household’s ­essential expenses.

Higher expenses than mutual funds As I explain in Chapter 3 some annuities have high fees, some have lower fees, and some have fees embedded in their payout rates. The fees cover the cost of providing guarantees, the cost of marketing and selling the contracts, the insurance company’s overhead, and the cost of managing investments that the insurance company purchased with your annuity premium. Mutual funds are, in fact, much cheaper, especially when you can buy no-load index funds directly from fund supermarkets. But mutual funds don’t guarantee your principal or provide guaranteed rates of return.

Reduced liquidity Buying an annuity means tying up your money for a period of time. The term of a fixed-rate annuity or fixed indexed annuity (FIA) may range from three to ten years. The surrender period of a variable deferred annuity may be as long as nine years. You may have no access to the money in an income annuity aside from your monthly check. Although not being able to access the money is a drawback of annuities, it’s also a necessity. In order to achieve higher rates of return, to make tax deferral effective, to reap the benefits of risk pooling, or to protect your money from loss, a life insurance company has to control your money and restrict your access to it. You can’t safeguard your money and expose it to risk at the same time. That said, almost all annuities now feature some liquidity. You can withdraw up to a specified percentage of your cash value from many deferred annuities during the surrender charge period without being charged a surrender penalty (but federal taxes and tax penalties on early distributions may still apply). Variable annuities with income benefits allow you to strike your own balance between access to your money and a minimum income for life. Some immediate income annuities allow owners to supplement their monthly income with one or two lump-sum withdrawals.

Annuity earnings are taxed as ordinary income You can defer, but not avoid, income tax through the purchase of annuities. Either you or your beneficiaries will eventually have to pay income tax on withdrawals.

CHAPTER 4 Weighing Annuity Pros and Cons


The tax will be levied on the entire withdrawal (if you bought the annuity with pretax money) or on the gains (if you bought the annuity with after-tax money). You won’t have the luxury of paying capital gains tax on your gains. There is no “step-up in basis” with inherited annuities. When beneficiaries receive investments in after-tax accounts, they owe no capital gains tax on the buildup in value that occurred during the life of the original investor. All annuity gains are taxed. This, too, is a necessity or trade-off rather than an unfair disadvantage. Through tax policy, the government purposely encourages saving for retirement and discourages the use of tax-favored retirement savings for bequests.

Low transparency, high complexity in some cases Annuities vary in their level of transparency and complexity. A simple ­investment-only variable annuity with no insurance features isn’t complicated or opaque. You can see how your investments are performing. Fixed-rate annuities are simple; you know how much you can expect to earn over a specific number of years. FIAs and variable annuities with guaranteed minimum withdrawal benefits resist easy inspection or analysis. FIAs rely on sophisticated, behind-the-scenes options strategies applied to the movements of customed, financially engineered market indexes to achieve their gains. Variable annuities with living benefits use notional “benefit bases” that differ from the cash value. The benefits of today’s popular deferred variable annuity contracts — which offer guaranteed lifetime income and access to your principal if you need it — require complex financial engineering and entail many different restrictions. The rules are always in the prospectus, but they can be extremely difficult or even impossible to understand.

Adverse selection Healthy, wealthy, well-educated people  — those with the longest life ­expectancies  — are the most likely to seek out and purchase income annuities. People with low incomes and poor health tend not to buy income annuities. Life insurers call this adverse selection. To a lesser extent, life insurers may be­ vulnerable to a form of moral hazard, where annuity owners may purposely work harder to maintain their health and lengthen their lives.


PART 1 Making Sense of Annuities

To compensate for this distortion, insurance companies have to charge more for life annuities than they would if random members of the population bought annuities. The expectation of adverse selection becomes a self-fulfilling prophecy on the part of life insurers. This makes income annuities more expensive for people with average longevity risk. Some insurance companies offer higher-paying income annuities for people with serious chronic illnesses.

Comparing Annuities with Their Competition Rather than ask, “Are annuities good or bad?” you may ask, “Would an annuity be better or worse than other financial tools for solving a specific financial challenge?” As I note at the start of the chapter, annuities don’t exist in a vacuum. Every financial strategy involves trade-offs. Are the net benefits of annuities greater or smaller than the net benefits of competing products? That answer depends on the situation and the matchup. (It also depends on you — as I explain in Chapter 5.)

Deferred fixed annuities versus CDs Deferred fixed annuities and certificates of deposit (CDs) are both tools for saving and earning interest on savings. The biggest difference is that annuities offer tax deferral and CDs do not. For example, the pros of deferred fixed annuities include

»» Tax-deferred gains »» Unlimited contributions »» Low risk (backed by an insurer) »» Guaranteed rates The cons of deferred fixed annuities include

»» Low transparency (the interest rates offered by some deferred fixed annuities may decline after the first year)

»» Low liquidity

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The pros of CDs include

»» Guaranteed rate »» Low risk (backed by the Federal Deposit Insurance Corporation, or FDIC) The cons of CDs include

»» Gains that are subject to current taxation »» Low liquidity It’s easy to compare CDs to deferred fixed annuities because the interest rates are readily available. Fixed annuity rates are posted on the internet (see Chapters 15 and 24 for specific sites), and CD rates may be posted in the lobbies of banks. It’s best to buy fixed-rate annuities when long-term interest rates are significantly higher than short-term interest rates; that’s when they usually offer higher rates than CDs. I would avoid buying a fixed-rate annuity whose rates are not guaranteed for the length of the term, however. Other fixed annuities may offer a higher first-year rate, but the rate may be subject to reduction at the will of the life insurer. For more on deferred fixed annuities, see Chapter 6.

Deferred variable annuities versus mutual funds Deferred variable annuities and mutual fund accounts are both ways of investing in mutual funds and building up your retirement savings. In this case, you’re trying to maximize the growth rate of your retirement savings. The pros of using a deferred variable annuity are

»» Tax deferral on unlimited contributions »» Death benefit »» Option for guaranteed living benefits The cons include

»» Generally high fees »» Low liquidity until age 59½ »» Gains taxed as ordinary income 56

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The pros of mutual fund accounts are

»» Generally low fees »» High liquidity »» Transparency Not bad. But now look at their cons:

»» Subject to current taxation (unless you hold them in an IRA or employersponsored retirement plan)

»» Stock market risk »» No income options or guarantees As a savings tool, mutual fund accounts generally grow faster than annuities because of their lower fees. However, as a retirement income tool, variable annuities offer payout options that ordinary mutual funds don’t offer. (Let’s ignore the impact of tax deferral for the moment, because many people hold mutual funds in tax-deferred retirement accounts.) So, keep your savings in cheap-as-possible mutual funds until you get close to retirement, and then buy your retirement income tool — either a variable annuity with guaranteed income options (Chapter 10) or an income annuity (see the next section). The decision between using an investment or an annuity often comes down to personal preferences regarding risk. Would you rather pay $22,000 for a “certified” used car with a warranty or pay $20,000 for the same car without a $2,000 warranty? When you’re playing roulette in Las Vegas, do you put your chips on red or black, or on both red and black? Would you rather have a 100 percent chance of earning a small gain with a fixed-rate annuity or a 50 percent chance of earning a big gain with an equity mutual fund? It’s your choice.

Income annuities versus systematic withdrawals When you reach retirement, you’ll probably weigh the benefits of immediate income annuities against the benefits of a “systematic withdrawal plan.” Both are time-honored ways to derive a river of retirement income from that glacier of savings it took you a lifetime to accumulate.

CHAPTER 4 Weighing Annuity Pros and Cons


Systematic withdrawal plans (also known as SWPs) are nothing more than strategies for keeping your savings in a blend of stocks, bonds, and money market accounts and withdrawing money as needed, usually from the money market account first. SWPs offer

»» Liquidity »» Maximum benefit for beneficiaries »» Low costs (gains taxed at low capital gains rate) And here are the cons:

»» Exposure to market risk in old age »» No system for generating retirement income »» No benefit from mortality risk pooling Now, take a look at an income annuity (either fixed or variable). The annuity pros are

»» Peace of mind »» Reduced investment risk (survivorship credits) »» A retirement distribution strategy And the cons are

»» Lack of liquidity »» Reduced benefit for beneficiaries »» Adverse selection (high prices) Overall, income annuities generally appeal to investors who want the peace of mind that comes from a guaranteed retirement paycheck and who find the concept of survivorship credits appealing. SWPs appeal to people who can tolerate market uncertainty and don’t need that guarantee — or who have so much money that they don’t ever have to worry about running low on it. For more on the creative use of annuities in retirement, see Chapter 17.


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»» Identifying candidates for annuities »» Knowing when to walk the other way »» Taking the suitability test



Deciding Whether an Annuity Is Right for You


oes anybody really need an annuity? Most people contribute to the­ Old-Age, Survivors, and Disability Insurance program — better known as Social Security — throughout their working lives. Many people tithe into tax-advantaged 401(k) or 403(b) plans at work or individual retirement accounts (IRAs) outside of work. Under what weird circumstances would you need another complicated way to plan for retirement? Why would you need another brace of financial suspenders, especially if you don’t fully understand the ones you have? These are the questions on the docket for this chapter. You can be a candidate for an annuity if you

»» Need or want more retirement income than Social Security will give you and have no pension, but you have enough personal savings with which to buy extra income

»» Have a lot more savings than you’re currently allowed to put into a 401(k)-type defined contribution plan at work or into either a traditional IRA or Roth IRA

»» Need a safe place to earn interest on your personal savings for a few years

but are not satisfied with the rate of return that your bank or credit union is offering on certificates of deposit

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I’ve come to believe that creating a portfolio of investments and annuities is the most efficient way to handle your finances in retirement. The right balance of probability and certainty, of wagers and safety, can make all the difference in an older person’s frame of mind. Before retirement, diversifying your investments is smart. In retirement, diversifying your sources of income can be smart.

Identifying Candidates for Annuities The question, “Should I buy an annuity?” is tough to answer briefly or succinctly. It shouldn’t be the first question you ask when you’re planning on how to meet your expenses during the last 20 or so years of your life. You may need to cross several other bridges before you can answer it. There are at least four ways to tell if you and annuities would be a good match:

»» Your personality or temperament: When you’re too risk-shy to put your money in stocks, bonds, or mutual funds, you can buy a fixed deferred annuity, which resembles a certificate of deposit (CD) from a bank.

»» Your demographics: Most annuity buyers are between 50 and 70 years old,

have about $100,000 to $200,000 in cash that needs a place to grow, and tend to be better educated than average.

»» Your life situation: When you start to plan for retirement, and you’re not in line for a pension, income-generating annuities should be on the table, at least for the sake of comparison with other income strategies.

You can’t necessarily rely on your adviser, broker, or agent to tell you whether an annuity, or which kind of annuity, would fit your needs. Some investment advisers never recommend annuities to any of their clients, and some insurance agents recommend only certain types of annuities. You may recognize yourself in one or more of the following hypothetical vignettes.

Boomer couples with 401(k) or 403(b) accounts Imagine a couple, John and Gerri Springer. He’s 56 years old; she’s 53. They both work full time, and so far, their two 401(k) plans are worth a combined $361,000. Neither John nor Gerri has a defined benefit pension, and they don’t currently own any annuities. They hope to retire when John turns 65 and their mortgage is paid off.


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Healthy and fit, the Springers would like to travel after they retire, and they’ve got pent-up desires to improve their home. But they’re not sure how much they can afford to spend in retirement. They’d also draw down their tax-deferred savings in a way that minimizes their annual income tax bill. Until they retire, the Springers should keep contributing as much as they can to their 401(k) accounts — at least enough to receive all their employers’ matching contributions. After they retire, they’ll have ample time to think about annuities. They’ll have several options. They can buy an immediate income annuity that, with Social Security, can cover their basic expenses for life. Or they can build a ladder of income annuities, like the ones described in Chapter 17. Another option would be to buy a deferred income annuity (DIA) or a qualified longevity annuity contract (QLAC), a DIA that’s compatible with required minimum distribution (RMD) rules. These income streams cost less than single premium immediate annuities (SPIAs) because they provide income for fewer years. It makes the most sense for DIA income to start around age 80. (For more on DIAs, see Chapter 11.) Any of these annuities could help the Springers spread out their tax liability. If they want guaranteed income plus complete access to all their assets, a deferred variable annuity with a guaranteed lifetime withdrawal benefit (GLWB) may fill the bill. Uncle Sam places a provision in tax-deferred retirement plans that nudges Americans to use them for retirement income. Starting at age 73 (as of 2023), owners of traditional IRAs and of defined contribution plan accounts — such as 401(k) and 403(b) plans  — must withdraw a certain minimum amount, known as RMDs, from those accounts each year. They don’t have to spend the money they withdraw. They just have to pay income taxes on it. Each required distribution (annual withdrawal) equals the value of the retirement account divided by the plan owner’s life expectancy in years. You can find an IRS Required Minimum Distribution Worksheet on the IRS website at

Women If you’re a married female baby boomer, you should do your homework on annuities. The law of averages says that you’ll outlive your husband. You may need an annuity more than he will. Rita Goldberg is a 94-year-old widow living in a south Florida retirement community. Lucky for her, she’s got a life annuity. In 2002, her late husband, Sam, put $200,000 in a joint-and-survivor life-contingent annuity with a 100 percent survivor benefit. It provides income for as long as either of the Goldbergs is alive.

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Every month, Rita still gets a check for $2,000 to supplement Social Security and other savings. (Payout rates from income annuities depend largely on corporate bond yields. You lock in the rate when you buy the contract.) Women, above all, should find out as much as they can about income annuities. On average, 65-year-old women live two or three years longer than 65-year-old men. After age 85 or so, women significantly outnumber men. Women are likelier to run out of money before they die (that’s called longevity risk) than men and, therefore, they’re more likely to benefit from either

»» A life-contingent income annuity: When you buy this type of annuity,

there’s a trade-off. You receive income for as long as you live, no matter how long you live, but you receive it in the form of monthly payments. Your ability to withdraw lump sums will be limited.

»» A GLWB rider: This rider, found mainly on deferred variable annuities and

deferred fixed indexed annuities, can be used to create an income that lasts as long as you live. Typically, it won’t pay out as much in income as a lifecontingent income annuity starting at the same age.

The middle class and the affluent John Knoll, a retired federal judge, has $1.6 million in savings; owns homes in Weston, Connecticut, and Martha’s Vineyard, Massachusetts; and dabbles in ­commercial real estate. He’ll also receive a government pension, so he doesn’t especially need an annuity. Neither does Knoll’s 61-year-old gardener, Bob Veldt, though for different ­reasons. Bob keeps all his modest savings of $71,000 in a money market fund, in case of emergencies. In retirement, he’ll supplement Social Security by working part time as a handyman. But Mike Sturges, who owns the car wash where Judge Knoll’s car is detailed, may gain a lot from annuities. Now in his 50s, he hopes to sell his business at age 65 and retire to rural North Carolina with about $600,000 in savings. At age 65, instead of putting 60 percent of his money ($360,000) in bonds and reaping at most about $18,000 a year in interest, Mike can put 40 percent of his money ($240,000) in an immediate income annuity and receive about the same amount of income while increasing his cash on hand by $120,000. Or he can take 10 percent of his $600,000 ($60,000) and buy a DIA to cover his expenses starting at age 80. He can add a “cash refund” feature to the DIA that would refund the value of the annuity to his beneficiaries if he dies before age 80.


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People like Mike — not rich but hardly poor — are prime candidates for annuities. Wealthier individuals, like John, can afford to self-insure. They’ll never run out of money. Less advantaged people, like Bob, don’t have enough surplus wealth for an annuity to make sense. But Mike has enough liquid assets to put some in income annuities (for peace of mind), put some in stocks (for growth), and still keep some in a money market (for splurges and emergencies). As a general rule, people who are still working and contributing to an IRA, 401(k) plan, or other tax-deductible defined contribution retirement savings plan don’t need to buy an investment-style annuity unless they’ve already contributed the maximum to their plan account. In 2023, $22,500 is the maximum contribution to a 401(k)-type plan and $6,000 ($7,000 for those over age 50) is the maximum contribution to an IRA. Here are some thoughts on wealth and annuities:

»» Under $250,000 in savings: Fidelity Investments has suggested that retirees

put no more than about 30 percent of their investable wealth (excluding home equity) in an income annuity; 30 percent of $250,000 ($75,000) would generate only about $500 a month in income at current rates. Others say that if someone needs an extra $1,000 a month in retirement just to cover expected basic expenses, then they may consider putting most of the $250,000 into an income annuity.

»» $250,000 to $1 million in savings: By putting half of their money in income annuities, for instance, people in this wealth range can give themselves the freedom to take bigger risks with the rest of their money, or spend without fear that they’ll end their days living on condensed soup and soda crackers.

»» Over $1 million in savings: People with significant assets face little risk of

running out of money, so they aren’t classic candidates for income annuities. If they expect to be in a high tax bracket in retirement, they’re better off investing in taxable accounts than in tax-deferred annuities, because their gains will be taxed at the long-term capital gains tax rate instead of their income tax rate. But wealthy people shouldn’t rule out annuities. Like all of us, they’re vulnerable to health risk. Extended illness and extraordinary nursing-home expenses could consume the money that they had planned to leave to their children or to charity. The nursing-home riders on some annuities can ease that concern. One financial adviser I know, Curtis Cloke of Burlington, Iowa, has had clients with $10 million or more who bought million-dollar income annuities. The annuity income gave them confidence to take more risk with the rest of their money.

CHAPTER 5 Deciding Whether an Annuity Is Right for You


HOW THE EXPERTS DETERMINE WHO NEEDS AN ANNUITY Several retirement researchers have tried to formalize the process of deciding who is and isn’t a good candidate for an income-generating annuity. The determining factors include your level of savings, your capacity for risk, and your temperament. In his 2008 book, Are You a Stock or a Bond?, York University (Toronto) finance professor Moshe A. Milevsky distinguished between people who have stable careers and people whose income is unpredictable. Members of the “stable” group are “bonds,” he wrote. Members of the unpredictable group are “stocks.” By definition, people who are “bonds” hold secure jobs and expect guaranteed pensions in retirement. Teachers and firefighters belong to this group. They don’t need to buy bonds or annuities. They can afford to invest most or even all of their personal savings in assets whose prices bob up and down, like stocks. Conversely, people whose earnings come in bunches and who don’t expect a pension other than Social Security are “stocks.” Real estate brokers and contract workers belong to this group. As a counterweight to their catch-as-catch-can incomes, they should consider investing most of their savings in predictable assets, like bonds or annuities. Another Canadian retirement researcher and author, Jim Otar, has created a three-part, color-coded model for categorizing pre-retirees and identifying their optimal investment strategies. In an article entitled, “Lifelong Retirement Income: The Zone Strategy,” he says most people are in one of the following zones:

• Green Zone: People in the Green Zone can fund an indefinitely long retirement

with their own investments. Annuities may add to their peace of mind, but they don’t need them. You’re in the Green Zone if you’re retiring at age 65 with about 25 times as much savings as you’ll need per year in retirement. If you retire at age 55, you’ll need a multiple of about 30 times savings. If you retire at age 75, you’ll need less than 20 times savings, according to Otar.

• Red Zone: Those in the Red Zone are in trouble. They don’t have enough personal

savings to cover their anticipated expenses in retirement. To avoid running short of money in their late 80s or 90s, they should put as much of their savings into lifecontingent income annuities (with payments lasting as long as they’re alive) as possible, while still holding back enough cash for emergencies. The “survivorship credits” of annuities (described in Chapters 1 and 7) can protect them from poverty in extreme old age.

• Gray Zone: The Gray Zone, as the name suggests, belongs to those in the foggy

middle. As long as future circumstances (financial markets, their health status) are


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favorable, they’ll likely have enough savings. If they’re unlucky (for example, the market crashes or they face a serious illness), however, they may run short of cash before they die. Members of this group can benefit from owning income annuities, but their need is not as dire as those in the Red Zone. Wait, there’s more. Wade Pfau, a researcher, teacher, and author with a strong following among financial advisers, has developed a four-part model for matching people with their optimal retirement plans, with or without annuities. He calls it the Retirement Income Style Awareness Profile (RISA). Pfau’s research showed that there are four personal orientations toward finance:

• Safety-first: People who shun risk • Optionality: People who like to keep all their options open • Probability-based: People who are comfortable with uncertainty • Commitment: People who are willing to make a plan and stick to it Pfau then created a four-square-style box of blended personalities:

• Safety-first/Optionality • Probability-based/Optionality • Safety-first/Commitment • Probability-based/Commitment Onto the four styles, he mapped four retirement income strategies. He recommended “partial annuitization” for only one of the groups: the Safety-first/Commitment folks. This personality-type regards annuities as a source of financial comfort rather than of financial claustrophobia.

Retirees who don’t have a defined benefit pension plan This probably means you! Between 1995 and 2005, the number of corporatedefined benefit plans fell by half. In the future, even more companies are expected to convert their pensions to defined contribution plans such as 401(k) plans. The disappearance of such plans is expected to drive the demand for income annuities over the next two decades. Bottom line? If you’re not covered by a traditional pension plan at work, you can use an income annuity to create a do-it-yourself pension.

CHAPTER 5 Deciding Whether an Annuity Is Right for You


People with rugged genes Many years ago, while exploring the wilderness near Ouray, Colorado, my wife and I met a snowy-haired couple with hiking poles in their fists, knapsacks on their backs, and grins on their faces. They were retired university professors, in their mid-80s, still flush with health. They were poster children for life annuities. Obviously, the longer you live, the more you need lifelong income and the more you get out of buying an annuity. Statistically, some segments of the population tend to live longer lives. These happen to be the same 20 percent to 30 percent of the U.S. population who receive life’s related blessings: affluence, good health care, a college education, and a supportive family. Of course, no one knows how long they’ll live, but that’s where annuities come in — to insure you against that uncertainty. People who buy life income annuities voluntarily tend to live about 10 percent longer than people who don’t buy annuities. That’s because people with average or below-average health avoid annuities entirely. This phenomenon is called adverse selection. (Do annuity owners tend to live longer than other people? The incentive is there.) People in poor health shouldn’t rule out annuities, however. One life insurer, Mutual of Omaha, offers “impaired risk” or “underwritten” annuities, which offer higher payouts to people with heart disease, diabetes, or other serious illnesses. If Mutual of Omaha decides that a 68-year-old man has the body and life expectancy of a 76-year-old, for instance, they’ll sell him an income annuity at the lower price (or higher payout rate) appropriate for a 76-year-old man. Note: Social Security is less affected by adverse selection because it’s not voluntary. Everyone, sick and healthy, is in the pool.

WHY EVEN THE WEALTHY MAY BENEFIT FROM INCOME ANNUITIES For more than a decade, University of Georgia economist Svetlana Pashchenko has been studying annuity-buying behavior. She believes she knows why most older Americans ignore annuities. “The most quantitatively important impediments to annuitization are preannuitized wealth, illiquid housing, minimum purchase requirement, and bequest motives,” she wrote in a 2012 article in the Journal of Public Economics. In other words, the demand for immediate income annuities would be much larger, her analyses show, if Americans didn’t have a substantial percentage of their retirement


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income already coming from Social Security, if the purchase price of an income annuity weren’t so large, if a large fraction of the average household’s wealth weren’t tied up in their homes, and if they didn’t care about leaving money to their children or charity. (Note: Pashchenko writes about SPIAs, not investment-style deferred annuities. SPIAs are priced according to life expectancies, while life expectancies are irrelevant to deferred annuity pricing.) Pashchenko found, in addition, that retirees who have high incomes and are in good health should find SPIAs to be financially attractive. First, people are most likely to experience high-cost medical care toward the end of their lives, simply because they’re likely to live a long time. “Insurance against longevity risk and insurance against medical costs uncertainty complement each other,” Pashchenko wrote. Second, annuity contracts tend to be underpriced for the same high-income, good-health retirees. Healthy retirees in the top quintile (above the 80th percentile) of the income scale pay 11.7 percent less for their annuities than they would pay if life insurance companies took their actual life expectancies into account. Healthy retirees in the second quintile (between the 60th and 80th percentiles) pay 5.1 percent less, according to her study. On average, “income annuities can increase the consumption levels of those wealthier owners by almost 9 percent,” she calculated. The opposite side of the coin: Lower income Americans in poor health tend to pay substantially more (in retrospect) for their annuities than they would if life insurers knew their actual life expectancies in advance. But life insurers don’t conduct medical exams when selling annuities as they do when selling life insurance.

Market bears and other pessimists Bill Nielsen and Mark Zeffrey are next-door neighbors. They both live in fourbedroom Colonials. They both drive Toyota Camrys. And at age 59, they both have about $400,000  in savings and neither has a pension. But they differ in one respect: Bill predicts a rosy economy ahead, and Mark thinks our financial system is on the brink of collapse. Two emotions are said to govern a person’s attitude toward money and drive the financial markets: fear and greed. If, like Mark, you’re more fear-driven than greed-driven, you may be a candidate for an annuity. You don’t have to be paranoid to have this fear. The fact is, everyone eventually faces sequence-of-returns risk — the chance that an ugly 2008-like recession will occur shortly before or after you retire. A market crash could persuade you to delay your retirement until markets recover. Or, if you retire, you may need to sell assets at unfavorable prices.

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A deferred variable annuity with a GLWB rider can protect you from sequenceof-returns risk. Some contracts may let you pay for the rider only during the five years before and after your retirement. If the market crashes during that period, you can activate the rider and, with certain exceptions, begin collecting an income based on your account balance before the crash. If the market doesn’t crash during those ten years, you can let the rider lapse. Some contracts may require you to drop the whole contract if you drop the rider. So, read the fine print. (For details, see Chapter 10.) Are deferred fixed annuities a smart alternative to a bond fund? Shares in a bond mutual fund can lose market value, at least temporarily, if the Federal Reserve raises the cost of borrowing. That’s called interest-rate risk. A multiyear guaranteed annuity (MYGA) offers a fixed yield for a specific number of years, with no interest rate risk. A fixed-rate deferred annuity is similar, but the life insurer reserves the right to change yields from one year to the next.

Neither the very young nor the extremely old Your age has a big impact on which annuity to consider and whether to consider one at all. At any age, however, your choice is complicated by trade-offs. For instance, buying a deferred variable annuity in your 20s or 30s to save for ­retirement gives you the benefit of three or four decades of tax-deferred, ­compounded growth. But the 10-percent federal penalty for withdrawals from a deferred annuity before age 59½ puts a stiff barrier between you and your money. In addition, you may have to pay certain rider fees — such as death benefit riders or guaranteed withdrawal benefit riders  — for many years before you use the option, if you use it at all.

COMMON “SUITABILITY” QUESTIONS The application form that you must fill out when buying an annuity is likely to include a lot of nosy questions about your personal finances. If your answers reveal that an annuity is not “suitable” for you or not “in your interest,” your agent or adviser may not submit the application to the life insurer or the insurer may reject it. For instance, if your age makes a fixed indexed annuity contract with a ten-year term unsuitable for you, or if you’re putting more than half of your available savings into an annuity, or if you already own a reverse mortgage, the agent may question the sale. Agents and life insurers have been sued for selling unsuitable contracts, especially when selling to retirees without much financial experience.


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Here are some of the questions you may see on a typical fixed indexed annuity application:

• What is your age? • What is your household income? • What is your total net worth? • What is your liquid net worth? • What are your debts and other liabilities? • Do you have sufficient cash or other liquid assets for living expenses and unexpected emergencies?

• How many years’ experience do you have with annuities? With life insurance?

Stocks? Bonds? Mutual funds? Checking/savings accounts? Employer-sponsored savings plans?

• What financial goals will the annuity help you achieve? Tax deferral? Protection of principal? Asset accumulation? Growth? Guaranteed retirement income? Preservation of wealth for the next generation?

• Do you intend to withdraw more than 10 percent of the contract value during the surrender period?

• How would you estimate your risk tolerance? Are you a conservative investor? Moderate? Aggressive?

• How will you pay for this annuity? With a transfer from another annuity? With money from a 401(k) plan or an IRA?

• How do you expect to take distributions (withdrawals) from this annuity?

It generally pays to postpone purchasing an immediate life annuity, or beginning payments, until you need the income. With each passing year, the survivorship credits (also called mortality credits) become larger. That’s the alpha of annuities, so to speak. Survivorship credits, as I explain in Chapters  1 and  7, are the bonus you get by outliving your fellow annuity owners and, conversely, by agreeing to sacrifice the unpaid balance of your money to them if you die before they do. When you suspect that your savings may not yield enough interest, dividends, and capital gains for you to live on, survivorship credits can help make up the difference. How much do survivorship credits beef up your savings? Raimond Maurer and others at Goethe University in Frankfurt, Germany, have suggested that at about

CHAPTER 5 Deciding Whether an Annuity Is Right for You


age 60, the survivorship credit is large enough to justify replacing bond investments with an income annuity. Starting at about age 75, they said, the survivorship credit is large enough to justify replacing stocks with an income annuity. It’s the benefit that comes from pooling your longevity risk with other income annuity owners of roughly the same age.

People who want to turn a tax bite into bite-size pieces If you’ve inherited the money in a tax-deferred retirement account or you have money in a deferred variable annuity, you’ll owe income tax on either all or part of the money. But you can avoid paying the tax all at once by converting the money to an income stream and spreading your tax burden over several years or over the rest of your life.

Those seeking less-expensive long-term-care insurance Many people worry about living so long that all their savings (and their children’s inheritance) will be swallowed up by nursing-home expenses. Today, full-time care can easily cost $6,000 a month or more. Long-term-care insurance can help, but it’s expensive. In Chapter 6, I briefly discuss hybrid fixed annuities, which allow you to put aside money for long-term care, instead of paying premiums for long-term-care insurance that you may never use. If you end up not needing long-term care, you keep your savings. There’s no free lunch, however. All else being equal, the yield on your hybrid fixed-rate annuity will be lower than on a conventional fixed-rate annuity.

People without beneficiaries If you have no heirs, or you’re not trying to preserve wealth for children or charities, there’s little to dissuade you from putting part of your money — enough to make you feel more secure — into an income annuity, thereby reducing your risk of running out of money. But even people with children can benefit from life annuities. If your annuity assures you an adequate income for as long as you live, there’s less chance that you’ll ever have to choose between paying your utility bills and leaving money to your kids. The annuity will pay the bills.


PART 1 Making Sense of Annuities

WHO OWNS ANNUITIES? Are you the annuity type? According to the Morning Consult Tracking Poll of 2,200 U.S. adults for Longevity Project in 2019, the people most likely to tell pollsters that they own an annuity were over age 65, white, active voters, Republicans, highly educated, and living in the suburbs with annual incomes of more than $50,000. Only 12 percent of American adults reported owning an annuity, but 25 percent of those age 65 and older and 17 percent of baby boomers (born from 1946 to 1964) said they did. Male annuity owners were twice as likely to identify as Republicans than as Democrats (20 percent versus 10 percent). Those with bachelor’s degrees or graduate school experience (19 percent and 15 percent, respectively) were more than twice as likely as those with less than a college degree (8 percent) to say they own annuities. But statistics vary. Morning Consult also found that annuities were the least common source of retirement income anticipated by Americans. Only 7 percent of those surveyed said they were “counting on” annuities if or when they retire. By contrast, 64 percent were counting on Social Security benefits, 38 percent on personal savings and investments, 35 percent on savings in a 401(k) or 403(b) plan, 20 percent on a pension, 20 percent on a traditional IRA, 14 percent on a Roth IRA, 11 percent on a family trust or inheritance, and 8 percent on financial support from family. Among Americans ages 40 and older with $100,000 or more in investments, about three in ten of the retirees (29 percent) and about one in six of the nonretired workers (16 percent) said they own one or more deferred and/or immediate annuities, according to the 2022 Retirement Investors Survey by LIMRA, a life insurance industry research organization. A 2021 LIMRA study that included Americans ages 20 to 39 and those with less than $100,000 in investments showed that about one in five retirees (22 percent) and 10 percent of nonretired workers owned one or more annuities. In 2020, a survey showed that 19 percent of retirees owned deferred (investment-style) annuities. Annuity owners have been shown to be a bit more confident in retirement than people who don’t own annuities. Asked if they “strongly agreed” with the statement, “I am confident that I will be able to live the retirement lifestyle I want,” almost three out of ten annuity owners (28 percent) said they did. Fewer than two out of ten nonowners (19 percent) strongly agreed with that statement. Those results came from a 2022 LIMRA survey of 4,008 retirees and nonretired workers ages 40 to 85 with $100,000 or more in investable assets.

CHAPTER 5 Deciding Whether an Annuity Is Right for You



Identifying the Major Annuities


Meet the family of fixed deferred annuities: fixed-rate, multiyear guaranteed, and fixed indexed annuities. Learn the difference between traditional variable annuities and structured variable annuities. Appreciate the appeal of the most underestimated annuity: the immediate income annuity. Take longevity risk off the table with a deferred income annuity or qualified longevity annuity contract. Find out how a reverse mortgage can help you age in place with either a line of credit or an income stream.


»» Seeing how fixed deferred annuities work »» Looking at the main types of fixed annuities »» Assessing the pros and cons of fixed annuities »» Buying a fixed annuity »» Maintaining your fixed annuity



Earning Interest with Fixed Annuities


ou may be familiar with certificates of deposit (CDs) issued by banks. They typically offer guaranteed rates of return over a term ranging from three months to five years. The safety of CDs is guaranteed by the U.S. Treasury. When the term ends, you withdraw your money or roll it into a new CD. Fixed-rate deferred annuities, or simply fixed annuities, serve a similar purpose in a different way: They’re issued and guaranteed by life/annuity companies. They tend to offer higher interest rates over longer terms than CDs. You can defer taxes on your gains. And you often can take partial withdrawals during the term. Both CDs and fixed annuities became a lot more attractive in 2022 when the Federal Reserve raised the borrowing rate for banks, which raised the yields on all new fixed-income investments. Like college kids bursting into their quads on the first Frisbee-friendly day of spring, savers rushed to buy them. The 14-year winter of low interest rates was over. During 2022, Americans put $112.1 billion into fixed annuities. These simple annuities outsold all other types of annuities and beat their own previous

CHAPTER 6 Earning Interest with Fixed Annuities


one-year sales record by 38 percent. Rising rates hurt prices of stocks and existing bonds but helped new bonds, CDs, and fixed annuities. No one knows the future path of interest rates — that’s up to the Fed. But if you’re a risk-wary saver approaching retirement, consider fixed annuities before you buy a CD or a fixed indexed annuity. In this chapter, I also explore the relatively new long-term care fixed annuity. It’s a potential alternative to long-term-care insurance. Don’t confuse these fixed-rate deferred annuities with fixed immediate annuities, which provide income streams in retirement (Chapter 7) or fixed indexed annuities (Chapter 8), whose returns are linked to fluctuations in market indexes.

Understanding How Fixed Annuities Work When you buy a fixed deferred annuity, you’re indirectly lending money  — ­without taking the risk that the borrower won’t pay you back. The process is fairly simple. In most cases, you hand a check to an agent, who sends it on to an insurance company. The insurer promises that your money will earn a certain rate of interest for at least the first year. When it receives your money, the insurance company adds it to its general account (where it pools most of its incoming premiums). It invests that money as it sees fit — usually in safe government securities or high-quality corporate bonds that pay a slightly higher rate of interest than the insurance company pays you. The difference between the rate the carrier earns and what it pays you is known as the spread. The wider the spread, the more money the carrier makes. If one of the carrier’s creditors defaults on its bonds, that’s the carrier’s problem, not yours. The carrier has to pay you back — it gave you a guarantee. The carrier pays you compound interest on your premium, which means that

»» In the first year, you earn interest on your investment. »» In the second year, you earn interest on your investment plus your first year’s interest.

»» In the third year, you earn interest on your investment plus your first year’s interest and your second year’s interest, and so on.


PART 2 Identifying the Major Annuities

It’s a snowball effect that’s often described as the “magic” of compound interest. At the end of the term (for example, one, three, five, seven, or ten years), you take your money out. At the end of the term, you have 30 days to decide whether to renew your annuity at your life/annuity company’s latest rate, transfer your money to another annuity, or withdraw your money and pay any taxes due.

What’s fixed about a fixed annuity? Fixed annuities generally offer higher interest rates than CDs or short-term bond mutual funds because the insurance carrier puts your money in longer-term bonds, which typically offer a better return than short-term bonds. Whenever fixed annuities pay higher rates than other safe investments, they’re worth considering. Characteristics of fixed annuities include the following:

»» Guaranteed principal: You can’t lose your money unless the insurance company fails, which is unlikely if it has a strong financial rating.

»» Guaranteed minimum interest rate: Your money never earns less than this rate, even if the insurance company reserves the right to reduce the rate it gave you in the first year.

»» Annual withdrawals: The top-selling contracts let you withdraw up to

10 percent of the value of the annuity (your original investment plus interest) every year with no penalty. If you’re younger than 59½, however, you may owe an Internal Revenue Service (IRS) penalty.

»» Surrender period and surrender charges: This is the waiting period (one to ten years in most cases) during which you can’t withdraw more than 10 percent of your money per year without a penalty or adjustment.

Surrender charges are also called contingent deferred sales charges. The first-year charge often equals the number of years in the surrender period; then the charge declines by 1 percent per year. For instance, a seven-year annuity may have a first-year charge of 7 percent, a second-year charge of 6 percent, a third-year charge of 5 percent, and so on.

»» Death benefits: If you die while owning the annuity, your money (including

the interest you’ve earned up to your death) goes to the beneficiaries identified in your contract. If you want, you can change the beneficiary after you buy the contract.

»» Income option: You can convert the value of the fixed annuity to a guaran-

teed income stream (regular payments to you) for a specific number of years or for as long as you (or you and your spouse) are living. Note: The deferred in

CHAPTER 6 Earning Interest with Fixed Annuities


deferred annuity indicates that the owner is postponing the decision to convert the annuity’s value to income. It isn’t a reference to tax deferral.

»» Premium requirements: The minimum initial investment for a fixed annuity ranges from $2,000 to $100,000. You can purchase a single-premium contract with one payment or a flexible-premium contract with ongoing payments. If you send in more than one premium, each premium may require the purchase of a separate contract.

Protection from two kinds of risks Why not just buy bonds on your own instead of buying an annuity that draws its yield from purchases of bonds? Because bonds entail two risks:

»» Default risk: The chance that the loan you made (by buying bonds) won’t be paid back.

»» Interest rate risk. The chance that interest rates will go up after you buy your bond. In this case, your bonds (which pay the old rate) will be worth less than new bonds (which pay the higher rate).

In contrast, when you buy a fixed annuity and follow all the rules of the contract, the insurance company assumes one or both of these risks for you.

THE TRADE-OFF BETWEEN YIELD AND RATINGS If you start browsing the internet for fixed annuity quotes, you’ll notice right away that the life/annuity companies with strength ratings in the B++ range offer relatively higher yields than the companies with strength ratings in the Magna Cum Laude range of A– or the Phi Beta Kappa range of A+ or A++. If safety is your top concern, you can shop among the companies with the highest ratings from AM Best or the highest Comdex score (an index that aggregates four rating agencies’ strength ratings in a 0 to 100 score). New York Life, MassMutual, Northwestern Mutual, Thrivent, USAA, and Guardian all have Comdex scores of 100 or 99. If yield is your top concern in a fixed annuity, you might shop among companies with B++ ratings from AM Best. These would include, for example, Atlantic Coast Life, Sentinel Security Life, EquiTrust Life, Nassau, or Investors Heritage. In 2023, they had


PART 2 Identifying the Major Annuities

Comdex scores as low as 39, but their B++ ratings mean they have “very good” balance sheets with “good ability to meet their obligations.” They may choose to accept lower financial strength in favor of taking more investment risk so they can offer higher yields for their policyholders. Financial strength isn’t the only factor that determines a fixed annuity’s yield. Longerterm contracts (ten years) and higher minimum contributions tend to offer higher yields than shorter-term contracts (three to five years) and lower minimum premiums. As noted in this chapter, contracts with market value adjustments pay more than book value contracts (see the later sidebar, “Market value adjusted versus book value fixed annuities”). Bonus annuities have one-year teaser rates. Companies may eliminate all or part of the annual 10 percent free withdrawal privilege in order to quote higher yields. All of these options can overwhelm your ability to make a choice. You’ll probably rely on your agent to help you with that. Yield should not be your only or even your first consideration. First, you’ll need to identify how much money you should put aside and when you’ll need it back. Those decisions will lead you to the appropriate premium amount and the term length. Then you can compare companies, contract features, and yield. On a $100,000 premium, a quarter of a percentage point difference in yield makes about a $4,000 difference in return after ten years.

Examining the Main Types of Fixed Annuities The two most common types of fixed deferred annuities are single-year guarantee fixed annuities and multiyear guaranteed annuities (MYGAs). Table 6-1 compares the two, and the following sections go into more details on both. I recommend the multiyear contracts because your rate can’t go down during the term of the contract.


Comparing the Two Main Types of Fixed Annuities Surrender Period

First-Year Bonus

Renewal Rates

Market Value Adjustment

Single-year guarantee fixed annuity


In most cases; as high as 10 percent



Varies by state

Multiyear guaranteed annuity





Varies by state


CHAPTER 6 Earning Interest with Fixed Annuities


MARKET VALUE ADJUSTED VERSUS BOOK VALUE FIXED ANNUITIES If a fixed annuity has an MVA, you’ll suffer a penalty (a negative “adjustment”) if you take withdrawals (in excess of the penalty-free withdrawal, if any) from your account value at a time when interest rates have gone up and newer products offer higher yields. This penalty is intended to discourage you from abandoning your contract in search of a better deal elsewhere. Any fixed annuity contract that has no MVA is a book value contract. All else being equal, MVAs tend to offer higher interest rates than book value contracts. An MVA triggers two penalties when you withdraw over 10 percent during the surrender period. Typically

• You have to pay a surrender charge (for example, equal to the number of years left in the surrender period).

• Your account value is adjusted — downward if interest rates have risen since you bought your annuity or upward if rates have declined.

When you buy a fixed annuity, the insurance company buys bonds with your money, seeking to earn a higher rate than it promised to pay you. If interest rates rise, the market price of the carrier’s bonds will drop. If you choose that moment to withdraw some or all of your money, the insurance company will have to sell some of those depressed bonds — at a loss — in order to pay you. The insurer will try to recover that loss from you. If you own a non-MVA annuity, the insurer will charge a surrender fee. If you own an MVA annuity, the insurer will charge a surrender fee and deduct its loss from the value of your contract. Here’s an example: Suppose you bought a $10,000 MVA fixed annuity, and the insurance carrier took the money and bought a bond paying 5 percent. Then rates immediately went up to 6 percent, and the value of the carrier’s bond dropped to $9,260. (See the earlier discussion of bond prices.) If you decide to withdraw all your money, the carrier will reduce (adjust) the value of your contract to its new market value ($9,260), and charge you, say, a $300 surrender fee. You’d get a check for only $8,960. Don’t be unduly distracted by surrender charges or MVAs. As long as you don’t try to withdraw more than 10 percent of your money per year during the surrender period, the charges and adjustments don’t matter much. If you think you may need your money before the end of the surrender period, don’t buy a fixed annuity in the first place! For more about bonds, see Bond Investing For Dummies, 3rd Edition, by Russell Wild (Wiley).


PART 2 Identifying the Major Annuities

Single-year guarantee fixed annuities The single-year guarantee fixed annuity is like an adjustable-rate mortgage, except that you’re the lender, and the borrower (the insurer) gets to adjust the rate of interest after the first year. Every year until the contract expires, the insurance company can raise or (more commonly) reduce that interest rate. The new rates are called renewal rates. At the end of the surrender period, the contract expires. You have to buy a new contract or roll over to it. Be sure you understand your actual rate; an agent or broker may throw several words at you, including all or most of the following:

»» Base rate: The interest rate the company pays you the first year. »» Bonus rate: The bonus the company adds to the interest rate in the first year. »» Current rate: The base rate plus the bonus rate. »» Current yield: The interest rate your money will earn over the entire term of the contract if the company doesn’t change its base rate.

»» Guaranteed yield: The lowest possible interest rate you can earn. »» Renewal rate: The rate after the first year. »» Banded rates: Different rates for different sizes of purchase premium. For

instance, you may receive 4.5 percent per year if you put at least $100,000 in your annuity, or only 3.9 percent per year if you put in less than $100,000.

Generally, the interest rate paid on a non-MYGA fixed annuity is fixed only for the first year. A table of renewal rates can tell you whether the company has a history of raising, lowering, or maintaining the base interest rates of its single-year guarantee contracts after the first year. Life/annuity companies don’t ordinarily disclose that information, but your agent may be able to obtain it.

BONUS ANNUITIES As a marketing feature, some fixed annuities offer a first-year teaser rate that’s higher than the interest rate paid in the remaining years of the contract. In the second and subsequent years, the interest crediting rate is reduced to the normal non-bonus base rate. That rate can go up or down, at the life/annuity company’s discretion. So, you probably won’t benefit from a bonus in the long run. MYGAs don’t include bonuses; they have a fixed interest rate for the entire term. (continued)

CHAPTER 6 Earning Interest with Fixed Annuities



At least one fixed annuity contract, New York Life Clear Income, features a guaranteed lifetime withdrawal benefit (GLWB) rider that offers an income for life without limiting your access to the cash value of your contract. Such riders are more common on traditional variable annuities and fixed indexed annuities. (See Chapter 10 for more on GLWB riders.) A couple can put $250,000 into this contract at age 57, rely on the GLWB benefit base to grow by a promised 5 percent per year, and then receive about $24,000 a year for as long as either one lives, according to illustrations on Fidelity’s website ( com). There’s a $50,000 minimum contribution and a 0.75 percent annual rider fee.

Multiyear guaranteed annuities A MYGA is a fixed annuity that will earn a guaranteed rate of compounding interest for a specific number of years. MYGAs are often called CD-type annuities or tax-deferred CDs because they serve the same purpose as CDs but typically offer higher yields. Aside from simplicity and transparency, MYGAs are important for their ability to help you plan for the future. What you see is what you get. You know the rate of interest your money will earn. Helping you plan out your retirement with certainty is one of the most important benefits that annuities offer. Investment advisers often recommend MYGAs over single-year guarantee contracts because MYGAs are more predictable. There’s no risk to you that the insurance company will reduce the interest rate after the first year. Variable annuities and index-linked annuities don’t offer that degree of certainty. When shopping for a safe place to earn interest on spare cash, compare the rates on MYGAs to the current rates for CDs. Depending on market conditions, one may pay a significantly higher interest rate than the other. Table 6-2 shows how these two types of low-risk investments differ. When assessing these products, pay close attention to the fine print. In at least some cases, you must

»» Wait out an elimination period before any health-care benefits will be paid. »» Pay out of pocket for care and wait for reimbursement. »» Exhaust your own money before the life/annuity company begins paying. »» Meet a health requirement before you can be approved for the 300 percent of premium coverage.


PART 2 Identifying the Major Annuities


A Comparison of Multiyear Guaranteed Annuities and Certificates of Deposit



Issued by an insurance company and sold by an insurance agent, broker, banker, or financial adviser.

Issued by and sold at a bank.

Assets are guaranteed by the strength of the insurance company.

Up to $100,000 per depositor is insured by the Federal Deposit Insurance Corporation (FDIC).

Grow tax-deferred; you pay no income tax on earnings until their withdrawal.

Interest is taxed as ordinary income for the year it’s earned.

Initial deposits range from $1,500 to $100,000.

Minimum investments start as low as $500.

When owners die, assets go to their beneficiaries without passing through probate court.

When owners die, assets become part of their estates and pass through probate court.

Withdrawals up to 10 percent each year usually have no surrender charge; withdrawals before age 59½ may be subject to a 10 percent federal penalty.

Withdrawals are penalized.

Option to annuitize assets (convert money to a guaranteed lifetime income).

No annuitization option.

Offer higher rates than CDs when long-term interest rates are higher than short-term interest rates.

Often offer higher rates than MYGAs when longterm interest rates are close to or lower than short-term interest rates.

FLOATING-RATE AND PASS-THROUGH RATE CONTRACTS Unlike any of the other fixed annuity contracts described so far, a few fixed annuity contracts offer interest rates that float from month to month. In other words, if interest rates go up a bit, you earn a little more that month. If interest rates go down, you earn less. Certain floating-rate fixed annuities give you a 30-day window once a year to take withdrawals without a penalty or a market value adjustment. You may also find annuities that offer pass-through rates of interest. Instead of paying you a fixed rate and keeping whatever interest it can earn on your money, the insurance company pays itself a fixed margin — perhaps 2 percent — and gives you the rest of the interest it can earn by investing your money. These annuities can be attractive because there’s no upper limit on the amount of interest you can earn.

CHAPTER 6 Earning Interest with Fixed Annuities


LONG-TERM CARE ANNUITIES No one wants to think about the cost of long-term care services. Ironically, the healthier you are, the more likely you are to live to an age at which you can’t take care of yourself. And there’s a limit to what spouses and children can provide. In part because health-care costs rise so quickly, insurance companies have had difficulty bringing affordable long-term-care insurance to market. After the Pension Protection Act of 2006 made withdrawals from annuities tax-free if they were spent on one of several categories of care in old age, fixed annuity providers have tried to create a product that fits the public’s need. Several products on the market — from Security Benefit Life, OneAmerica, and Global Atlantic, for instance — try to fill the bill. Global Atlantic’s ForeCare fixed annuity with long-term care benefits promises to pay out as much as double or triple the account value of the annuity for a variety of health-care services in old age. (Go to www. forecare to learn more.) If the need for assisted living, home health care, or nursing-home care never arises, your money stays in the annuity and your beneficiaries inherit it. Unlike long-term-care insurance premiums, your money isn’t necessarily lost. You do have to pay an annual rider fee, however. If you make withdrawals from the contract for reasons other than long-term care, you’ll owe taxes on it.

Without knowing more about the annual fee for the long-term care coverage of the rider, it’s difficult to evaluate these products. In the pre-2008 versions of long-term-care fixed annuities, the yield on the annuity paid for long-term-care insurance with a large deductible. That is, you had to spend your own annuity assets on long-term care before the insurance coverage would kick in.

Weighing the Pros and Cons of Fixed Annuities Fixed deferred annuities offer safe, moderate returns that are based on the current returns of the highly rated corporate bonds that life/annuity companies invest in. They also offer tax-deferred growth.


PART 2 Identifying the Major Annuities

Investors buy them when they offer higher interest rates than CDs, when the stock market is declining or appears headed for a fall, when they’re saving for a specific goal, and when they’ve already parked as much money as possible into other savings vehicles, like employer-sponsored retirement plans. The pros include

»» Safety: Buying a MYGA and holding it for the entire term is a safe, conserva-

tive way to grow your money. It’s even safer than a bond or shares in a bond fund because a bond’s price or the share prices of a bond fund can fall in response to rising interest rates.

»» Tax deferral: Annuities, like individual retirement accounts (IRAs) and 401(k)

plans, grow tax-deferred. You earn interest each year, but you don’t pay taxes on it until you withdraw it. The advantage? Your savings grow faster than they would if your gains were taxed every year.

»» Stable rates: When you buy a MYGA, you know its annual interest rate and the exact worth of your investment at the end of the term. As long as you don’t make withdrawals, the result is entirely predictable.

»» Higher returns when bond-yield curve is steep: A steep bond-yield curve

occurs when bonds of longer maturities (like a ten-year Treasury bond) pay higher rates of interest than bonds of shorter maturities (like a three-month Treasury bill). At such times, fixed annuities often pay higher interest rates than CDs.

»» Avoiding probate: It’s hard to get excited about a benefit triggered by your

own demise, but annuities are famous for them. If you die while owning a fixed annuity, your money goes straight to the beneficiaries on your contract.

»» The option to annuitize: Like all annuity contracts, a fixed annuity can be

converted to a retirement income stream. Although this option is the defining feature of annuities, few people know about it or care about it and even fewer use it.

The cons include

»» Low liquidity: Generally, if you take more than 10 percent of your money out

of your fixed annuity during any single year of the surrender period, you pay a charge. You can avoid charges by buying a fixed annuity with a short surrender period or by using other sources of cash for emergencies.

»» Uncertain returns: With single-year guarantee fixed annuities, you don’t know the exact interest rate after the first year.

CHAPTER 6 Earning Interest with Fixed Annuities


»» Lower returns when the bond-yield curve is flat: When the yield curve is

flat — that is, when long-term interest rates are the same as or lower than short-term rates (as they were during the mid-2000s) — you may get a better rate from a CD. (You can find an illustration of the yield curve in the business section of the Sunday New York Times.)

»» Federal penalty for early withdrawal: If you withdraw money from a fixed

annuity before age 59½, you may have to pay a tax penalty (10 percent of the amount withdrawn) to the IRS. Note: Regarding the last bullet in this list, under certain circumstances such as illness, you can withdraw money from an annuity before this age without that penalty. You may also be able to withdraw the money penalty free by taking substantially equal period payments (SEPPs) over a minimum of five years. The penalty is Uncle Sam’s way of discouraging Americans from using annuities and other tax-deferred investments for anything but saving for retirement.

A WORD ABOUT FEES Fixed annuities do charge fees, but you don’t pay them directly. Instead, the company deducts its own profits and expenses from what it earns by investing your money in bonds and other securities. You get the rest. A company with lower fees can, in theory, afford to offer a higher rate. What about commissions? Think of the insurance company as the manufacturer of the annuity and the brokerage as the distributor. A broker who sells you a $100,000 fixed annuity issued by an insurance company may earn

• A 2 percent commission ($2,000) • Another 0.8 percent ($800) for incidental costs • A trailing fee equal to 0.1 percent (starting at $100) every year you own the contract The insurance company pays these fees and commissions out of the spread (the difference between what it earns by investing your money and what it pays you). You don’t see the fees, and they shouldn’t necessarily matter much to you. The important number is the interest rate that the insurance company promises to pay you.


PART 2 Identifying the Major Annuities

Buying a Fixed Annuity You can purchase fixed annuities from captive agents (full-time employees of an insurance carrier) or from independent insurance agents. Because fixed annuities are insurance products and not securities (such as stocks, bonds, and mutual funds), they can be sold by agents who have insurance licenses but not securities licenses. The agent or broker may search through an annuity database to find a product that fits your needs, or they may recommend one of the annuities that they’re most familiar with. In some cases — and you may never discover this — the seller may be paid a direct or indirect incentive to sell certain products. In any case, be prepared to ask the seller the following questions before you buy:

»» What is the interest rate? »» How many years is the interest rate guaranteed? »» How does the rate compare to the rates of other fixed annuities? »» How good is the rate compared to CDs? »» Does the annuity have a market value adjustment? »» How long is the surrender period? »» How much can I withdraw each year without a penalty or adjustment? »» What financial rating does the insurance company have? »» What will the contract be worth at the end of the surrender period, assuming that I make no withdrawals?

»» Can I get my money out without a penalty if I become seriously ill? The following are questions you should ask yourself:

»» Can I benefit from tax deferral? In other words, when I withdraw money from my annuity, will my income tax bracket be lower than it is today?

»» Do I intend to convert the contract to an income stream in retirement? »» Can I afford to cover a financial emergency without dipping into my annuity? »» Do I know and trust the agent? Are they likely to act in my best interest or in their own?

CHAPTER 6 Earning Interest with Fixed Annuities


NAMING AN ANNUITANT AND BENEFICIARY When you buy any annuity, you — the contract owner — must name an annuitant and a beneficiary. The annuitant’s life expectancy is used to calculate the size of your income payments if you convert your fixed annuity to an income stream. (For more on annuitants, see Chapter 3.) The beneficiary will receive the cash payment of your fixed annuity’s current value if you die while the money is still invested.

Unscrupulous insurance agents sometimes try to sell annuities to elderly individuals who have no need for a long-term investment. To prevent such abuses, regulatory agencies now insist that an annuity be a “suitable” investment for the purchaser. During the course of a sale, the seller should offer a suitability assessment form to help determine whether a fixed annuity is right for you. You can pay for your fixed annuity in several ways:

»» Check or electronic transfer: Simply attach a check to your application form and hand both to your insurance agent. You can also mail them to the post office box of a direct marketer.

»» A transfer of mutual fund assets: If you already have mutual funds at a

financial services company with a life/annuity company subsidiary or partner (such as Fidelity or Vanguard), you can buy one of their fixed annuities with a transfer of mutual fund assets. On the annuity application, simply indicate the mutual funds you want to sell.

»» IRA assets: You won’t gain any new tax advantages by buying an annuity with

money from an IRA. Your IRA already grows on a tax-deferred basis. But many people use money from rollover IRAs (IRAs filled with money “rolled over” from an employer-sponsored retirement savings plan) to buy an income annuity. The federal government created qualified lifetime annuity contracts (QLACs) in 2014 to make it easier for people to use IRA savings to buy deferred income annuities (DIAs). (For more on DIAs and QLACs, see Chapter 11.) For many retirees, the bulk of their savings will be in employer-sponsored plans or IRAs.

»» A 1035 exchange: If you own a non-IRA deferred annuity (as opposed to an income annuity), you can transfer the assets into a new annuity with a 1035 exchange. (See Chapter 19 for more on 1035 exchanges.)

»» The proceeds of a cash-value life insurance policy: If you have a life

insurance policy that you no longer need, you can convert it to a fixed annuity.


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DECIDING WHAT TO DO WHEN YOUR CONTRACT ENDS When the term of your three-, five-, seven-, or ten-year contract ends, you’ll need to choose one of the following options:

• Take your money out. If you do this before you’re 59½ years old, there may be tax consequences.

• Leave your money where it is and accept the interest rate the life/annuity

company offers you. The renewal rate probably won’t be the same as the rate you had been earning during the previous term.

• Roll your money into a different multiyear contract.

Before you initiate a 1035 exchange, call your current insurance company to find out whether you’ll incur a surrender charge or market value adjustment on the withdrawal. If the answer is “Yes,” reconsider the transfer. Be wary of contracts where the first-year surrender charge is higher than the length of the surrender period, or where the surrender period lasts longer than the guaranteed rate period. For instance, you may see a seven-year contract with a 10 percent first-year surrender charge, or a contract that guarantees a specific rate for seven years but assesses a surrender charge for ten years.

CHAPTER 6 Earning Interest with Fixed Annuities



»» Getting acquainted with income annuities »» Tailoring an income annuity to your needs »» Deciding how to buy and pay for an income annuity »» Seeing how single premium immediate annuities have been innovated



Creating Retirement Paychecks with Income Annuities


any teachers, postal workers, and employees at Fortune 500 companies can still look forward to pensions when they retire. But most of us will retire without a traditional pension. We’ll have to rely on our savings and possibly our home equity to support us in retirement. If you’re not in line for a pension but wish you were, income annuities may be the cushion you need. When you buy an income annuity with a chunk of your savings, you create a stream of pension-like income. Pioneered by the ancient Romans, the popularity of income annuities today is said by academics to suffer from the “annuity puzzle.” In a 1965 research paper, Israeli economist Menachem Yaari suggested that most people who don’t have pensions should buy income annuities. The fact that they don’t perplexed him.

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But most near-retirees and retirees find at least three reasons not to buy these simple products:

»» Income annuities require you to trust an insurance company with a big chunk of your savings for years at a time.

»» Most Americans already have a modest annuity, called Social Security. »» Annuities are much more complicated than mutual funds. So, why consider them? When combined with Social Security, income annuities solve the problem of not knowing how long you’re going to live and how long you have to make your savings last. If the following apply to you, income annuities may be your ticket to a more serene retirement:

»» You have no corporate, union, or public-sector pension. »» You haven’t saved quite enough to live on the interest, dividends, and capital gains from your nest egg alone.

»» Social Security alone won’t cover your basic monthly expenses. In this chapter, I explain how and why to use this type of annuity. Income annuities are fundamentally different from the deferred fixed and variable annuities I describe in Chapters 6 and 10. Those are largely pre-retirement savings tools. Income annuities are in-retirement income providers. People who want to invest in stocks during retirement should like income annuities. That may sound counterintuitive, but it’s true. When you know that your basic monthly expenses are more or less covered by guaranteed income from Social Security and an income annuity for the rest of your life, you can invest most of the rest of your savings in stocks and not worry that a crash will wipe you out. You’ll have no reason to panic and sell your assets at fire-sale prices. Annuities reduce the financial risk in one area of your life so that you can afford to take risks in another part of your life. You’re the only person who knows what that other risk may be. It may simply be the gamble you take by stepping away from a full-time job. Trip insurance is fairly standard, but every trip is unique.

Understanding Income Annuities In my opinion, income annuities are the only annuities that deserve the name annuity. The other annuities are mainly investments with annuity features. They can be converted to income annuities but rarely are. When economists or


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academics study the pros and cons of annuities, they’re usually studying annuities that pay out income to retirees. Income annuities couldn’t be simpler. The hard part is sending a big check to a life/annuity company. (Ouch! Imagine if you were required to pay for Social Security benefits with a lump sum at retirement.) The easy part is receiving a guaranteed monthly, quarterly, or annual income for as long as you or your spouse are alive. If you buy an immediate income annuity, income will start, by definition, within 13 months after purchase. If you buy a deferred income annuity (DIA), you will schedule your income to start arriving at some point later in retirement. (Don’t confuse this type of “deferred” annuity with the deferred annuities of Chapters 6, 8, 9, and 10. People rarely convert those annuities to income annuities.) You can think of income annuities as life insurance in reverse. With life insurance, you make installment payments to an insurer. If you die while the policy is in effect, your surviving spouse or other beneficiary receives a big payment. Life insurance is a hedge against dying too young and leaving your survivors penniless. With an income annuity, you flip that formula on its head. Generally, you pay a lump sum at retirement and receive regular income payments until you die. Life annuities are a hedge, along with Social Security, against living too long and being poor in your old age. Lifetime income annuities (as distinct from period certain income annuities that pay out for a specific number of years) let you to tap into what actuaries call the survivorship benefit or mortality benefit. When you buy an income annuity, you pool your savings with other annuity owners your age and agree in advance that those who die early will leave their unpaid benefits in the pool where the surviving annuity owners can share them. In practice, you should prefer an income annuity that pays income for life and for no less than ten years. That kind of contract will give you at least a partial survivorship credit plus the reassurance that most of your premium will come back to you or your beneficiaries if you die early in the life of the contract. One unappreciated benefit of annuity income is that you can spend it guilt-free. You may find that, as soon as you retire and stop receiving regular income from work, you don’t feel comfortable spending any money at all from savings. Because you don’t know how long you’ll live or how long your money has to last, you may tend to hoard your savings against an unknowable future. You may not feel confident enough to pursue a few of your “bucket list” goals.

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INCOME ANNUITIES VERSUS THE 4 PERCENT RULE Income annuities are an alternative to the so-called 4 percent rule. In a famous 1994 research paper, adviser William Bengen hypothesized a “safe withdrawal rate” from a balanced portfolio of stocks and bonds. Based on historical returns, he calculated that if you retire at 65 and limit your annual spending to 4 percent of your savings per year for the rest of your life, you’ll never run out of money. Income annuity payout rates vary, but even when prevailing rates are abnormally low, an income annuity can usually pay more than 4 percent. If you and your spouse bought a lifetime annuity at age 65, with at least ten years of payments in early 2023, you’d receive about 6.5 percent of your initial premium per year for the rest of your lives. Per $200,000 in savings, you can spend $13,000 per year for life with the annuity but only $8,000 by using the 4 percent rule. There’s also less maintenance with the annuity. With the 4 percent method, you may have to dial down your annual spending in years with poor market returns, or hoard your gains in positive years. With an income annuity, you know that you can spend $13,000 every year, with no need to bother about cutting or raising your annual allowance. Some experts recommend investing in relatively small income annuities just to take pressure off their withdrawal rate or stabilize it. If you have $1 million in savings, you have a lot of flexibility to combine annuities and investments. With $1 million, for instance, you could spend $40,000 a year under the 4 percent rule and/or you can buy an annuity paying $1,000 a month for $200,000 (at April 2023 rates) and then withdraw only 3.5 percent of the remaining $800,000 per year (or $28,000) to achieve the same spending power. Because the 4 percent rule allows retirees to keep all their savings invested and, therefore, offers a chance for hypothetically unlimited growth, it’s highly popular. But it also puts you at risk of running low on money in retirement. If you can afford to live on 4 percent (or 3.5 percent, when bond rates are low) of your savings each year, the 4 percent rule may make perfect sense for you. But if you need to spend more than that to cover your basic expenses, you should look into an annuity.

Income annuities give you “permission” to spend down some of your savings in retirement. It’s easier, psychologically, to spend money from an income annuity than it is to dip into savings every time you want to buy something. If you buy just $500 of monthly guaranteed income for ten years, you can call it your mad money.


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It’s painful to part with hundreds of thousands of dollars at the stroke of a pen or a single keystroke. But that’s a once-and-done pain, not a daily pain. Buying an income annuity should almost never be an all-or-nothing decision. But only you and your adviser will know what percentage of your money you can afford to lock up in an annuity, or keep on hand for emergencies, or leave invested in the financial markets. Almost any amount of guaranteed lifetime income you buy will reduce your risk of ever running low on money in retirement. It’s a gift that keeps on giving. Here are some guidelines:

»» Pause before putting more than 30 percent of your savings in an income

annuity. This is the conventional wisdom. Advisers can be fairly sure that they won’t get into trouble if they recommend no more than this amount.

»» A 40 percent contribution can eradicate longevity risk. Respected

authorities such as Morningstar have calculated that if you follow this advice, you’ll reduce your chances of running low on money before you die to virtually zero. Obviously, guaranteed income, in any amount, will lower your risk of destitution in old age.

But there is an exception to those rules. If, for instance, you need $3,500 a month in retirement (on top of Social Security) and the only solution is to put 80 percent, 90 percent, or even 100 percent of savings into an income annuity, then you should. That was the belief of David Babbel, the late annuity expert at the University of Pennsylvania and New  York Life. One hundred percent is probably too much, in my opinion. You need to set aside some money for emergencies.

HOW MUCH ANNUITY INCOME DOES A PERSON NEED? Here’s a useful formula for deciding how large an income annuity you need:

1. Estimate your essential monthly living expenses in retirement. Let’s imagine a best-case scenario where you’ve paid off your mortgage, car loans, and credit card debt. You’ve even worked until age 70 to get the maximum Social Security benefit. (continued)

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Perhaps you can live on $6,000 a month before taxes if necessary. Estimating your “essential” expenses in retirement may not be easy. One person’s luxuries can be another’s necessities, and vice versa. Gifts for all the grandchildren at Christmas might be an essential budget item for some people. Others may require first-class seats when they fly. You’re the only one who can tell which expenses are “essential” and which are “discretionary.”

2. Subtract your monthly household Social Security benefit from that number. Let’s assume a benefit of $4,000 a month, indexed to the Consumer Price Index. Let’s also assume that you have no other source of safe income. In such a situation, you might consider an income annuity that brings in $2,000 per month. At the start of 2023, an immediate annuity paying $2,000 per month for as long as either spouse is alive (with a minimum of 120 payments guaranteed) would cost about $350,000, according to

Customizing Your Income Annuity You’ll hear it said that annuity owners are more likely than other people to be struck down by city buses shortly after they buy their contracts. Pow! The contract owners, their spouses, and their children lose all their savings. That’s an urban myth. But, to be on the safe side, you should never buy a life-only income annuity that may leave your family with no benefits if you happen to die the day or month or year after you buy it. You can tailor your income annuity for maximum peace of mind.

Deciding who will receive income You can buy a life annuity for yourself (single life) or for two people (joint and survivor) such as yourself and your spouse:

»» Single-life annuity: If you purchase a single-life annuity for yourself, you

receive payments for as long as you live. Generally, payments under the single-life option are larger than those under the joint and survivor option.

»» Joint and survivor annuity: If you purchase a life annuity for yourself and your spouse, the payments continue for as long as either of you is living.


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Under most contracts, you can decide in advance whether the surviving spouse should receive 100 percent or a reduced percentage of the original payment. To maximize the income while both spouses are living, choose the lowest survivor benefit percentage.

Deciding how long payments will last If you buy a life annuity, you should add the ten-year period certain. It won’t cost much (that is, it won’t reduce your monthly payments much) and you’ll feel a lot more secure. One insurance company is so sure you’ll want the ten-year period certain that the option comes “standard” with its income annuity.

Accessing your money after you buy the contract Although you should look at an annuity as an irrevocable decision (in other words, don’t convert money you think you may need sooner rather than later), some options give you flexibility:

»» Single life with cash or installment refund: If you choose a single-life

annuity with fixed income payments, you can usually select either a full cash or installment refund. If you die before receiving payments equal to your original premium, your beneficiaries will receive the remaining premium in a lump sum or installments.

»» Withdrawal of assets: A few income annuity contracts let you withdraw part

of your annuity assets, but usually you must choose variable payments with a guaranteed period to qualify, and each withdrawal may trigger a fee. A withdrawal generally reduces the size of your remaining income payments and/or shortens the length of the guaranteed period.

Deciding whether to add an inflation-protection rider If you can remember when gasoline cost 59¢ a gallon or when $5,000 could cover a year’s tuition, room, and board at a state university, then you understand how much the purchasing power of an unchanging income annuity payment may shrink over the next two to three decades.

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Suppose you buy an annuity with a fixed payout of $2,000 a month. Twenty years from now, that $2,000 might have only half its current purchasing power, depending on the rate of inflation over those years. Many income annuities, such as those found on the Fidelity Investments single premium immediate annuity (SPIA) website, come with annual 1 percent to 3 percent increases in the monthly payout, so your income roughly keeps pace with inflation. Some retirement experts, such as Zvi Bodie of Boston University, have strongly recommended that people add inflation riders to income annuities in order to avoid the erosion of their purchasing power in retirement. Bodie also disbelieves the conventional wisdom that says stocks are an effective hedge against inflation. He has questioned the popular assumption that stock prices always go up in the long run. He could be right. Stock prices have risen in the long run on average. That much is true. But averages are often misleading. They can hide wide disparities in individual returns without showing you how wide the range of returns has been. As for relying on the “long run,” the great economist John Maynard Keynes noted that none of us will be here in the long run. But almost no one puts inflation riders on their annuities because they increase the cost of the annuity by quite a bit. Here’s an example from the brochure for Pacific Life’s Income Provider SPIA. Without the rider, the first and every monthly payment would be $1,200. With a 3 percent cost-of-living rider, the first payment would be $900 a month. After ten years, the rider would raise the payout to $1,200. After 20 years, if you’re still alive, the contract would pay $1,600 per month. Inflation is a serious problem for retirees. But I’m not sure that life/annuity companies have any uniquely efficient way to reduce inflation risk that compares with their expertise in dealing with longevity risk or mortality risk. They can and will sell you protection against inflation, but not at bargain prices.

Deciding whether to add a cash refund or installment refund Most income annuities offer you the option of adding a refund feature to your contract at the time of purchase. If you die while receiving income payments, your beneficiary will receive your purchase premium, less the amount of income you’ve already received in monthly or annual payments. The beneficiary can receive a


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lump sum (cash refund) or a series of payments (installment refund). If you add this option, you’ll lower the monthly payment from your annuity a bit. But if it makes you feel better, do it.

Deciding when to buy your annuity When you buy an annuity depends on how you intend to use it. An income annuity does double duty  — it’s a tool for efficiently turning savings into guaranteed income, and it’s insurance against longevity risk. Consider these guidelines for buying:

»» If you’re using an income annuity to create pension-like income, you should buy it as soon as you need monthly income.

»» If you’re highly risk-averse, and you’re afraid you might lose your savings if you keep it in stock funds for one moment longer, you should buy an income annuity sooner rather than later.

»» If you’re using an income annuity purely as insurance against living too long, and not to supplement Social Security to cover your basic investments, then buy an annuity today to fund an income that starts in 10 or 15 years (see Chapter 11 for details).

Here’s a general rule that I’ve heard from annuity researchers. When you reach age 60, you should replace the bonds in your portfolio with income annuities. At age 75, you should replace the stocks in your portfolio with income annuities. They’re talking about life-only annuities, however, which have the largest survivorship credits. Buy your income annuity from a gilt-edged, A-rated company. A life annuity guarantees that you’ll receive an income as long as you live (or as long as either you or your spouse is living). This guarantee depends on the ability of the life/ annuity company to meet its obligations to you for a long time. Most people buy their life annuities from the biggest, most stable of the life/ annuity companies. Not coincidentally, most of those companies are mutual companies (owned by their policyholders) or private insurers. The top six sellers of individual income annuities are New  York Life, MassMutual, MetLife, USAA, Northwestern Mutual, and Pacific Life. They alone accounted for more than half of the $12.5 billion income annuity sales in 2021.

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WHY PEOPLE BUY INCOME ANNUITIES If you’re not sure you can afford to retire on your savings and Social Security, you need to at least become familiar with income annuities and how they can stretch your savings. Here are some of the reasons Americans buy income annuities:

• So they know exactly how much they can afford to spend each month in retirement • So they don’t have to hoard money against the chance that they’ll live five years longer than they expected

• So they can spread the payment of the taxes due on their savings out over their many years

• So they can receive an annual income from savings that’s larger and safer than using the 4 percent safe withdrawal method

• So they can take more risk with their non-annuitized savings

WHY PEOPLE AVOID INCOME ANNUITIES Relatively few Americans buy immediate or deferred income annuities. And even though they have some $2 trillion invested in deferred variable annuities — a fraction of the amount they invest in mutual funds — Americans rarely annuitize those contracts (turn them into income). Here are the most common reasons why they don’t convert their savings to pension-like, lifetime income:

• They underestimate the value of survivorship credits. • They underestimate their chances of living past the average life expectancy. • They have never heard of income annuities and don’t know they can convert a deferred fixed or variable annuity to an income stream.

• They don’t believe that income annuities offer a good return on their investment. • They needed 40 years to accumulate their retirement nest egg, and they want total control over it.

• They’re afraid that the insurance company will get their money if they die too soon (even though that’s rarely true).


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Buying and Paying for an Income Annuity Decisions, decisions. Before you buy an income annuity, you face some important tactical choices. In this section, I review your options with regard to when you buy your contract and how you pay for it. I tread lightly on the tax implications of annuities here (taxes are discussed in greater detail in Chapter 18).

Deciding how to pay for your annuity If you make the decision to buy an income annuity, you have to come up with the cash — typically $100,000 to $200,000 and sometimes much more — to pay to the broker, agent, or financial adviser, who in turn sends it to the issuing insurance company. People generally pay for annuities

»» With savings or investments in taxable accounts »» With savings or investments in tax-deferred accounts such as traditional IRAs and retirement plans

»» With assets from an annuity they already own (such as a deferred variable annuity) into an income annuity through a 1035 exchange

After-tax money If you have after-tax cash savings (money in certificates of deposits [CDs] or money market accounts at mutual fund companies, for example), you can use it to purchase your income annuity. You can also use

»» Proceeds from the sale of mutual funds in taxable accounts, most of whose gains have already been taxed

»» Any tax-free money you may have received as the beneficiary of a life insurance policy

Pretax money If most of your savings is in a qualified retirement plan — for example, a 401(k), a 403(b), or a traditional or rollover individual retirement account (IRA) — you can buy an income annuity with that money. Keep in mind that you gain no tax advantage by doing so. All withdrawals from traditional IRAs and annuities purchased with assets from traditional IRAs are taxed as ordinary income.

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UNDERSTANDING THE ANNUITY MONEY’S WORTH RATIO When annuity experts (finance professors, actuaries, and others who like nothing better than to start each day with a bowl of crisp calculus equations) want to measure whether an income annuity is a good deal for the purchaser, they examine the annuity’s MWR. Anybody who has shopped around for a furnace knows that each brand has an efficiency rating that shows how much heat it produces compared to the potential heat in the fuel it burns. The MWR performs a similar function. It’s usually the ratio of the present value of the sum of your expected annuity payments (discounted at current interest rates) to the premium the company is charging you. Here’s an example: Suppose you wanted to buy an income stream of $40,000 a year for 25 years, and an insurance company charged a premium of $500,000. But is that a low price or a high one? To find out the rock-bottom cost of a $40,000/25-year income stream, you’d calculate its net present value (NPV), discounted at today’s interest rates. If the NPV turned out to be $500,000, your MWR would be 100 on a scale of 100 ($500,000 divided by $500,000). That’s excellent. If the NPV is only $400,000, your MWR would be only 80. By asking $500,000, the carrier may be overcharging you. (For a link to an online NPV calculator, see Chapter 15.) MWRs range anywhere from 80 to 100. Insurance carriers can afford to offer better MWRs when their own profit margins are high. That usually occurs when long-term interest rates (the rates that carriers earn on their investments) are significantly higher than shorter-term interest rates (the rates that carriers pay you).

How do you know if you’re getting a good price on an annuity? Imagine that you want to buy $1,500 of fixed monthly income for exactly ten years (120 payments) to supplement Social Security during your first decade of retirement. Your ­insurance agent comes back with an estimated purchase premium of $165,000. If you go to and plug in those numbers, you’ll discover that such an income stream has a wholesale cost of $148,155. Divide $148,155 by $165,000, and you get a MWR of about 90 percent. To evaluate an annuity properly, you may also want to compare its cost to the cost of self-insuring against living too long. Researchers have found that, from a specific amount of savings, a retired person can enjoy a higher standard of living throughout retirement by purchasing an annuity than by not doing so.


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A new retiree without access to an annuity needs at least 30 percent more in savings than a retiree with an annuity to achieve the same level of income and the same security against running out of money, according to a still-relevant 2006 book, Annuity Markets and Pension Reform by George A. (Sandy) Mackenzie ­(Cambridge University Press). Other reports say that the person without an annuity would need 40 percent more savings. Annuities are insurance. Homeowner’s insurance pays off if a storm rips your roof off. It spares you the inefficiency of keeping enough money on hand just in case you have to buy a new roof. An income annuity is insurance against living long enough to run out of savings. It spares you the inefficiency of keeping enough money in reserve “just in case” you live to 85 or beyond.

Comparing an income annuity to a variable annuity with a guaranteed lifetime withdrawal benefit A variable annuity with a guaranteed lifetime withdrawal benefit rider (VA/GLWB) is one alternative to an income annuity. Like income annuities, they can provide lifetime income streams. But they don’t require “annuitization” and they let you take out big chunks of your own money when you need it. On the other hand, they often don’t produce as much guaranteed income as income annuities do, and your income is likely to drop when you withdraw lump sums. Many people like the flexibility of VA/GLWBs, but their popularity has waned since 2010. You can find more information on variable annuities in Chapter 10.

Choosing fixed or variable income payments One of the best annuity contracts, in my opinion, is one you may never have heard of. That’s the variable income annuity. For those who can’t get enough acronyms, we call it the SPIVA (short for single premium immediate variable annuity). Not everyone agrees with this assessment, but I’m sticking to it. Like traditional variable annuities, SPIVAs are “separate account” products that let you hold a balanced portfolio. Your money doesn’t go into the general account of the life/annuity company. SPIVAs appeal more to people who like fixed income annuities than those who like traditional variable annuities, so it’s in this chapter.

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COMING UP FOR AIR If you buy a SPIVA, the life/annuity company will ask you to choose an assumed interest rate (AIR). This is an estimate of the rate of growth of your separate account assets in the future. This number, along with the amount of your premium, the current price of an accumulation unit value (similar to net asset values of mutual funds), and the estimated term of your contract based on the owner’s life expectancy, allows the life/ annuity company to calculate your first annuity payment. You’ll probably have a choice of AIRs, such as 3.5 percent or 5 percent. If you choose the more conservative 3.5 percent, your first payment will be lower, but you’ll have a better chance of receiving rising income in the future. If you choose the more bullish 5 percent, your first monthly payment will be higher, but you’ll have less chance of receiving rising income in the future. The number of units remain the same for the term of the contract, but the unit value fluctuates over time.

With a SPIVA, you can adjust the ratio of stocks to bonds to suit your risk tolerance and your desire for potential (not guaranteed) gains that may help your retirement income keep up with inflation. Some contracts are highly flexible. Rather than hold 50 percent stock funds and 50 percent bond funds, for instance, you may be able to generate a fixed monthly income from half your premium and a fluctuating income from the other half. Not many life/annuity companies appear to promote SPIVAs actively. But many deferred variable annuity contracts, in my experience, allow you to convert your assets to a SPIVA. The ultimate source on SPIVAs is The Handbook of Variable Income Annuities, by Jeffrey K. Dellinger (Wiley).

Comparing quotes A life/annuity company determines how much monthly income it will pay you on the basis of how many payments it thinks it will have to make to you. Your age, gender, and marital status enable the company to make that calculation. So do the guarantees you add to the contract, such as a guarantee to receive payments for a specific number of years or that your beneficiaries will receive any principal that you didn’t receive during your lifetime. As Table 7-1 shows, benefits are generally higher for men than for women, and higher for life-only contracts than for contracts with cash refunds.


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Monthly Payouts Per $100,000 Premium under Different Scenarios

Covered Individuals

Life Only

Life with 10 Years Certain

Life with Cash Refund

10 Years Certain

Male, age 65, fixed





Female, age 65, fixed





Couple, age 65, fixed





Male, age 70, fixed





Female, age 70, fixed





Couple, age 70, fixed





You can often get two kinds of income annuity quotes from life/annuity companies. You can ask, “How much monthly income can I get per $100,000 of ­premium?” In that case, go with the carrier that offers the highest quote. Or you can ask, “How much premium will you charge me per $1,000 in monthly income?” In that case, go with the carrier that offers the lowest quote. When looking for annuity calculators online, avoid sites that ask for your name, address, phone number, and email address. The sponsor of the site may simply be fishing for sales leads, and you may receive an unwanted phone call from a telemarketer or insurance agent.

Catching Up on Single Premium Immediate Annuity Innovations The mutual life insurers, both large and small, have tried to overcome some of the resistance to the purchase of SPIAs and DIAs (purchased several years before lifetime income starts). For example, they’ve introduced features that let contract owners take money out in lump sums. They’ve added dividends to create rising payments. They continue to offer specialized SPIAs for people with health problems. There is even a SPIA option that helps people delay Social Security benefits. There are only so many pennies in a dollar. Every SPIA add-on that gives you more access to cash or steps up your monthly payments also reduces the base payment. For every year you delay income from a SPIA, your base payment increases.

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Medically underwritten income annuities People with severe health problems can buy income annuities at discounts. Mutual of Omaha offers medically underwritten or impaired annuities. If their medical exam shows that you have a potentially life-shortening illness, the company may offer you a life-contingent annuity at a price that an older person would pay. For example, an exam might give a 65-year-old man with emphysema a rated age of 72. Instead of receiving the normal 65-year-old’s rate of $748 a month for life for a $100,000 premium payment, his shorter life expectancy would qualify him for a payout of $902 per month. Cancer, diabetes, heart disease, and stroke are listed on Mutual of Omaha’s website as illnesses that can qualify retirees for a 10 percent to 20 percent payment increase. The retirement expert Moshe Milevsky has suggested that the life expectancies of people in poor health are actually less predictable than those of healthy people. So, a medically underwritten annuity can turn out to be a bargain.

Easing into retirement with a bridge annuity Perhaps you’re one of the many 60-somethings who will transition from fulltime work to half-time work and then to full retirement. Or you might retire at 66 but want to delay claiming Social Security benefits until age 70, when benefits are about one-third higher than at full retirement age. There’s an income annuity for those scenarios. Pacific Life’s Income Provider contract offers a future adjustment option. Under that option, at age 66 you can buy an income that adjusts downward four years later when you claim Social Security. It’s a way of “buying” the higher Social Security benefit four years early. The same contract allows you to do the same in reverse. If you plan to earn income from a part-time job in your late 60s, you can buy an income starting at age 66 that adjusts upward four years later when you claim Social Security at age 70.

Accelerating your income payments Some income annuity contracts give you the flexibility to accelerate your payments after you’ve begun receiving your income payments for life. New York Life allows owners of at least one of its nonqualified (not purchased with IRA money) income annuities to withdraw up to eight months of payment three times during the life of the contract.


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Pacific Life’s Income Provider allows you to take up to three months of income in a lump sum. Three months later, you begin receiving your usual income payments again. You can exercise this option only twice during the life of the contract, starting after the first contract year. You must also be at least 59½ years old, and your accelerated payments must all fall in the same tax year.

Dividend-paying “mutual” income annuities In a few cases, mutual life insurers pay dividends to annuity owners as well as to life insurance policyholders. Owners of New York Life’s Mutual Income Annuity receive a guaranteed income stream plus a chance for dividends when New York Life declares them. The contract is available as a SPIA or a DIA. The annual dividends can serve as an inflation adjustment. Owners of this New York Life annuity can take their dividends as lump-sum cash payments or they can apply the payments to the purchase of more annuity income. As with an inflation-adjusted annuity, the catch is that you start with lower initial payments and wait several years to catch up to the payout rate. There are no dividends until the end of the second contract year. Unlike the annual increases you get with an inflation-adjusted annuity, there’s no guarantee that you’ll get a dividend every year or how large the dividend will be. New York Life has paid its life insurance customers a dividend for 168 consecutive years, and it recently paid out a whopping 6 percent dividend. But owners of this annuity won’t necessarily receive the same dividend as life insurance customers.

Income annuities that let you take all your money out The single biggest objection to purchasing life annuities is that you can’t get your money back if you need it. (Never mind that the point of locking up your retirement money means keeping it safe from panic, whims, crashes, and so on.) New York Life offers a few options on its non-IRA contracts that let you take all your money out. The cash withdrawal option lets annuity owners with period certain annuities — those with 5 to 30 years of guaranteed payments — withdraw the present value of any portion of the payment still due to them during the guaranteed period. ­(Present value means the sum of your future payments minus the interest that they would have earned in New York Life’s general account.)

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New York Life offers another, alternate, cash withdrawal option for people with life-only contracts. At the 5th, 10th, or 15th anniversary of your first income ­payment, or “if at any time you can provide upon proof of significant, nonmedical financial loss specified in the policy,” you can withdraw 40 percent of the ­discounted value of remaining payments, based on life expectancy when the policy was issued. Your future payments would be reduced by 40 percent for the rest of the life of the contract.

Medicaid-compliant or restricted annuities Medicaid compliant annuities (MCAs) are different from medically underwritten annuities. MCAs are special income annuities that allow ill spouses in nursing homes to prove poverty and qualify for Medicaid coverage of their long-term care expenses while allowing their healthy spouses to protect part of the couples’ shared financial wealth. Consider an 80-year-old woman whose husband has been confined to a nursing home and is paying for care. The healthy wife (or community spouse) can use half of her shared savings, up to $137,400, to buy an MCA income annuity. The annuity would pay a fixed income for not longer than an 80-year-old woman’s life expectancy (9.1 years in the United States). (Couples do not have to liquidate their homes to qualify for Medicaid.) At early 2023 rates, a $137,400 premium would buy a monthly income of about $2,500 for five years and about $1,400 for ten years. The healthy spouse doesn’t have to give up Social Security benefits, and the couple can have home equity up to about $1 million, according to the U.S.  Department of Health and Human Services. If the healthy spouse dies before the annuity payback period ends, the Medicaid authority in her state may claim any remaining benefits under the annuity. In most states, the state Medicaid agency must be named the primary beneficiary of the annuity. The rules for MCAs vary by state. By all accounts, an elder-law attorney needs to weigh in. MCAs appear to be most appropriate for couples near the end of their lives and the end of their financial assets, where an institutionalized spouse wants to transition to Medicaid-financed services. In 1988, Congress enacted provisions to prevent what has come to be called spousal impoverishment, according to the Medicaid website. Since then, it has been government policy to leave the healthy spouse with enough income or resources to “live out their lives with independence and dignity.”


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LESS EXPENSIVE, “SECONDHAND” ANNUITIES Looking for a bargain? Look no further. Secondary market annuities (SMAs), which provide you with either a fixed income for a specific number of years or a future lump-sum payment, dollar for dollar, can deliver 10 percent or 15 percent more annual income than typical retail income annuities can. These contracts are issued by major life/annuity companies to plaintiffs who win large settlements in personal injury lawsuits. The settlements typically include combinations of lump sums and income streams. The plaintiffs often sell the income streams to Wall Street firms for less than their full value. The firms slice them into segments and sell them, through insurance agents, to retirees. You can find such contracts listed at For instance, the website features a Brighthouse Financial contract that has 226 monthly payments of $1,102 each from February 2023 to November 2041. It costs about $158,000 and pays out about $249,000 over those 18½ years. SMAs have a better reputation today than they once had. In a few cases that received wide press coverage, purchasers of settlements earned a reputation for taking advantage of naïve people by underpaying them for their lawsuit awards.

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»» Understanding fixed indexed annuities »» Finding the fixed indexed annuity that’s best for you »» Looking at the performance of a fixed indexed annuity »» Considering the pros and cons of fixed indexed annuities



Gambling on Fixed Indexed Annuities


ould you rather have a 50 percent chance of winning $100 or a 100 ­percent chance of winning $50? Among annuity products, there’s a real-world example of that hypothetical toss-up.

You can buy a fixed-rate annuity with a guaranteed return. Or you can buy a fixed indexed annuity (FIA) that yields zero in some years and double the fixed-rate annuity’s return in other years. Welcome to the paradoxical world of FIAs! They’re investment annuities that you can use to create personal pensions. They’re substitutes for bonds but rely on the equity markets for yield. They’re feats of financial engineering that few people fully understand. From 2008 to 2022, older Americans invested hundreds of billions of dollars of retirement savings in FIAs. With bonds and certificates of deposits (CDs) delivering next to nothing and stocks still too scary, many people were willing to take a leap into the unknown.

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In this chapter, I share what the folks who design and sell FIAs have taught me. This discussion heads into the realm of options, which can be challenging. But when you’re finished with this chapter, you’ll know if FIAs are for you.

Defining Fixed Indexed Annuities An FIA “gives you the potential for hopefully earning competitive interest over time, with a worse case that you will never lose what you’ve already earned,” wrote Jack Marrion, author of the pioneering 2003 book Index Annuities: Power & Protection and a follower of FIAs since their birth in the late 1990s. FIAs represent a significant departure from other annuities. When you buy a fixed-rate annuity or a multiyear guaranteed annuity (MYGA), your returns are tied to the yield on the corporate bonds and other securities in a life/annuity company’s general account, minus the company’s expenses. When you invest in a traditional variable annuity, you’ll typically invest in a more or less balanced portfolio of tax-deferred versions of active or passively managed mutual funds. You bear the risks and rewards of those portfolios, minus various fees. That’s also pretty straightforward. When you buy an FIA, however, you’re dealing with options. The life/annuity ­company uses the interest that you would otherwise receive from a fixed-rate annuity — say, 3 percent or $3,000 per year per $100,000 invested — and sets up an “option spread” on the movement of the S&P 500 Index or another market benchmark, usually over a one-year period. If the index value is higher at the end of the period than at the beginning, the FIA manager exercises the option and, generally speaking, locks in a gain for you that’s equal to a portion of the rise in the index. When the stock market goes down, your account is credited with 0 percent interest and the balance doesn’t change. In other words, you lose nothing. Options themselves are often used as a form of insurance. An airline, for instance, may buy an option to purchase jet fuel next year at today’s price. In the spring, an Ohio soybean farmer may buy an option to sell their crop for a certain price come harvest time. Because an option’s price can fluctuate between its purchase date and its expiration date, some traders buy and sell them in order to capture short-term profits. When you own an FIA contract, a life insurer buys options on the performance of the market indexes that you’ve selected from the contract’s offerings. The S&P


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500 Index and the Nasdaq-100 Index are among the most popular. New indexes, both more exotic and more predictable, are regularly invented by Wall Street banks. FIAs were born in the late 1990s. Bob MacDonald, who as CEO of Allianz Life of North America built a huge FIA business in the United States in the early 2000s, has said that the FIA was created to solve a problem that to this day bedevils issuers of fixed-rate annuities. The problem was this: People who bought fixed-rate annuities (commonly known as fixed annuities) were prone to canceling them if newer annuities with higher crediting rates came on the market  — perhaps after a rate hike by the Federal Reserve. That’s fine for the investors who can jump in and out, but it’s disruptive for the annuity industry.

Searching for the Right Fixed Indexed Annuity No another annuity confronts you with as many different options and choices as FIAs do. You’ll need to choose an agent and a specific contract from a specific life insurer. After you’ve picked a contract, you’ll face decisions about term lengths, indexes, crediting formulas, bonuses, and income riders. I unpack those choices and decisions in the following sections. Even if your agent or adviser recommends a specific contract and customizes it for you, I recommend that you learn a bit about these moving parts. The more you know, the better you can help your agent adapt the contract to your needs.

Step 1: Finding an FIA-savvy agent If you’re in the market for an FIA, the purchase process typically begins with an insurance agent. Indeed, you can’t buy an annuity without an agent’s help. Given the inherent complexity of FIA contracts, you’ll probably need guidance from an agent who is familiar with them. Agents often reach out to prospective buyers. Many agents become comfortable over the years with particular products from their go-to list of specific life insurers. An agent will either be affiliated with a single company or be “appointed” by several companies to sell their products. (See Chapter 14 for more on agents and advisers.)

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You may also find an agent online. At one of the online annuity marketplaces, you can ask for a quote or an illustration for a particular product. A licensed insurance agent will probably call you quickly. AnnuityFYI ( and ( are useful websites for consumers. For more on shopping for annuities online, see Chapter 15. Work with an agent or adviser you know and trust. Agents earn more by selling FIAs than by selling any other type of annuity. In the last quarter of 2021, according to Wink, Inc., the Des Moines–based annuity market data source, about twothirds of FIA sales paid commissions of up to 7 percent and about one-third paid between 7 percent and 9 percent. The length of the surrender charge period often indicates the percentage of the commission. Some agents take a reduced commission at the time of sale and an annual “trail” commission of less than 1 percent of the value of the contract. This factor, and the fact that life/annuity companies can change their crediting rates on FIAs from one year to the next, are reasons to keep your guard up.

Step 2: Finding a strong life insurer Choose a life insurer that’s financially strong. (That applies to any annuity ­purchase.) When surveying the FIA landscape — hundreds of contracts and thousands of variations are available — note the financial strength rating of the life insurers that issue the contracts. Life insurers with A ratings from rating agencies like AM Best or Standard & Poor’s are the safest places for your money. (I discuss life insurers in Chapter 13.) Life insurers with B++ ratings are slightly less safe, but not unsafe, in the eyes of rating agencies. They tend to offer richer crediting formulas than insurers with A ratings. Indeed, 15 to 20 years ago, life/annuity companies with B ratings flourished in the FIA business, but no more. Companies with lower than B ratings are not competitive in the annuity market. Today, a handful of A-rated life insurers dominate the FIA market, including Allianz Life, American Equity, Athene (formerly Aviva), Corebridge (formerly AIG), MassMutual Ascend (formerly Great American), Midland National (part of Sammons Financial Group), and Nationwide. F&G and Global Atlantic have emerged as major issuers of FIA in recent years. But dozens of other life insurers offer FIA contracts.

Step 3: Choosing and customizing an FIA After you’ve found a trustworthy agent and a strong company, you and the agent can study the company’s FIA lineup. You’ll need to choose a specific contract, and


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then choose specific term lengths, market indexes, and crediting formulas. In this section, I walk you through these choices in logical order. Here’s a shortcut: Your best bet in customizing your contract is to choose a medium term length, a traditional index with a long track record, and an annual reset crediting method with a participation rate. Avoid volatility-controlled indexes, bonuses, and so-called “two-tier” contracts.

Choosing a term length How long can you afford to lock up your money? One year, five years, seven years, and ten years are the most common term lengths. If you’re 55 years old and you plan to retire at 65, then the ten-year term length may be appropriate. A ten-year FIA can protect a chunk of your savings from loss during the sensitive “red zone” period around retirement, when a market crash could wreak permanent havoc on your savings. Perhaps you’re saving for a particular expense at a particular time in the future. If you want to buy a house in three years, for instance, you can protect your down payment by putting it in a three-year contract. You may also choose the threeyear term if you think interest rates may be higher in three years and you want the freedom to switch to a richer investment.

Setting a reset interval Aside from term lengths, each FIA contract may offer a variety of crediting intervals (the dates within the term when your interest gains are measured and credited to your account). With an annual reset, you lock in the gain, if any, that your index posted over the preceding year. Choose an annual reset that locks in your gains at the end of each contract year, regardless of the number of years (the term) you intend to hold the contract. ­Biennial or triennial resets and five-year point-to-point contracts are considered less beneficial.

Choosing a market index A market index is a way to measure and record the average price movements of a specific set of securities over time. Perhaps the best known is the S&P 500 Index of the 500 largest U.S. companies by market capitalization. The number of market indexes has grown explosively in recent decades. As of 2022, more than $15 trillion was invested in mutual funds based on more than three million indexes, according to The Index Standard (

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When you buy an FIA, you have to pick one or more indexes to bet on. Along with variations of the S&P 500 Index, the Nasdaq-100 (tech stocks), the Russell 2000 (small-cap stocks), or the MSCI EAFE (developed-country stocks), you’ll increasingly find newfangled volatility-controlled indexes (see the next section). Consider diversifying your investment across several indexes. “Don’t put all your eggs in one basket,” Laurence Black, founder of The Index Standard, told me. “The U.S. equities index is not always the winner, and one should sprinkle exposure across regions, factors, and asset classes.”

Volatility-controlled indexes Volatility-controlled indexes (VCIs) are now common among the investment options in FIAs and in variable annuities with guaranteed lifetime withdrawal benefits (GLWBs). The S&P 500 used to be the go-to index for FIA owners. But, according to Wink, Inc., FIA owners now allocate about 60 percent of their money to these risk-dampening indexes and only 33 percent to the S&P 500 Index or one of its variations. VCIs typically contain two sets of assets. There’s a risky set, containing stocks, and a safe set, containing bonds or cash. When stock prices become volatile — and start jumping up or down by hundreds of points day  — a formula in the index shifts money out of risky assets and into safe ones. When the stock market calms down, the formula shifts money back into the stocks. Most of these indexes have a target volatility of 5 percent. That’s about one-third of the average long-term volatility level of the S&P 500 Index. In other words, an index with a target volatility of 5 percent will rise or fall only about one-third as high or low as the S&P 500 does, according to Laurence Black. Jack Marrion wrote this about VCIs in the Spring 2021 edition of his Advantage Compendium newsletter:

If a volatility-controlled index does not have a stated ceiling on the amount of interest that might be earned, this may create the impression that potential interest is unlimited. However, the reason for using volatility-controlled indices is to provide a way of limiting interest to reduce hedging costs. Their very design limits interest. Due to this design it can create unrealistic expectations if the index is referred to as uncapped or unlimited, because the design effectively works as a governor on the amount of the return generated. Although it is often technically true that one gets “all of [the] index upside less a spread,” the consumer needs to understand that this upside does have limitations.


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LOOKING INSIDE THE AiMAX INDEX Consider, for example, the AI Powered Multi-Asset Index (AiMAX), which is available on Athene’s AccuMax 5 and AccuMax 7 FIA contracts. For the five-year point-to-point crediting method, the participation rate for the client was listed in July 2022 as 300 percent. In other words, the client buying the product today would receive three times the net positive change of the index over the next five years. We can assume that if the index is 20 percent higher in five years than it is today, the client should experience a 60 percent gain. That sounds very generous. On average, this index holds about 26 percent stocks and 40 percent bonds, according to a product fact sheet. In October 2022, however, more than 60 percent of its assets were cash. That’s a conservative index. The product boasted an annualized return of more than 6 percent over ten years, and eight of those years were simulated results. For the only two years when the index was in actual use, it lost 1.2 percent in 2021 and 13.9 percent in 2022. EquBot, the provider of the volatility control mechanism in the index, is paid 0.75 percent per year. “Because the index applies a volatility control mechanism,” one of the product disclaimers says, “the range of both the positive and negative performance of the index is limited.” The evidence suggests that you should steer clear of untested volatility-controlled indexes. Your best bet is to use the traditional all-equity, non-volatility-controlled indexes like the S&P 500 Index, the Russell 2000, the MSCI-EAFE, or the Nasdaq-100.

Choosing a crediting formula After you’ve chosen an index or indexes, you must choose a crediting formula for each one. Your choices may include a cap, a participation rate, a spread, or a trigger:

»» Cap: A cap is the limit on the amount of interest you can earn in a single

crediting interval. For instance, you may have an annual reset crediting method with a 5 percent cap. If the index gains 22 percent, you get 5 percent. If the index gains 6 percent, you get 5 percent. If it gains 3 percent, you get 3 percent.

»» Participation rate: A participation rate is a percentage of the index gain that

goes to you to keep. If the participation rate is 50 percent, and the index goes up 10 percent during one of your contract years, you’ll lock in a 5 percent gain. If the index goes up 30 percent, you’ll book a 15 percent gain.

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»» Spread: A spread in an FIA is the hurdle rate that an index has to exceed

before you receive any interest. If the spread is 2 percent, and the index gains a net 10 percent over the course of your crediting period, you lock in an 8 percent gain.

»» Performance trigger: This type of crediting formula offers you a specific,

predetermined rate of return during a given crediting period whenever the index you’ve chosen posts any increase or when it reaches a certain threshold. The predetermined rate may be higher or lower than the actual index return.

HOW FIAs CAN RESEMBLE MOUNTAIN CLIMBING FIAs achieve their returns through the purchases of options on market indexes. As an analogy, imagine mountain climbers using rope and metal wedges to scale a rock wall. As they ascend the wall, the climbers hammer the wedges into crevices in the rock, clipping the rope to the wedges. This technique protects the climbers from deadly falls. Suppose climbers have been working their way up a rock face. They hammer one wedge into the wall. They climb 10 feet higher, hammer in another wedge, and so on. The uppermost wedge marks their progress up the wall. The wedge that’s 10 feet below them prevents a fall of more than 10 feet. Like those wedges, the options in an FIA set the highest amount of interest that FIA owners can earn during a crediting period and limit the potential loss to zero. The options allow FIA owners to capture part of the upward movement of a market index while protecting their principal. Here’s how experts explained the process to me. (This is technical stuff.) Let’s say you invest $100,000 in an FIA and the life/annuity company expects to be able to credit you with a 3 percent gain, or $3,000, in the coming year, out of the returns on its own investments. That $3,000, in effect, represents your portion of an FIA manager’s “budget” for buying options on a market index. To create a 5 percent cap on the index performance, the manager would buy a call spread (a bracket of two other options) that entitles you to any index gain between zero and 5 percent. On your $100,000 investment, you would earn up to $5,000 with no risk of loss. (This is just an example. With a bigger options budget, the FIA manager could have bought rights to more of the potential index gains.)


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To create a 50 percent participation rate, the manager uses the same options budget to buy a call spread entitling you to the index gains between zero and 10 percent, but the option applies only to half of your $100,000. So, if the index happens to go up 8 percent in the crediting year, your $100,000 would grow by 4 percent (8 percent of $50,000). When your crediting formula has a spread or margin, it means that the life/annuity company takes part of the index gain before passing on the rest to you. If the index gain during the crediting period was 6 percent and the formula involved a 2 percent spread, you would earn 4 percent for the year. What happens when the index posts a loss during the crediting period? The manager just lets the options expire. You won’t lose any principal, because the options were purchased with the expected gains on your $100,000. You do, however, lose the $3,000 you would’ve earned had you invested your $100,000 on a fixed-rate annuity instead of an FIA. Note that the three crediting formulas each used $3,000 to buy options. But they produced three different outcomes for the annuity owner. When you select crediting formulas, you can’t predict which one will perform the best. But you can be certain that you won’t lose principal.

There are so many potential costs and people to pay in an FIA strategy  — the insurance agent, the wholesaler, the life/annuity company, the options dealer, the creator of the index, and perhaps the creator of the volatility-control mechanism inside the index — that it’s hard to imagine how these products can beat simple fixed-rate deferred annuities. Indeed, the only way you can win big with an FIA may be if stock indexes rise much higher than options sellers expected, and if the rise occurs at the right time in your contract year.

Other choices and decisions Term lengths, indexes, and crediting formulas aren’t the only aspects of FIAs that you’ll need to consider before you buy. Other features and factors to consider include lifetime income riders, bonuses, enhanced performance fees, surrender charges, and market value adjustments.

Lifetime income riders At the beginning of the chapter, I categorize FIAs as both investment-style products and potential income-generating annuities. They can generate income in either of two ways. Every FIA contract can be converted to pension-like income through annuitization, though very few people use that option. Many life/annuity companies today also offer FIAs with GLWBs.

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In Chapter  10, I look at lifetime income riders in variable annuities. Generally, these riders give you the opportunity, but not the obligation, to convert the cash value of your annuity contract to a monthly or quarterly payment that is guaranteed to last for the rest of your life. Variable annuities (VAs) with these riders enjoyed big sales in the period from 2005 to 2010. Many people prefer VAs with GLWBs to income annuities because you can take withdrawals from your account even after your lifetime income stream begins (albeit at the cost of proportionately reducing your monthly income). A study conducted by CANNEX, a company that collects and distributes annuity contract data, suggested that the lifetime income riders on FIAs can deliver higher rates of income in retirement than the same riders on variable annuities if the owner postpones taking income until several years after the purchase date. There’s a reason for that. An FIA’s returns are more predictable than the returns of variable annuities, so it costs less to offer income guarantees on them. In addition, the word on the street is that FIA owners have a higher rate of canceling their contracts before they collect income. The fees that they paid (for an income rider they never used) help finance higher rates of income for the people who keep their contracts for life.

Bonuses FIA contracts often offer tempting premium bonuses. Bonuses are calculated to reward you for putting more money into your contract when you buy it, for not taking money out of your contract along the way, or for leaving your money there for the rest of your life. The threat of losing a bonus steers you away from taking your money out early. The descriptions of bonuses in annuity product brochures are not always clear, even to the trained eye and ear. To understand them fully, you may need to study an illustrated example, read a hypothetical case history, or ask your agent or adviser to explain it to you. For example, the brochure of one popular FIA contract offers “a 35 percent bonus on any premium you put into your annuity in the first 18 months, and an interest bonus resulting in a credit of 150 percent of any interest you earn from your chosen allocations. When you’re ready to start receiving income, your lifetime income withdrawals can increase based on any interest you’ve earned, in addition to the 150 percent interest bonus factor. Plus, you can double your annual maximum withdrawal under qualifying circumstances.” Was that clear?


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Enhanced performance (“strategy”) fees FIAs are often sold as having no explicit fees. But many of today’s FIAs do have explicit fees. There may be fees for optional income riders (about 1 percent) and fees of 0.5 percent or 0.75 percent for choosing exotic indexes. FIAs may also charge fees for enhanced participation rates. These fees, which can range from 0.95 percent to 2.2 percent, can buy you a bigger participation rate or a higher cap. But, like any investment fees, they can cannibalize your gains.

Surrender charges and market-value adjustments You’ll find surrender charges on any annuity where the life insurer paid the selling agent a commission. The first-year surrender charge is likely to be close to the percentage of the commission. In a ten-year FIA, the surrender charge may be 9 percent in the first year, 8 percent in the second year, and so on. Suppose you withdrew $20,000 from a $100,000 FIA in the second year. You exceeded the 10 percent withdrawal allowance by $10,000. Eight percent of $10,000 is $800. That’s not unreasonable. You knew you were buying a long-term contract, and your withdrawal costs the insurer money. How so? Because you’ve hindered the life insurer from recovering the $7,000 or more in sales commissions that it paid your agent and the agent’s wholesaler. FIAs sold without commissions to clients of registered investment advisors (RIAs) don’t have surrender charges, but the client will still have to pay the adviser’s usual advice fee. A market-value adjustment (MVA) discourages you from canceling your contract to move your money to a higher-paying annuity or investment. If you do that, the life insurer can lose money. It has matched your money with a long-term investment. Breaking the match has a cost. Your annuity application will contain an example of an MVA calculation. In the past, FIA owners could count on the freedom to withdraw up to 10 percent of the cash values of their contracts without being charged a surrender charge. You were assured that your money wasn’t entirely locked up for three, five, seven, or ten years. But 10 percent is no longer the standard, according to The Advisor’s Guide to Annuities, 6th Edition (The National Underwriter Company), by John L.  Olsen and Michael E. Kitces, which cites Sheryl Moore, an annuity expert and owner of Wink, Inc., a collector and distributor of annuity sales and product data in Des Moines, Iowa. “Ten percent annual withdrawals are no longer a standard feature,” Moore told Olsen and Kitces.

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Such benefits have not vanished completely. In late 2022, an application for a Midland National RetireVantage 10 FIA indicated that 10 percent penalty-free withdrawals were allowed in the second contract year. Midland National’s ­Guarantee Pro multiyear guaranteed rate annuity, however, limited penalty-free withdrawals to the index gain in the previous contract year. Why would life insurers remove the 10 percent penalty-free withdrawal? Because the withdrawal has a cost, and every cost reduces the life insurer’s ability to offer more competitive rates of return. Insurers often reduce or remove one feature of a contract to make room for another one. Insurers face many cost/benefit tradeoffs when designing annuity contracts.

FAQs ABOUT FIAs Why is my return so different from the annual index return? For two reasons: First, FIAs never deliver more than a portion of the index return in any one-year period. Second, your “contract years” are not calendar years. They begin on the date you buy the contract and end on each anniversary of that date. Your returns also depend on the crediting formulas you chose. Returns will vary from one person to another. Why doesn’t my fixed rate of return appear on my annuity application? Because a month or more may pass between the time you apply for your annuity and the time the insurer issues the contract, interest rates can change. The final rate will appear on your contract. Why do the participation rates and caps change from year to year of the contract term? “Insurance companies maintain the freedom to change the crediting factors (such as the fixed rate, participation rate, cap rate, or spread) at the beginning of each new term, subject to a minimum or maximum value . . . allowed in the contract,” writes Wade Pfau in his Retirement Planning Guidebook (Retirement Research). They do this because their own costs can change from year to year, but at the risk of antagonizing their policyholders. What is the difference between the rate on the annuity’s fixed account and the guaranteed minimum rate? On your contract, you may see a fixed account rate of 3.5 percent and a guaranteed minimum rate as low as 0.1 percent (on certain 2021 contracts) or as high as 3 percent (on pre-2008 contracts). What gives? You earn the fixed rate on any portion of your premium that you assign to the fixed account. This rate may change from one year to the next. The guaranteed minimum rate determines your minimum guaranteed surrender value (MGSV). This is the minimum amount you can receive if you took no cash out of your account for the entire term.


PART 2 Identifying the Major Annuities

Most index annuity contracts today offer an MGSV of 1 percent per year times 87.5 p ­ ercent of your initial cash payment for your annuity. For instance, if you put $100,000 into a ten-year annuity with a guaranteed minimum rate of 1 percent, you should expect to receive at least $96,654.44 at the end of ten years. That assumes a ten-year bear market and no index gains, which is unlikely. Should I diversify my premium across all the index choices that my contract offers? Many people do. You have no way of knowing which indexes, which asset classes, or which market segments will achieve the highest returns over the coming year. When I receive only part of the index returns, who gets the rest of the gain? No one. The life insurer buys a call spread (a pair of options) to capture gains on the index. The call spread is itself an asset that can gain or lose value, depending on the movement index from which its value is derived. (That’s why options are also called derivatives.) Your gain comes from the appreciation of the value of the call spread, not from the appreciation of the index.

WHICH CREDITING METHOD IS BEST? If you’ve ever shopped for tires, you know that some tread designs are better for wet roads, some for dry pavement, and others for offroad trails. Certain index annuity crediting formulas are more appropriate for some markets than for others, the experts believe. According to Jackson National Life’s website:

• In rising equity markets, when stock prices are expected to climb gradually, the “annual reset point-to-point cap” is recommended.

• In bull equity markets, when stock prices are expected to surge, the “annual reset point-to-point participation rate with spread” is recommended.

• In flat equity markets, when stock prices are expected to drift sideways or slightly

up for a while, the “annual reset point-to-point method with performance trigger” is recommended

You’ll notice that the “annual reset point-to-point” is recommended in each case. The conventional wisdom has always been that you should use the annual reset or “ratchet” method. That’s where you lock in a year’s worth of index performance (zero or better) at the close of every contract year. In The Advisor’s Guide to Annuities (National Underwriter), Olsen and Kitces write, “There is, unfortunately, no magic formula for the method that will work best in an unknown and unknowable future. In theory, if the underlying options for any crediting method are equally and fairly valued, on average the long-term return should be similar.”

CHAPTER 8 Gambling on Fixed Indexed Annuities


YOU’RE NOT INVESTING IN STOCKS Buying an FIA doesn’t involve buying or owning stocks, bonds, or shares in index funds. But, generally speaking, the prices of stocks must rise for FIAs for the FIA owner to capture a gain. In that sense, FIA returns are correlated with equity returns. They don’t provide the risk-diversification that bonds provide to an equity portfolio. Until 2007, FIAs were known as equity-index annuities (EIAs). That name clearly referred to the product’s linkage to the performance of stock indexes. Some insurance agents were accused of leading prospective clients to believe that buying an FIA was a way to dabble in stocks without risk. In that year, the U.S. Securities and Exchange Commission (SEC) charged that the EIAs were, in fact, securities, not insurance products, and that the SEC, not state insurance commissioners, should regulate them. The insurance industry won, and FIAs continued to be regulated by the states. But life insurers changed the name of the product to fixed indexed annuities and agreed not to promote FIAs as a way to invest safely in the stock market.

“Two-tiered” index annuities sometimes end in tears. Most index annuities are single-tier products. When you’ve owned the contract for several years and the surrender period is over, you can do whatever you want with your money. You can withdraw all of it without an early-withdrawal penalty. You can roll your account value into a new annuity. You can even use the money to buy an income annuity (see Chapter 7) that promises pension-like income for life. No strings attached. Two-tiered index annuities are different. They often offer tantalizing up-front bonuses. In one case, they offered to amplify the account value by 35 percent by the end of a ten-year term. The owner expected to receive at least 135 percent of their initial investment if they waited ten years before withdrawing their money. But the owner overlooked the contract’s fine print. They could receive credit for the bonus only if they annuitized their entire account by converting it to an ­irrevocable guaranteed lifetime income stream. Aside from the monthly income, they couldn’t access the bulk of their savings. Despite complaints from contract owners, two-tiered contracts continue to be sold. Also, avoid “monthly point-to-point” crediting methods. Consider the example of an FIA contract with a “monthly point-to-point” crediting method and 3 ­percent-per-month cap. You may assume that, during a bull market, you may earn as much as 36 percent over 12 months.


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But the market is likely to be volatile, and losses can erase early gains. If your contract earned the maximum for three consecutive months (or 9 percent, for instance), a 10 percent decline in the index over the following month would erase your earlier gains.

Tracking Index Annuity Performance You’ll hear FIA owners boast of double-digit returns in one year. You’ll see ­ten-year FIA contracts that advertise 455 percent participation rates and report hypothetical annualized returns of 15 percent or more per year over the past ten years. You’ll hear people say that FIAs are built to yield between 4 percent and 7 percent annually. But decades of survey data suggest that FIAs will average about 3 percent or 4 ­percent per year. Over the five years from November 2001 to November 2006, life/annuity companies that shared their data with Jack Marrion reported annual returns of 2.25 percent to 6.25 percent, for an average of 4.25 percent. From 2007 to 2012, FIAs returned an annual average of 3.27 percent, Marrion found in a subsequent survey. More recent figures also show modest returns. In 2021, LIMRA, the research and marketing arm of the life insurance industry, released data on FIA returns from 2011 to 2020 (see Table 8-1). The ten-year annual average return was 3.23 percent. Average returns ranged from 1.59 percent in 2016 to 4.52 percent in 2013. In a 2021 report, Runnymede Capital expected one of the top-selling index annuities to generate annual returns of 2 percent to 5 percent.


FIAs: Average Returns to Contract Owners, 2011–2020

Calendar Year

Average Returns (%)*

Average Assets**

Average Returns ($)**



$195 billion

$6.4 billion



$215 billion

$7.9 billion



$241 billion

$11.6 billion



$276 billion

$10.9 billion



$315 billion

$7.5 billion



$351 billion

$5.6 billion



$388 billion

$15.5 billion (continued)

CHAPTER 8 Gambling on Fixed Indexed Annuities


TABLE 8-1 (continued)

Calendar Year

Average Returns (%)*

Average Assets**

Average Returns ($)**



$431 billion

$15.6 billion



$475 billion

$10.8 billion



$506 billion

$13 billion

2011–2020 Average Return


*Numbers based on data provided by LIMRA Secure Retirement Institute. **Numbers calculated by author based on LIMRA data.

Weighing the Pros and Cons of Fixed Indexed Annuities Clearly, FIAs have pros and cons. Let’s start with the pros:

»» Protection from loss: People who buy FIAs like the “ratchet” effect. Their accounts can grow, but the principal is protected from market losses.

»» Guaranteed minimum return: Thanks to state non-forfeiture laws, the issuer of the FIA must guarantee you a minimum return.

»» Higher potential returns in certain markets: When interest rates, certifi-

cate of deposit (CD) rates, and bond yields are low, stock prices tend to be high, making it the perfect time to own FIAs. Their returns are correlated with stocks’ returns.

»» Protection from sequence-of-returns risk: A steep investment loss within five years before or after you retire can put you in a financial hole that you can’t dig out of. By keeping your money in any fixed annuity during that period, you can protect it from this risk.

»» Tax deferral: You pay no tax on the growth of your FIA account until you start

taking withdrawals. If you bought the annuity with after-tax money, you withdraw gains first and pay income tax on them. You pay no tax on withdrawals of principal. If you purchased the contract with pretax individual retirement account (IRA) money, all withdrawals are taxed as ordinary income. No minimum distributions are required from after-tax FIAs.

»» Potential lifetime income option: All index annuities let you convert the

value of your account to a pension-like income. This is the “annuitization” path that almost nobody chooses. Some FIA contracts offer GLWBs. These combine a guarantee of income for life with the freedom to take withdrawals from your account whenever you need to. (See Chapter 10 for details on those benefits.)


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Now, here are the cons:

»» Complexity: FIAs put you at an information disadvantage. Their options

strategies and volatility-controlled indexes make them comparable to electronic slot machines that are programmed to deliver predictable returns for the house but randomized returns for the gamblers.

»» Unpredictability: Life/annuity companies can change their FIA crediting

formulas at regular intervals and aren’t required to make public their “renewal rate” histories. FIA returns are unpredictable, making them a counterintuitive choice for conservative investors.

»» High commissions: On FIA applications, the agent must attest, “I have considered only the interests of the consumer in making my recommendation; my receipt of compensation or other incentives has not influenced my recommendation.” It’s a stretch to believe that high commissions on FIAs don’t bias agents, however, even if it’s only to bias them in favor of selling FIAs instead of simpler products.

»» Distribution by insurance agents: Annuities should be purchased only as

pieces of long-term holistic retirement income plans, in my opinion. Insurance agents aren’t necessarily licensed to give advice and may not be prepared to create holistic plans.

»» Illiquid, overly cautious: Fixed annuities tie up your money for three to ten

years. That can be a good thing — you don’t have to worry about losing any of it. But never lock up money that you think you may need. And, although equity returns may or may not grow more stable over longer holding periods, many advisers recommend holding stocks and bonds when your investment horizon is ten years or more away.

»» No dividends to reinvest: It’s estimated that dividend payments account for

up to 20 percent of your returns from investing in equity funds. But indexes in FIA issuers are often stripped of their dividend yields, because options on the rise of dividend-less indexes are cheaper.

»» Questionable “back-testing”: Bright, shiny new indexes are constantly being invented and added to FIAs. Many are only a year or two old. Because they have little or no track record, their creators advertise hypothetical ten-year performance histories. New indexes that “illustrate well” over cherry-picked market periods are widely used.

»» Federal penalty for withdrawals before age 59½: Unless you qualify for

one of the exceptions, the Internal Revenue Service (IRS) will charge a 10 percent penalty for withdrawals from annuities before age 59½. That charge would be added to any applicable surrender charges or income taxes the withdrawal would trigger.

»» No control over timing of sales: Your crediting periods and term lengths may end at points in time that may or may not be lucky for you.

CHAPTER 8 Gambling on Fixed Indexed Annuities


Modern Portfolio Theory suggests that you can smooth your portfolio’s long-term returns and reduce your risk by holding a variety of assets that don’t all go up or down at the same time. So, should FIAs, whose returns are safe like bonds but correlated with those of stocks, replace stocks or bonds in your portfolio? Bonds, one expert says. In his Retirement Planning Guidebook, retirement guru Wade Pfau writes, “FIAs provide returns comparable to bonds and can be treated as such even when linked to a stock index.” In other words, pay for your FIA with bond money, not stock money. If you’re retiring with seven-digit wealth, your main financial challenge in retirement (as I mention elsewhere) will be to prevent a lot of money from shrinking into a little money. The no-loss guarantee of FIAs checks that box. If you have FOMO (fear of missing out) on a long bull market or sudden upward swoosh in stock prices, the FIA scratches that itch, too. But if you have only the median amount of savings at retirement  — about $150,000 in the United States, according to the Stanford Center on Longevity, you may not be able to afford a zero return. You may need a positive return and a noloss guarantee. A multiyear guaranteed annuity (MYGA) meets those criteria. (See Chapter 6 for details on MYGAs.)

BUYING AN FIA THROUGH AN RIA Registered investment advisor (RIA) firms rarely recommend annuities to their clients, except for the purpose of tax deferral. Because investment advisor representatives (IARs), who work at RIAs, don’t take commissions and may not have insurance licenses, they often lack the incentive and the credentials to deal in annuities. At sites like DPL Financial Partners ( or Halo (https://, a licensed insurance agent can help IARs choose nocommission “advisory” versions of FIAs and set up a flow of advisory fees from the contract to the adviser that’s not a taxable distribution. No-commission FIAs tend to offer richer crediting formulas and higher returns, all else being equal. But advisers must still be paid. In the long run, their monthly or quarterly fees may reduce the contract returns as much as a commission would.


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»» Getting acquainted with registered index-linked annuities »» Setting up your annuity the way you want »» Digging deep into registered indexlinked annuities »» Buying a registered index-linked annuity »» Seeing who regulates registered index-linked annuities »» Looking at recent similar savings products



Aiming Higher with Registered Index-Linked Annuities


egistered index-linked annuities (RILAs) are the bright, shiny new objects in the firmament of annuities. They appeared about three years after the 2008 financial crisis, when interest rates were low. In the multi-millennial history of annuities, they’re the new kids on the block. Most people use RILAs for tax-deferred investment growth over discrete terms of one to six years. The life/annuity industry defines RILAs as offering the potential for growth with “defined protection.” They’re classified as securities, which means you’d buy one from an adviser at a brokerage firm, not from an insurance agent not licensed to sell securities.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities


RILAs are the annuity counterpart to the structured products of the securities world. Buying a RILA means turning over control of a big chunk of money to a life/ annuity company that uses a small part of it to buy options (make precise bets on a stock market index like the S&P 500 Price Index). When the indexes go up between the beginning and end of your contract, you win. When the indexes go down, you’re protected from part of the potential loss. Since their introduction in 2011 by AXA Equitable (now Equitable Financial), RILAs have gradually filled a vacuum left by declining sales of traditional variable annuities (VAs). In 2022, 20 different life/annuity companies together sold almost $41 billion worth of RILAs, up from $13 billion in 2018. Equitable, Allianz Life of North America, Brighthouse Financial (formerly MetLife’s retail annuity business), Prudential Annuities, and Lincoln Financial Group accounted for about three-quarters of those sales. In this chapter, I explain what RILAs are (and aren’t) and how to customize them to fit your retirement plans. I also look under the hood of a top-selling RILA and hear from someone who actually owned one. RILAs require so many complex choices and decisions that, unless you’re very experienced with options and variable insurance products, you should enlist the help of an experienced financial adviser.

Understanding Registered Index-Linked Annuities First, let’s unpack that mouthful of a name:

»» Registered indicates that these contracts are registered with the Securities and Exchange Commission (SEC) of the U.S. Treasury Department. That fact alone sets RILAs apart from all the state-regulated fixed annuities.

»» Index-linked means that RILAs’ growth relies on the appreciation of options on

the performance of a market index, such as the S&P 500 Index. In this respect, RILAs resemble fixed index annuities (FIAs). But the two differ significantly, as I explain in this chapter.

»» Annuities, of course, means that RILAs share certain features with all other

annuities. They’re issued by life/annuity companies. They offer the benefit of tax-deferred growth with no required minimum distributions in retirement. They can be (but rarely are) converted to a fixed or variable stream of lifetime income.


PART 2 Identifying the Major Annuities

With a RILA, as with an FIA, the life/annuity company is, in effect, buying options on a market index for your account instead of buying shares in an market index fund. The options allow you to place specific upper and lower limits on the amount you can lose over a given number of years. Figuratively speaking, the RILA puts training wheels on your investment bicycle. They prevent you from extreme gains and extreme losses. A RILA is an annuity contract that

»» Credits interest based on the performance of an external securities index,

such as the S&P 500 Index, over a specified period of time (the return period)

»» Limits both positive and negative returns »» Limits positive returns by imposing a cap on your potential returns (for example, giving you only up to a 6 percent gain)

»» Limits negative returns by providing either a buffer (where the insurer bears the loss up to a certain specified percentage) or a floor (where the insurer bears all loss in excess of a specified percentage)

Customizing Your Registered Index-Linked Annuity You can customize a RILA contract much the same way as you’d customize an FIA contract. You can choose a market index to bet on, a term length, and a crediting formula. You can also tack on a lifetime income guarantee if you’re so inclined.

Choosing terms or segments Your first decision is to choose a term length or segment length. This is simply the amount of time you want your money to simmer and, hopefully, grow. Common term lengths are one year, three years, and six years. Unlike FIAs, RILAs don’t come with ten-year term lengths. That’s probably because RILAs are federally regulated securities, and the feds frown on tying up investors’ money for that long. A six-year RILA term may come with a surrender fee as high as 7 percent in the first year. You won’t pay a surrender charge unless you pull money out of the contract too soon.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities


A RILA may allow you to remove some or all of your money if you need it before the end of the term, but you may still face a surrender charge. It’s true of most annuities: Don’t tie up money for several years if you think you may need it in the meantime.

Choosing indexes A RILA contract, like an FIA, involves the purchase of options (by the life/annuity company) on the movements of a market index, such as the S&P 500 Index. So far, I haven’t seen any RILAs with the volatility-controlled indexes that now dominate FIA contracts. If that’s true, it may be because RILAs are more growthoriented than FIAs, and volatility-controlled indexes can stifle extreme growth. You will, however, find price indexes in RILAs (see the last paragraph in this section). Here are examples of the types of indexes you’d see in a RILA:

»» S&P 500 Price Return Index of large U.S. company stocks »» NASDAQ-100 Price Return Index of 100 technology companies »» Russell 2000 Price Return Index of 2,000 small companies »» MSCI Emerging Markets Price Return Index of developing country stocks »» MSCI EAFE ETF of global developed market stocks Many people divide their contributions to RILAs and FIAs equally or in different weights among several or even all the indexes. To anyone used to diversifying their holdings of stocks, that strategy will come naturally. Because you can’t predict the future, you may as well put part of your money into each. The price return versions of market indexes don’t include the dividends that add to the original index’s growth. Options on price-return indexes cost less than options on the original indexes, which in effect allows the insurer to buy more of a smaller product, all else being equal.

Choosing buffers and floors When customizing your RILA, you must choose a buffer or a floor. These cushion you from loss in two very different ways:

»» A floor would stop your losses at 5 percent, 10 percent, or 30 percent in a

crash, for instance. If the index lost value between the beginning and end of your contract term, you would absorb the losses down to the floor.


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»» A buffer would spare you the first 5 percent, 10 percent, or 30 percent of losses in a crash. You would be responsible for net losses beyond those boundaries.

You or your adviser will notice, when you examine the sales literature, rate sheets, prospectuses, or applications for these products, that the bigger your buffer or floor, the lower the ceiling on your potential gains. That’s just another of the many trade-offs between risk and reward that characterize the investment world. If you choose a buffer, you’re liable for all losses beyond the buffer line. For instance, if you chose a 10 percent buffer and your index is down 30 percent from its original value at the end of the contract term, your loss would be 20 percent. A 10 percent floor, on the other hand, would limit your loss to 10 percent in a 30 percent crash. Keep in mind that you wouldn’t necessarily lock in a big loss if the market recovered before the end of your contract term.

Adding a lifetime income guarantee Lifetime income guarantees  — otherwise known as guaranteed lifetime withdrawal benefit (GLWB) riders — are features on some RILAs. As Chapter 10 shows, this type of rider lets you stay in control of your investments and retain access to your money while promising you an income for the rest of your life that will not go down (unless you withdraw too much of your money).

Choosing which “cap” to wear Most people (and their advisers) are drawn to the crediting formulas that are either uncapped or have high caps. Uncapped means that you receive what the index returns at the end of six years. The shorter the term or segment length, the higher the cap (and vice versa). If you choose a one-year term, your potential gain may be capped at 20 percent for the year. If you choose a six-year term (a common term for a RILA), the cap may be as high as 650 percent. Of course, it would take more than a 48 percent average annual compound gain to exceed a 650 percent cap. Each of the thousands of RILA owners will have a different pattern of returns depending on the start and end dates of the terms they choose. Two people may choose the same term, index, and cap, but if they buy their contracts weeks or months apart, they’ll probably have different returns.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities


STRUCTURED CAPITAL STRATEGIES PLUS As an example, let’s look at a recent version of the very first and still one of the topselling RILAs, the Structured Capital Strategies PLUS contract from Equitable. All specific rates are taken from the contract rate flyer. These rate flyers are available online. Rates fluctuate over time. The following table includes only buffers (not floors) and caps (not participation rates) for the standard six-year term and the standard one-year term. This contract also offers six-year terms with more complex crediting formulas. Six-Year Segment Buffer


Cap Rate

–10 percent

S&P 500


Russell 2000

250 percent



S&P 500

500 percent

Russell 2000

150 percent


650 percent

S&P 500

125 percent

Russell 2000

100 percent


200 percent

One-Year Segment Buffer


Cap Rate

–10 percent

S&P 500

18.0 percent

Russell 2000

21.0 percent


17.5 percent


21.0 percent

MSCI Emerging Markets

26.0 percent

–20 percent

–30 percent

*All are “price return” versions of the index. Note: Not all indexes are available in all firms or jurisdictions. Source: SCS Plus Rate Flyer. April 20, 2023

Perhaps you’re 60 years old and you plan to retire at age 66. You would like to grow $100,000 without fear of taking a big stock market loss. With your broker’s help, you


PART 2 Identifying the Major Annuities

decide to buy a Structured Capital Strategies PLUS contract with a standard six-year segment. You can then choose one or more indexes, each of which will have its own performance cap rate. At the end of six years, you’d receive either the net gain of each index you chose (the difference between its starting value at the beginning of the term and its value six years later) up to the cap, or pay the net loss (in excess of the buffer). If you chose the 20 percent buffer and the index was down 25 percent after six years, for example, your account value would have dropped by 5 percent.

Seeing How RILAs Work When the first RILAs appeared in 2011, they were called structured VAs. In the wine world, structure refers to the delicate balance between a wine’s tannins, acidity, glycerol, and alcohol. In the financial world, structure means using options to invest within a definable range of risk and return. Options are both strange and familiar. You probably know that Hollywood producers can buy options from novelists to make movies out of their books. Perhaps a producer pays a writer $10,000 for rights to a book for one year. By the end of one year, the producer will have decided either to make the movie or to let the option expire. If the book suddenly becomes a bestseller six months into the options contract, the producer might be able to sell their option for much more than $10,000. In finance, options can be more complex. Highly customized structured investments have long been sold to institutional investors (pension funds) or wealthy individuals by wealth managers at full-service brokerages or wirehouse. RILAs are a standardized version of those wire house products for a wider audience — older investors with independent financial advisers. Along the spectrum of risk and reward, RILAs are said to be halfway between FIAs and VAs. When you buy an FIA, you have no risk of losing principal and you have the potential to outperform bonds by about 2 percent per year. When you buy a VA, you own mutual fund–like investments and have no protection against investment risk. RILAs are in the middle. You have more downside protection than in a VA but less than in an FIA, and more upside potential than in an FIA but less than in a VA.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities


HOW RILA CREDITING RATES ARE SET Exactly how does a life/annuity company set the crediting rates of a RILA? By purchasing a package of options, which it might do through the options trading desk of an investment bank. The package will include a call spread to capture potential gains and either a buffer or floor to limit losses. The call spread has two components:

• One component is the purchase of an at-the-money (ATM) call. It gives you the right (but not the obligation) to sell your share of the index at today’s price one year from now.

• Another component is the sale of an out-of-the-money (OTM) call, which gives somebody else (a counterparty) the right to sell your share of the index one year from now at a price higher than today’s price.

Together, the two calls form a bracket with a floor and ceiling. You get the gain from the floor to the ceiling. Any gain above the ceiling belongs to the owner of the OTM call you sold. If the index doesn’t rise, the options expire with no value. The call spread determines your potential for gain. RILAs also offer buffers and floors to limit a potential loss. As noted earlier, a 10 percent buffer means that you lose money only if the index value falls farther than 10 percent. A 10 percent floor means that you can’t lose more than 10 percent if the index drops. To set a 10 percent buffer, the insurer sells an OTM put. (A put option gives it’s owner the right, but not the obligation, to sell a specific amount of an investment at a predetermined price within a specific time frame.) This will require you to pay someone else the difference if the index falls more than 10 percent. If the index falls less than 10 percent, you lose nothing but the price of the options. To set a 10 percent floor, the insurer sells an ATM put and buys an OTM put. This means that if the index falls less than 10 percent, you will owe that amount to the buyer of the ATM put. But your potential loss stops at 10 percent. Which provides more upside potential: buffers or floors? The answer depends on market conditions when the RILA contract is purchased, actuaries say. The designs of crediting formulas depend on many factors. These include the index you choose, the expected volatility of the index, and the prevailing interest rates when you buy your contract.


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COMPARISON WITH DEFINEDOUTCOME ETFs RILAs have a counterpart in the non-annuity world. It’s called a defined-outcome ETF or buffered ETF. Like RILAs, buffered ETFs offer investors the prospect of returns within a performance band, a cap that limits how much you can win, and a buffer defines how much you can lose. You can customize buffered ETFs by picking an index, a term length, a cap, and a buffer or floor that suits your needs. As with RILAs, you lock in your gains and then take your money out or roll it over into a new term period with new parameters. Unlike RILAs, buffered ETFs offer no guarantees. Where a RILA may promise that you’ll receive up to 150 percent of the gain of the S&P 500 Price Index at the end of a contract term, buffered ETFs give you whatever the index and the crediting formula give you. You can also buy into a buffered ETF in the middle of a term. They don’t offer lifetime income benefits, bonuses, or death benefits that are typical of RILAs and other annuities. They also don’t have the fees that typically come with those features. The products also have different tax consequences for investors. For instance, RILAs offer more opportunity for tax deferred buildup of investment gains than do buffered ETFs, and tax penalties that can apply to early withdrawals (before age 59½) from a RILA would not apply to withdrawals from a buffered ETF.

Finding Out Who Buys or Sells Registered Index-Linked Annuities You may buy a RILA if you feel more comfortable with a vehicle (a word that lets me avoid the misdemeanor of calling any annuity an “investment” even when it’s used as an investment more than as insurance) that gives you a return with upper and lower boundaries rather than a return with no lower limit. You’re most likely to be offered a RILA by an investment adviser who works for an independent brokerage firm. Because RILAs are registered products overseen by the SEC, only investment advisers with licenses to sell securities can sell them.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities


ONE MAN’S EXPERIENCE WITH A RILA Several years ago, a 53-year-old actuary decided to buy a RILA. He wanted to earn a higher return than he could get at that time by investing in books. But he was afraid to invest in stocks as he approached his retirement red zone, when it becomes harder to recover from a big loss in the value of savings. After doing some homework, he decided to move $50,000 from certificates of deposit (CDs) into a RILA. “My money was in CDs, earning between 1 percent and 2.5 percent, and I wanted to earn more without too much risk,” he told me. “So, in 2016, I took $50,000 and bought a contract with a five-year lock [term].” Within the contract, he divided his $50,000 evenly among four crediting strategies:

• –10 percent buffer, S&P 500 Price Index, 86 percent cap • –10 percent buffer, Russell 2000 Price Index, 67 percent cap • –20 percent buffer, S&P 500 Price Index, 38 percent cap • –20 percent buffer, Russell 2000 Price Index, 39 percent cap If the S&P 500 Index rose over the next five years, he would receive all the gain up to 38 percent (with a –20 percent buffer) or 86 percent (with a –10 percent buffer). If the Russell 2000 showed a net gain, he would receive up to 39 percent (with a –20 percent buffer) or 67 percent (with a –10 percent buffer). For example, if the S&P 500 Index were up by 50 percent after five years, his investment earns 50 percent with the –10 percent buffer and 38 percent with the –20 percent buffer. If either of the indexes were down 25 percent after five years, his actual loss would be either 15 percent or 5 percent, depending on whether the –10 percent or –20 percent buffer applied. “As long as the markets didn’t have a bad five-year run,” he said, “I knew I wasn’t going to lose any money.” Before we tell you exactly how he’s fared so far, here’s some background: If the index is down after five years, he would lose nothing unless it fell more than 10 percent (or 20 percent, with the bigger buffer). Note that the larger caps come with smaller buffers. Four years after he bought the RILA, the S&P 500 Index had gained 55 percent and the Russell 2000 had gained 31 percent. He received the full gain on three of his four index strategies. On the S&P 500 strategy with a –20 percent buffer, he received 38 percent instead of 55 percent.


PART 2 Identifying the Major Annuities

Considering that he could have let his savings languish in CDs, this investor was satisfied with his RILA performance. He could not help noticing, however, that if he had invested his $50,000 directly in shares of an S&P 500 Index Fund, instead of buying options on the S&P 500 Price Index, his returns would have been greater. That’s because the S&P 500 Index includes dividend yield from the stocks in the index, while the S&P 500 Price Index doesn’t. Dividends added another 25 percent to the total return of the S&P 500 Index, relative to its Price Index clone.

Regulating RILAs Because RILAs are relatively new, securities and insurance regulations haven’t completely caught up with them. Regarding regulation, RILAs have historically been somewhat of a square peg being squeezed into a round hole, as one securities and insurance lawyer wrote. The lawyer meant that current regulations don’t include a precise category under which life/annuity companies should submit new RILA contracts to the SEC for its approval. But the square peg/round hole metaphor applies generally to this type of annuity.

SEC New RILA contracts are regulated by the SEC because, like VAs, RILAs involve risky securities on which you can lose money. The buffers in RILAs at first mystified the SEC. What could Wall Street’s policeman make of a product that leaves the customer with potentially unlimited exposure to loss? (Contract owners with –10 percent buffers, after all, would lose 80 percent of their money if the index fell 90 percent.) Maybe because indexes have never lost that much, the SEC approves RILAs.

FINRA The investment advisers who sell RILAs are supervised by the Financial Industry Regulatory Authority (FINRA), the financial industry’s internal watchdog, which answers to the SEC.  It considers RILAs and buffered ETFs to be “complex” products.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities


FINRA has pointed out that investors like you may become confused by RILAs and not understand their features and risks. This danger could become greater as more and more investors shop for RILAs and other annuities on the internet without help from a personal adviser.

State insurance commissioners RILAs are annuities, so they’re regulated by insurance commissioners in all 50 states, plus Washington, D.C., and five U.S. territories. All those commissioners belong to the National Association of Insurance Commissioners (NAIC), but the NAIC itself is not a regulatory body. States differ in their stance on RILAs. New York is especially tough on annuities, including RILAs. In New York State

»» Only independent, external, publicly available indexes may be used. Proprietary indexes and indexes tied to an ETF are prohibited.

»» Crediting periods cannot exceed six years. »» A buffer cannot be less than 10 percent or greater than 30 percent. »» A floor cannot be less than 15 percent or greater than 25 percent. »» Caps are subject to minimum levels (3 percent to 5 percent annually) based on the level of buffer or floor and the length of the crediting period.

»» Step credits are subject to minimum levels (3 percent to 5 percent annually)

based on the level of the buffer or floor and the length of the crediting period.

»» Participation rates may be no less than 100 percent.

Considering Recent RILA-like Savings Products Since 2011, RILAs have seen growing sales. More and more life/annuity companies offer them. New product features appear regularly as companies innovate to stand out in the marketplace and respond to requests from brokerage firms and­ financial advisers for new bells and whistles. Here are a few of the life/annuity companies with recent product launches and their new products:


PART 2 Identifying the Major Annuities

»» American General Life: American General Life launched the Advanced

Outcome Annuity in 2022. This contract offers investors a chance for a percentage of index gains, index gains in excess of the insurer’s costs, and a stacker cap that combines the returns of the NASDAQ-100 and the S&P 500, each up to a cap. The contract offers a buffer, a floor, or the ability to participate in a percentage of the index loss during each term. It also has a capture-reset-reinvest feature that allows you to change your upper and lower limits at any time.

»» Principal Financial Group: Principal Financial Group announced it would

offer buffered ETFs as investment options in its VAs in 2023. With returns based on the performance of the S&P 500 Price Return Index, the funds would have a 10 percent cap, a 10 percent buffer or floor, and a chance to participate in a portion of the index gains above 10 percent.

»» Pacific Life: Pacific Life said it would make Invesco V.I. Defined Outcome

Funds available with certain VAs. These funds offer index-linked returns, up to a cap, as well as downside protection through a buffer that protects against the first 10 percentage points of loss over a one-year period.

»» Nationwide: The Nationwide Defined Protection Annuity is a single-purchase payment annuity that features five strategies, each including several factors used to credit earnings, such as protection level, strategy term, and strategy spread.

The annuity also includes a lock-in feature: After each strategy term, a contract owner may lock in the index value on any business day before the end of the strategy term. The locked-in index value is then used when calculating earnings any time between the lock-in date and the end of the strategy term.

»» F&G Life: F&G Life recently brought out a combination FIA and RILA called

Dynamic Accumulator. On any given contract anniversary, contract owners who have already booked gains can then switch to a RILA-type crediting strategy that offers more upside potential than the FIA crediting.

CHAPTER 9 Aiming Higher with Registered Index-Linked Annuities



»» Understanding variable annuities »» Looking at investment-only variable annuities »» Considering variable annuities with income riders »» Weighing the pros and cons of variable annuities



Tapping Variable Annuities for Tax Breaks and Income


ariable annuities (VAs) are best suited for near-retirees or retirees who want to invest in mutual funds, defer income taxes, and perhaps establish a guaranteed “floor” income in retirement. They’re for people who want to maintain control over their investment portfolios but also want some of the protections that annuities offer. Four types of VAs are described in this book. I talk about two of them in this chapter:

»» Investment-only variable annuities (IOVAs) »» Variable annuities with a guaranteed lifetime withdrawal benefit (VA/GLWB)

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


These contracts share certain characteristics. Your money goes into mutual fund– like investments instead of the life insurer’s general fund. You can trade in and out of these funds, to a point, without generating an unwanted tax bill. You can also lose money, which is why the federal government regulates them and why only securities-licensed advisers can sell them. The IOVA and the VA/GLWB serve different purposes for different types of people. IOVAs offer tax breaks. They’re best for people in high tax brackets who have filled their quota of contributions to individual retirement accounts (IRAs) or workplace retirement savings plans. By design, IOVAs have few insurance features and low fees. Today, Americans hold some $2 trillion in savings in all types of VAs, primarily in IOVAs and VA/GLWBs. If you’ve owned one for several years, you may want to reevaluate it, based on the information in this chapter. The deferred VAs described in this chapter differ from the two other major classes of VAs. Those are the immediate variable income annuities (see Chapter 7) and the structured variable annuities, also known as registered index-linked annuities (RILAs; see Chapter 9).

Understanding Variable Annuities An annuity contract is variable when your premium (your investment) goes toward the purchase of “subaccounts” that resemble mutual funds. Each subaccount contains dozens or hundreds of individual securities. The annuity’s market value fluctuates throughout the business day until officially locking in at 4 p.m. When you buy a VA, your money isn’t commingled with other people’s money in a life insurer’s general account (as a fixed annuity premium is). Instead, your subaccounts stay in a separate account. You can move money from one subaccount to another, just as you would change investments in a 401(k) plan. If the life insurer goes bankrupt, your money is safe from the claims of its creditors. In short, you have more control over the risks you take with your money than you would if you bought a fixed annuity. You’ll most likely hear about VAs from an adviser at an independent broker-dealer (like Raymond James or LPL Financial) or from a captive agent working for an annuity company (like Ameriprise Financial, Brighthouse Financial, or Lincoln Financial).


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About four in five VAs sold are B-share contracts, in which the life insurer pays a commission to the agent or adviser at the time of sale and then gradually recovers it by deducting an annual fee from your account. I comment on VA share classes later in this chapter, in the section “The cons.” Less often, you’ll hear about VAs from someone with the title of investment advisor representative (IAR) at a firm legally categorized as a registered investment advisor (RIA). These advisers do not receive commissions from life insurers. Instead, they charge annual fees that are usually a percentage of all your wealth that they manage. Less than 5 percent of VAs are sold through RIAs. Because VAs are risky and don’t protect you from losses the way fixed annuities can, their sale is regulated by the Securities and Exchange Commission (SEC) and monitored by the Financial Industry Regulatory Authority (FINRA), the securities industry’s internal watchdog. As insurance products, they’re also regulated by state insurance commissions. The average annual premium paid for VAs in 2021 was about $211,000, with a range from $12,000 to $326,000, according to Wink, Inc., a Des Moines, Iowa, firm that gathers annuity sales data. The average age of purchasers was 61 years, with a range of ages from 45 to 66. All deferred annuities offer the advantage of tax deferral. But VAs give you (or your adviser) the most control over the investments while the contract is in force. Most VA contracts put a limit on the number of trades allowed in a year, however. Some contracts require you to invest in certain moderate-risk portfolios when you use certain riders. If there are joint owners of a deferred annuity, make sure the two are spouses. If the two are not related, the contract will end and a death benefit will be paid if either owner dies. Every VA/GLWB contract includes a variety of fixed costs, free services, and optional insurance features (such as income benefits and death benefits) that are available for separate annual fees. There are also penalties that are assessed only if you break the terms of the contract. These penalties include surrender charges, market value adjustments, and changes to the value of the insurance features. Some fees may be fixed percentages that stay the same through the life of the contract. The life insurer may also reserve the right to raise or reset certain fees when owners take advantage of rising investment values and opt to increase their benefit base.

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


ELEMENTS OF VARIABLE ANNUITIES In this chapter, I describe individual deferred VAs. Individual means contracts that you’d buy from an investment adviser for yourself or for you and your spouse, as opposed to contracts offered through employer-sponsored savings plans. Deferred means that the contract hasn’t been annuitized. Variable means that the cash value of the contracts can fluctuate with the value of the underlying mutual fund–like investments (the “subaccounts”). When choosing between competing VA contracts, you should pay close attention to the following features. They’re common to most VA contracts, but they differ from contract to contract. Those differences will help tell you if a contract is right for you.

• Minimum initial premium: Every VA has a minimum initial investment (called the premium) that may be as little as $5,000 or as high as $50,000. Some contracts are purchased with a single investment, while others are purchased with a series of investments. There are group and individual contracts.

• Surrender period: The typical VA contract — one that is sold by a commission-

earning broker or agent — has a surrender period during which you’ll be penalized if you withdraw more than an allotted amount, which may be 10 percent of the account balance per year.

• Investment options: By definition, deferred VAs allow you to invest your premiums in subaccounts, which are similar to mutual funds.

• Death benefit options: When contract owners die, deferred VAs pay death benefits to the contract owner’s beneficiaries. The standard death benefit pays beneficiaries the cash value of the contract. Some contracts offer enhanced death benefits, where the beneficiaries may receive more than the cash value, for an extra fee.

• Guaranteed income riders: Over the years, different VA contracts have offered

several kinds of income riders. In different ways, and for different fees, they protect your potential annual income (but not the cash value of your contract) from the impact of market crashes. In this chapter, I focus on GLWB riders because they’re the most widely offered.

• The option to annuitize: VAs, like all deferred annuities, offer you the right to convert your account value to a fixed or variable income stream. The conversion is known as annuitization.


PART 2 Identifying the Major Annuities

Basic fees in the top-selling VA/GLWB contract include the following:

»» Core contract charge (1.3 percent): This annual fee covers the life insurer’s expenses, including overhead and the costs of paying broker-dealers and investment advisers to sell the contracts to the public.

»» Annual fund expenses (0.52 percent to 2.01 percent): These annual fees

cover the cost of the management of the subaccounts by third-party mutualfund managers.

»» Living benefit riders (from 1 percent to 2 percent or more): Some of the largest fees on VAs are the fees you pay for riders that offer guaranteed income streams that last as long as you live.

»» Death benefit riders (from 0 to 2 percent): Fees charged on death benefit

riders vary. A death benefit that offers your beneficiaries the cash value of your account at your death may cost nothing. A death benefit that promises your beneficiaries an amount equal to your original premium, or that promises them the highest amount that your account value ever reached, will cost 1 percent per year or more.

Life/annuity companies levy these penalty fees on several types of annuities if you withdraw money from your account in a way that causes the company to lose money:

»» Surrender charges (starting at 8.5 percent and declining to 0 over seven years): These charges are assessed only if you take too much money out of your contract during the first seven years you own it.

»» Market-value adjustments: These fees may be subtracted from your

withdrawals if you withdraw money from the fixed-interest investment option in a VA contract. (For details on market-value adjustments, see Chapter 6.)

VA/GLWB fees, not counting surrender charges and market-value adjustments, can easily mount up to 3 percent or 4 percent a year. Those fees are large enough to negate half or more of a contract’s investment gains each year. For that reason, a VA/GLWB only makes sense if you intend to make full use of the income guarantee.

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


VAs FOR CLIENTS OF REGISTERED INVESTMENT ADVISORS Firms that are called RIAs, and the IARs who work there, have a history of rarely recommending insurance products or annuities to their clients. They provide financial advice; they don’t sell products. RIAs and their IARs have no personal financial incentive to recommend annuities to you. They earn money by charging you a fee based on the amount of your wealth that they manage. They don’t accept sales commissions from life insurers. They may not be personally licensed to sell life insurance or annuities. But life/annuity companies are eager to market to the clients of RIAs, especially the clients who are nearing or in retirement. Many life insurers have created no-commission annuities, and annuity distributors have created internet platforms where a licensed agent can broker a no-commission annuity sale for RIAs and their clients. The first successful product in this category was the Monument VA from Jefferson National Life. Nationwide Financial, one of the largest life insurers in the United States, bought Jefferson National in 2016 and began offering a selection of no-commission annuities. The Monument contracts offered an opportunity for tax deferral but no insurance features. Other life insurers have followed suit with their own no-commission VAs for RIAs. Additional sellers of such products in 2021 included Lincoln National Life, Transamerica, Jackson National Life, Pacific Life, Ameritas, TIAA Life, and Protective Life, according to Wink, Inc. Two pioneering insurance platforms for RIAs include DPL Financial Partners ( and RetireOne (

Investment-Only Variable Annuities The simplest type of VA is the IOVA. You would use this type of traditional VA primarily for tax-deferred investing. A typical IOVA may offer a hundred or more different fund-like investment choices from a multitude of mutual-fund companies. Life insurers compete to offer IOVAs with large selections of funds. You’ll find stock funds, bond funds, balanced funds, real estate funds, and commodity funds from the entire range of fund companies, from American Funds to Zebra Capital. Each individual fund may include securities from hundreds of different U.S. or global companies. Fund expenses vary from less than 0.5 percent to more than 2 percent per year.


PART 2 Identifying the Major Annuities

People who have several hundred thousands of dollars on which they have already paid income taxes may buy this type of annuity as a decades-long investment. Because the investments in the contract grow tax-deferred, the funds do not distribute earnings each year. These contracts are especially valuable for people who could otherwise lose a third or more of their realized capital gains to income taxes. IOVAs are popular with investors who like trading funds frequently. They know they won’t owe taxes on the profits generated by such trades until they withdraw money from their contracts. (The life insurer may limit the number of free trades in a year, however.) The contracts do not distribute any gains, dividends, or interest that will be taxed as ordinary income in the year they’re earned. Owners of VAs can choose not to withdraw any money from their contracts during their lifetimes. Those who inherit the contracts will have to pay taxes, however. IOVAs typically don’t offer enhanced death benefits, so they aren’t commonly used for intergenerational wealth transfers. IOVAs have the lowest costs of any VA contracts. Aside from the fund fees, their only expense may be the annual or monthly contract fee. Clients of advisers who don’t accept commissions can buy fee-only versions of IOVAs that have only minimal contract fees. The client is obtaining access, in effect, to a life insurer’s curated list of investment funds and the tax advantages granted by the U.S. government. Although these contracts typically don’t have income riders, they do have annuitization options. You can use the cash value of the contract to buy a fixed income annuity or a variable income annuity. (Chapter  7 has more details on income annuities.) Think carefully before buying a VA with money from a traditional IRA. Although the purchase may give you access to an interesting set of investment options, you won’t gain any additional tax benefits by doing so. You don’t avoid required minimum distributions (RMDs) starting at age 73.

Variable Annuities with Income Riders The other major type of deferred VA is the VA/GLWB.  Where an IOVA’s main attraction is tax deferral, people use VA/GLWBs to lock in guaranteed income for life while retaining the right to make withdrawals from their account whenever they want to.

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


The GLWB is an ingenious bit of financial engineering. When you own a VA with this feature, you must keep track of two numbers:

»» Your account value: This is simply the cash value of your investments in the

VA. Your purchase premium is your initial account value. Depending on the performance of your investments (the subaccounts), the value can go up or down. It can increase if you contribute more money to the contract, and it can decrease if you take withdrawals from the contract.

»» Your benefit base: When you first buy the contract, your benefit base will be

the same as your account value. After you activate the rider and begin drawing a monthly income from your account, your income will equal a certain percentage of your benefit base.

Here’s an example: Imagine that you invest $200,000 in a VA at age 60. Ten years later, when you’re 70, you decide to retire. Over that time, the life/annuity company increased your benefit base by 5 percent (simple interest) for every year you skipped all withdrawals from your contract. At age 70, your account value may be $280,000 or $320,000. But your benefit base will be at least $300,000, thanks to those bonuses. In this hypothetical case, your contract entitles you to an income of 6 percent of $300,000 (or $18,000) per year for the rest of your life. Even if your account value drops to zero because of your withdrawals, the company’s fees, or losses in bear markets, you’ll still get $18,000 a year — as long as you follow the contract rules. Those rules vary from contract to contract. Generally, your income will go down if you withdraw more money in any given year than you’re allowed (in this case, $18,000). If your account value becomes higher than your benefit base, you may be able to mark up your benefit base to match it. Also, if you had waited until age 75 to begin taking income, you may have been entitled to 7 percent of your benefit base instead of 6 percent, for an annual guaranteed payout of $21,000.

How best to use a variable annuity with a guaranteed lifetime withdrawal benefit Most VA/GLWB contracts offer lots of flexibility in the way you can use them. You can simply use them as way to save for retirement and in retirement. You can take withdrawals from them or not.


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At any time, you can “switch on” the income feature and begin drawing a monthly income for the rest of your life. Even after you’ve started drawing an income, you can still take withdrawals as you need them. But your income will be reduced proportionately if you do (see “Calculating the impact of VA withdrawals,” later in this chapter). .

One school of thought says that you should switch on the income feature as soon as you buy the contract. For instance, if you put $500,000 into the contract at age 65 and you’re allowed to start taking a guaranteed 5 percent (or $25,000) for life, you should. But there are other ways to use the contract. As previously noted, many contracts offer you incentives to delay turning the income feature on. For instance, your benefit base (and your future income) may rise by 5 percent (to $525,000, in the example) for every year (for up to ten years, in many cases) in which you take no withdrawals. Or the contract may allow you to increase your withdrawal rate by a quarter of a percent (say, to 5.25 percent from 5 percent) if you delay taking income until you’re a year older. These incentives aren’t as valuable as they may look. Retirees have only a finite number of years left to live. By delaying income, you lose a year of income. You may also lose between 3 percent and 4 percent of your account value to investment fees and rider fees in every year you own the VA/GLWB contract. Another school of thought says that you should switch on the guaranteed monthly income-for-life feature when the account value of your contract drops below the value of your benefit base. For instance, if a market crash reduces your account value to $400,000 from $500,000, but your rider still entitles you to 5 percent of $500,000 for life, you should take the $25,000 in annual income. After all, preservation of your income stream is why you’re paying for the rider. You may enjoy keeping all your options open — the flexibility of VA/GLWBs is a big part of their attraction. Or you may find all these rules confusing. You may not like having to make so many decisions. You may not like paying the rider fees, especially if you’re not using the rider. If so, you may prefer to buy a single premium immediate annuity (SPIA) and a portfolio of mutual funds instead of buying a VA/GLWB. If you have $500,000 at age 65, you could buy a SPIA for $350,000 and get a no-fee, joint-and-survivor annuity paying 6.5 percent per year (or $22,800, at 2023 rates) and put $150,000 in index funds with virtually no fees.

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


If you’re mainly interested in tax-deferred growth of your money through investments in mutual funds, you should buy an IOVA. If you want the option to set up a retirement income stream that lasts for the rest of your life, you should buy the VA/GLWB.

What to do with old variable annuities with guaranteed lifetime withdrawal benefits Suppose you bought a VA/GLWB five or ten years ago and you’ve since changed financial advisers. You’ll naturally ask your new adviser what to do with your existing contract. If you do the wrong thing, you may be throwing away a valuable financial resource. First, you should find your contract, dust it off, and check to see if it’s still in the surrender period. If it is, you would then owe a surrender fee if you cancel your contract. Depending on how long ago you bought the contract, the surrender fee may be zero by now. Some of the older VA/GLWB contracts had very generous income riders. Some of them offered to double your benefit base after ten years. If you invested $250,000 at age 55, you could get at least 5 percent of $500,000 ten years later for the rest of your life. That’s probably a keeper. If the issuer of your GLWB annuity calls you and offers to buy back your contract, that’s a sign that your contract is deep in the money. The life insurer may offer you more than the cash value of the contract. In that case, you and your adviser will have to assess the value of your living benefit and death benefit to see if they’re worth more to you and your family than the cash.

Lifetime income versus annuitization There’s more than one way to convert your contract to lifetime income. In addition to your VA/GLWB’s income riders, your contract (like all annuity contracts) gives you the right to annuitize. This means you can convert your deferred VA to an income annuity (see Chapter 7) issued by the same life insurer. Both features give you income for life, but in very different ways. When you exercise a VA/GLWB income rider, you receive a percentage of your benefit base for as long as you live. You can also dip into your account for emergency cash, but at the cost of reducing your income.


PART 2 Identifying the Major Annuities

When you annuitize, you use the cash value of your annuity to buy a lifetime income stream, and you give up unrestricted access to your money. Your cash value may be larger or smaller than your benefit base, and the amount of lifetime income you can get may be larger or smaller. Lifetime withdrawal or minimum withdrawal riders are also available on fixed indexed annuities and, less commonly, on fixed-rate deferred annuities and RILAs. The life insurer often reserves the right to raise rider fees in the future. For instance, the current annual fee for a lifetime income rider may be a certain percentage when you buy the contract, such as 1.5 percent. But the maximum fee may be much higher, such as 3 percent.

THE TOP-SELLING TRADITIONAL VARIABLE ANNUITIES Ten large life insurers account for about three-quarters of annual sales of traditional VAs. About 43 percent of sales go through investment advisers at independent brokerdealers who take commissions from the insurers for selling them. Another 28 percent are sold by captive advisers who work directly for life insurers. Most of these contracts have seven-year surrender periods, when excessive withdrawals may be penalized. Less than 10 percent are sold by advisers at RIA firms. Here are the ten top-selling contracts as of 2021, according to Wink, Inc.:

• Jackson National Perspective II • American General Polaris Platinum III VA • Equitable Financial Equi-Vest • Pacific Life Pacific Choice 5-Year • Jackson National Elite Access II (B Share) • RiverSource RAVA5 Advantage VA 10-Year 7 • New York Life Premier VA II Fidelity • Nationwide Life Nationwide Destination B 2.0 • Nationwide Life Nationwide Destination Navigator 2.0 B Share 10 • Equitable Financial Retirement Cornerstone Series 19 B

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


ANALYZING THE TOP-SELLING VARIABLE ANNUITY WITH A GUARANTEED LIFETIME WITHDRAWAL BENEFIT At the time of this writing, the Perspective II VA from Jackson National Life Insurance Company had been the top-selling contract of its type for several years in a row. Let’s take a look at its features and fees. Investments The popularity of this contract rests in part on its wide selection of investment options. Purchasers of the Perspective II can choose from 99 different variable and fixed account options. These include low-cost index funds and exchange-traded funds (ETFs), as well as actively managed funds from firms like BlackRock, Capital Group, and AllianceBernstein. In Perspective II, you can find stock funds, balanced funds, and bond funds. You can focus on mid-cap or small-cap, value or growth, or dividend-paying stocks; on different sectors of the economy (such as real estate and commodities); or on geographic regions (domestic or international). Optional riders and their fees Here are examples of the insurance benefits and other features that are available in this contract for an additional annual charge. The maximum annual charges range from as little as 0.4 percent to as much as 3 percent per year:

• Four-year withdrawal charge schedule: Contract owners can reduce the surrender charge period to four years from seven years. The surrender charges will be 8.5 percent, 7 percent, 5.5 percent, and 3 percent.

• Enhanced death benefits: These enhancements guarantee that your beneficiaries

will receive more than the cash value of your contract if you die while the contract is in effect. The enhancements may guarantee return of premium and may guarantee a benefit that rises each year by a certain percentage, a benefit that steps up to match investment gains, or a benefit that increases the death benefit by up to 40 percent of the earnings of the contract, which may help offset state and federal taxes owed by your beneficiary.

• AutoGuard: This is a GLWB that permits an owner to make partial withdrawals prior to the income date that, in total, are guaranteed to equal the guaranteed withdrawal balance, regardless of the contract value.


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• LifeGuard Freedom Net: This GLWB allows you to withdraw a percentage of your

investment earnings each year during retirement in addition to the minimum guaranteed withdrawal.

• LifeGuard Freedom Flex: This living benefit promises a minimum income for life, along with opportunities to create a custom blend of benefits, plus opportunities for bonuses and step-ups in the income base if the cash value of the contract reaches a new high-water mark.

• LifeGuard Freedom Accelerator: This benefit is for those looking for opportunities for growth to increase the annual withdrawal amount and who are seeking flexibility to start and stop withdrawals, without negatively impacting the guarantees.

The income rider fees may be a percentage of the benefit base and not the account value. For instance, if you’re 80 and your benefit base is $200,000 but your account value has gradually fallen to $100,000 because of withdrawals, market losses, or fees, your rider fees will remain a percentage of $200,000, not a percentage of your sunken account value. Note also that your freedom to choose among investment options may be limited if you use one of the income riders. After the 2008 financial crisis, some issuers of VAs have required contract owners who elect income riders to invest only in balanced funds that hold stocks and bonds, or in funds that have algorithms that automatically reduce the amount of equities in the fund when financial markets get choppy. The returns of these funds are relatively predictable, allowing the life insurer to forecast its liabilities (the money it will owe you) more accurately. The life insurer won’t let you put all your money into high-flying “tech funds” or “growth funds” that may, in a sense, crash and burn unexpectedly. That would be comparable to letting you pay the same price for collision coverage on a new Formula One Ferrari as you’d pay on a used Honda Civic. As of 2020, the SEC began allowing life insurers to publish abbreviated versions of their annuity prospectuses. A full prospectus can run to 250 pages or more and contain detailed descriptions and disclosures of riders, expenses, investments, and risks. A summary prospectus may run to a much more practical 30 pages. It may not contain all the details you and your adviser need, however.

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


CONTINGENT DEFERRED ANNUITIES Contingent deferred annuities (CDAs) are lifetime income guarantees that can be purchased separately from a VA and attached to another set of investments. In other words, you can get the guarantee against running out of money in your old age without using a life insurer’s investments. When introduced in 2007, these products were called stand-alone living benefits. At RetireOne (, for instance, you can find the Constance Group Contingent Deferred Annuity, a lifetime income guarantee issued by Midland National Life. Like other GLWBs, the rider promises that if you obey certain rules, you’ll never run out of money, no matter how long you live.

Weighing the Pros and Cons of Variable Annuities Most of the pluses and minuses listed in this section apply to VA/GLWBs. IOVAs are relatively simple and inexpensive. What you see is what you get. You get tax deferral but your gains are taxed at the income tax rate instead of the lower capital gains tax rate. VA/GLWBs, on the other hand, are relatively complex, confusing, and expensive. They present you with trade-offs that may not be apparent when you sign the contract. If you buy one, do so with the help of an adviser you trust and who has experience with VA contracts.

The pros Here are some of the advantages of VAs:

»» One-stop retirement planning: VA/GLWBs are like cruise ships in the sense that they cater to every financial anxiety in retirement — living too long or dying young, experiencing a bull or bear market at the worst possible time, spending too much money or not enough — while letting you keep all your options open.


PART 2 Identifying the Major Annuities

»» A “panic prevention” tool: When the stock market takes a dive, you may feel

the urge to sell stocks. It has been said that a VA with an income rider gives you the confidence to resist. That’s because, no matter how low stocks go, your future income can’t fall below, say, 5 percent of your original investment.

»» Tax management: Earnings on after-tax (non-IRA) contributions to a VA are

not taxed until you withdraw them. You don’t have to take RMDs from an after-tax (nonqualified) VA at age 73. You can trade into and out of your funds without facing a Form 1099 in January.

»» Potential inflation protection: If the account value of your VA rises, you may be entitled to increase your benefit base, which, in turn, will increase in your guaranteed annual income.

»» Guaranteed income with liquidity: These riders allow you to lock in a

guaranteed income stream in retirement without locking you out of access to the glacier of savings from which that stream runs.

»» A wealth of death benefits: Many VAs offer more than one death benefit. »» Investment control: With a VA, you or your adviser can change investments in response to market conditions.

»» No limit on the contribution of after-tax money: If you’ve already maxed

out your contributions to other tax-favored retirement accounts, you can put your extra savings in a VA. You may need special permission from the life insurer to invest more than $1 million.

»» Potential protection from sequence-of-returns risk: Academics have

proposed that a GLWB rider may protect you from sequence-of-returns risk. You may be able to buy the rider just for the five years before and after you retire. Then, if you don’t expect to use it for guaranteed income, you can let it lapse.

The cons Here are some of the disadvantages of VAs:

»» Expenses: The total annual expense ratio of a VA/GLWB varies widely from

contract to contract, but it frequently exceeds 3 percent. Check to see which riders and fees can or can’t be added or dropped after you buy the contract.

»» Unexpected fee hikes: In the fee section of a VA prospectus, you may see references to a current fee and a “maximum fee.” Be aware that the life insurer can unilaterally raise one or more of the contract fees.

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income


»» Step-up fees: Your opportunity to “step up” the benefit base to a higher cash value may be limited to one day per year, on the anniversary of the purchase of your contract. Your fees may also go up if you take advantage of a step-up opportunity.

»» Complexity of GLWBs: An untrained person won’t easily understand the

lifetime income riders. To evaluate their features and make sensible choices among them, you’ll need help from an adviser who has a track record of using VA/GLWBs.

»» High maintenance: You should keep tabs on your contract. You may need to make important decisions by or on certain dates, such as contract anniversaries.

»» When withdrawn, earnings are taxed as ordinary income: You or your beneficiaries will owe income taxes, not capital gains taxes, on previously untaxed withdrawals. This is true of all annuities.

»» The 10 percent federal penalty tax on withdrawals before age 59½: This is a reason not to buy any deferred annuity (unless it’s a group annuity in an employer-sponsored retirement plan) when you’re youngish.

»» The potential for your account balance to drop: A GLWB can guarantee

you a specific level of income in retirement, but it can’t protect you from a decline in the market value of your investments. The cash value of the contract can sink. If you want guaranteed returns without possible loss, look into a fixed deferred annuity.

»» Surrender periods: If you buy a B-share annuity, where the life insurer pays your adviser a commission and then recoups the expense from you, you’ll face restrictions on the amount you can withdraw each year without a penalty. (For more on surrender periods and surrender charges, turn to Chapter 3.)

»» No guarantee of inflation protection: Many people believe that owning

stocks enables you to keep up with inflation, and GLWB riders have been promoted as ways to establish a retirement income that keeps pace with inflation. But the drag from the annual fees of VA/GLWBs may prevent your account from growing fast enough to deliver the step-ups that can raise your annual income.


PART 2 Identifying the Major Annuities

CALCULATING THE IMPACT OF VA WITHDRAWALS You’re free to take withdrawals from a VA contract. But a withdrawal will reduce not just the cash value of your contract but also the benefit base of your insurance riders, such as the income benefit and the death benefit. The size of the changes depends on whether the life insurer uses the dollar-for-dollar or pro rata method to calculate them. According to “Understanding Variable Annuities,” an October 2022 report from Morgan Stanley, A pro rata reduction means that the withdrawal will reduce the benefit base by the proportion that the withdrawal reduces the contract value. If at the time of withdrawal, the contract value is less than the benefit amount, a pro rata reduction will reduce the benefit base by an amount greater than the withdrawal. For example, if the contract value is $200,000 and the death benefit is $300,000, a withdrawal of 50 percent of the contract value (or $100,000) will reduce the death benefit by 50 percent (or $150,000), not merely by the amount of the withdrawal. If the contract value is higher than the benefit base, the pro rata reduction will reduce the benefit base by less than the withdrawal. For example, if the contract value is $300,000 and the benefit base for the income rider is only $200,000, a $100,000 withdrawal will reduce the benefit base for the rider by one-third, or only about $67,000.

A BRIEF HISTORY OF VARIABLE ANNUITIES In mid-2022, Americans held about $1.7 trillion in individual VA contracts, down from more than $2 trillion in 2020 and 2021. Americans hold a total of about $33.7 trillion in all tax-favored retirement savings accounts, according to the Investment Company Institute. The first VA was created by the Teachers Insurance and Annuity Association (TIAA) in 1952 as an investment option in qualified retirement plans for college and university employees. In 1959, the Supreme Court ruled that VAs, unlike fixed annuities, are subject to regulation by the SEC. The Variable Annuity Life Insurance Company (VALIC) marketed the first nonqualified VA (those purchased with after-tax money) in 1960. Between 1977 and 1980, the IRS passed various rules for VAs. It ruled that annuity owners can’t manage individual stocks (continued)

CHAPTER 10 Tapping Variable Annuities for Tax Breaks and Income



in their contracts, that those who inherit annuity assets (unlike beneficiaries of appreciated stocks or mutual funds) must pay income tax on the contract’s gains, and that certificates of deposit (CDs) can’t be held in VAs. In 1982, new federal legislation required that VA owners withdraw all their taxable earnings before withdrawing any of their tax-free principal from their contracts. Four years later, the Tax Reform Act of 1986 eliminated most tax-sheltered investments other than VAs. In 1991, the National Association of Variable Annuities (NAVA) was formed. In 2008, NAVA was reconstituted as the Insured Retirement Institute. Sales of VAs soared in the late 1990s, along with sales of stocks and mutual funds. Between 1996 and 2004, insurance companies introduced the first living benefits, including the guaranteed minimum income benefit (GMIB), the guaranteed minimum withdrawal benefit (GMWB), the guaranteed minimum accumulation benefit (GMAB), and, in 2004, the GLWB. Each of these riders promised owners that they could count on an income or an account balance that would never fall below a certain level. After peaking at about $156 billion in 2008, VA sales declined to about $100 billion in 2020 before rebounding to $125 billion in 2021. Sales of traditional VAs (excluding structured VAs or RILAs) were only $35 billion in the first half of 2022, according to LIMRA, a market research group tied to the life insurance industry. Since 2012, there has been a steady net outflow of money from traditional VAs. The Great Recession of 2008 revealed both the strengths and weaknesses of this product. VA owners’ account balances fell by double digits, but their minimum income in retirement didn’t budge. That was good for the owners. But it was bad for the life insurers, who needed high account balances in order to protect themselves from losing money on their guarantees. On paper, their solvency was on the line. VAs with GLWB riders haven’t gone away. But far fewer are sold today than in years past. Their guarantees aren’t nearly as attractive as they were pre-2008.


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»» Considering deferred income annuities »» Understanding qualified longevity annuity contracts »» Shopping for the annuity that’s right for you



Aging Gracefully with Deferred Income Annuities and Qualified Longevity Annuity Contracts


etirement has three phases, the old-timers say. During the initial “go-go” years, you feel like you’re on a permanent vacation. The “slow-go” years come next, when a cruise sounds nicer than a rock climb. Last are the “nogo” years, when you may need help climbing out of a chair. Deferred income annuities (DIAs) pack their biggest punch when they’re used to provide income only in the no-go years, but they can be applied to any segment of retirement. Also, known as “longevity insurance,” DIAs are typically purchased at least a decade before they pay out.

CHAPTER 11 Aging Gracefully with DIA and QLAC


Note that the word deferred in the context of DIAs doesn’t mean what it does when discussing deferred fixed or variable annuities. DIAs create pension-like income that starts years after you buy them. Deferred fixed or variable annuities are primarily savings or investment tools. In 2014, the U.S. Treasury enabled a new kind of DIA, called qualified longevity annuity contracts (QLACs). QLACs allow retirees to buy DIAs with up to $200,000 from traditional or rollover individual retirement accounts (IRAs) without violating the rules for required minimum distributions (RMDs). I explain QLACs later in this chapter. Chapter 7 shows that single premium income annuities (SPIAs) help you solve the problem of not knowing how long your money has to last. DIAs and QLACs can help you hedge that same risk with much less up-front cash because they generate income only if and when you reach extreme old age.

Understanding Deferred Income Annuities DIAs differ from single premium immediate annuities (SPIAs; see Chapter 7) in two important ways:

»» SPIA payments start today and DIA payments start several years in the future. Most DIA contracts stipulate that you must start income by age 85.

»» You’ll get a much bigger monthly payment for the same premium with a

DIA. That’s because your premium will be earning interest or dividends during the 10- or 15-year waiting period before income starts and because you’ll be older then and receive payments for fewer years.

In a DIA, you give a portion of your retirement savings — 10 percent to 25 percent — to an insurance company in return for a guaranteed specific monthly income starting at whatever age you choose — 75, 80, or 85 years. If you die before income begins, you can arrange for your beneficiaries to receive a cash refund. The earlier you pay for the contract, the better, because your premium will have time to grow in the carrier’s coffers and buy you more income later. The later you start receiving payments, the more income you’ll get each year, simply because you’ll collect your benefits for relatively fewer years.


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DIAs are like SPIAs with “big deductibles,” according to Moshe Milevsky, author of many books on retirement and finance professor at Toronto’s York University. With a SPIA, the life/annuity company pays you an income starting at age 65 or 70. When you buy a DIA, you’re telling the insurer, “I’ll cover my own expenses until age 80 or 85, so I expect you to charge me a lot less for the annuity.”

Hedging longevity risk with deferred income annuities Extreme longevity is a blessing, surely, but it can be a financial catastrophe for those who don’t plan for it. And most people underestimate their longevity risk. Few retirees expect to live past the average age of death (about 83 years) even though half of them inevitably will. Surveys show that you’ll live, on average, about five years longer than you expect to. Because you have a better than 50/50 chance of living into your late 80s, you should consider insuring yourself against it. Table  11-1, based on National Vital Statistics Reports (updated in 2007), shows that the older you get, the longer you’re likely to live.

TABLE 11-1

The Half-Lives of Average American Retirees Half of Americans Who Reach Age . . .

Will Reach This Age













These statistics apply to the U.S. population as a whole. Some groups tend to live longer than others. For example

»» At age 65, the average woman can expect to live about 18 months longer than the average man.

»» The average Caucasian can expect to live about 18 months longer than the average African American.

CHAPTER 11 Aging Gracefully with DIA and QLAC


»» People with higher incomes tend to live longer than those with lower incomes. As Ben Franklin suggested long ago, health and wealth tend to go together.

Table 11-2 looks at life expectancy from another angle — your odds of living from age 65 to subsequent age milestones. Notice that for more than half of all married couples, one member will reach age 90.

TABLE 11-2

Probability of Survival at Age 65 To Age



One of a Couple




























Source: Society of Actuaries

DIAs can also be used to prepay retirement. In his “Retirement Planning Guidebook,” Wade Pfau, who is also the host of the Retirement Researcher website (, writes, “In practice, DIAs are used less as longevity insurance and more for prepaying for retirement and removing market risk in the pivotal preretirement years.” In that same guidebook, Pfau suggests that DIAs are most often purchased by people who want to lock in their retirement income perhaps ten years in advance of their retirement date. DIAs are arguably much more appealing when you add a refund feature. You can arrange in advance for your family to get your money back if you pass away before income starts. But there’s a cost to that, of course. The refund feature would lower your DIA’s monthly payout rate. But if you think of the income reduction as the cost of a life insurance policy for your DIA, it may make sense.

Weighing the pros and cons of deferred income annuities Before I tally up the advantages and drawbacks of DIAs, I should mention that most people underestimate their likelihood of living to age 85 or 90.


PART 2 Identifying the Major Annuities

Generally  — and studies bear this out  — many people expect to die about five years earlier than they will. If you’re fit and well-off, you have about a one-in-four chance of reaching age 90. That statistic should motivate more people to consider DIAs. (My grandmother said, “I should be so lucky!” when we warned her that she might live to 100. She did.)

The pros Insurance is most cost-effective when it covers events that are both rare and catastrophic. Frequently occurring disasters, like hurricane damage to beachfront homes in Florida, tend to be too common and costly to insure at affordable rates. Expensive but uncommon catastrophes, like living to 100, are good candidates for insurance. Just as life insurance is cheapest when you’re young, annuities are cheaper when you’re old. Before retirement, your long investment time horizon helps you accumulate wealth. In retirement, your ever-shrinking time horizon helps boost your income. That’s the logic of DIAs in a nutshell. Here are specific reasons to buy a DIA:

»» A DIA is the most efficient way to reduce longevity risk. If you’re 60 and

you want to take the risk of being broke after age 80 or 85 off the table, DIAs are the ticket.

»» DIA income is guaranteed. It’s not uncommon for retirees to set aside a

modest “granny fund” at the beginning of retirement, put the money in stocks, and count on it to grow substantially by the time they reach age 80 or 85. Then they’ll use it or leave it to their children. But you don’t know whether the granny fund will grow enough. A DIA lets you make sure that the money will be there when you need it.

»» A DIA gives you more bang for your buck than a SPIA. The folks at Financial Engines once suggested that putting 10 percent to 15 percent of your 401(k) savings into a DIA that pays out at age 80 would give you just as much safety from poverty in extreme old age as putting 60 percent of it into a SPIA that pays out at age 65.

»» A DIA makes financial planning in retirement much easier. In the previous example, you would keep 85 percent to 90 percent of your money invested and spend it carefully over the 15 years until the DIA starts. It’s much easier to design an income plan for a period of 15 years than it is to design one for a retirement of unknown length.

CHAPTER 11 Aging Gracefully with DIA and QLAC


»» A DIA helps you beat the 4 percent rule. Suppose you retire at age 65 with

$400,000 in invested assets. Financial advisers often say that, to ensure that your money lasts your entire life, you should limit your annual withdrawals to 4 percent of that amount, or $16,000 per year. If you put 25 percent of that money ($100,000) into a DIA starting at age 80, you could lock in ten years of guaranteed, no-loss income of about $28,000 a year at 2023 rates (or $32,000 a year for life with no refund), according to The remaining $300,000 would provide you with income between ages 65 and 80.

The cons The biggest drawback of a DIA is that it’s insurance. As with any form of insurance, not everyone who owns it will get to file a claim and receive a benefit. (If they did, the insurance would cost a lot more.) Here are two other drawbacks of DIAs:

DIAs AND QLACs ARE MOST SUITABLE FOR WELL-EDUCATED, HIGHLY PAID PEOPLE Highly paid, highly educated people are the ideal users of DIAs and QLACs, according to 2023 research from economists at the University of Pennsylvania and Goethe University in Frankfort. Relative to less-educated people, the well-educated live longer on average and, therefore, benefit more from annuities that produce income for life. The well-educated are also likely to manage their investments during the interim period between retirement and the date on which DIA or QLAC income begins. “Better educated males and females benefit far more — 7 to 11 times more — compared to the least educated” from a DIA strategy, they wrote. The researchers, who were studying ways to help participants of 401(k)-type savings plans convert their savings to pensionlike income at retirement, suggested starting DIA income at age 80. Less-educated, lower-income plan participants may be better off using a chunk of their tax-deferred savings to cover their expenses while they delay taking Social Security benefits until age 70, when benefits are highest. Because Social Security benefits replace a bigger share of the pre-retirement incomes for lower-income people, they have the most to gain, relatively speaking, by maximizing their Social Security.


PART 2 Identifying the Major Annuities

»» You give up direct access to a large sum of money for several years. In

plain English, you may never recoup the money that you’ve paid for your DIA. Even if your contract includes a death benefit or cash refund, your heirs receive the money, not you.

»» You could miss out on a bull market. You have to consider the opportunity cost of buying a DIA. That is, would you be better off using the money to buy real estate or stocks? Sure, but you’ll only know that in hindsight. In retirement, you want security more than opportunity. A DIA provides security.

Annuities provide guaranteed income, but the guarantee is only as strong as the insurance carrier that offers it. If the company fails (a rare event, fortunately) and isn’t absorbed by another carrier, you can lose your money. That’s why buying an annuity from a company with high ratings for financial strength is so important.

Postponing Required Minimum Distributions with a Qualified Longevity Annuity Contract In 2022, Congress made DIAs a lot more attractive to tax-conscious retirees who don’t like being obligated by the dreaded required minimum distribution (RMD) rules that to withdraw money that they don’t need from their tax-deferred traditional IRAs and employer-sponsored plans. It’s all about the QLACs. A QLAC is a DIA whose income you don’t have to pay taxes on until age 85 at the latest. Congress raised the limit on the amount of money you can put into a QLAC to $200,000 and removed the 25 percent cap on contributions to QLACs entirely. Let’s say you have a $200,000 traditional IRA and no other tax-deferred savings. You can postpone all your RMDs until age 85 at the latest by buying a QLAC with the whole $200,000. If you have $500,000 in a traditional IRA, you can cut your RMDs by 40 percent by putting $200,000 in a QLAC. But you’ll pay your RMDs at an accelerated rate when you start making withdrawals.

CHAPTER 11 Aging Gracefully with DIA and QLAC


The SECURE 2.0 law also expands the types of QLACs that you can buy and still postpone RMDs. The following DIAs can all be used as QLACs, according to the new law:

»» Those that increase your annual income by 5 percent or more »» Those where you can take out lump sums of cash that shorten the payment period

»» Those that allow you to take out a year’s payments in advance »» Those with refunds paid to beneficiaries at the owner’s death »» Those that pay certain dividends If you have no choice but to withdraw money from your traditional IRA or 401(k) to cover your living expenses in retirement, you’ll probably withdraw enough to satisfy your RMD requirements each year. But retirees in high tax brackets, who stand to lose a third or so of their RMDs to income taxes, may find QLACs to be a welcome source of tax relief. Here are some facts about QLACs from the Internal Revenue Service (IRS) and life/ annuity companies that offer QLACs and DIAs:

»» Contract owners, if living, can’t convert the contract to cash after buying it. »» When the contract is issued, the contract must state that it is intended to be a QLAC.

»» The contract has to be a deferred income annuity. It can’t be a deferred variable or fixed annuity, or a fixed or variable indexed annuity.

»» QLACs can be life-only contracts or life with cash refund contracts. They can be single or joint contracts.

»» When income payments start (between ages 73 and 85), they must be large

enough to meet the minimum distribution required at that age according to the IRS.

»» At the death of a contract owner, QLACs can pay death benefits to beneficiaries in amounts equal to the difference between the premium and the amount of income already paid out to the contract owner.

If you buy a DIA intending to use it as a QLAC, you must indicate that on your application for the product.


PART 2 Identifying the Major Annuities

USING A QLAC AS A HEDGE AGAINST NURSING-HOME COSTS Here’s a useful illustration provided by a mutual life insurer that issues QLACs. It posits a 65-year-old man who has $580,000 worth of tax-deferred savings in a rollover IRA. According to the example, he faces a 30 percent income tax load. He’s looking for ways to reduce his annual income tax bill. He’s in good health today, but he wants to earmark some money for potential assisted living or nursing-home costs 20 years from now. He puts $145,000 of his IRA savings into a single life QLAC that pays out nothing to him until age 85. (Under the 2022 SECURE 2.0 Act, the cap on contributions to QLACs is now $200,000.) The $435,000 remaining in his IRA will be the amount that he and his accountant will use to calculate his RMDs between ages 73 and 85. This strategy will produce two big effects, in chronological order. It will reduce his annual RMDs to about $16,000 from about $25,000 during each of those 12 years, and it will reduce his income taxes by about $2,000 per year. At age 85, his RMDs and his income taxes will spring back. His annual RMDs will be about $55,000 between ages 85 and 90, and his taxes on them, according to the illustration, will be about $16,000. Without the QLAC, the man’s RMDs will have done what federal policymakers designed them for — that is, compel retirees to spend down tax-deferred savings at an even, annuity-like pace over their life expectancy (instead of hoarding them or using them for bequests). The birth of the QLAC strategy alters that pattern. It pulls RMD income (and taxes) out of the middle years of retirement and piles them into the final years, when they’re likely to be needed for health care.

REPORTING A QLAC TO THE IRS Your insurance company is required to submit Form 1098-Q to the IRS in order to report the status of your annuity as a QLAC. The insurance company is required to submit this form beginning with the first year in which premiums are paid, and ending with the earlier of the year in which the policyholder reaches age 85 or dies. When the income from your QLAC begins, you’ll receive a 1099-R from your insurance company. The 1099-R form reports the taxable income you’ve received from your QLAC.

CHAPTER 11 Aging Gracefully with DIA and QLAC


Shopping for a Deferred Income Annuity or Qualified Longevity Annuity Contract As of January 2023, seven life/annuity companies were offering DIAs and QLACs. All these companies are mutual insurers except Brighthouse Financial, which is a stock company. Mutual life insurance companies are owned by their customers (policyholders), while stock companies are owned by investors (shareholders). Most issuers of income annuities are mutuals. These firms offer DIAs and QLACs that are highly similar. All the companies have high strength ratings from the rating agencies. They may have different minimum initial premiums, different maximum premiums, and slightly different limits on how old or young you can be to buy a contract. Even when contracts are similar, they may offer different levels of income per amount contributed. When life/annuity companies are striving to increase sales of a particular annuity contract, they might make the terms more attractive, and vice versa. That’s why it pays to shop around for the best deal. If your adviser subscribes to an annuity database service, they may have access to monthly price changes. Here are three go-to places online where you can explore DIAs in general or study specific DIA contracts:

»» Blueprint Income ( »» Charles Schwab ( »» ( You can also get access at these sites to an agent who can help you buy one. Here are the seven companies that offer DIAs and QLACs. All the companies listed here have impeccable strength ratings from the Nationally Recognized Statistical Ratings Organizations. All except Brighthouse Financial are mutual life insurers; Brighthouse Financial is a stock company that was part of MetLife before 2015. All the contracts described offer varying degrees of flexibility in taking your money out of the contract before or after income payments start.

»» Brighthouse Financial Guaranteed Income Builder: Brighthouse Financial has a DIA with a number of opportunities that let you change your mind or


PART 2 Identifying the Major Annuities

dip into your savings after you buy the contract. If you have a DIA with a cash refund or period-certain feature, there’s an option that lets you start receiving income within a ten-year window of time either five years before or after your original income start date. You can advance or delay your income start date by up to five years from the original date you chose. If you’re willing to accept a lower monthly payment, you can reserve the right to withdraw all your money within 30 days of any contract anniversary.

»» Guardian SecureFuture Income Annuity: This contract, from a mutual life

insurer with the highest possible strength rating from AM Best, sells DIAs and QLACs with a minimum initial contribution of $5,000 and subsequent contributions as low as $100 each, up until 13 months before income begins. This contract allows a lot of flexibility. You can move your income start date forward by up to five years. You can increase your payments each year by between 1 percent and 5 percent. Once during the life of the contract, you can get six months’ payments at once and skip the next five. Those benefits may not be available with a QLAC.

»» MassMutual RetireEase Choice Flexible Premium Deferred Income

Annuity: This contract lets you make additional payments of at least $500 up to 13 months before income begins if you want to increase your income. MassMutual offers its contract owners a lot of access to their money after income payments begin. Owners of nonqualified contracts not purchased with traditional IRA money can take either three months’ or six months’ income at a time, up to five times during the income payout period.

»» United of Omaha Deferred Income Protector: This DIA is aimed at pre-

retirees between the ages of 55 and 65 who plan to retire in the next five to ten years and who are looking to defer income only until their 60s. Pre-retirees can start the contract with as little as $5,000 and can make subsequent contributions of no less than $2,000. There’s also a QLAC version of this product. But it appears to be built for those who want to prefund their retirement because they’re afraid that a stock market crash when they’re between ages 55 and 65 could ruin their retirement plans.

»» New York Life Future Mutual Income Annuity: This contract, from the

largest mutual life insurance company in the United States, is unusual in that the company may pay you annual dividends during the deferral period. The dividends aren’t guaranteed every year, and they won’t necessarily be as large as the dividends that New York Life pays its life insurance policyholders, but New York Life has paid a dividend every year since 1854. You can take the dividends as cash or apply them to the purchase of higher income when payouts begin. This contract is available as a DIA or QLAC. The QLAC version has certain restrictions. For instance, you can’t take dividends as cash when you own the QLAC.

CHAPTER 11 Aging Gracefully with DIA and QLAC


»» New York Life Guaranteed Future Income Annuity II: This contract is like

the preceding one but without dividends. Instead of dividends, it would have a higher starting payment than the mutual income annuity. It’s available as a DIA or a QLAC.

»» Pacific Life Secure Income: The Pacific Life DIA, which is also available as a

QLAC, offers flexibility in moving the income start date forward or backward as far as five years in either direction. An earlier start date would mean smaller income payments when payments begin. A later start date would mean larger income payments. After income begins, you can arrange to take several monthly payments in advance, if necessary.

»» Integrity IncomeSource Select Deferred Income Annuity: Similar to the

Guardian contract, this contract has a minimum initial premium of $10,000. It allows you take out up to six months’ income in a lump sum twice during the life of the contract. Inflation adjustments and period-certain options are available on the DIA, but not on the QLAC. If you want to contribute more money to your annuity, the contributions have to be at least $1,000. Other contracts require as little as $500 or even $100.

PAYING FOR YOUR DIA OR QLAC If you reach retirement and want to buy a DIA or QLAC, you have to decide how and when to pay for it. You can buy as large a DIA as you like with after-tax money and pay no tax on the buildup in value during the deferral period. When income begins at age 80 or 85, you pay taxes on the portion of your income that came from gains rather than principal. If you’re using money from a traditional or rollover IRA, and income will not start until after you reach age 73, you must buy a QLAC so that you don’t run afoul of the RMD rules. The limit on contributions will be $200,000. DIAs can be paid for with a lump sum or in installments. As noted earlier, life/annuity companies vary in the amount of minimum initial premium they require and the minimum amount required when you pay additional premiums to enhance your future income. Although you’ll buy a new contract with each installment payment, companies typically arrange for them all to start paying income on the same date.


PART 2 Identifying the Major Annuities

Deciding on your purchase date and income start date can be challenging. As Wade Pfau pointed out, many people buy DIAs at ages 55 to 60 with the intent of starting income payments at ages 65 to 70. Life/annuity companies say they target that demographic when marketing DIAs. I would describe that strategy as “buying a SPIA ten years early” rather than “buying a DIA.” The timing of your purchase of a DIA will depend in part on whether you plan to use the contract for retirement income (as those who purchase at 55 do) or as insurance against the unknowable costs of living into extreme old age. If you intend to use it as pure longevity insurance, you would delay income until age 80 or later. Chapter 17 has more about the use of DIAs, and other annuities, in a person’s unique retirement income plan. Remember: Annuities deliver the most value, in terms of improving your financial life in retirement, when you make them part of a holistic retirement income plan. A holistic plan is one that covers your needs from the beginning to the end of retirement, and includes all your sources of wealth (including home equity) and all your probable expenses.

CHAPTER 11 Aging Gracefully with DIA and QLAC



»» Understanding reverse mortgages »» Getting the equity out of your home »» Considering whether a reverse mortgage is right for you »» Getting a home equity line of credit »» Working with a trusted adviser



Tapping the Liquidity in Your Home


ome, bittersweet home. Don’t get me wrong, my spouse and I adore our little abode. But so far it has been a one-way street, money-wise, between us and our three-bedroom castle. Our renovations of the kitchen, bathrooms, floors, basement, family room, sun deck, septic systems, and heat pumps have cost a bundle. Fortunately, our mortgage-free ’70s-vintage “ranch” also contains a lot of builtup equity. Indeed, home equity can be an income-generating asset for millions of retirees. As you plan for retirement, you should consider whether, when, and how you’ll tap into it. You can do that in several ways: You can simply enjoy the economies of postmortgage living, and preserve the equity for long-term care and bequests. You can downsize into a condo and pocket the difference. Or you can use the house to secure a traditional home equity loan. Then there are reverse mortgages. Although technically not an annuity, a reverse mortgage lets you convert the proceeds of a loan against the equity in your home into a retirement income stream. Reverse mortgages have been mocked as “last

CHAPTER 12 Tapping the Liquidity in Your Home


resorts” for retirees who didn’t save enough. Over the years, predatory lenders and evictions of borrowers have tainted their reputation. They also cost a lot more than conventional “forward” mortgages. But, like annuities, they’re a potential income-generation tool that every retiree should be aware of.

Defining Reverse Mortgages Of the two major kinds of reverse mortgages — private and federally insured — I’ll be talking mainly about the government version. Known as home equity conversion mortgages (HECMs), they involve borrowing against the equity in or value of your home. There are closing costs, appraisal fees, and so on, and an interest rate on your loan. The amount you can borrow depends on the amount of equity in your home and the interest rate at the time of the loan. The more equity you have in the house, or the higher the value of the house and the lower the interest rates, the more you can borrow. The beautiful part is that, as long as you abide by the HECM rules (see the section, “Abiding by the rules”) the loan doesn’t have to be repaid until you move out of the house or die. In the meantime, the loan grows (instead of shrinking, like a forward mortgage). When you no longer live in the house, you or your beneficiaries can sell it, pay off the loan, and pocket the difference, if any. Otherwise, the house will belong to the reverse mortgage lender, or institutional investors who bought the deed from the lender. The lender or investors will recoup the loan, interest, fees, and so on by selling the house. The first reverse mortgage is said to have been written in 1961 by a Portland, Maine, banker who wanted to give the widow of his high school football coach the means to stay in her home. The modern era of HECMs began in 1988, when the U.S. Department of Housing and Urban Development (HUD) was allowed to begin insuring reverse mortgages as an experiment. The first HECM was issued to a woman in Kansas in 1989. The HECM program became permanent in 1998. Its rules are regularly updated, so you should check with the HUD website ( for the latest ones. Several financial companies offer “proprietary” reverse mortgages with lending limits as high as $4 million. These loans are not guaranteed by HUD and do not require borrowers to seek HUD-approved financial counseling. They’re intended to serve wealthy individuals with unusually large amounts of home equity.


PART 2 Identifying the Major Annuities

Certain states also have loan programs to help people leverage their home equity to cover specific expenses, such as new backyard septic systems. Under the Home Equity Conversion Mortgage Insurance Demonstration authorized by the Housing and Community Development Act of 1987, HUD said it would insure up to 2,500 reverse mortgages on the homes of elderly homeowners over the next two years, enabling people to turn their equity into cash. A proposed rule for the demonstration was published in the Federal Register on October 25, 1988. HUD announced its intention to invite lenders to apply for reservations of insurance authority, allowing them to train HUD-approved counseling agencies about reverse mortgages and their alternatives. In the financial year ending in September 2021, more than 49,000 HECMs were granted. Wells Fargo, American Advisor Group, and Financial Freedom Senior Funding Corp. were some of the leading reverse mortgage providers in 2020.

Releasing Your Home Equity If you use the HECM program, you can choose among five different ways of accessing your home equity. The lender isn’t allowed to restrict you or assign you to any minimum monthly payment or line-of-credit draw. As long as you maintain your home and live in it, you can choose among these five drawdown methods:

»» Tenure: You receive fixed monthly payments based on your life expectancy, but not necessarily for as long as you live.

»» Term: You receive fixed monthly payments for a specific number of months. »» Line of credit (LOC): You can take withdrawals whenever you like, in any amount, up to the credit limit.

»» Modified tenure: You can combine a tenure payment plan with an LOC. That is, you can set aside a portion of the principal limit as an LOC and receive the rest in equal monthly payments.

»» Modified term: You can combine a term payment plan (fixed monthly

payments for a term of months) with an LOC. It’s the same as the modified tenure, except that you receive monthly payments for a fixed number of months.

CHAPTER 12 Tapping the Liquidity in Your Home


Changing your mind You’re not locked into any of the payment methods listed earlier. If you choose a term or tenure option, you can get an unscheduled payment later if you need it, as long as you don’t go over the borrowing limit. If you do take an unscheduled withdrawal, however, you would have to set up a new plan and choose a new monthly payment or LOC. The mortgage lender determines the amount of equity in your home and the amount that it will lend you under the HECM program. You can’t borrow more than that amount. The government increases your loan capacity each month by one-twelfth of the sum of the expected average mortgage interest rate plus the monthly mortgage insurance premium rate. But your loan capacity shrinks over time by the amount of interest that your lender earns, the mortgage insurance premiums, and any capacity that you’re required to set aside as a buffer.

Deciding what to do with the money Although this book focuses on the potential use of an HECM to fund a lifetime income, you can use the proceeds of your loan in several ways. You can use the equity in your home to

»» Pay off an existing mortgage. Given all the home refinancing that went on

during the 2010s, some retirees will no doubt enter retirement with a small or midsize mortgage balance. If you’re in that spot, and your equity in the home is large relative to your loan balance, you may be able to pay off the existing mortgage with the proceeds of an HECM.

»» Finance a more expensive home. The federal government almost certainly

didn’t intend the HECM program to be used for new home purchases. But as long as you meet the requirements, you can sell an existing home, invest the proceeds in a more expensive home, and then use an HECM secured by the equity you’ve just established in the new home to pay it off. Just remember that there’s no easy money here. Your HECM amount will probably be less than half of what you put down on the new home.

»» Use an HECM-LOC to manage money more efficiently in retirement. You can open an HECM-LOC at the beginning of your retirement and use it to supplement your income when you need emergency cash or whenever you want to avoid selling assets for current income.


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FIXED-RATE VERSUS ADJUSTABLE-RATE REVERSE MORTGAGES Reverse mortgage borrowers may choose a loan with an adjustable interest rate or a fixed interest rate, according to HUD, which oversees the Federal Housing Administration (FHA). People who want a lump-sum payment at closing, perhaps to pay off the balance of an existing mortgage, must use a fixed-rate mortgage. All other uses of the HECM require the use of an adjustable-rate mortgage, with rates that adjust monthly or annually. Adjustable-rate loans that are reset on an annual basis are limited to adjust by no more than two percentage points per year and by not more than five percentage points over the life of the loan. In other words, if you start with a mortgage rate of 5 percent, your interest rate can never go above 10 percent. The FHA does not require any limits on the rate changes of reverse mortgage loans that adjust monthly.

»» Use an HECM-LOC to hedge a big drop in home values. As noted earlier,

the government increases your borrowing capacity under the HECM program each year. In theory, you can open an HECM-LOC when you retire and watch your borrowing limit rise while drawing down nothing. If your home loses market value over the years, the capacity of your LOC would still be high. You can borrow from the line to offset your loss. This “hedge” isn’t free — you’d still have to go through the HECM process and pay loan origination fees.

Abiding by the rules Government programs usually come with a lot of rules. Here are the rules that govern reverse mortgages:

»» You must be age 62 or older. The younger you are when you take the loan and the greater your life expectancy, the smaller the annuity based on the loan amount.

»» You must own and live in the home you’re borrowing against. If you move out of the house, you must pay back the loan. There can be no other lien on the home than the HECM.

»» You must stay up to date on your property taxes. Your property taxes can range from $1,000 a year to more than $20,000 a year, depending on where you live. The reverse mortgage doesn’t eliminate them.

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»» You must maintain the home, insure the home, and use the loan

proceeds to do so if necessary. The lender will require you to protect its investment in the home.

»» You must show proof of HECM counseling. You can find an HECM coun-

selor through the HUD website. You can find more on counseling later in this chapter.

»» You must work with an FHA-approved lender. When you have a few lenders in mind, go to HUD’s website to see if they’re FHA-approved.

»» You can’t be delinquent on any federal debt. »» You may not take out a lump sum larger than 60 percent of the loan principal at closing or within the first 12 months after closing.

Determining your loan amount Here are the factors that the government uses to calculate how much you can borrow against your home under the program:

»» Age of the youngest borrower or eligible non-borrowing spouse: The younger you are when you borrow the money, the less you can borrow against your home, all else being equal.

»» Current interest rate: All else being equal, you’ll be able to borrow more

when interest rates are lower. The same principle exists in the conventional home market.

»» The appraised value of the home: The HECM FHA mortgage limit — the

largest loan amount that the government will guarantee — is $1,089,300 in calendar year 2023. If you’re using an HECM to purchase a home, the sale price of the home serves as the limit.

»» Your creditworthiness: Your income, assets, monthly living expenses, and credit history will be verified.

»» Deduction of other fees: Closing costs, initial mortgage insurance expense,

cash disbursed to you at closing, as well as “set-asides” for repairs, for monthly servicing fees, and for first-year property taxes may all be deducted from the final amount that you can use to finance lump-sum withdrawals, monthly payments, or lines of credit.

When mortgage interest rates are low, you can borrow against your house more than when interest rates are high. When interest rates are high, on the other hand, payout rates on income annuities tend to be higher.


PART 2 Identifying the Major Annuities

Accepting your property as collateral The following eligible property types must meet all FHA property standards and flood requirements:

»» Single-family home or two- to four-unit unit home with one unit occupied by the borrower

»» HUD-approved condominium project »» Individual condominium units that meet FHA single-unit approved requirements

»» Manufactured home that meets FHA requirements

PAYING FOR YOUR REVERSE MORTGAGE You can pay for most of the costs of an HECM by financing them and having them paid from the proceeds of the loan. Financing the costs means that you don’t have to pay for them out of your pocket. On the other hand, financing the costs reduces the net loan amount available to you. The HECM loan includes several fees and charges, which include:

• Mortgage insurance premiums (initial and annual) • Third-party charges • Origination fees • Interest • Servicing fees The lender will discuss which fees and charges are mandatory. You’ll be charged an initial mortgage insurance premium (MIP) at closing. The initial MIP will be 2 percent. Over the life of the loan, you’ll be charged an annual MIP that equals 0.5 percent of the outstanding mortgage balance. The mortgage insurance guarantees that you’ll receive expected loan advances. You can finance the MIP as part of your loan. Closing costs from third parties can include an appraisal, title search and insurance, surveys, inspections, recording fees, mortgage taxes, credit checks, and other fees. You’ll (continued)

CHAPTER 12 Tapping the Liquidity in Your Home



pay an origination fee to compensate the lender for processing your HECM loan. A lender can charge the greater of $2,500 or 2 percent of the first $200,000 of your home’s value plus 1 percent of the amount over $200,000. HECM origination fees are capped at $6,000. Lenders or their agents provide servicing throughout the life of the HECM. Servicing includes sending you account statements, disbursing loan proceeds, and making sure that you keep up with loan requirements, such as paying real estate taxes and hazard insurance premiums. Lenders may charge a monthly servicing fee of no more than $30 if the loan has an annually adjusting interest rate or has a fixed interest rate. The lender may charge a monthly servicing fee of no more than $35 if the interest rate adjusts monthly. At loan closing, the lender sets aside the servicing fee and deducts the fee from your available funds. Each month the monthly servicing fee is added to your loan balance. Lenders may also choose to include the servicing fee in the mortgage interest rate.

One rewarding source for information about reverse mortgages  — who I hope lives forever — is Jack Guttentag (also known as “The Mortgage Professor”). For years, Guttentag has hosted the Mortgage Professor website (www.mtgprofessor. com). As a professor emeritus of the Wharton School (the University of Pennsylvania’s business school), he has impeccable credentials. As of April 2023, at the age of 99, he was still contributing articles to and promoting what he calls “kosher” mortgages. By his definition, these include HECMs from companies that offer transparent, competitive pricing. Using a nifty screening tool, Guttentag helps match you with the right companies for your HECM.

Weighing the Pros and Cons of Reverse Mortgages I feel the same way about reverse mortgages as I do about annuities. If you can’t safely retire on an income of dividends, interest, capital gains, or business income, you should familiarize yourself with every other available source of retirement income.


PART 2 Identifying the Major Annuities

Like annuities, reverse mortgages involve trade-offs. Here are the major benefits and drawbacks of reverse mortgages. They’re not for everyone, but they can come in handy in a pinch.

Pros Reverse mortgages were established because the government became convinced that many Americans needed them and wanted them. Here are reasons you may want to consider one:

»» Ability to age-in-place: If you prefer to live in your home as long as you can, you can use an HECM or HECM-LOC to cover the costs of maintenance and taxes that can otherwise force you to sell your home.

»» Eligibility: If lack of earned income disqualifies you from getting an LOC from a bank, you might still be eligible for an HECM.

»» Tax advantage: You owe no taxes on the amount you borrow against your home equity.

»» Advantage over home equity line of credit (HELOC): In contrast to an

HELOC, an HECM is noncancellable. With an HECM, the borrower controls if and when the loan is used and whether it will be repaid. The LOC also grows over time, independent of home value.

»» Inflation protection: If you open an HECM-LOC, your borrowing capacity rises with the rate of inflation.

»» No mortgage payments: You aren’t obligated to pay down a reverse mortgage until or unless you leave your home.

»» Flexibility: You can use an HECM to obtain lump sums, set up an LOC, or

arrange from a stream of income payments that can last until you leave your home. You can open an HECM-LOC and not tap it unless an emergency arises. You can use the money from a reverse mortgage for anything, including long-term care costs.

»» Protection from sequence risk: If the stock market crashes shortly after you

retire, you can use cash from an HECM or HECM-LOC to avoid selling assets at depressed prices.

»» Protection from longevity risk: If you run low on money in extreme old age, you can use cash from an HECM instead of turning to your children for help.

»» No prepayment penalty: You can pay off your HECM loan in part or in full at any time.

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Cons There are reasons why HECMs acquired a reputation for being “last resort” solutions for those facing retirement income shortages. Here are some of the reasons people avoid reverse mortgages:

»» Reverse sticker shock: You may be surprised to see how little you can

borrow against your home, especially if you’re under age 70 when you apply for an HECM. Reverse mortgages are considerably more expensive than conventional mortgages. The market is much smaller, loan volume is much lower, and competition is not as great.

»» Restrictions on amounts of money you can use right away: Borrowers are capped at 60 percent of their available loan proceeds in the first 12 months, unless the money is needed to pay off existing liens and costs to obtain the loan.

»» Responsibility for upkeep: The amount you borrow against your house

can easily be swallowed up by the costs of maintaining your home and paying for taxes.

»» Government hoops to jump through: You must go through a formal

counseling session with an approved HECM counselor. The government wants to make sure that you understand all your options and that you’re not being hustled into a transaction that’s not beneficial for you.

»» Fear of a new mortgage: After paying off a forward mortgage, you may prefer to enjoy the debt-free feeling.

If you’re interested in a reverse mortgage, beware of scam artists who charge thousands of dollars for information that is free from HUD. Also, beware of any reverse mortgage broker who makes exaggerated, unsupported claims about the value of your house, or who fails to mention the limits of your loan or the fact that you can lose your house if you don’t maintain it and pay your taxes.

HOW MUCH CAN YOU BORROW AGAINST YOUR HOME? Mutual of Omaha, a writer of HECMs, has a calculator on its website that allows you to estimate your loan amount in advice. For the sake of example, let’s assume a 3.8 percent ten-year Treasury yield. (If the yield is higher when you read this, the payout amounts will be lower.)


PART 2 Identifying the Major Annuities

Using the Mutual of Omaha calculator, I found the following: Home Equity

Age of Youngest HECM Borrower 65


































Source: (April 13, 2023)

In this grid, you can see that you’ll only be able to borrow between about one-third to one-half of the value of your home equity. Why so little? As soon as you take the loan, annual interest begins compounding. The lender must recoup not only the value of the loan but also its own borrowing costs. The lender can’t lose money on the loan, however, because the loan is guaranteed by the federal government. The lender must also contend with the fact that, if your house has appreciated beyond the loan amount, your beneficiaries or heirs can sell the house, pay off the loan, and pocket the difference. Protected from large speculative losses (through the depreciation of the property) and barred from big gains (because heirs can capture any appreciation) by the program rules, the lender may have to take its profits up front or not at all. It can do so by lending conservatively.

Setting Up a Standby Line of Credit Back in 2012, when interest rates were very low and reverse mortgage loan amounts were high, several retirement researchers published papers demonstrating how wealthy retirees could use HECM-LOCs to manage their wealth more efficiently. The HECM-LOC could, according to their calculations, improve the 4 percent safe withdrawal method (see Chapter 7). An individual would establish the LOC at the beginning of retirement and not use it except as a kind of emergency bridge loan.

CHAPTER 12 Tapping the Liquidity in Your Home


BUYER BEWARE Over the years, you may have seen the actors Peter Graves, Fred Thompson, and Tom Selleck appear as pitchmen in TV commercials for California-based American Advisors Group (AAG), which originates about one-third of the reverse mortgages in the United States each year. In 2016, and then again in 2021, AAG was charged by the Consumer Financial Protection Bureau (CFPB), an independent agency within the Federal Reserve System, for allegedly sending consumers direct mailers showing them inflated values of their homes to help entice them to take out reverse mortgages. The values provided by AAG were 18 percent to 28 percent higher than the actual value of the homes, the CFPB charged. As part of a proposed 2021 settlement, AAG agreed to pay $1.3 million in civil redress and civil penalties. AAG also agreed to stop advertising the allegedly inflated estimated home values to consumers, and to refer its potential customers to certain CFPB materials on reverse mortgages.

During a bear market, when the 4 percent method might require a retiree to spend less, retirees could take money from the LOC and add it to the cash accounts that they typically maintain for short-term expenses. During the next bull market, retirees could pay off the LOC with their investment gains. Setting up an HECM-LOC can cost thousands of dollars, depending on the loan amount. But LOCs are worth it, according to the researchers. By providing a hedge against stock market volatility, they allow retirees to spend more in retirement with less fear of running out of money. “The benefit of this product is a non-cancellable LOC that may be used at the discretion of the borrower free of taxes,” researcher and adviser Harold Evensky of Texas Tech University wrote. Instead of spending only a real, inflation-adjusted 4 percent per year, hypothetical 65-year-old retirees who used an HECM-LOC as a buffer could safely spend 5.25 percent to 6.75 percent per year, depending on their specific circumstances. Some older people are secretive about their finances, and withhold information even from their immediate relatives. The children don’t know much about the reverse mortgage until the parent dies and they receive a letter from the lender. In the midst of mourning, they have to decide whether to sell or surrender the house. If they do nothing, the parents’ house may sit empty until a sheriff’s sale. The lender may have little incentive to resolve the matter, because HUD insurance protects it from a loss. If you decide to take out a reverse mortgage and you have


PART 2 Identifying the Major Annuities

adult children, you should involve them in the application and closing process. They may be willing to help you financially, or they may want to keep your home in the family. Married couples who take out HECM loans need to make sure in advance that, if one of the spouses dies, the surviving spouse can continue to live in their home if they want. It’s possible for one member of a couple to take out the HECM loan and to have a “non-borrowing” spouse listed on the loan. To continue living in the house, however, non-borrowing spouses must meet certain requirements set by HUD. They must, for instance, be identified as the spouse when the loan closes. If they meet the requirements, they can live in the home indefinitely. But cash disbursements under the HECM will stop when the borrowing limit, including the initial loan and all the interest that built up over the years, is reached.

Finding an HECM Counselor The federal government guarantees HECMs. In other words, it protects lenders from defaults on HECM loans and protects borrowers from the failure of a lender. To prevent bad loans from happening, HUD requires HECM borrowers to participate in preloan counseling. Proof of counseling is required during the loan approval process. Counseling typically takes about 90 minutes and can cost up to about $200, depending on the provider. (Some providers are nonprofit organizations.) You can locate a HUD-certified HECM counselor by visiting programs/housing-counseling/intermediaries-shfa/. There are two types of HECM counseling services:

»» Origination counseling: Origination counseling is for loan applicants. It will

show you if you’re qualified for an HECM. In person or by phone, counselors will review eligibility requirements, loan amounts, loan limits, and future repayments. Lenders are not allowed to steer you toward a particular counselor or pay for the counseling. Origination counselors must be certified and registered within FHA Connection (an online interface between counselors, lenders, and the FHA). They’re required to update their skills and knowledge twice a year. If you qualify, you’ll receive a certificate that you can show to your lender at closing.

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»» Default counseling: Default counseling is a lifeline for people on the brink of defaulting on their HECM loans and losing their homes. The government wants to avoid defaults and evictions. Defaults make the program look like a potential trap for the poorest and most fragile people, instead of a public service. Unlike origination counselors, default counselors don’t have to be HUD approved.

THE REVERSE MORTGAGE PUZZLE The reverse mortgage business was thriving back in the first decade of the 21st century. From 2005 (when limits on the size of HECMs was set) to 2009, the number of reverse mortgages written each year rose to almost 115,000 from just over 43,000. That’s also the period when the over-issuance of mortgages helped bring on the 2008 financial crisis. The HECM market hasn’t recovered from that crisis. The number of reverse mortgages gradually sank to 31,000 in 2018, before rebounding to 49,000 in 2021. Why aren’t reverse mortgages more popular? Partly because most financial advisers, unless they have real estate licenses or specialize in holistic retirement income planning, have no occasion or incentive to recommend HECMs to clients. The marketing of HECMs is, therefore, limited to a relatively few specialists. As noted in the “Buyer beware” sidebar earlier in this chapter, some HECM sellers used infomercials to hook seniors and, worse, overcharged them with fees or didn’t give them enough money for their homes. Over the years, some elderly borrowers lost their homes because they couldn’t maintain them or didn’t pay their taxes. As a result, the reputation of HECMs suffered. Wealth inequality has also slowed the public’s take-up of HECMs. Like income and financial wealth, real estate wealth isn’t evenly distributed throughout the U.S. population. The people with the most home equity often have the most financial wealth and, therefore, may not need reverse mortgages.


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Shopping in the Annuity Marketplace


Enter the diverse world of life/annuity companies, where all annuity contracts are born. Meet the licensed agents, brokers, and advisers who sell or recommend annuities to the public. Enjoy the convenience of pressure-free shopping for annuities online. See how Congress made it easier for companies to include annuities among the investment options in their 401(k) plans.


»» Figuring out how strong a life insurer is »» Looking at the different types of life insurers »» Regulating the life/annuity industry



Issuing Annuities: It’s What Life Insurers Do


hen you buy an annuity, you’re embarking on a relationship with a large, bureaucratic life insurance company. The relationship could last for as few as 3 years or as many as 30 years. Can you trust any company for that long? Will your money be safe? The answer is yes, but be careful. You’ve got several lines of defense. Assuming that you’ve chosen a trustworthy agent or adviser, they probably represent only the most reliable companies. These intermediaries typically rely on their wholesalers and brokerage firms to recommend the best life insurers. Various watchdogs and safety nets are also in place. Four competing rating agencies track the financial strengths of life insurers. State insurance commissioners regulate all insurers in their jurisdictions, and every state has a guaranty association to refund at least part of your money if your insurer fails. Financial services companies have become insolvent, of course. Rating agencies famously didn’t identify troubled companies in time to prevent the Great Recession of 2008. State insurance commissions don’t always put as much pressure on life insurers as they should. Insurers themselves tend to be secretive.

CHAPTER 13 Issuing Annuities: It’s What Life Insurers Do


LESS LIFE INSURANCE, MORE ANNUITIES Life insurers have a monopoly on the sale of annuities in the United States. In fact, even though we still call most of these firms “life insurance” companies, as an industry, they’ve been selling a lot more annuities than life insurance for decades. Every year from 2004 to 2021, in fact, U.S. life/annuity companies took in $50 billion to $70 billion more from annuity sales (both to individuals and to groups) than from life insurance sales. In 2021, the industry sold $237 billion worth of annuities and $164 billion worth of life insurance, both records, according to LIMRA, a market research group tied to the U.S. life insurance industry. The “graying” of the U.S. population explains part of that. The oldest baby boomers reached age 55 in 2001. That’s the age when many people turn their attention to retirement income planning. Since 1986, annuities have also become attractive as a taxdeferral strategy among those with lots of extra money to save.

That said, the risk of life insurer insolvency for you, the annuity owner, is small. Failures of life insurers are rare. Instead, you need to be wary of insurers who exaggerate the benefits of their products; bury “rusty nails” in the fine print of their prospectuses; or simply don’t provide fast, efficient, accurate customer service. Keeping up with the rebranding of life/annuity companies can also be a challenge. Brighthouse Financial used to be MetLife’s retail annuity business. Corebridge Financial used to be AIG’s retail annuity business. Small life insurers have been bought and put on big growth paths by Wall Street asset managers or buyout firms. In this chapter, I offer some tips on what to look for before you leap into the arms of a life/annuity company. Years of reporting have taught me that product pricing and financial strength are not the only factors you need to consider. A company’s ownership structure is important, too.

Measuring a Life Insurer’s Strength Before you buy an annuity, you need to check the life insurer’s financial strength rating. That should not be difficult. To find out a company’s ratings, just click the Investor Relations link on their corporate home pages and then click through to Ratings.


PART 3 Shopping in the Annuity Marketplace

Four independent rating agencies currently track the financial strength of U.S. life insurers. AM Best is the oldest. The others are Standard & Poor’s, Fitch Ratings, and Moody’s. All are designated and registered as nationally recognized statistical rating organizations (NRSROs) by the Securities and Exchange Commission (SEC) of the U.S. Treasury Department. In addition, an organization called Comdex combines the NRSROs’ ratings into an easy-to-compare score. That score helps resolve the confusion that may stem from the fact that each of the NRSROs uses a slightly different alphabetic and numeric system for rating financial strength. Lincoln National Life’s website, for instance, shows an “A rating with stable outlook” from AM Best (3rd highest of 16 ratings), an “A+ rating with negative outlook” from Fitch (5th of 19), an “A1 rating with negative outlook” from Moody’s (5th of 21), and an “A+ with stable outlook” from Standard & Poor’s (5th of 21). These ratings are intended to indicate that the company will be able to pay back the money you entrusted to it according to the rules of your contract. They attest to the current solvency of the company, as well as the outlook for its future solvency. The ratings system isn’t perfect. On its website, the National Association of Insurance Commissioners (NAIC), an umbrella organization for the state insurance commissioners of the United States, concedes that NRSRO ratings may lag behind events at the companies, as they did in 2008. The NRSROs also suffer from a conflict of interest. Their fees are paid by the very companies that they rate. In the 2015 film The Big Short, a fictional NRSRO analyst reveals how that conflict may have contributed to the failures of 2008. A multi-trillion-dollar industry relies on their reports and ratings, however. Major brokerage firms, which are policed by both federal and state regulators, may refuse to represent companies with a rating in the B range. The largest issuers and annuities in the United States — companies like New York Life, Jackson National Life, and Athene, to name a few — all have A-level ratings. The NRSROs pay close attention to an insurer’s solvency (its possession of more assets than liabilities). In plain English, a company’s solvency is its ability to pay back the money that it has promised to its life insurance policyowners and annuity contract owners. The NRSROs study the company’s balance sheet and other statutory filings that it submits to regulators every spring.

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The insurer’s surplus is a focal point of scrutiny. The surplus is the amount by which the insurer’s assets (its investments, which are primarily loans to other corporations) exceed its liabilities (the money it owes to creditors and policyholders like you). If the surplus is 5 percent, for instance, that means that the value of the company could withstand a 5 percent drop in the value of its assets and still meet all its obligations. Buying an annuity from a B-rated company isn’t always a bad idea. It depends in part on the kind of annuity you’re buying. B-rated insurers frequently offer higher payout rates on fixed deferred annuities than do A-rated insurers. If the annuity has a three-year term, you may decide that it’s worth taking more risk to get more return. In fact, the issuer might have earned its B rating by taking more risk with its own investments in order to generate a higher return for you. (I make a similar point in Chapter 6 on fixed-rate annuities.) If you’re buying a variable annuity (VA), you’re putting your money in a separate account. The cash value of your account remains within your control. With a VA, investment selection and reasonable fees may be your biggest concern, unless you buy a lifetime income rider. (For more on VAs, see Chapter 10.) A top rating becomes most important when you’re buying an income annuity. If you buy one at age 65, you may be collecting monthly payments from that company for decades. You need complete confidence in the long-term stability and creditworthiness of that company. Little wonder that the very strongest companies, which have Comdex ratings in the high 90s, sell the most fixed income annuities.

LOOKING BEYOND STRENGTH RATINGS In 2021, I met a Pittsburgh-area insurance agency owner, Matt Zagula, and a Richmond, Virginia–based forensic accountant, Tom Gober, who’d devised a new way to measure the financial strengths of insurance companies. They called it the transparency, surplus, and riskier assets (TSR) ratio. During the 2010s, the two noticed a trend among certain large publicly traded life insurers that troubled them. A growing number of companies appeared to be purchasing “reinsurance” from insurance companies based in Bermuda, the Cayman Islands, or certain U.S. states. The purchase of reinsurance — which transferred part of their risks to other insurers — enabled the U.S. insurers to reduce their liabilities, enlarge their surpluses, invest in riskier companies, and in several cases distribute hundreds of millions of dollars to their equity shareholders.


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Gober and Zagula noticed that the life insurers and reinsurers were often part of the same holding company or closely affiliated. They believed that the reinsurance was intended to help the companies look stronger, in terms of their ability to serve policyholders, even as they were being made weaker. The NRSROs have given high ratings to these companies. The TSR ratio, by contrast, gives them much poorer grades. In effect, the ratio removes the benefit of the doubt from the companies’ accounting maneuvers and assumes that what isn’t transparent is untrustworthy. Economists at the Federal Reserve and the Senate Banking Committee have studied the issue. The upshot is that the TSR ratio turns out to be most positive for mutual life insurers and fraternal life insurers, less so for publicly traded life insurers, and least so for life insurers that are owned by or affiliated with large Wall Street firms that are characterized as “private equity,” “private credit,” or “alternative asset managers.”

Classifying the Life Insurers Until only a few years ago, I was clueless about how different life/annuity companies could be. I could tell their mascots and symbols apart — the Rock of Gibraltar (Prudential), the humpback whale (Pacific Life), the origami squirrel (Voya)  — but the firms themselves seemed to be as alike as their standardized office towers, suburban campuses, and cubicle farms. But the companies have striking differences. Those differences never show up on NRSRO strength ratings. Two companies with A-level strength ratings from AM Best or Standard & Poor’s could have very different business models and ownership structures. And those elements influence or determine almost everything about it, including

»» Its profitability needs »» The kinds of annuities it prefers to bring to market »» The type of advisers or agents who sell its annuities »» Which governmental bodies regulate it »» Whether it can buy or be bought by other companies »» Its loyalties to policyholders or shareholders »» The character and quality of its customer service

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»» Its corporate culture »» Its relationship with you Ownership structure, in the life/annuity world, is the invisible elephant in the room. It’s a truth that hides in plain sight but that almost no one sees. Insights about ownership should be one of your key takeaways from this book. In the next section, I describe the main types of life insurers and some of the characteristics and qualities of each. Most life/annuity companies, if they can, try to impress you with how long they’ve been in existence. In theory, the longer they’ve been keeping promises to policyholders and contract owners, the more likely they can be trusted to keep their promises to you. Some life insurers are quite old. New York Life was founded in 1845, MetLife in 1868, Prudential in 1875, and MassMutual in 1851. But over the past two or three decades, a whirlwind of mergers and acquisitions has occurred among life insurers. Some of the dignified old companies — like The Hartford and John Hancock, to name two — have partly or completely dropped out of the retail annuity business since 2008. New companies and older companies under new names — like Athene, Brighthouse Financial, Global Atlantic, Corebridge Financial, and Forethought — have entered the picture in a big way.

Mutual life insurers A mutual insurance company, in theory, “is owned by its policyholders and operates for the exclusive benefit of its policyholders,” according to Joseph Belth, an emeritus professor of insurance at Indiana University and long-time publisher of the Insurance Forum, an independent publication about the life insurance industry. A mutual insurer issues policies, takes in insurance premiums or annuity premiums from its customers, and invests their money mainly in corporate bonds (helping finance a large portion of American industry). It earns a profit when the interest from its investments more than covers the benefits it pays to the policyholders. The major mutual insurance companies (or companies owned by mutual holding companies) in the United States include New York Life, MassMutual, Northwestern Mutual Life, CUNA Mutual, Thrivent, USAA, Guardian, Nationwide, and Pacific Life.


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The meaning of “on your side” The satisfaction of its policyholders and contract owners is a mutual company’s primary concern. They don’t control the activities of the managers and must trust the managers to act in good faith. Management demonstrates its good faith by issuing dividends to policyholders when it earns excess profits. Managers of a mutual insurer serve one master. They have self-interests, but no dramatic conflicts of interest with policyholders. When a mutual company shares product information through brochures and disclosures, it can speak plainly. It has little or no motive to tell two different stories to two sets of constituents. These companies may advertise that they are “on your side.” On the other hand, as companies, mutual life insurers aren’t required to disclose as much information about their finances to their policyholders (or the public at large) as stock companies are required to disclose to their shareholders. As investors, shareholders risk losing money when they buy stock. Policyholders have guarantees. In the years after the stock market crash of 1929, the U.S.  Treasury started protecting shareholders. It established the SEC and required stock companies to disclose (issue public reports on) much of their finances to prospective shareholders. Mutual companies don’t come under many federal security laws unless they sell products defined as securities  — like traditional VAs and registered indexlinked annuities (RILAs). It’s complicated. Often, but not always, a mutual life insurer will use its own full-time agents — called a captive force — to promote and sell its products. These agents represent only the products sold by the life insurer that employs them. Ideally, they enter into long-term client relationships and sell long-term products that require a high degree of trust.

Specializing in simple annuities Mutual life insurers account for the largest share of income annuity sales. These are the annuities, discussed in Chapter 7, that produce a monthly income for life, starting either when you buy them or several years later. The “mutuals” also sell the lion’s share of the fixed-rate annuities and multiyear guaranteed annuities (MYGAs; see Chapter 6). These are the savings tools that compete with the certificates of deposit (CDs) that you can buy at banks. New York Life, the largest mutual life insurer in the United States, is the top seller of both income annuities and fixed-rate deferred annuities. Other big mutual sellers of income annuities include Massachusetts Mutual, Northwestern Mutual Life, Pacific Life, and USAA.  Fixed-rate annuities are now commonly sold by private equity-affiliated life insurers (see “Private equity-linked life insurers,” later in this chapter).

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THE DEMUTUALIZATION WAVE During the demutualization wave of the 1990s and early 2000s, several large insurers that had been mutual companies for many years went through complex regulatory and financial procedures to become stock companies. Equitable Life became a stock company in 1992. Over the next decade or so, MetLife, Prudential, Principal, and others permanently demutualized. Mutual companies saw demutualization as a path to raising capital by selling shares to the public, acquiring other companies, or entering new lines of business. It also helped them compete with other stock companies in the increasingly deregulated U.S. financial services industry. According to Belth and others, managers sometimes used demutualization to capture part of the wealth of a mutual insurer and divide it among themselves.

Stock life insurers Stock companies (also known as publicly traded companies) offer shares to the investing public. Shareholders, in effect, own the company and more or less monitor the performance of the senior executives who manage it. The largest stock life insurance companies, or life insurance companies that are owned by stock companies, include AIG, Athene, Equitable, Global Atlantic, ­Jackson National Life, Lincoln Financial, MetLife, Principal, and Prudential. You may also have heard of Brighthouse Financial, which includes what used to be MetLife’s individual annuity business, and Corebridge Financial, which includes what used to be AIG’s individual annuity business. Stock companies are referred to as public, but this word can have several meanings. The company is called closely held when family members or a relatively small number of shareholders own it. It may be widely held, or owned by thousands of individuals and institutions, including mutual funds. And it may be owned by a mutual holding company.

Conflicting interests “Corporations have no higher purpose than maximizing profits for their shareholders,” wrote the late Nobel Prize–winning economist Milton Friedman. Publicly traded companies do that, whenever possible, by posting higher earnings, by driving up their share prices, and sometimes by issuing dividends or buying back stock from shareholders at a premium.


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Stock-company executives work hard to meet the demands of Wall Street equity analysts, whose buy or sell recommendations influence shareholder demand for the stock. A life insurance executive told me once, “Equity companies need equitysized returns.” If you own an annuity from a stock life insurer, you’re second to the shareholder in terms of management’s priority of concern. For you, that’s a conflict of interest. Managers of stock companies may have one message for their shareholders and a different message for their customers. An announcement that shareholders may cheer  — like managers investing in riskier assets to drive up investment returns and increase profits — may make policyholders nervous.

Selling variable annuities It makes sense, then, that stock companies like to sell VAs, where the policyholder stands to benefit from higher overall stock market returns. VA buyers are risk takers. They can lose money on their annuities. Even though they may not be shareholders in the life insurer, their interests are aligned with the interests of shareholders. Prior to the 2008 crisis, recently demutualized stock companies like MetLife, Prudential, AXA Equitable, and John Hancock, pursued the baby boomer retirement market by offering them VAs with guaranteed lifetime withdrawal benefit (GLWB) riders. These products were designed and intended to offer boomers (as long as they followed the complicated rules of the contract) the best of all retirement worlds, including

»» Investment growth through ownership of balanced stock/bond portfolios »» Tax deferral on gains »» Liquidity (access to their money if they needed it) »» Inflation-protected monthly income that wouldn’t decline and would last until they died

»» The ability to transfer the product to another annuity if they changed advisers »» Attractive commissions for SEC-regulated advisers at brokerage firms VAs with GLWB riders also pleased Wall Street analysts and investors. They generated steady annual revenues from investment fees and insurance rider fees. Those fees rose in tandem with the overall stock market. The stock life insurers expected that high sales of these products would stir demand for their shares and help drive up share prices.

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Americans currently hold a collective $2 trillion of their retirement savings in these annuities. But annual sales of traditional VAs, with and without the GLWB riders, gradually have fallen to about half of what they were before the 2009 financial crisis. VAs with GLWB products needed help from a rising stock market and normal, stable interest rates in order to deliver all the benefits listed earlier for a reasonable level of fees. But the stock market crashed in late 2008, and the Federal Reserve responded by bringing interest rates down to historically low levels. Then those conditions vanished. VAs with GLWBs became increasingly expensive to offer. In 2011, the stock companies began dialing down sales of VAs with GLWBs. One by one, they switched to selling RILAs (see Chapter 9). Like fixed indexed annuities (FIAs), RILAs create gains for investors using options on market indexes. RILAs offer a wider range of returns than FIAs, however. That is, you can earn higher profits, but you can also lose money. At many brokerage firms, sales of RILAs gradually overtook sales of VAs with GWMBs.

Private equity-linked life insurers Starting around 2013, large investment companies became major investors in the annuity branch of the life insurance business. When stock life insurers were weakened by stock market volatility and low interest rates, these large firms — also called private equity firms, private credit specialists, buyout firms, or alternative asset managers — provided help. Apollo, Blackstone, Goldman Sachs, Guggenheim, KKR, and other large investment firms changed the annuity industry. First, they showed stock life insurers how to invest their policyholders’ money in more sophisticated and profitable ways; then they invested in life insurers; and eventually, they purchased or started their own life insurers. Prominent life/annuity companies now affiliated with or owned by these and other investment companies include Athene (owned by Apollo), AIG/Corebridge (Blackstone), Fidelity and Guaranty Life (Blackstone), Midland National (Guggenheim), Global Atlantic (KKR), Security Benefit (Eldridge), American Equity Investment Life (multiple asset managers), and others.

Selling fixed indexed and fixed-rate annuities Of the $47 billion that Americans invested in FIAs in the first three quarters of 2022, most of it went into contracts issued by those companies. The major exception is Allianz Life of North America, which is backed by the giant German financial services firm, Allianz.


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Private equity–linked life/annuity companies have reasons for focusing on the sale of FIAs, especially long-term contracts. FIAs provide those firms with money that they won’t need to return to the annuity contract owners for up to seven or even ten years. They can use that money to make loans that won’t be repaid to them for up to ten years. Long-term fixed-rate deferred annuities can provide a similar benefit. Private equity–led companies have begun to challenge the mutual companies for leadership in sales of those products. In the first three quarters of 2022, Global Atlantic, AIG companies, and American Equity Investment Life had joined New York Life and MassMutual in the top five issuers of fixed-rate annuities.

Distributing through insurance agents Because they offer guarantees against loss, FIAs and fixed-rate annuities are considered pure insurance products. That means they’re regulated by the states, not the federal government. It also means that life/annuity companies can hire independent insurance agents without securities licenses to sell these products. By selling through the independent agent “channel,” FIA issuers are able to reach a much bigger audience with more complicated products and with higher commissions for agents than would be possible if FIAs were regulated by the U.S. Treasury Department. I explain that in a bit more detail in the “Keeping the Life/ Annuity Industry Honest” section, later in this chapter. These life/annuity companies have come to dominate sales of FIAs, and their share of the market for fixed-rate annuities has grown in recent years. They offered contracts with highly competitive potential returns during the period after 2008, when returns on bonds were minimal. Financial wizardry helped them do that. Their asset management partners are experts in loan origination and leveraged loans. In brief, they take a percentage of a life insurer’s general account and lend it to borrowers whose borderline credit ratings make it too expensive for them to obtain financing elsewhere. Evidently, the asset managers can customize the terms of the loans in ways that make such deals feasible. The asset managers also securitize these loans. Figuratively speaking, they bundle hundreds of loans into packages called collateralized loan obligations. They divide the bundles, like sides of beef, into cuts of different levels of quality and rates of return. Then they sell these segments to large institutional investors, such as life/ annuity companies and pension funds.

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To further reduce their costs, the asset managers use reinsurance to reduce expenses for their life/annuity partners. They hire low-cost reinsurers to assume or share the risk that the life/annuity company won’t earn enough on its investments to keep its promises to annuity owners and other customers. The reinsurers are typically headquartered in places like Bermuda, the Cayman Islands, or a U.S. state such as Vermont or Arizona, where regulations are lighter and costs are lower. In some cases, the asset managers, the life/annuity companies, and the reinsurers are all part of the same company. In my publication, Retirement Income Journal, I called this practice the Bermuda Triangle strategy. It’s intended to enhance the life/annuity company’s profits for its shareholders.

Other types of life insurers Besides mutual, stock, and private equity–affiliated life insurers, foreign-owned and fraternal life insurers operate in the United States. Fraternal life insurers are nonprofit organizations that are permitted to sell insurance to their members, who may share a common profession, philosophy, or religion. In some cases, anyone can become a member and buy their products and services. The largest of these in the United States is Thrivent, formerly known as Thrivent Financial for Lutherans. Once open only to Lutherans, it expanded its membership in 2013 and has more than two million members. Another large fraternal is Modern Woodmen, a 140-year-old Illinois company with more than 750,000 members. Its members aren’t loggers, woodworkers, or cabinet makers — the founder just liked the name and its association with the self-reliant pioneer spirit. Several European companies purchased U.S. life insurers from the late 1980s onward. In 1986, Britain’s Prudential plc bought Jackson National Life. In 1992, France’s AXA took over Equitable Life, making it AXA Equitable. In 1999, Aegon of the Netherlands bought Transamerica. In 2000, ING Groep NV of the Netherlands bought the Minnesota life insurer ReliaStar and segments of Aetna and turned them into ING USA. Except for Aegon and Transamerica, most of those transatlantic mergers have ended. AXA parted with Equitable, ING spun off ING U.S. as Voya, and Prudential plc spun off Jackson National Life as a separate company. In their place, Asian companies have acquired U.S. life/annuity companies. In 2015 and 2016, Japan’s Dai-ichi Life and Sumitomo Life bought Protective Life and Symetra Financial, respectively.


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Keeping the Life/Annuity Industry Honest Each of the U.S. life/annuity companies is regulated by the insurance commission in the state in which that company is headquartered. A giant insurer like Athene or New York Life might sell annuities in almost every state in the union, but Des Moines–based Athene is regulated by the Iowa state insurance commission and New York Life is regulated by the New York State insurance commission. The 50 state insurance commissioners share the resources of an umbrella organization, the NAIC. The NAIC is not a regulator. Instead, its staff supports the activities of the commissioners by studying common problems and preparing standardized “model” regulations for all 50 states. State commissioners are free to adopt those models in their own jurisdictions or ignore them. Although branches of the federal government regulate certain securities products sold by life/annuity companies, the federal government doesn’t directly regulate the companies. But after the 2008 financial crisis, Title V of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 legislation provided for the creation of a Federal Insurance Office (FIO) within the U.S. Treasury Department. FIO publishes an Annual Report on the Insurance Industry; it’s available on the Treasury website (

DUELING OVER DUAL REGULATION For more than 150 years, a debate has smoldered in the United States over the question of who should regulate the insurance industry. Should it be the federal government or the states? For the past 75 years, the states have been in control. Life/annuity companies that sold products all over the United States have never liked having to file separate legal documents in dozens of states. But in 1875, this problem was eased by the creation of the NAIC. Its efforts at national standardization helped relieve the need for federal intervention. In 1890, the Supreme Court supported state regulation by ruling that insurance was not a form of interstate commerce and, therefore, not subject to federal oversight. In 1944, the Supreme Court reversed that ruling. In 1947, Congress passed the McCarran– Ferguson Act, which settled the matter in favor of the states. (continued)

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At times, however, the federal government has felt a need to get involved. In the 1990s, the bankruptcy of the Executive Life Insurance Company temporarily revived doubts about the states’ ability to regulate large financial services companies. In 2007, the SEC, roused by network TV coverage of predatory sales practices in the annuity business, tried to regulate FIAs as securities. In 2016, the Department of Labor’s Employee Benefits Security Administration (EBSA) tried to police the sale of FIAs and VAs to anyone purchasing their contracts with taxdeferred savings that they had rolled over from 401(k) plans to individual retirement accounts (IRAs). EBSA passed a rule that required agents and advisers to pledge that they would sell those products to IRA owners only if the purchase was in the investor’s “best interest.” The agents and advisers could face class-action lawsuits in federal court if they violated the pledge. Several organizations within the life/annuity industry challenged the new regulation. In 2019, a judge in the U.S. Court of Appeals, Fifth Circuit, annulled the EBSA rule, and the Department of Labor didn’t appeal the ruling to the U.S. Supreme Court. Later, however, the SEC passed a compromise regulation requiring advisers and agents to work in the investor’s best interest but did not carefully define the term or set formal consequences for its violation.


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»» Seeing who sells annuities »» Knowing which questions to ask »» Getting the kind of service you’re entitled to



Meeting the Annuity Salespeople


s complicated as annuities are, the world of annuity distribution is even more complex. Life insurers, in a real sense, are the manufacturers of annuities. They distribute their products through almost as many channels as there are bayous in the Mississippi River Delta. In this chapter, I explore these channels and introduce you to their denizens. In the insurance channel, you’ll find agents selling fixed annuities. In the brokerdealer channel, you’ll find investment advisers pitching variable annuities (VAs). And in the fee-only channel, you’ll find just a few financial planners recommending annuities. If you ask these financial intermediaries the right questions, you’ll soon learn their attitudes toward annuities, their command of retirement income planning, how they get paid, and their degree of responsibility for putting your “best interests” ahead of theirs. As you paddle your canoe through the annuity bayou, you’ll discover that different agents and advisers have different attitudes toward annuities and retirement planning. Surprisingly, few of them specialize in helping you convert your savings to income in the most efficient way.

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Surveying the Annuity Sales Landscape There’s an old saying that “annuities are sold, not bought.” Life/annuity companies don’t sell annuities directly to the public. Instead, they work with various types of wholesalers who work with the individual advisers and agents who work with members of the public. As Yogi Berra, the Hall of Fame catcher and manager for the New York Yankees, supposedly said, “You can see a lot just by looking.” So, let’s look at the various channels in the vast river of financial services, and see where annuities are often, sometimes, or rarely recommended.

Meeting the distributors The major annuity distribution channels include banks, brokerages, insurance marketing organizations, and registered investment advisors (RIAs). Annuities are also offered to the public through defined contribution plans, so-called senior seminars, and online. Here’s a list of the venues where you’re likely to find annuities sold:

»» Banks: The major banks, or bank holding companies, own brokerage firms and insurance agencies where you’ll find licensed agents and advisers who can sell you several kinds of fixed annuities or VAs. A small regional bank may employ an adviser who visits the local branches on certain days.

»» Brokerages: Thousands of large and small brokerage firms operate in the

United States. They focus on investments, but their advisers may also recommend annuities through their retirement services programs. The four national full-service brokerages — Merrill, Morgan Stanley, UBS, and Wells Fargo — are called wirehouses. The biggest independent broker-dealers include LPL Financial, Advisors Group, and Lincoln Financial Network. Some brokerages are owned by or affiliated with life/annuity companies.

»» Insurance agencies in your community: Independent agents and career

agents (employed by an insurer) have offices in most U.S. cities and towns. In rural America, the insurance agent may be the only financial professional in town. Independent agents offer several types of insurance products from many insurers. Career agents represent the products of one company.

»» RIA firms: After the 2008 financial crisis, many wealth managers and

investment advisers left wirehouses to start or join RIA firms, which offer investment advice and are not brokerages (though they may own or partner with brokerages).


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»» Employer-sponsored retirement plans: Recently, life/annuity companies have been trying to persuade more employers to offer annuities to their participants in their 401(k) plans. (See Chapter 16 for more on annuities in defined contribution plans.)

»» Senior seminars: Independent advisers and insurance agents sometimes

market their products and services through free luncheon seminars to older investors in a community. Fixed index annuities (FIAs) are commonly promoted this way.

»» Online: The internet has changed the distribution method of almost every

product, including annuities. (Chapter 15 is devoted to this topic, so I won’t cover it here.)

Meeting the agents and advisers It’s difficult to generalize about the people who sell annuities. Financial professionals often wear multiple hats. Depending on their licenses, they can be insurance agents (and recommend fixed annuities) or investment advisers (and recommend VAs or recommend no annuities at all). On any given day, their recommendations may depend on your wealth status, on whether interest rates are high or low, on their employers’ goals, or on whether they think annuities are underpriced. In such a fluid situation, it helps if you know what you’re looking for. (For a quick visual breakout of the annuity sales force, see Table 14-1.) Financial professionals can have as many licenses, certifications, and designations as they can pass the exams for. Depending on their credentials, advisers and agents may be able to sell or recommend many types of investments and insurance products, while others can sell only one or two types.

Insurance agents If you buy an annuity, your adviser must have an insurance license or must partner with a colleague who has a license. Insurance agents without securities licenses can only sell fixed annuities, such as multiyear guaranteed annuities (MYGAs), fixed-rate annuities, FIAs, income annuities, and long-term care annuities. To sell VAs, including registered index-linked annuities, a person must have insurance and securities licenses.

CHAPTER 14 Meeting the Annuity Salespeople


TABLE 14-1

How Financial Intermediaries Think about Annuities

Financial intermediary*

Stance on Annuities


Independent insurance agents

Often recommend fixed annuities


Career insurance agents

Often recommend fixed annuities


Investment advisor representatives at RIAs

Favor investments, but may recommend nocommission annuities for some clients


Investment advisers

Favor investments, but may recommend either variable or fixed annuities

Not necessarily

Registered representatives

Can sell securities but can’t give advice without additional licenses


Dually registered or fee-based advisers

Favor investments but may recommend annuities and receive commissions

In certain roles

Bank-based advisers

Often recommend fixed annuities and certificates of deposit (CDs)

Not necessarily

Fee-only planners

Avoid annuities; may recommend income annuities where appropriate


*Financial professionals may hold multiple licenses and titles and perform multiple roles. **Those who hold themselves out as fiduciaries are required to strive for the highest ethical standards, always putting their clients’ interests first.

RECOGNIZING RETIREMENT INCOME SPECIALISTS If you’re looking specifically for advisers who specialize in retirement income planning per se, look for certain acronyms on their business cards. Many advisers in the United States have studied income planning and have passed exams entitling them to display the letters RICP, RMA, or CRPC, after their names. Those letters indicate that these advisers have earned the Retirement Income Certified Professional (RICP) designation from the American College of Financial Services, the Retirement Management Analyst (RMA) designation from the Investment and Wealth Institute, or the Chartered Retirement Planning Counselor (CRPC) designation from the College of Financial Planning, respectively. Advisers with these designations will likely know that planning for retirement demands an individualized, holistic, and risk-based approach. I’ve found only one country, Israel, that requires special training for those who give financial advice to retirees. There’s no such requirement in the United States.


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You’ll probably encounter one of these two types of insurance agents:

»» Independent insurance agents: Independent insurance agents can recommend and sell any life/annuity company’s products, assuming they’re appointed by the insurer to represent them to the public, and as long as the state in which they’re licensed allows the sale of that particular contract. (Some states, especially New York, are fussy about which contracts they’ll allow.)

Independent agents typically work with insurance marketing organizations. These are wholesalers who sit between insurers and agents. Insurers pay sales commissions to agents and separate “override” fees to the wholesalers. The agent may ask for a single commission of 2 percent to 7 percent or more, depending on the type of annuity. Or the agent may prefer to receive a smaller up-front commission coupled with a smaller trail commission that the insurer pays them each year for as long as contract is in force (active).

»» Captive or career insurance agents: Captive or career insurance agents are typically full-time employees of a single mutual insurance company (see Chapter 13). They sell only the contracts issued by their employers. They sometimes earn both a salary and sales commissions.

You’re most likely to hear about fixed income annuities from career agents. That’s because mutual insurers sell, by far, the most income annuities. Some mutual insurers have expanded their offerings to VAs and even to FIAs, so you might hear about VAs and FIAs from career agents, too, depending on their licenses. Many insurance agencies have online storefronts, and many agents work with clients over the phone and by mail. In Chapter 15, you can find a discussion of the online annuity world.

Advisers at banks Bank advisers are best known for recommending fixed-rate annuities or MYGAs to their clients, especially when those products offer higher yields than the CDs commonly sold to bank customers (who are said to be older and more conservative than brokerage customers, on average). In 2021, roughly 17 percent of all deferred annuities sold in the United States were sold through banks, according to data gathered by Wink, Inc.

Brokerage advisers Brokerage firms distribute investment products regulated by the Securities and Exchange Commission (SEC), like mutual funds and individual securities. But their advisers may also be qualified to sell investments, annuities, and life

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insurance. These advisers can create financial plans and retirement plans. They may earn fees based on a percentage of the value of the assets they’ve recommended for your managed account, or earn commissions on products they sell you for your brokerage account, or some of each.

REGISTERED REPRESENTATIVES Everyone who handles securities transactions at a brokerage is registered with the SEC and can represent their brokerage to customers. Those who are registered but don’t have advice-related licenses can execute transactions, but they can’t provide ongoing advice or charge for it.

INVESTMENT ADVISERS Investment advisers who are employees of brokerages are, in addition to being registered reps, licensed to be paid for advising clients. They can earn commissions for selling mutual funds or annuities, or earn fees for providing advice. Depending on their seniority, these full-time employees of brokerages may be able to make independent recommendations or they may simply follow guidelines set by the brokerage. Brokerage advisers are most likely to recommend VAs (including RILAs), which are both securities and insurance products. More brokerages, however, now allow or encourage the sale of FIAs, especially now that FIAs are routinely sold by insurers with A strength ratings. Some brokerage advisers recommend immediate or deferred income annuities for certain clients. These advisers will typically sell only curated lists of annuities that their firms have approved. If the advisers themselves aren’t licensed to sell insurance products, an insurance-licensed associate may complete the sale.

INDEPENDENT ADVISERS AT INDEPENDENT BROKER-DEALERS When advisers are independent  — not employees of brokerages  — they will be affiliated with an independent broker-dealer (like LPL Financial, Advisor Group, or Lincoln Financial Network, to name the three biggest). The brokerage approves and executes the advisers’ transactions. It may also provide back-office functions and software (for client relationship management and investment management) for its advisers. Independent advisers, like independent agents, sell the products of many different investment and insurance companies.

INVESTMENT ADVISER REPRESENTATIVES AT REGISTERED INVESTMENT ADVISOR FIRMS If an adviser is an investment adviser representative at an RIA firm, they probably won’t recommend that you buy an annuity. (The CEO of the biggest RIA firm in


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the United States, Fisher Investments, is famous for his advertising tagline, “I hate annuities. And you should, too.”) RIAs and their investment adviser representatives specialize in giving investment advice for a fee that’s equal to about 1 percent or 1.5 percent of the value of your investments. (They cater to people with more than $500,000 worth of investments for that reason.) They’re fiduciaries — that is, they promise to act as their clients’ trusted advisers and to put their clients’ interests ahead of their own. Because RIA advisers don’t sell products per se or accept commissions from life/ annuity companies (or mutual fund companies) for selling their products, they don’t sell most annuities. But life/annuity companies have developed nocommission products for them. They can buy these products for their clients at online insurance sales platforms, such as DPL Financial Partners (https://, with the help of insurance-licensed agents. Some RIA advisers are dually registered — they’re registered representatives associated with broker-dealers and investment adviser representatives associated with RIAs, at the same time. They’re sometimes called fee-based advisers, which means that they can accept commissions or charge investment management fees. Their RIA firm may also be a brokerage firm, or the advisers themselves may be associated with a brokerage unrelated to their RIA. A brokerage and a broker-dealer are related but not identical entities. A brokerage “brokers” securities transactions between unrelated customers as a neutral intermediary. A broker-dealer also has its own inventory of securities from which it “deals.” You can find out the disciplinary or criminal history of any brokerage firm and sales representative online via the Financial Industry Regulatory Authority (FINRA) and its BrokerCheck service (

Financial planners Fee-only planners differ from other types of advisers in that they never accept commissions. They prefer to work for a percentage of the assets they manage, or an hourly fee, or a project-by-project fee. As “planners,” these advisers usually offer broad financial advice, without limiting their plans to investments alone. Many fee-only advisers belong to the National Association of Personal Financial Advisors (NAPFA).

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ASK FOR YOUR ADVISER’S FORM ADV Before you sign your name and enter into a formal investment agreement with a financial adviser at a brokerage firm or RIA, take time to read the adviser’s Form ADV. All advisers have to file this form with the SEC and show it to you. Form ADV is officially known as the Uniform Application for Investment Adviser Registration and Report by Exempt Reporting Advisers. As part of the Form ADV, there will be a brochure with details about the adviser’s company and its ownership, clients, employees, business practices, affiliations, and any disciplinary actions against it for regulatory violations. The SEC requires the brochure to be written in “plain English.” In Part 2 of Form ADV, advisers must include information about their education, investment policies and practices, risks that you’ll face when investing, and compensation. They have to disclose their conflicts of interest and explain how they handle those conflicts.

At any financial adviser conference, the best-educated people in the room often hold the Certified Financial Planner (CFP) or Chartered Financial Consultant (ChFC) designation. The exams for these designations are said to be tough. The advisers who hold these designations often have MBA degrees or degrees in economics, or have passed the difficult test to become actuaries, the rocket scientists of the annuity world. (Actuaries calculate the future costs of the promises that life/annuity companies make to their policyholders today.) As a rule, you should only consider an annuity as one component, and not the largest component, in a holistic retirement income plan that factors in Social Security, home equity, health care, and beneficiary goals, as well as the impact of taxes and inflation. Be wary of anyone whose plan starts with a recommendation to buy an annuity, or who applies pressure to you in any way.

TESTS THAT INVESTMENT ADVISERS MUST PASS To sell and recommend investments, brokerage employees must pass certain exams and acquire certain licenses. The exams are administered by the North American Securities Administrators Association (NASAA). NASAA’s members are state-level securities regulators. They directly supervise the investment advisory firms in their state that manage less than $100 million for clients. They also monitor all the securities firms that


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do business in the state. NASAA works with FINRA, the brokerage industry’s in-house watchdog, which works with the SEC. Here are the exams advisers must pass:

• Series 63 exam: This is the most basic exam for securities agents, investment

advisers, registered reps, and investment adviser representatives of RIAs. Individual states require it of the advisers in their states. The examination covers the principles of state securities regulation reflected in the Uniform Securities Act, a “model” statute that NASAA created to guide states in writing their securities laws and regulations. It acquaints new advisers with their obligations to clients and with the rules that govern what they tell the public.

• Series 65 exam: This exam includes questions about annuities, including fixed,

variable, and indexed contracts. It’s more comprehensive than the Series 63 exam. Questions require a college-level familiarity with economic concepts, the valuation of securities, tax issues, estate planning basics, and portfolio management. This license is mandatory for anyone intending to provide financial advice.

• Series 66 exam: This exam combines the subject matter of the Series 63 and 65

exams into a single test. If advisers have passed this test, they have both of those other licenses.

• Series 7 exam: To be a general securities representative (a “registered rep”) at a

brokerage firm, a person has to pass this exam and the Securities Industry Essentials Exam. It allows the brokerage employee to execute the sales of corporate, municipal, and investment company securities, along with VAs, options, and government securities. Series 7 licensees can’t sell commodities, futures, real estate, or life insurance.

Today there are about 15,000 SEC-registered advisers in the United States, of whom about 60 percent provide asset management services for individuals. They are said to manage $128.4 trillion in financial assets for 64.7 million clients, according to the Investment Adviser Association (, a trade association.

Asking Smart Questions Before meeting with prospective advisers or agents, I recommend asking yourself the following questions. The answers will narrow your search and point you to professionals whose skills and ethical standards most closely match your needs and values.

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Do I need a product or do I need advice? If you already know the product that you want, then you may only need to talk to a broker (for investments), an insurance agent (for fixed annuities), or a person with investment and insurance licenses (for VAs). You may be able to do that over the phone after setting up an account at a financial services firm. If you’re not sure how or where to begin, and you need advice about retirement planning, then you may need to consult someone licensed to give advice. That may be an account executive at a brokerage firm, an RIA, or a financial planner.

Who serves people at my level of wealth? Time is money, of course. The more money you have, the more time financial services companies will spend on you. People with two cents to rub together are steered to online, automated advice “engines.” People with a couple hundred thousand dollars tend to be offered prepackaged insurance and investment products where advisers earn commissions from the products’ manufacturers. People with at least $500,000 may be offered a managed account where they pay the adviser a 1 percent (or more) fee for giving them advice. That’s $5,000 per year. There may be additional fees charged for the use of certain investments. The adviser may also set up a brokerage account where the adviser can earn commissions for selling certain products. So, where should a middle-class person on the brink of retirement go? You might visit a planner who charges by the hour for advice, or who will develop a retirement income plan for a fixed fee. Many people balk at writing a four-figure check for advice that they may or may not take. (Isn’t “advice” what your brother-inlaw gives you for free?) But there are advantages to paying a self-employed planner out of your own pocket.

What conflicts of interest do advisers have? No one can serve two masters equally well. If someone other than you is paying commissions, 12b-1 marketing fees (fees paid by some mutual-fund companies to broker-dealers to help cover the expense of marketing their funds), performance bonuses, or even just salaries to your insurance agent or investment adviser, their advice for you will be conflicted (or biased) to a degree. Fee-based advisers claim to have no conflicts between their interests and your interests because “they do better when you do better.” But fee-based advisers are biased in favor of gathering a bigger share of your wallet. When the stock market


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goes up, they earn more for the same amount of work. They’re also biased against income annuities, because moving your $100,000 or $200,000 to an insurance company means a cut in fees for them. Independent insurance agents lean toward selling the contracts that pay them the highest commissions. That explains why they recommend so many FIAs. They sometimes advertise FIAs as having “no fees,” but the company deducts the commission from the clients’ premiums at the time of sale, which reduces future returns. It’s also why young brokerage advisers, whose assets under management are still too small to generate much of a 1 percent fee, sell VAs with commissions. Regulators seem to believe that the conflicts become harmless if the advisers “disclose” them. I disagree. Disclosures simply immunize the financial services companies from complaints.

Which hat does my adviser wear today? Advisers wear many hats. They may wear their insurance hats to sell annuities, their brokerage hats to sell securities, and their RIA hats to sell advice. As hats switch, you may not know from one moment to the next whether the advice you’re receiving is merely “suitable” for you or in your “best interest.” Because advisers may combine insurance and investment products in the same financial plan, they could be wearing two hats at once and getting paid in two different ways. You need to find out if advisers are configuring your account in a way that maximizes their rewards or yours. Your interests won’t necessarily be aligned.

Which designations are meaningful? Certified Senior Advisor, Certified Senior Consultant, Chartered Advisor for Senior Living, and Chartered Senior Financial Planner are four senior designations listed at the FINRA website, along with links to the organizations that offer them. Advisers or agents sometimes style themselves as senior specialists, elder planners, or retirement advisers, but they don’t always have specific training or certificates.

Am I getting customized advice? Some investment advisers work for brokerage firms that provide them with ready-made financial plans. When my wife and I first visited a financial adviser

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for retirement advice, he simply told us to buy a balanced portfolio of stock and bond mutual funds that were offered by his company. The adviser was confident that our investments would earn an average of 8 percent a year. If we spent 4 percent of our current savings per year during retirement, he said, we would die richer than we’d ever been before. That was an appealing thought. When I said we wanted to add an annuity to our plan, he said he couldn’t do that. And his company sold annuities! One-size-fits-all investment plans can work fairly well for people who are still saving for retirement — that’s why target date funds fit many 401(k) plan participants  — but retirement income plans require much more customization. No two households have exactly the same resources or expenses in retirement. If two households happen to be alike today, they’ll be different by tomorrow.

Expecting Service in Your “Best Interest” It may seem strange, because we should all be able to expect perfect honesty, but there’s more than one ethical standard in the sale of financial products and advice. There’s the suitability standard, the fiduciary standard, and best interest standard. The lines are blurred.

The suitability standard In Chapter 3, I mention the suitability tests that are part of any application you fill out when buying a fixed annuity through an insurance agent. In the past, state regulators held that, because insurance agents didn’t offer advice but merely executed occasional transactions, they didn’t bear the same burden of loyalty to their customers that advisers, for instance, bore toward their clients. In practice, this meant that agents could accept commissions from life/annuity companies despite the conflicts of interest they created. Agents could also promote annuity contracts with the highest commissions and use high-pressure sales tactics. These practices led to negative publicity and calls for federal regulation of the sale of indexed annuities. The fact that life/annuity companies had begun distributing products through independent agents instead of career agents in the 1990s may have contributed to a decline in supervision of agents. Responding to the public’s concerns about annuity sales, in 2010 the National Association of Insurance Commissioners (NAIC) passed a model regulation requiring that annuities be suitable for clients. In 2020, the rule was revised and


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strengthened. It requires agents “to act in the best interest of the consumer without placing their or the insurer’s financial interest ahead of the consumer’s interest.” State insurance commissioners are not bound by the NAIC model regulations, however. The revised version of this rule still allows agents to accept commissions from life/annuity companies for the sale of their products. But agents “must prominently disclose to a consumer . . . their relationship with the consumer, the role they will play in the transaction, and a description of the cash and non-cash compensation they will receive.” If they do, the NAIC “determined that compensation was not a material conflict of interest.” The industry’s position is that the public understands that salespeople deserve to get paid. But if members of the public knew the impact of the size of the commission on sales recommendations, they wouldn’t be so understanding. The NAIC also said that agents can compete in sales contests and earn bonuses as long as the rewards aren’t based on the sale of specific annuity products within limited time frames.

The fiduciary standard The gold standard for an adviser’s conduct is the fiduciary standard. It signals a higher degree of loyalty toward clients. Advisers who describe themselves as fiduciaries must act in their clients’ best interests, must put their clients’ interests ahead of their own, must be loyal to their clients, and must avoid conflicts of interest. Advisers who work for RIAs claim to be fiduciaries. Any holder of the CFP, ChFC, or Chartered Life Underwriter designation, to name three of the most respected credentials, takes an oath to meet the fiduciary standard. Technically, all financial advisers who are registered with the SEC are supposed to act in their clients’ best interests. The definition of fiduciary is not always clear-cut, however. Fiduciaries can have conflicts of interest as long as they disclose them to their clients. Advisers may act as fiduciaries in some matters and not as fiduciaries in others.

The best interest standard In 2019, the SEC established a standard of conduct that applies to all sellers of investments and annuities. It requires all agents and advisers to act in the “best interest” of their clients. But the SEC didn’t say exactly what that means.

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Best interest emerged as a provocative term in annuity circles in 2016 when the Department of Labor (DOL) passed a rule aimed at regulating the sale of VAs and FIAs to people with rollover individual retirement accounts (IRAs). Under the rule, advisers and agents had to formally pledge to act only in the best interest of their IRA clients when selling those two annuities. The DOL had, in effect, raised the standard of conduct (for FIA sellers especially) to “fiduciary” from “suitability.” Because agents’ acceptance of commissions from life insurers for selling FIAs put them in conflict with their clients, they would clearly have difficulty meeting a higher standard. The annuity industry and its allies sued the DOL. In 2018, the U.S. Court of Appeals, Fifth Circuit, ruled in their favor and invalidated the DOL’s best interest rule. The SEC, hoping to fill the regulatory vacuum with a universal ethical standard in financial services, issued its own fiduciary rule in 2019. But the term best interest remains undefined.


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»» Finding reliable places to shop for fixed annuities online »» Putting robo-advisers to work for you »» Doing the math yourself »» Visiting the websites of annuity issuers



Site-Seeing in the Annuity Web World


iven the ocean of online information about annuities, which sites should you visit first? There’s no simple answer, but I recommend at least four entry points: fixed annuity sales sites, income planning software sites, sites with free calculators, and the websites of name-brand insurance companies. Fixed-rate annuities are the most suitable annuities for buying online. They’re sold by transaction-driven agents, the contracts are fairly standardized, and their features are specific and easy to compare. In this chapter, I point you to sites where you can meet an agent and seal a deal. Or perhaps you’re looking for inexpensive advice. There are lots of “robo advice” sites that provide a combination of self-service digital tools and personalized assistance. Not many are dedicated to annuities or retirement income planning, however, so I identify a few of them for you. Retirement income planning is a numbers game, so calculators are essential tools. I include a list of the ones I’ve found especially useful. Finally, I direct you to the sites of the major life/annuity companies. Obviously, they’ll have tons of product brochures there — just be sure to read the fine print.

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Shopping for Fixed Annuities Online You’ll find lots of information, little sales pressure, and insurance professionals with long track records of consistent service at the annuity sales websites listed in this section. Most of the sites are run by entrepreneurs with a bigger-thanaverage passion for annuities. Many annuity-related websites, including some informative, balanced sites like (, exist primarily to capture your name and email address or phone number so that an adviser or agent can call you. These lead collection sites ask questions about your financial net worth so the agents follow up with only large-fry, not small-fry, investors. Just something to keep in mind. ( is the granddaddy of annuity websites. It was founded in 1996 by veteran insurance man Hersh Stern, now retired. On the home page, you’ll find an easy-to-use income annuity calculator that tells you how much monthly income you can get from an immediate or deferred income annuity. You can test endless “what if” retirement planning scenarios with this tool. It will instantly answer questions like, “What if I delay income for five years?” or “What if I apply $25,000 more or less savings?” Users of “bucketing” to build retirement income should find the tool empowering. (See Chapter  17 for more on bucketing.) The site is a virtual insurance agency, and you’ll be prompted to call a toll-free number that rings through to an agent. But the site’s generosity with information and educational material makes it more than a mere lead collector. It even includes a virtual annuity museum. Despite its name, also deals in fixed-rate annuities, fixed indexed annuities (FIAs), and even secondary market annuities. Because isn’t a securities-licensed shop, you won’t see traditional or structured variable annuities (VAs) there.

The Annuity Man Stan Haithcock is a licensed insurance agent, podcaster, blogger, and public speaker who operates an annuity sales and educational website called The Annuity Man ( You can learn about annuities and buy annuities at the site.


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Haithcock has a strong point of view. He recommends only fixed annuities that provide principal protection, income for life, or the funding of legacies or financing for long-term care. That includes fixed-rate annuities, deferred income annuities, and immediate income annuities. He doesn’t sell VAs, life insurance, or long-term-care insurance. His stated focus is on “contractual guarantees using all fixed annuity types.” Haithcock believes annuities “shouldn’t be used for market growth.” He invented an acronym (PILL) that identifies the only purposes for which he believes annuities are appropriate: principal protection, income for life, legacy, and long-term care/confinement care. “If you don’t need to contractually solve for one or more of the items in the PILL, then you do not need an annuity,” Haithcock writes. The site offers a number of useful links and calculators, as well as links to Haithcock’s own books on specific types of annuities.

Blueprint Income/AARP AARP, as almost everyone knows, is the former American Association for Retired Persons, and it has evolved into a substantial insurance sales platform. AARP has partnered with Blueprint Income, an independent site where anyone can learn about fixed-rate and income annuities, check current interest rates or payout rates on fixed annuities, and set up sales calls. Check it out at www.blueprintin Blueprint Income publishes annuity guidebooks in PDF form that you can download from the website for free. For accuracy and thoroughness, I was impressed with its 94-page Annuity Decision Guide ( annuity-guide), which covers fixed-rate annuities and the three types of income annuities: immediate, deferred, and qualified longevity annuity contracts.

Fidelity and Schwab Boston-based Fidelity ( is well known as a diversified financial services giant that markets proprietary mutual funds, employer-sponsored retirement plan services, brokerage services, and investment advice. On its website, you can also find a Fidelity Insurance Network page at annuities/overview. Charles Schwab, once a pioneer in online discount brokerage services and now a household name, also hosts an annuities page on its website ( annuities). It provides answers to frequently asked questions, links to pages for specific types of annuities, and contact information for phone reps or advisers.

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Licensed to handle inquiries about insurance products or securities, Fidelity and Schwab both feature VAs as well as fixed annuities. In both places, you’ll find curated lists of annuities from select life/annuity companies. Schwab offers most types of annuities, all provided by third-party life insurers. The VAs are issued by Protective Life but include Schwab investments. Schwab requires a minimum annuity premium of $100,000. Fidelity, which owns a life insurance company, offers proprietary VAs as well as third-party fixed annuities. Fidelity has different investment minimums for different annuities, some as low as $5,000. Its shelf of annuity providers includes only mutual companies. They include Guardian, MassMutual, New  York Life, USAA, and Western & Southern. (See Chapter  13 for more about life/annuity companies.)

Income Solutions Years ago, Minneapolis-based financial services entrepreneur Kelli Hueler had a dream: to host a website where life/annuity companies would submit competing bids and retirees could get the best possible rate for immediate or deferred income annuities. That dream solidified into Income Solutions ( As the domain name suggests, Income Solutions deals only in SPIAs, deferred income annuities (DIAs), and longevity insurance (DIAs or qualified longevity annual contracts [QLACs]) where income doesn’t start until after age 80. You can customize your annuity to make it for one life or two, for life with cash refund, for life with a fixed period, or for a fixed period only. At Income Solutions, you’ll find annuities from Integrity Life (a Western & Southern company), Lincoln Financial, Mutual of Omaha, Nationwide, Symetra, and Securian Financial. You receive their quotes in a grid, allowing for easy apples-toapples comparisons between products.

Annuity Straight Talk If you’d like to connect directly with someone whose specialties are fixed-rate annuities and FIAs, there’s Annuity Straight Talk (https://annuitystraight The host of the site is insurance agent Bryan Anderson, a former wilderness fishing guide and college decathlete based in northwest Montana. Anderson, who also writes and podcasts on the topics of annuities and retirement planning, has refined what he calls the FLEX Strategy for using FIAs to generate retirement income as alternatives to immediate annuities or annuities with guaranteed lifetime withdrawal benefits (GLWBs).


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ANNUITY WEBSITES FOR FEE-BASED ADVISERS Perhaps you’d like to use an annuity to add safety to your retirement income plan, or maybe you want to exchange your current annuity for a different one. But what if your fee-based or fee-only adviser has little experience with annuities and no insurance license? There are a few relatively new websites designed to serve those types of advisers. Over the years, I’ve become familiar with two such sites: DPL Financial Partners (https:// and RetireOne ( DPL Financial acts as an intermediary on the purchase of several types of annuities. RetireOne emphasizes the sale of contingent deferred annuities (the stand-alone income riders that I described in Chapter 10).

The method involves buying fixed deferred annuities and using the annual 10 percent free withdrawal features of certain contracts to provide yourself with an income. You can download a FLEX Strategy brochure and access Anderson’s videos and podcasts on the website.

Working with Robo-Advisers Robo-advisers emerged in the mid-2010s as a branch of financial technology, or fintech. The first robo-advisers were websites that could help individuals choose mutual funds from a list and manage their own mutual funds for a nominal monthly or annual fee. Retirement planning can be more complex than investment planning. That may be why most of the software for income planning, such as the Income for Life Model featured at Wealth2k (, is meant for advisers to use with clients rather than for people to use on their own. Some fintech firms offer retirement planning software directly to individuals, however. The following sections cover a sampling of these. The topic of annuities is a narrow, specialized niche, but that niche is bottomless on the internet. Because information overload is a hazard, a targeted approach will save time. First, identify your needs. Short-term safe growth? Semi-safe long-term growth? Safe retirement income? A hedge against medical bills in old age? In other chapters of this book, you’ll find keywords that can rocket you to the right websites.

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NewRetirement Fintech entrepreneur Steve Chen has taken a cue from the retirement planning software that financial advisers use and adapted it to the needs and abilities of the do-it-yourself retirement planner. At NewRetirement (, he gives you the tools that serve as a kind of “flight simulator” for exploring the possibilities of your own retirement. Annuities aren’t the central focus of NewRetirement, but they’re presented as potential components in building an overall retirement income strategy. NewRetirement offers three levels of involvement: There’s a free, Basic introductory module; a more sophisticated PlannerPlus program; and a PlannerPlus Academy program that includes live and recorded classes.

IncomeConductor Time segmentation (see Chapter 17) is an approach to retirement income planning that involves dividing your retirement into specific three-, five-, or ten-year segments or “buckets.” IncomeConductor ( provides planning software based on the ideas of a pioneer of bucketing. IncomeConductor features a basic plan for do-it-yourselfers at a modest price, along with more robust versions of the software for financial advisers and financial services firms at higher prices. Like NewRetirement (see the preceding section), IncomeConductor can be described as software as a service — you get the software, learn how to wrangle it, pay a subscription fee, and use it with ongoing support from the company.

Income Strategy Deciding when to claim Social Security benefits is one of the most important financial decisions that a 60-something couple or individual will ever make. ­William Reichenstein and William Meyer literally wrote the book on that topic. Their Social Security Strategies: How to Optimize Retirement Benefits is in its fourth printing. Their retirement income planning software is available at Income Strategy ( This software addresses spending issues, tax issues, and Social Security planning issues. There are at least three subscription levels, depending on how much assistance you want in coordinating your investments, annuities, tax liabilities, and Social Security benefits.


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Retirement Researcher When financial advisers need advice about retirement income planning, they go to Wade Pfau, PhD, whose website is Retirement Researcher (https://retirement Author of award-winning articles in the Journal of Financial Planning, author of the Retirement Planning Guidebook, blogger, consultant, and public speaker, Pfau backs up all his advice with thorough and credible data. Pfau has a long history of thought-leadership in the retirement field. At the American College of Financial Services, he has been Professor of Retirement Income in the college’s doctoral program in financial and retirement planning, codirector of the college’s Center for Retirement Income, and program director of the Retirement Income Certified Professional designation. At the website, you can download comprehensive booklets on retirement planning (in return for joining Pfau’s email list). If you like the free material and want more, you can become a paid member of the Retirement Researcher Academy, which entails workshops, forums, consultations, and group discussions.

Retirement Optimizer One of the seminal thinkers in retirement income planning, in my opinion, is a Canadian engineer turned retirement guru named Jim Otar. His ideas on the role of historical luck in your retirement success or failure and his classifying of retirees into green, yellow, and red groups have helped me understand annuities and retirement planning on a deeper level. You can buy the simple version of the Otar Retirement Calculator on Jim’s website ( for just under $10. (It requires familiarity with Microsoft Excel.) You can also download Jim’s books and articles for free or at modest prices. I recommend the Kindle or paperback version of Advanced Retirement Income Planning.

Calculating Your Financial Future Before you can plan concretely for retirement, you need to brainstorm. And nothing seeds the brainstorming clouds like the right calculating tool. If you crunch a few of the annuity numbers yourself, you’ll know whether agents and advisers are blowing smoke at you.

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Whether you’re estimating the cost of guaranteed lifetime income, or your expected retirement expenses, or your risk of running low on money, or the payout rate from a reverse mortgage, there’s an unbiased online wizard for that. Here are some of my favorites.

»» Savings Distribution Calculator (

Calculators/Savings-Distribution-Calculator): A service of the American Institute of Certified Public Accountants, this calculator is designed to tell you how much of your savings would remain after years of withdrawals. Enter your starting amount, how much you intend to withdraw and how often, and the wizard will calculate your expected final balance.

»» Income Annuity Calculator ( As noted earlier in this chapter, the calculator on the home page of this website is indispensable for fixed annuity seekers.

»» Retirement Funds Integrator Calculator. (https://rfiretirementplan.

com/ext/retirement/Retirement-Chart.aspx): Jack Guttentag’s Mortgage Professor website has several calculators. It’s the only place you’ll find this calculator, which can show older homeowners how to combine annuities, reverse mortgages, and withdrawals from investments to maximize spendable funds in retirement.

»» Present Value of Annuity Calculator (

calculators/financial/present-value-annuity-calculator.php): Found on the website Calculator Soup, hosted by Edward Furey of Ashland, Massachusetts, I used this calculator to find out what an annuity paying a 65-year-old man $2,000 a month over his 20-year life expectancy should cost.

»» Required Minimum Distribution Calculator (

financial-tools-calculators/calculators/required-minimumdistribution-calculator): The Securities and Exchange Commission’s

Office of Investor Education and Advocacy sponsors a website,, that has this useful wizard for calculating annual required minimum distributors.

»» Lifetime Income Calculator ( This

calculator, provided by the Employee Benefits Security Administration of the Department of Labor, asks for five pieces of information: your expected retirement age, your current retirement savings, your current annual addition to savings, your years to retirement, and the date of your latest savings data. Then it tells you how much savings you may have at your retirement age and how much annuity income that may buy for one person or a couple.


PART 3 Shopping in the Annuity Marketplace

»» Compound Interest Calculator (

compound_interest_calculator.htm): If you want to know the future value of your savings, try this wizard at Moneychimp. Unlike the calculator in the preceding bullet, it lets you specify an investment growth rate.

»» The Fidelity Retirement Score ( fidelity-retirement-score-tool): Fidelity offers many calculators, but

this one will give you a reality check on whether you’ve saved enough — and whether you still are saving enough — to retire at your current lifestyle.

Landing on the Annuity Issuers’ Sites Visiting the websites of individual life/annuity companies can be useful. Between them, the following companies sell most of the annuities in the United States:

»» Allianz ( »» American Equity ( »» Athene ( »» Brighthouse Financial ( »» Corebridge Financial ( »» Equitable ( »» Fidelity & Guaranty Life ( »» Global Atlantic Financial Group ( »» Jackson National ( »» Lincoln Financial Group ( »» MassMutual ( »» Midland National ( »» Mutual of Omaha ( »» Nationwide ( »» New York Life ( »» Pacific Life (

CHAPTER 15 Site-Seeing in the Annuity Web World


»» Principal ( »» Security Benefit ( »» Symetra ( »» Thrivent ( »» TIAA ( »» USAA ( These companies don’t typically sell annuities directly to the public. Mutual companies have traditionally employed their own armies of agents. Other insurers reach individual agents or advisers through insurance marketing organizations (IMOs) or brokerage firms. Insurer sites will have links to PDFs of brochures and prospectuses. If an adviser or agent recommends a particular contract to you, you can usually go to the insurer’s website, open or download material about the product, and study it at your leisure.


PART 3 Shopping in the Annuity Marketplace


»» Seeing how an annuity can fit into a 401(k) »» Differentiating among different 401(k) annuities »» Looking at the 401(k) annuities available to you »» Buying an annuity with your 401(k) savings



Adding Annuities to 401(k)s


o buy most annuities, you need a significant pot of money. For many American retirees, the largest caches of cash they’ll ever see in one spot will be their 401(k) accounts. Wouldn’t it make sense, then, to offer annuities inside 401(k) plans, where they’d be easy to find and buy? You might think so. But, partly for regulatory reasons and partly because mutual fund companies have dominated the 401(k) business since its birth in 1980, you won’t find many of the 600,000 401(k) plans in the U.S. offering an annuity purchase option to participants.

If you work for a college or university, you might participate in a TIAA group annuity. But group annuities are found mainly in 403(b) plans, which are offered to employees of nonprofit organizations, not-for-profit corporations, or stock companies. The melding of 401(k)s and annuities may be near, however. In 2019, with the SECURE Act, Congress recognized that many 401(k) plans lacked annuities because employers feared that retirees might sue them if the annuity company chosen by the employer ever defaulted on its payments. The SECURE Act addressed that concern.

CHAPTER 16 Adding Annuities to 401(k)s


Life insurers had lobbied for years for the SECURE Act. They claimed that unless plan participants had easier ways to turn their balances into personal pensions, they might mismanage their savings, run out of money, and need government help in their old age. As soon as the SECURE Act passed, life insurers and others brought several new kinds of retirement income products to market. More are undoubtedly coming. This chapter acquaints you with some of them. One of them may be coming to a 401(k) near you. If your Social Security benefits are large enough, you may not need another annuity. Common sense suggests that if you saved enough in your 401(k) to buy an annuity, then you probably earned a good living. Along the way, you probably also a earned a significant Social Security benefit. Those benefits, especially if taken at age 70, and especially if combined with a spouse’s benefits, may satisfy your need for guaranteed income in retirement. On the other hand, the more money you earned while working, and the higher your standard of living in retirement, the less of your essential expenses Social Security alone is likely to cover. Another layer of guaranteed income, purchased with 401(k) savings, could maximize your sense of financial security in retirement. Only you can decide whether you and your family need that.

Fixing the Flaw in 401(k)s The sponsors of 401(k) plans (employers, that is) bear no explicit responsibility for helping their former employees spend down their savings systematically in retirement. The federal government tries nudging people to spread their savings out across retirement. The IRS requires retirees to start taking age-adjusted withdrawals from their tax-deferred plans at age 73. But many retirees resent these required minimum distributions (RMDs), regarding them simply as occasions for unwanted tax bills. The arrival of annuities in 401(k) plans will likely be gradual. So far, the supply of these initiatives from life insurers is running ahead of demand. Employers and employees are not clamoring for them. The SECURE Act didn’t say which annuities would be best for 401(k) sponsors and participants. In this chapter, I try to make up for that lapse in communication.


PART 3 Shopping in the Annuity Marketplace

A BRIEF HISTORY OF THE 401(K) The 401(k) spread quickly in the 1980s after a benefits consultant named Tex Benna recognized that a paragraph in the Revenue Act of 1978 could help one of his bank clients. The bank wanted its employees to be able to make pretax contributions to a deferred compensation plan. The bank also wanted to make voluntary tax-deferred profitsharing contributions to employee accounts. Since World War II, tax breaks have been the cream and sugar in the U.S. compensation coffee. Soon, many companies added these defined contribution plans. Employers designate a menu of investments for participants. Employees decide how much to defer to their personal 401(k) accounts each payday and what funds to invest in. Employees are responsible for their gains or losses. Over the next 40 years, defined contribution plans have gradually replaced private pensions. Those pensions paid defined benefits — either a lump sum at retirement or an income based on an employee’s average or final pay, multiplied by years of employment. Today, most of the remaining defined benefit plans cover public-sector employees and union members, such as firefighters and teachers. The 401(k) plan has evolved over time. The federal government insisted that companies open their plans to all their full-time employees, not just highly paid ones. Restrictions on the amount of money participants may contribute have risen. The government set the ages when participants may start withdrawing money without a penalty (age 59½) and when they have to start taking money out or suffer a penalty (age 72). Withdrawals are taxed as ordinary income. In 2006, the Pension Protection Act began allowing companies to auto-enroll new employees into 401(k) plans. If the new enrollees didn’t pick their own investments, the employer or plan provider could steer their contributions into so-called qualified default investment alternatives (QDIAs). The two available QDIAs are target date funds (TDFs) and managed accounts. Subsequent laws have allowed plans to raise the amount that employees contribute to their plans over time automatically. The 401(k) has certain flaws, however. The law doesn’t require employers to offer plans or, if they do, to supplement their employees’ contributions with matching contributions. As a result, about half of America’s full-time workers don’t have access to a savings plan at work and don’t save enough. Not all plans are equal. The biggest, most profitable companies tend to offer the best plans, the largest matching contributions, and the least expensive investment options. If you’re in a superior plan, consider yourself fortunate. (continued)

CHAPTER 16 Adding Annuities to 401(k)s



Workers in the lowest-paying jobs are least likely to have access to 401(k) plans. Many people change jobs every few years, interrupting their accumulation of an adequate nest egg. Many people spend their 401(k) savings when they change jobs, especially if their accounts are small. In the United States, workplace retirement plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA). They’re overseen by the Employee Benefits Security Administration of the U.S. Department of Labor. Annuities, however, are regulated by the states.

The 401(k) subculture has its own vocabulary. One piece of jargon is “401(k)” itself. This is merely a type of workplace savings plan whose exact design varies by company. “Plan sponsors” are primarily employers. “Plan participants” are workers like you. A “rollover” is the process that lets you move 401(k) savings to an IRA without triggering an income tax bill. “TDFs,” or target date funds, are series of pre-packaged balanced portfolios of mutual funds. When participants don’t choose their own investments, sponsors can “default” them into a TDF.  They’re offered by many different mutual fund companies. TDFs are typically stamped with dates like 2045, 2040, 2035, etc. You would use the fund whose date corresponds most closely to your own expected retirement date. Over time, as you approach your retirement date, the ratio of bonds to stocks in your TDF automatically rises. That makes the investment mix more conservative and less likely to move up or down quickly.

Telling 401(k) Annuities Apart In passing the SECURE Act of 2019, Congress widened the crack in the regulatory door that has helped keep annuities out of 401(k) plans. But Congress didn’t say which of the many kinds of annuities plan sponsors should offer. Table 16-1 names and defines several of the income-producing features that are used in some 401(k)s or may soon be added to others. Some but not all are annuities. Later in this section, I contrast income annuities and target date funds with income riders, and compare individual annuities with group annuities.


PART 3 Shopping in the Annuity Marketplace

TABLE 16-1

Annuity Solutions You May Find in 401(k) Plans

Annuity or Service

How It Works

A target date fund (TDF) with a guaranteed lifetime withdrawal benefit (GLWB)

An in-plan investment account with an insurance rider offering participants retirement income for life while allowing them to control and access their savings.

Deferred income annuity (DIA)

An in-plan annuity where 401(k) contributions prepurchase chunks of future income.

Annuity sales website

Some 401(k) plans provide links from the plan website to individual retirement account (IRA) platforms where participants can buy out-of-plan income annuities or qualified longevity annuity contracts at retirement.

Qualified longevity annuity contract (QLAC)

An out-of-plan deferred income annuity purchased at retirement. Payments start after age 72 (when RMDs begin) and no later than age 85.

Managed accounts

Custom investment portfolios within 401(k) plans, professionally managed for a fee. The manager may or may not recommend that you buy an annuity.

Payout mutual fund

A mutual fund that pays you an income of 4 percent or 5 percent of the fund’s value per year until it runs out of money. Income isn’t guaranteed for life.

Immediate fixed annuity

The plan makes it easy for you to roll 401(k) savings into an IRA and then buy an outside-the-plan income annuity at retirement, with income starting right away.

Periodic payment

Some plans make it easy to schedule periodic transfers from your plan to your bank account.

Systematic withdrawals

Your plan sponsor may let you set up regular transfers of a specific dollar amount or percentage of your assets from your plan account to your bank account.

Income annuities versus annuities with guaranteed lifetime withdrawal benefits Two kinds of lifetime income guarantees have been offered to 401(k) participants so far:

»» Income annuities: Income annuities provide pension-like income in retirement. You can learn more about them in Chapter 7.

»» Target-date funds with guaranteed lifetime withdrawal benefits

(GLWBs): These are tax-deferred investments with insurance riders, available for an extra fee. Under a GLWB rider, the life insurer might allot you an income of 5 percent of your peak account balance each year and promise, with certain exceptions, to pay you that amount every year until you die — even if your account balance falls to zero before then.

CHAPTER 16 Adding Annuities to 401(k)s


In the case of the income annuity, you lose direct control of and access to your money. But, all else being equal, you get a higher income. In the case of GLWBs, you never lose control of or access to your money, but you get less income and you pay fees. And if you dip into your money for an emergency, your income could go down. It’s a trade-off. (See Chapter 10 for more information on income riders.)

In-plan versus out-of-plan annuities Some 401(k) annuities are “in plan” while others are “out of plan.” A deferred income annuity (DIA) is an “in-plan” annuity where you buy chunks of future income with your plan contributions. A TDF/GLWB is also an in-plan annuity. You pay a rider fee while you’re a plan participant. To buy an out-of-plan annuity, you would roll over all or part of your 401(k) savings to an IRA at or after separation from the employer. Then you would buy an individual annuity contract with a single payment and hold it inside the IRA. Your plan may offer a specific annuity provider, or you may be able to choose your own.

Annuities in TDFs or managed accounts If you don’t actively enroll in your company’s 401(k) plan, the Pension Protection Act of 2006 made it legal for your company to auto-enroll you and start transferring some of your pay into a QDIA. You can drop out of the program if you want. Two types of QDIAs — TDFs and managed accounts — are available. The investment mix of a TDF, as noted earlier, gets more conservative over time, on a fixed schedule. A managed account follows an investment plan set by the company providing the managed account service to the plan.

Deferred contracts, immediate contracts, and qualified lifetime annuity contracts As the examples in the next section illustrate, your 401(k) plan provider can help you buy an income annuity (as opposed to a GLWB) in three main ways:

»» You can purchase future income, starting at retirement, with part of each biweekly or monthly payroll contribution.

»» You can wait until retirement to decide to buy an annuity that provides income right away.

»» You can wait until retirement and buy a QLAC that delays taxable income until you’re in the 75 to 85 age range.


PART 3 Shopping in the Annuity Marketplace

If your employer offers a 401(k), take advantage of it — especially if your employer offers to match all or part of your contribution. Now that most private employers have stopped offering pensions to workers, 401(k)s have become the best way to save for retirement at work. When you change jobs, don’t spend your savings. Transfer it to your next 401(k) plan and keep your nest egg growing.

Browsing the 401(k) Annuity Shelf As of 2022, several large investment companies and life/annuity companies began announcing or launching new annuity products to offer employers, who would then offer them to the participants in their 401(k) funds. Several of those products are described in this section. The products are still relatively new. It remains to be seen if employers will embrace them.

BlackRock LifePath Paycheck BlackRock, the giant investment company, offers its own lineup of LifePath target date funds to 401(k) plan participants. BlackRock has also partnered with two life/ annuity companies, Brighthouse Financial and Equitable, to create a path for TDF investors to buy an income annuity at retirement.

THE LEGAL BATTLE OVER ANNUITY RECOMMENDATIONS After 2008, the U.S. Department of Labor (DOL) became concerned that financial advisers were too aggressive in soliciting near-retirees or retirees to roll over their 401(k) savings to IRAs and then into deferred variable or fixed indexed annuities. To protect plan participants, the DOL under President Barack Obama passed regulations in 2016 requiring sellers of those two types of annuities to pledge that their recommendations would always be in the best interest of the retirees. The regulation also stipulated that advisers could be sued in federal court for giving advice in their own best interest instead of the client’s. The American Chamber of Commerce, the American Council of Life Insurers, and adviser organizations sued the DOL to remove the new regulation, which hurt sales of certain annuities. In March 2018, a U.S. Fifth Circuit Court of Appeals Judge ruled that the DOL had overstepped its authority with the regulation and invalidated it.

CHAPTER 16 Adding Annuities to 401(k)s


The TDF puts most of your contributions into stock funds when you’re young. But by the time you reach age 55, when 60 percent of your money is in bond funds, BlackRock would move part of your bond allocation to a group annuity. At retirement, about 30 percent of your savings would be in the group annuity. When you’re ready to retire, BlackRock would move your share of the group annuity assets into a rollover IRA where you can buy a single premium immediate annuity (SPIA). If you buy the SPIA, which is optional, the other 70 percent of your money would stay in your 401(k) plan. About half would be in BlackRock bond funds and half in stock funds.

Prudential Income Flex Like LifePath, Prudential’s Income Flex 401(k) annuity program involves contributions to a target date fund. Unlike BlackRock’s program, however, it doesn’t lead to the purchase of a SPIA.  Instead, it protects your future income with a GLWB. As noted earlier, a GLWB doesn’t require you to annuitize your savings in order to receive a guarantee of income for life. That’s its appeal. Instead, all your money stays in the TDF and in your 401(k) plan. With Income Flex, your account value at age 55 would be locked in as your “protected” balance. Later, you would pick a date in retirement to start receiving regular income. Your annual income would equal a percentage of your protected balance, based on your age when income starts. The percentages for one person are 4.25 percent between ages 55 and 64, 5 percent between ages 65 and 69, and 5.75 percent at age 70 or older. Rates for spouses of similar ages would be 0.5 percent less.

Nationwide Lifetime Income Builder Like Prudential’s Income Flex and BlackRock’s LifePath, Nationwide Lifetime Income Builder puts an annuity into a TDF. The funds in the TDF are American Funds. The annuity is a Nationwide fixed indexed annuity (FIA) with a GLWB rider. Starting at about age 50, Nationwide begins to transfer part of your money from the TDF’s bond funds to the FIA while leaving the rest of the money in American Funds stock funds. At age 65, participants become eligible for annual incomes equal to 6 percent of their protected income base, which may be the high-water mark of their accounts. If all the participant’s American Funds are paid out, their income drops to 4.5 percent of the income base.


PART 3 Shopping in the Annuity Marketplace

Principal Pension Builder This in-plan, DIA program lets 401(k) participants buy a specific amount of future income with each contribution. Of all the programs I describe here, Pension Builder is most like a traditional pension. Here’s an illustration provided on Principal’s website. Suppose that, starting at age 50, you put $400 a month ($4,800 per year) into Pension Builder. By age 65, you’ll have contributed $72,000 and you’ll be eligible for an income for life of $7,055 a year ($585 per month). By age 85, you would have received a total of $141,000. You can stop and restart your contributions to the annuity, or change the amount you contribute, at any time. You can’t assign more than half of your total biweekly or monthly contribution to the annuity, according to the plan’s rules. You can’t put more than half of your entire 401(k) balance in the annuity. If you drop the annuity or take tax withdrawals, you may be penalized with surrender charges.

MetLife Guaranteed Income Plan: Income Now or Income Later MetLife Guaranteed Income Plan program for 401(k) plans includes two income tracks. The Income Now track leads to the purchase of a SPIA at retirement (see Chapter  7). The Income Later option leads to the purchase of a QLAC (see Chapter 11). These are out-of-plan annuities. To buy the annuity, you must move part of your 401(k) savings to a rollover IRA. Like the Principal Pension Builder, MetLife Guaranteed Income Plan annuities require annuitization. Unlike Pension Builder, this program involves only one payment, at retirement. Like Principal, MetLife allows you to customize the income stream. You can add a spouse, a cash refund, guaranteed payments for certain periods (5 to 30 years), and annual cost-of-living increases in income (of 1 percent, 2 percent, or 3 percent).

GuidedChoice Retirement Income Planning As noted earlier, managed accounts are professionally managed bundles of investments for 401(k) participants. They’re also QDIAs. Such accounts carry a fee of about 0.5 percent per year.

CHAPTER 16 Adding Annuities to 401(k)s


GuidedChoice, a major provider of managed accounts, offers an optional Retirement Income Planning service to 401(k) plans. The service includes an annuity evaluator that shows participants, prior to retirement, if and how they could improve their spending power in retirement by purchasing an income annuity with part of their 401(k) savings.

TIAA Secure Income Account If you ever worked at a college or university, you may have participated in the TIAA pension program. Created in 1918 by steel tycoon and philanthropist Andrew Carnegie, TIAA established the first variable annuity in the U.S. in 1952. TIAA plan members usually put part of their savings into a Secure Income Fund that delivers a guaranteed interest rate return (plus bonuses during highperformance years) and part into stock mutual funds. At retirement, TIAA members can leave their money invested and take withdrawals from their stock funds as needed or from their Secure Income Fund at a specified, moderate pace. Or they can convert any portion of their savings to an income annuity. In 2022, many of those receiving income from TIAA fixed annuities enjoyed a 5 percent increase in their lifetime income payments  — the largest bump in 40 years. In 2022, TIAA began offering a modified version of its Secure Income Account to 401(k) plans. The 401(k) version is more liquid (accessible for withdrawals), so it pays a slightly lower guaranteed rate of interest than the 403(b) version.

State Street Global Advisors IncomeWise State Street is a large investment company that offers a proprietary TDF. Under its IncomeWise program, 401(k) participants would be automatically enrolled in the TDF and then be given the option between ages 65 and 69 to buy a QLAC with a portion of their accumulated savings. Participants can buy a single-life QLAC or a joint-life QLAC. If electing a joint-life contract, they can choose a benefit for the surviving spouse to be 50 percent or 75 percent of the original payment. The QLAC payout rate would grow 2 percent per year to maintain the purchasing power of the benefit. Income would begin when the retiree or oldest member of a couple reaches age 80. If all owners die before either reaches their 80th birthday, the beneficiaries will receive the original purchase amount as a death benefit.


PART 3 Shopping in the Annuity Marketplace

“HONEY, THEY BOUGHT OUR PENSION” If you’re covered by a traditional defined benefit pension plan at a big corporation, you may wake up one day and find that the company sold your pension to a large life insurer through a financial transaction known as a pension risk transfer (PRT) or pension buyout. Boeing, General Motors, Lockheed Martin, and other large corporations have sold their defined benefit pension plans to life insurers like Prudential, MetLife, MassMutual, and Athene in recent years. Countless smaller firms have also sold their pensions. This trend worries some pension advocates. They say that plan members may lose certain protections under U.S. pension law as the result of a PRT. Retirees wonder if the life insurer will be reliable, especially if it’s owned by or affiliated with a private equity company or alternative asset manager known for risky investment practices. Two major types of pension risk transfer strategies are offered in the United States, according to the National Association of Insurance Commissioners (NAIC). In a buyout, the life insurer pays the retirees directly. In a buy-in, a life insurer pays the original pension plan sponsor, which then pays the retirees. Pension buyouts are the most common form of PRT. Total U.S. single premium buyout sales were $26.1 billion in the third quarter of 2022, a 66 percent increase from the prior year, according to LIMRA’s U.S. Group Annuity Risk Transfer Sales Survey. As of September 30, 2022, buyout sales totaled $41 billion, 89 percent higher than the same period in 2021.

Deciding Whether to Buy an Annuity with 401(k) Savings Certain people may benefit more from 401(k) annuity programs than others, according to Morningstar, the mutual fund data and research firm in Chicago. In 2022, Morningstar’s newly formed Center for Retirement & Policy Studies issued a 54-page report on precisely this topic. Called “The Retirement Plan Lifetime Income Strategies Assessment,” Morningstar’s report studied several of the types of 401(k) income strategies mentioned here. The authors concluded, not surprisingly, that your level of wealth can determine your need for an annuity. Morningstar analysts suggested that

»» If your total financial wealth is at least 36 times the amount you’ll need

from your investments each year in retirement to cover basic expenses

CHAPTER 16 Adding Annuities to 401(k)s


(net of Social Security benefits), you can skip the annuity. For instance, if a retired couple needed $50,000 a year on top of Social Security and had $1.8 million in savings, they wouldn’t need an annuity.

»» If your total financial wealth is 30 times your minimum income need,

buying an immediate income annuity at retirement with 30 percent of your 401(k) savings should protect you from ever running out of money.

»» If your total financial wealth is 20 times your minimum income need,

Morningstar recommends a Social Security bridge strategy. It calls for you to postpone claiming Social Security benefits until you reach age 70 (when benefits are largest) and to tap 401(k) savings during the intervening years, if necessary.

»» If Social Security alone covers a high percentage of your monthly

retirement expenses, you don’t need any other annuity than Social Security, according to Morningstar.

»» If you haven’t saved enough for retirement, an annuity-based strategy won’t make up the shortfall.

»» If you’re savvy about money, you might put 10 percent of your savings to a DIA or a QLAC (a tax-deferred DIA). Because there’s a risk that you may spend all your liquid savings before the DIA or QLAC income kicks in (that is, between ages 72 and 85), Morningstar recommends this strategy only to financially literate retirees.

»» Relative to the other options, Morningstar found that variable annuities

with GLWBs can help prevent you from running out of money, but not as effectively as the other methods.

Here are answers to some common questions about 401(k) annuities:

»» How much of my 401(k) money should I move into an annuity? A better

question may be, “How much guaranteed income per month or year do I need in addition to Social Security?” The answer will help you decide how large an annuity to buy.

»» Should I put as much into an income annuity as I would into an annuity

with a GLWB rider? Probably not. You shouldn’t put all or even most of your money into a deferred or immediate income annuity because that money may not be accessible to you except as periodic payments. You can put all your money into a deferred annuity with an income rider because you don’t give up access to any of it.


PART 3 Shopping in the Annuity Marketplace

»» How much savings does the average retiree have in a 401(k)? Vanguard,

in its annual survey, “How America Saves,” says that $88,000 is the median savings for 65-year-olds in its 401(k) plans. That is, half have more and half have less. Vanguard estimates that only 15 percent of its participants have accounts worth $250,000 or more. These estimates may be low, however, because they don’t account for savings that plan participants or their spouses may hold outside of Vanguard.

»» Is my 401(k) “big enough” for a SPIA? To put it another way, “How big a SPIA

can I afford?” As of early 2023, a SPIA paying $13,704 per year for life (with ten years of payments guaranteed) would cost a 65-year-old couple $200,000, according to If you wanted to limit your SPIA budget to 30 percent of your savings, you’d need about $670,000 in savings to be able to buy that SPIA.

»» Does a QLAC make sense? It can, especially if you’re in a high tax bracket in retirement. Thanks to the SECURE 2.0 legislation of 2022, you can put up to $200,000 from a 401(k) or traditional IRA into a QLAC. You could then skip RMDs and income taxes on the $200,000 until as late as age 85.

»» Why so much interest in 401(k) annuities now? Life insurers want access to the 401(k) market, worth $7.3 trillion in 2022. The SECURE Act of 2019 made that easier.

»» Can I get a better deal by buying an annuity outside the 401(k)? Thanks to

economies of scale, it may cost less to buy an annuity through your 401(k). But it can’t hurt to get a second opinion.

DON’T FORGET YOUR OLD 401(K) When you leave a job or retire, you may have to figure out on your own what to do with the money in your 401(k) and how to do it. Some plan sponsors want you leave your money in the plan. Other plan sponsors prefer that you take it out. Thousands of people, believe or not, leave money behind in 401(k) accounts and forget it’s there. The law lets plan sponsors send those accounts to trust companies that hold the assets until the owners claim them. As an alternative, a company called Retirement Clearinghouse has invented a system that can automatically forward your old 401(k) account to your next 401(k) account, if and when you join one.

CHAPTER 16 Adding Annuities to 401(k)s



Getting the Most out of Your Annuity


Take charge of your retirement by incorporating annuities into your income plan — and everybody needs an income plan. Turn the tax code into your friend by maximizing the tax benefits of annuities. Save thousands of dollars by recognizing and preventing common annuity mistakes. Learn how to tap into your annuity when you need cash — and do so without incurring costly penalties.


»» Making annuities part of your retirement income »» Getting income without singlepremium immediate annuities



Building Safe Retirement Income


elcome to this book’s most rewarding chapter. Earlier chapters cover accumulation annuities (which are investments with guarantees) and income annuities (which resemble personal pensions). They give you an opportunity to evaluate each annuity as a stand-alone appliance, like a smart TV or a snow blower. In this chapter, you find out how to blend annuities, investments, Social Security benefits, and home equity in retirement. When these four types of assets work in synergy, they can produce more retirement income with less risk than any of them can alone. That’s a bold statement. But it’s based on a simple, virtually indisputable principle: The closer you can get to meeting all your basic retirement expenses with guaranteed sources of income, the more risk you can take with the rest of your savings. The variety of strategies cited here go by several informal names. There’s the time-segmentation method and the floor and upside approach. There’s goal-based investing and the flex method. All these approaches are recommended by retirement income specialists, supported by academic research, or both.

CHAPTER 17 Building Safe Retirement Income


These approaches represent alternatives to the 4 percent “safe withdrawal” rule, which calls for investing your savings in a balanced portfolio of mutual funds or exchange-traded funds (ETFs) and spending about 4 percent of the original amount per year. The strategies in this chapter are meant to improve on that. Please don’t interpret any technique described in this chapter as more than general financial education. I’m a financial journalist who specializes in retirement finance, but I’m not a financial adviser or insurance agent. Just as important, all the variables that factor into a retirement income plan — your age, your family’s health, your expenses, interest rates, investment returns, inflation rates  — are constantly changing.

HOW SAVINGS RELATES TO INCOME There’s an income annuity calculator on the home page at ( that’s fun to brainstorm with. You don’t have to do any homework. It will help if have a rough idea of your Social Security benefits and your monthly expenses in retirement, but you don’t need to be precise. This exercise is exploratory. The calculator requires seven pieces of information. You input the amount of money that you may want to apply to an income annuity, the ages of the people on the contract (one person or a couple) at retirement, the state you live in, and how soon the annuity income should start (one month is the earliest). There are no right numbers. You can change the numbers as many times as you want. As a first step, enter $100,000 in the Amount to Invest field, plus the other bits of information mentioned earlier. Then click the Get My Quote button. I used age 70 for both people. The calculator said $7,224 for a life annuity for two people with at least ten years of payments guaranteed to them or their beneficiaries. But wait, there’s more! The calculator will also tell you that you can get $6,960 a year for a life with a cash refund annuity, or that you can receive a guaranteed $12,000 a year for ten years or $21,888 a year for five years. You can experiment with different ages, different amounts of money, and different start dates. Whether or not you ever buy an annuity, now you have a benchmark. You can begin to orient yourself in the three critical dimensions of space, time, and money. You’ll start to understand the relationship between savings and income.


PART 4 Getting the Most out of Your Annuity

Weaving Annuities into an Income Plan Annuities are like jigsaw puzzle pieces that you can combine with your other financial assets (like investments or home equity) to complete a stable, sufficient retirement income plan. In this section, I show you examples of plans that make tactical use of annuities.

Topping up Social Security with an annuity A simple way to make your retirement more secure is to calculate the gap between your Social Security benefits and your essential expenses in retirement, and then to buy an income annuity that will close that gap. Imagine that you and your spouse have $6,000 a month in essential expenses and an anticipated $4,000 a month in Social Security benefits. You need $2,000  in annuity income to close the gap and ensure that you’ll always have enough money to pay your basic bills. At 2023 rates, such an annuity would cost about $350,000 at age 70. Obviously, the lower your expenses and the higher your benefits, the smaller the gap will be. You can shrink the gap by paying off your mortgage and car loans before you retire. The higher-earning spouse can delay claiming benefits until age 70 (or close to it). Even if you bought an annuity that covered half that gap, you’d feel more secure in retirement. If you worry about dying early and forfeiting money with the ­annuity, you can always attach a “guaranteed period” or a “cash refund” to the contract and be certain that your beneficiaries will receive the rest of your money. Alternately, you could invest in a multiyear guaranteed annuity (MYGA) paying 5 percent per year. Suppose you had $600,000  in savings. You could keep $50,000  in emergency cash, invest $150,000  in a stock mutual fund, and put $400,000 in the MYGA. You could draw $20,000 a year in interest from the annuity without ever reducing the $400,000 principal. Your assets (savings, Social Security, and home equity) should help you three ways in retirement:

»» A cash bucket can finance short-term expenses. »» Part of your savings should be dedicated to producing income. »» Part should be socked away for long-term growth. CHAPTER 17 Building Safe Retirement Income


The amounts circumstances.









Bucketing your retirement savings I’m not talking about bucket lists here. I’m talking about an income planning technique known as bucketing or time segmentation. It breaks the daunting task of planning a 20- or 30-year retirement into more manageable chunks of time. To create a bucketing plan, you and your adviser divide your retirement into ­segments. There might be two segments of ten years each, for example, or four segments of five years each. Or you could have one segment of three years, one segment of five years, and one segment of ten years. (The possibilities are virtually endless.) Then you decide how much of your savings to allocate to each bucket and which assets to buy with that portion of your savings. You can fill them with a stack of immediate, deferred, or period-certain annuities. Or, if you’re willing to take some risk, you might fill a sequence of buckets with cash, and then bonds, and then stocks. You can’t simply assume, however, that the assets in each bucket will grow at their average historical rates until — voilà! — the date arrives when you can cash them in at a predictable value. This uncertainty can make bucketing a highmaintenance strategy. Transitions from one bucket to another may not be smooth. You and your adviser may have to make annual adjustments. For instance, if one bucket grows faster while another grows more slowly than you expected them to, you may need to transfer money from one bucket to the other during a particular segment. Let’s assume that you’d like to buy an income annuity by the time you reach age 70. Which part of your savings should you sell to buy the annuity? Stocks? Bonds? A mix of both stocks and bonds? Wade Pfau, professor of retirement income at the American College of Financial Services, recommends using your bonds to buy the annuity and preserving your stocks for potential long-term gains. There may be an exception to that rule, however. For instance, if your bond holdings aren’t large enough to buy the amount of annuity income you need or want, you may consider selling some highly appreciated stocks so that you can pay for the right annuity. If your portfolio has become overweighted in stocks, you may have intended to sell some of them anyway.


PART 4 Getting the Most out of Your Annuity

MEET THE M. T. KNESTORS You may know couples like the Knestors. Mike, 64, and Laura, 63, are a real (but incognito) suburban professional couple near retirement. Each earns about $150,000 today. They’ve saved about $1.2 million, most of it in tax-deferred retirement accounts. They own a $1.2 million primary residence and a $450,000 house that they rent out. Both houses still have mortgages. Mike is willing to work until age 70, but he wouldn’t mind retiring sooner. Laura is ready to go part-time ASAP. They aren’t sure if they’ll keep their primary residence indefinitely or downsize later. Both are nonsmokers and exercisers. They have wills and long-termcare insurance, but no estate plan. Their two children are both self-supporting twentysomethings. Mike and Laura both had long careers as professionals. They have their own individual retirement accounts (IRAs) and Social Security benefits (at least $36,000 each). Their financial adviser wrote a separate plan for each, recommending only fixed-payment, single-life, single-premium immediate annuities (SPIAs). He suggested that they use one of their two homes as a retirement residence and preserve all their home equity for future medical needs. The adviser recommended that Mike buy a SPIA for $288,000 at age 70 with part of his tax-deferred retirement money from the IRAs. Laura, he said, should purchase a $330,000 SPIA at age 70. Each SPIA would pay out a taxable $24,000 a year for life. (SPIA payout rates fluctuate with market interest rates.) To make sure their purchasing power kept up with rising prices, Mike and Laura would also each buy a small SPIA every year. Mike would pay $2,200 at age 71 for a SPIA, increasing the premium to $3,100 by age 85. Laura would pay $3,300 at age 71 for a SPIA, increasing the premium to $4,300 by age 82. With a substantial amount of their income coming from guaranteed, inflation-protected sources (SPIAs and Social Security), Mike and Laura would have enough risk capacity to invest the rest of their savings (about $300,000 each) in stocks. From that amount, they would withdraw up to 7.5 percent per year, producing income of about $22,500 per year each. Their total household income starting at age 70 would be about $165,000 before taxes and investment fees (0.75 percent of $600,000, or $4,500 per year).

CHAPTER 17 Building Safe Retirement Income


Leapfrogging your annuities A split annuity strategy may appeal to anyone who’s leery of stock market investments. This strategy can also reduce or eliminate sequence of returns risk (the risk that the stock market will tank in the first few years of your retirement, shrinking your portfolio or reducing your purchasing power). Suppose that at age 65 you’ve saved $200,000 for retirement outside of IRAs or employer-sponsored retirement plans. You could invest in an immediate annuity and a deferred fixed-rate annuity:


With $78,000, buy a period-certain SPIA paying you about $9,360 a year at 2023 rates for a period certain of ten years. Of that $9,360, not much will be taxable because you purchased the income with after-tax money.


With the remaining $122,000, buy a fixed-rate deferred annuity that yields 5 percent interest annually and matures in ten years. After 10 years of tax-deferred growth, your annuity will be worth almost $199,000 — very close to your original nest egg.

It’s simple: You receive a guaranteed income of $9,360 a year for the first ten years and end with roughly the same amount of money that you started with — $200,000. The dollar amounts don’t matter here. The strategy works the same way for any amount of saving. If you die, your beneficiaries are entitled to the money in your deferred annuity. If you don’t die, you repeat the process, buying a ten-year income annuity and a fixed deferred annuity that matures in ten years. You may want to consider other strategies. At age 65, you could buy a SPIA paying $13,000 per year for the rest of your life at age 65. You could buy a $78,000 periodcertain annuity at age 65, and then, at age 75, put $200,000 into a life-with-tenyears-certain annuity paying $16,000 for life.

Pairing home equity with an annuity Let’s imagine a 65-year-old couple with $300,000 in combined savings, a paidoff home worth $300,000, and $2,500 a month in Social Security benefits at age 65. Jack Guttentag, the Mortgage Professor (see Chapter 12), created a calculator that can show such a couple how to retire on that amount of wealth.


PART 4 Getting the Most out of Your Annuity

Jack’s calculator would tell you to fund the first ten years of your retirement with a reverse mortgage with a ten-year tenure payment (an annuity-like income stream, in reverse mortgage jargon) of $1,167 and withdrawals from your investment portfolio starting at $614 per month and ending ten years later at $961 per month. This plan also included the purchase, at age 65, of a joint-life deferred income annuity costing about $227,000, with payments of $2,171 per month for life starting at age 75. Combined with Social Security, the couple would have a monthly income starting at about $4,281 per month at age 65. To improve their retirement outlook, the couple could continue working until age 70 and claim Social Security at age 70. Many people, especially in urban or suburban America, might have difficulty living on this much money. But judging by 2020 data, this couple would have a higher net worth than 67 percent of­ Americans their age.

DON’T FORGET PERIOD-CERTAIN ANNUITIES Period-certain annuities can serve as building blocks in a bucketing plan. Instead of buying a SPIA for $250,000 at age 70 and receiving $1,500 to $1,800 per month (for single or joint contracts, respectively), you could turn that same $250,000 into a guaranteed monthly income of about $4,500 for five years or about $2,500 for ten years. The jury is out on whether this makes much sense. Academics prefer SPIAs. SPIAs transfer your biggest retirement risk — outliving your money — over to a life/annuity company. When you outlive other SPIA owners, a piece of their savings comes to you. But SPIAs contain their own element of uncertainty. You don’t know whether you’ll die early and leave money on the table. With period-certain annuities, what you see is what you get. You can divide your retirement into segments and assign a five- or ten-year period-certain annuity to each. You can buy them in advance or when you need them. You can combine them with a deferred income annuity that starts at age 80 and runs for life. And you can take comfort in the knowledge that, in a worst-case scenario, any payments you miss will go to your beneficiaries.

CHAPTER 17 Building Safe Retirement Income


Creating an Income Plan without SinglePremium Immediate Annuities Maybe you’d rather stay more in control of your retirement savings, and not use an income annuity except in certain late-inning situations (like a relief pitcher). In this section, I cover strategies that

»» Use annuities on a “wait-and-see” basis »» Leverage the annuity aspect of required minimum distributions (RMDs) »» Use a ladder of Treasury inflation-protected securities (TIPS) for income instead of annuities

»» Squeeze income out of fixed deferred annuities

Using a Nobel Laureate’s method Bill Sharpe, who shared the 1990 Nobel Prize in Economics for his game-changing Capital Asset Pricing Model, has famously called retirement income planning the hardest problem in all of finance. A few years ago, he wrote software to solve that problem. Sharpe divided retirement into two periods. The first period would last for 19 years, stretching from age 65 to age 84. Nineteen years, not coincidentally, is roughly the average life expectancy for a 65-year-old American. It doesn’t matter how much savings are involved. Over that period, a retired couple would plan to spend 64 percent of their savings. Each year of this systematic withdrawal period would be represented by a ­“lockbox” containing a blend of TIPS and an investment portfolio of ultralow-cost diversified stock index funds and bond index funds. “The idea is to provide the discipline to say to yourself, ‘I will only cash the number of shares in this year’s lockbox,’” Sharpe told me in a 2017 interview. “Obviously, the lockboxes aren’t really locked. If you have an emergency, you can take money out. You still have the key.” In the 20th year of retirement, the couple, if living, would decide if they wanted to buy a joint-and-survivor fixed life annuity with the 36 percent of their savings that had been growing for 19 years. (At a 4 percent growth rate, it would have more than doubled.)


PART 4 Getting the Most out of Your Annuity

The ratio of TIPS to stocks and bonds could be tailored to each couple’s tastes. It would take a bit of high-level computing to decide how much of each would go into each of the lockboxes. “For implementation, you’d buy a certain number of TIPS, and a certain number of mutual fund shares,” Sharpe said. “Once a year, you would sell off that year’s portions of the two at their current price. It’s an accounting/spreadsheet task.” Variations on this method exist. In one variation, a retired couple starts out using the traditional method of spending an amount each year equal to 4 percent of their original savings. Once a year, they would look up the price of an income annuity that would pay them enough, with Social Security, to cover their essential costs indefinitely. If their remaining savings appeared to be in danger of falling below that amount, they could either cut their monthly expenses (perhaps by downsizing their home) or buy the annuity. Like skydivers, they would pull the ripcord of their parachute before falling too far. All retirement income plans require annual adjustments in response to changes in tax rates, inflation, interest rates, and market returns.

MEET THE M. T. KNESTORS, PART 2 Our hypothetical couple, the M. T. Knestors, decided to get a second opinion about their retirement finances. One of America’s leading authorities on retirement income suggested a plan for them. They still hope to stop working and retire on their savings and Social Security benefits by age 70. The Knestors have about $1.2 million in investment savings, in both tax-deferred and after-tax accounts. They own two homes with mortgages: a $1.2 million primary residence and a $450,000 rental property. Now approaching their mid-60s, they each expect at least $36,000 in Social Security benefits starting at age 70. Laura also has a small pension. The Knestors told their financial adviser that they hoped to spend $150,000 a year in retirement, including inflation-adjusted annual withdrawals of about $75,000 from their $1.2 million diversified investment portfolio and about $75,000 in combined annual Social Security and pension benefits. (continued)

CHAPTER 17 Building Safe Retirement Income



The financial adviser told the Knestors that spending $75,000 a year from their portfolio would be dangerous. The adviser proposed a plan based on the “household balance sheet” approach to retirement planning. He advised the Knestors to replace their balanced portfolio with a more targeted, goal-based plan that would produce as much income with much less risk. The adviser suggested that they separate their retirement expenses into essential and discretionary (optional) spending, and reduce their essential expenses to an inflationadjusted pretax value of $110,000 per year (including Social Security). They should also try to limit their spending on luxuries (vacations, clothing, gifts, and so on) to $30,000 per year. Here are the steps in his plan:

• For growth, he recommended allocating one-third of their savings ($300,000) to a diversified, low-cost, ETF holding stocks from all over the world. They could use gains as current income or reinvest them.

• To smooth out the impact of market volatility on their income stream, the adviser

recommended an empty $300,000 home equity conversion mortgage line of credit (HECM-LOC) as an emergency source of income when weathering a bear market in stocks (see Chapter 12).

• For safe income, he recommended building a $600,000 “ladder” of TIPS, starting in

three years. The TIPS would mature one at a time for 14 years, until Laura reached age 80. Each would deliver a year’s worth of safe, predictable income to cover essential costs.

• To insure against longevity risk, he suggested applying 10 percent of savings

($100,000) to the purchase of a joint-life qualified longevity annuity contract (QLAC) producing $1,500 per month in income from Laura’s 80th birthday and ending when neither Mike nor Laura is still living.

The adviser saw this blend of stocks, Treasury bonds, a standby HECM-LOC, and a deferred income annuity as a more robust alternative to the 4 percent safe withdrawal method. It would give the Knestors ample, flexible spending, with little risk of running low on money in their old age and a strong likelihood that could leave their children more than $1 million.


PART 4 Getting the Most out of Your Annuity

Turning required minimum distributions from foe to friend You can use RMDs to turn your tax-deferred savings into an annuity-like income that should last your entire lifetime. If fact, RMDs were designed for that. Most retirees with large 401(k) accounts dread those irritating RMDs that everyone who has tax-deferred retirement savings must take, starting at age 73. After all, they raise your taxable income. But you can make RMDs work for you in retirement. RMDs are intended to force retirees to turn their tax-deferred savings into annuity-like income. The IRS Uniform Lifetime Table shows you a rate of withdrawal that will ensure that you will have an income, even if you live to the improbable age of 120. Suppose you and your spouse have $500,000 in 401(k) or IRA savings. At age 72, your life expectancy is a maximum 27.4 years, according to the IRS.  When you divide $500,000 by 27.4, you get $18,248. That’s about 3.65 percent of your taxdeferred savings. Depending on your income tax rate, that may net out to about $14,000 after taxes. By age 80, you’ll withdraw about 5 percent per year. By age 93, about 10 percent. At age 100, you’ll be required to withdraw 50 percent per year. You can’t calculate exactly how much your after-tax income will be, because you don’t know how fast your investments may grow or how your tax rate may change as you age, but you get the idea. As an alternative to the 4 percent rule, the RMD can serve as a guide to spending down savings at a sustainable rate. RMDs exist for this purpose. Contributions to qualified retirement plans and traditional IRAs were made deductible to encourage saving for retirement. RMDs force retirees to use that savings for income, not for gifts to children or charities. Withdrawals from Roth IRAs are usually tax-free in retirement because contributions to Roth IRAs aren’t deductible.

Flexing your deferred annuity muscles Here’s another low-risk, safety-first retirement income strategy: Put two-thirds of your savings into a fixed-rate deferred annuity (or, if you prefer, a fixed indexed annuity [FIA]) that allows annual withdrawals of up to 10 percent of the principal. At the end of seven years, buy an immediate annuity.

CHAPTER 17 Building Safe Retirement Income


Suppose you and your spouse have $750,000 in savings at age 65. You could purchase a balanced portfolio of stocks and bonds and withdraw 4 percent per year (starting at $30,000, plus annual cost-of-living increases). Or, you could split your $750,000 into two parts, putting one-third ($250,000) into stocks and twothirds ($500,000) into a MYGA contract paying 5 percent per year for seven years. The MYGA allows you to withdraw up to 10 percent of principal per year. Using the Savings Distribution Calculator at 360 Degrees of Financial Literacy (, you can calculate that a growth rate of 5 percent and an annual withdrawal rate of $32,000 (6.4 percent) will produce a balance at the end of seven years of just under $430,000. That’s a guaranteed outcome. Meanwhile, your $250,000  in risky stocks has grown for seven years. If it grows by a conservative 4 percent per year, it’ll be worth just shy of $329,000 after seven years, ignoring fees and taxes. With the $430,000 left in your fixed annuity at the end of seven years, you and your spouse will be 72 years old. At 2023 rates, you could buy an immediate income annuity paying about $32,000 for life, with ten years of payments ($320,000) guaranteed to you or your beneficiaries. If, as a couple, you have $4,000 in Social Security benefits, you have a reliable base income of $80,000. If either of you lives to age 92, you’ll have received a total of $640,000 in annuity benefits. By then, your original $250,000  in stocks will have been growing for 25 years. If we assume a conservative 6 percent average annual compound growth rate and no withdrawals, those stocks will be worth $1,073,000, ignoring fees and taxes. The first part of this strategy was suggested by Bryan Anderson at Annuity Straight Talk (, who sells fixed annuities. The addition of the income annuity at age 72 is just a brainstorming idea. You can use either MYGAs or FIAs for this strategy. In 2023, yields on seven-year MYGAs were high enough to support this strategy. Because you can’t know in advance what the returns on FIAs will be, the MYGA version of this strategy may be more appropriate for someone who needs a predictable income.


PART 4 Getting the Most out of Your Annuity

MEET THE FORSYTHES, THE KNESTORS’S NEIGHBORS The Knestors have neighbors who also need retirement income planning advice. Bobbie Forsythe is 66 years old. She plans to work full-time for four more years, claim Social Security, and work part-time for a few years after that. Her wife, Jaye, is 63 years old. Already retired, Jaye plans to claim Social Security at age 67. The Forsythes hope to leave money to their children. They have $755,000 in savings. Of that amount, $530,000 is currently located in three IRAs. The remaining $225,000 is in an after-tax brokerage account. When both claim Social Security, they’ll have combined starting benefits of about $4,000. Their adviser recommends that the Forsythes:

• Invest $500,000 ($330,000 of IRA assets and $170,000 of after-tax savings) in a

diversified portfolio of mutual funds. Of the after-tax savings, $170,000 should be invested in both high-quality corporate bonds and dividend-paying stocks.

• Take withdrawals from these accounts over the first ten years of full retirement. To

maintain their purchasing power in the face of inflation, they should increase their income by 1 percent, 2 percent, or 3 percent per year when their investment equity returns are 4 percent, 6 percent, or 8 percent, respectively.

• Purchase a joint-and-survivor SPIA (life with ten years guaranteed) with about

$55,000 of the bond portion of their after-tax savings when Bobbie reaches age 70. It will supplement their monthly income by $638 (at 2023 rates).

• Purchase two QLACs with cash refund features when Bobbie retires, using $100,000 each from their IRAs. Income from the QLACs will begin when Bobbie reaches age 80. The contracts will pay the Forsythes a combined $2,852 per month for as long as they live. It will be supplemented by the $638 per month and by their Social Security benefits.

CHAPTER 17 Building Safe Retirement Income



»» Getting clear on tax rules for annuities »» Looking at the benefits of tax deferral »» Considering the pros and cons of nonqualified annuity taxation »» Dealing with miscellaneous annuity tax issues



The Taxing Side of Annuities


ax deferral is one reason Americans buy deferred annuities. Note that I just used the concept of deferral in two different ways in the same sentence, without any warning at all. No wonder annuities and annuity tax rules confuse most people.

Tax deferral means Uncle Sam doesn’t tax the growth of the investments in your annuity contract until you take money out of it. A deferred annuity is one whose owner hasn’t yet annuitized the contract by formally converting it into a pensionlike income stream in retirement. In this chapter, I sort out the tax rules that govern annuities and the trade-offs they present to the annuity owner. When you recognize the difference between annuities bought with qualified and nonqualified money, the rest should be fairly easy. Tax deferral isn’t the most valuable feature of annuities for most people.­ Annuities are better at protecting you from the financial risks of retirement  — market risk, interest rate risk, sequence risk, and the risk of outliving your savings (see Chapter 2).

CHAPTER 18 The Taxing Side of Annuities


Understanding Annuity Tax Rules The U.S. tax code is complicated, and annuities are complicated, so you can assume that the tax rules for annuities are complicated, too. I describe the taxation of annuities briefly in Chapter 4. In this chapter, I wade deeper into the weeds, but not too deeply. Just remember that the tax rules for qualified annuities are different from the tax rules for nonqualified annuities, and the tax rules for withdrawing money from deferred annuities can be different from the tax rules for withdrawing money from income annuities. In the following sections, I unpack that.

Qualified annuities After decades of contributions, your 401(k) may be worth hundreds of thousands of dollars at retirement. If you “roll over” those untaxed savings into a traditional IRA (not a Roth IRA) when you separate from your employer or retire, you may then have quite a large rollover IRA. A rollover involves the tax-free transfer, within a 60-day window, of untaxed assets from one qualified plan to another. The custodian of your qualified plan can help you with the rollover.

Purchases of qualified annuities You can use money in a rollover IRA to buy a qualified annuity. Most life/annuity companies will accept new annuity premiums of as much as $1 million.

Withdrawals from qualified annuities Any withdrawals you take from your qualified annuity will be taxed as ordinary income. If you take withdrawals before age 59½, the withdrawal may also be subject to a 10 percent penalty. When you reach age 73, you’ll need to take RMDs from your annuity. If you die while the contract is active, your annuity beneficiaries will receive benefits under the rules for inherited traditional IRAs. Those rules changed a bit with the passage of the SECURE Act in 2019, which reduced the withdrawal options available to certain beneficiaries of traditional IRA and 401(k) money.


PART 4 Getting the Most out of Your Annuity

Nonqualified deferred annuities You can also purchase an annuity with nonqualified, or after-tax, savings — money that you may have saved in a money market account or in a taxable mutual fund account at a brokerage.

Purchases of nonqualified annuities Though you can’t deduct the payment for a nonqualified annuity from your taxable income, taxes on future gains will be deferred. Without the drag of those taxes, your money should accumulate at a faster rate. The longer you allow your savings to appreciate, the more valuable tax deferral can be.

Withdrawals from nonqualified annuities The IRS doesn’t require you to take RMDs from nonqualified annuities. The tax treatment of withdrawals depends on whether the annuity is still deferred or whether it has been annuitized:

»» Withdrawals from deferred annuities: Most annuities are purchased as

deferred annuities and are never annuitized — that is, their owners never convert them to streams of fixed monthly income that last for as long as they live, no matter how long they live. If a nonqualified annuity is still in deferred status, the accumulated gains must all be withdrawn first. Your principal — what you paid for the annuity — can’t be withdrawn until all the gains have been withdrawn. Then you can withdraw your principal tax-free.

»» Withdrawals from annuities that have been annuitized: If you’ve converted your nonqualified annuity to a lifelong income, or if you bought a single-premium immediate annuity (SPIA) with nonqualified money, you don’t have to withdraw all the taxable gains first.

Instead, using what life/annuity companies call the exclusion ratio, you’ll be able to spread out your tax obligation over your entire retirement instead of facing it in big chunks. In the nearby sidebar, I explain how to calculate the exclusion ratio. When income annuity owners reach their life expectancies  — in their mid- to late 80s, typically  — they’ll have received all their principal back. After that, 100 percent of their annuity payments are subject to ordinary income tax. That’s cause for celebration, not regret. It’s a sign that the decision to buy the annuity is paying off! The annuity owner is receiving the life insurer’s money.

CHAPTER 18 The Taxing Side of Annuities


The calculations for customized fixed income annuities — contracts that guarantee a certain number of payments, or that provide income for two spouses, or that offer a refund of any unpaid portion of your premium if you die — are somewhat more complicated. You can rely on the insurance company for the calculation of the exclusion ratio.

CALCULATING THE TAX-FREE PART OF NONQUALIFIED ANNUITY INCOME You can think of the original payment for your nonqualified income annuity as the “skim” and the growth of your annuity account as the “cream.” You’ve already paid income tax on the skim, and it won’t be taxed again, but you’ll owe tax on the cream. The proportion of skim to cream is your exclusion ratio. The life/annuity company that issued your income annuity will calculate that ratio for you. For do-it-yourselfers, the basic calculations for single-life fixed income and variable income annuities are described here. If you’d like more detail, IRS Publication 939, General Rule for Pensions and Annuities, may help (you can find it at https:// To calculate the exclusion ratio of a fixed income annuity (one that pays the same amount every month) you’ll need to know the amount of after-tax money you used to purchase your annuity (your principal), the amount of each income payment (provided by the insurer), and the number of years the IRS expects you to live, based on IRS mortality tables. Suppose that at age 65 you paid $100,000 in after-tax money for a SPIA. The insurance company has agreed to pay you $700 a month ($8,400 a year) for the rest of your life. Your expected return multiple — similar to, but not the same as, your life expectancy — is 20, according to Table V of the IRS annuity tables. Your expected return then equals $168,000 ($8,400 × 20). Because your original $100,000 premium is 59.52 percent of $168,000, you can exclude $5,000 (59.52 percent of $8,400) of your annuity income from your taxable income and pay tax on the remaining $3,400. Assuming a 22 percent marginal tax rate, the tax on your annuity income would be $748. Here’s the formula for calculating the exclusion ratio of a fixed income annuity: Investments in the contract ÷ Expected payments = Exclusion ratio In this example, that would be: $100,000 ÷ $168,000 = 59.52 percent


PART 4 Getting the Most out of Your Annuity

Special withdrawal cases In this section, the focus shifts to the taxation of withdrawals from specific types of annuities.

Withdrawals taken as guaranteed lifetime withdrawal benefits You may already own a nonqualified variable deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB) rider. Suppose you paid an initial premium of $200,000 but the contract’s benefit base (the notional amount used to calculate benefits) has since grown to $300,000. At age 70, you can “switch on” the rider and withdraw at least $15,000 a year for the rest of your life. Your withdrawals will be subject to the rules for nonqualified deferred annuities. You must withdraw all your gains first and pay income tax on them. When you’ve withdrawn all but the original $200,000, you can withdraw the rest as principal, tax-free. When you’ve withdrawn all your principal before you die, and your account balance (the cash value of your account) has dropped to zero, the rider ensures that you’ll continue to receive your $15,000 a year for as long as you (or you and your spouse in a joint-and-survivor contract) are living. You’ll owe ordinary income tax on all that income.

Withdrawals from qualified longevity annuity contracts The qualified money you put into a qualified longevity annuity contract (QLAC) won’t be included in the calculation of your RMDs from qualified accounts until you begin receiving income or when you reach age 85, whichever comes first. Under rules passed in 2022, you can contribute up to $200,000 to a QLAC. When the money comes out — as income for you or as a refund to your beneficiaries if you die before taking income  — you’ll owe ordinary income tax on the income. Depending on how much qualified money you still have outside the QLAC, the annuity payment may be large enough to satisfy your RMD.

Withdrawals from contingent deferred annuities You’ve probably never heard of contingent deferred annuities (CDAs), which I briefly mention in Chapter  10. They’re free-standing GLWB riders, similar to those offered on deferred annuities, but they can be attached to taxable managed accounts. The money in the taxable accounts isn’t turned over to a life/annuity company or placed in tax-deferred separate accounts.

CHAPTER 18 The Taxing Side of Annuities


None of the tax benefits or tax drawbacks of annuities apply to the investments protected by the GLWB.  The assets in the taxable accounts don’t grow taxdeferred, gains don’t have to be withdrawn before principal, and long-term gains are taxed as capital gains, not as income. If you want, your life/annuity company or the trust company that has custody of your IRA annuity may withhold federal income taxes from your withdrawals for you.

Weighing the Benefits of Tax Deferral Tax deferral has long been touted as a major benefit of owning annuities. That belief may have begun in the late 1980s. The 1986 tax reforms eliminated many tax shelters but left the tax benefits of deferred annuities intact. Taxpayers and their accountants soon became more interested in annuities. Since then, tax deferral has become a less important driver of annuity sales. Today, according to life insurance industry data, about half of annuities are ­purchased with after-tax money and half are purchased with pretax money from traditional IRA or 401(k) accounts. Why would someone buy a tax-deferred annuity with money from an IRA or 401(k), where it already enjoys tax benefits? Often it’s because that’s where the bulk of their savings is located. For 90 percent of Americans, retirement accounts represent the majority of their financial wealth, according to the Washington Center for Equitable Growth. Only the wealthiest 10 percent of Americans have more after-tax investment wealth than pretax investment wealth. Still, as long as annuities offer tax deferral, you should know if you can benefit from it. I provide a hypothetical example in the nearby sidebar, “Illustrating the benefits of tax deferral.” As a general rule, the longer you let your money grow tax deferred, and the lower your income tax rate in retirement, the bigger the boost your savings will get from deferred growth. When you choose to buy an annuity with after-tax money, you’ll be paying ordinary income tax on part of the money you withdraw instead of paying capital gains tax. Because the capital gains tax rate is no higher than 20 percent (and as low as zero) and the maximum income tax rate is 37 percent, that may sound like a foolish trade.


PART 4 Getting the Most out of Your Annuity

But that’s an apples-and-oranges comparison. In retirement, very few Americans are in the highest tax brackets. Your income tax rate in retirement is likely to be much closer to the capital gains tax rate (assuming that Congress doesn’t raise them). So, you’re not giving up much by paying income tax on withdrawals from your nonqualified annuity instead of capital gains tax. Table 18-1 shows a quick reminder of marginal income tax rates in 2023. If you’re married and filing jointly, you pay only 10 percent tax on the first $22,000 and only 12 percent on the next $67,350. Even if your income is $190,000 in retirement, your average income tax rate will be only about 17 percent (10 percent to 12 percent on the first $89,450 and 22 percent on the next $101,000).

TABLE 18-1

Marginal Tax Rates, 2023 Ordinary Income for Single Filers

Ordinary Income for Couples Filing Jointly

Is Taxed at the Rate of . . .

$11,000 or less

$22,000 or less


$11,001 to $44,725

$22,001 to $89,450


$44,726 to $95,375

$89,451 to $190,750


$95,376 to $182,100

$190,751 to $364,200


$182,101 to $231,250

$364,201 to $462,500


$231,251 to $578,125

$462,501 to $693,750


$578,126 or more

$693,751 or more


ILLUSTRATING THE BENEFITS OF TAX DEFERRAL How much juice can tax deferral add to your savings? I used one of the many online tax deferral calculators and created a hypothetical scenario. Here are the results I got from the calculator, based on the following inputs:

• Initial contribution to the annuity: $10,000 • Number of years for it to grow: 20 • Anticipated return: 8 percent, based on a moderate-risk investment mix (continued)

CHAPTER 18 The Taxing Side of Annuities



• Income tax rate: 25 percent • Monthly contributions: $100 The calculator indicated that this hypothetical investment, after 20 years, would grow at 8 percent to $76,471 in a taxable account but $108,170 in a tax-deferred account, before taxes. After taxes (at 25 percent), the tax-deferred account would’ve been worth $87,402, or almost $9,000 more than the taxable account. The benefit of tax deferral increases when the contributions are higher, the return is greater, and the tax rate is higher.

Weighing the Pros and Cons of Nonqualified Annuity Taxation Here are the main tax advantages of nonqualified annuities, which will vary according to your circumstances:

»» You can contribute virtually any amount of after-tax money to a

nonqualified annuity. How many dollars can you fit inside a nonqualified annuity? As many as you have.

»» You can buy and sell the funds inside a variable deferred annuity and

not owe ordinary income tax on your gains from the trades, if any, until you start withdrawing money from the contract.

»» You don’t have to begin taking taxable RMDs from your contract at age 73. »» Your original after-tax investment is returned to you tax-free. »» When you annuitize an after-tax deferred annuity or buy an immediate income annuity with after-tax money, you can spread your tax burden across your retirement, taking advantage of the exclusion ratio.

Here are the main tax disadvantages of nonqualified annuities, which will also vary according to your circumstances:

»» It takes ten or more years for tax deferral to produce a significant benefit. »» Investment gains are taxed as ordinary income rather than at the capital gains rate.

»» Withdrawals from a deferred annuity before age 59½ are subject to ordinary income tax and to a 10 percent federal penalty tax (unless certain hardship exceptions apply).


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»» Annuities, like all tax-favored retirement accounts, aren’t good tools for

passing money to your descendants. Beneficiaries will inherit your tax liability along with any money they receive.

There’s no room in this chapter for a discussion of every single tax aspect of annuities. If you need additional detail, I recommend The Advisor’s Guide to Annuities, 6th Edition, by John L.  Olsen and Michael E.  Kitces (National Underwriter Company).

Remembering Miscellaneous Annuity Tax Issues In this section, I offer brief discussions of several other tax issues that affect annuities.

Paying state premium taxes A few states tax annuity premiums, thereby adding to the cost (see Table 18-2). Note, however, that qualified premiums are lightly taxed, if at all.

TABLE 18-2

States that Tax Annuity Premiums* State

Tax (Qualified Contracts)

Tax (Nonqualified Contracts)








1% (waived if tax savings are credited to annuity holder)

1% (waived if tax savings are credited to annuity holder)







South Dakota


1.25% on first $500,000, 0.08% on amounts above $500,000







*If you reside in more than one state, consult your financial adviser or accountant on the best place to buy your annuity. Source:

CHAPTER 18 The Taxing Side of Annuities


No tax on 1035 exchanges If you don’t like the annuity you have, you can swap it for a different contract. A 1035 exchange is the technical term for a tax-free transfer of one nonqualified deferred annuity contract for another. The exchange doesn’t count as a withdrawal, so you don’t have to pay tax. (For more on 1035 exchanges, see Chapter 19.) Surrender fees are not tax deductible. If you take money out of a deferred variable annuity before the end of the surrender period, you could pay a surrender charge. You’ll owe income tax on your entire withdrawal, not your withdrawal minus the surrender fee.

Taxes and annuity beneficiaries If you die while owning or receiving income from an annuity, your beneficiary may be entitled to a payment. The payment could be a death benefit, the current market value of the investment in the contract, a refund of unpaid premium, or any remaining unpaid guaranteed payments. The exact amount will depend on several factors: whether you had already converted the assets to an income stream, whether you chose a period-certain or refund option, and whether the beneficiary is your spouse. The timing of the payments can also vary: immediately after your death, over a period of five years after your death, or over the beneficiary’s lifetime. If the annuity was a nonqualified annuity, and paid for with nondeductible money, the beneficiaries owe income tax on whatever they receive in excess of what the owner paid into the annuity. If the annuity was purchased through a retirement plan or with the money in a rollover IRA, the beneficiaries owe income tax on every cent they receive. See Chapter 20 for tips on structuring your contract so you know exactly what will happen to the money in your contract if you die. Unless you’re already an expert in personal finance, I recommend that you consult a tax specialist on the potential tax ramifications of owning an annuity. If you make a mistake in this area, unintended consequences can result. Your money may not end up in the hands of the person you intended. Even when the owner of an annuity contract isn’t the one who receives income from it, they’re still on the hook for the tax on that income. If you buy an immediate annuity for your aunt and she receives the monthly checks, the IRS will look to you for the income tax. In most cases, however, someone who buys an income annuity intends the income to be paid to themselves alone or to themselves and their spouse.


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»» Knowing how to get out of your contract »» Doing a 1035 exchange »» Turning your annuity into life insurance



Recognizing Annuity Exit Ramps


nnuities are contracts. That’s one of the first things everyone reads in articles about annuities. Like car leases, movie deals, mortgages, and even marriages, annuity contracts involve binding agreements that can be difficult and expensive to break. And that’s not necessarily a bad thing. Without the stickiness of the contracts, so to speak, annuity issuers can’t deliver on their guarantees. If contract owners didn’t agree to leave their money in a multiyear guaranteed annuity (MYGA) for a specific number of years, for instance, a life/annuity company couldn’t promise a guaranteed rate. Nonetheless, most deferred annuity contracts offer flexibility when it comes to withdrawals. If your financial situation changes unexpectedly, and you have to pull some money out of your deferred annuity, you usually can. In this chapter, I offer a map of an annuity contract’s exit ramps. You can enjoy the benefits of an annuity and still keep your money within reach for yourself or your beneficiaries. But don’t forget that annuities, like traditional individual retirement accounts (IRAs) and employer-sponsored retirement plans, involve a serious commitment of both money and time.

CHAPTER 19 Recognizing Annuity Exit Ramps


Knowing Where Your Contract’s Exits Are When it comes to withdrawals, annuities are not as inflexible as you may have thought. Most deferred annuities allow you to withdraw at least some of your money each year. A few immediate annuity contracts let you withdraw several months of income at once during the payout period. Later in life, you may be able to use the money in your annuity for nursing-home costs. If your annuity has outlived its usefulness for you, you may be able to swap it for a new one.

Taking free withdrawals during the surrender period Many deferred annuities with surrender periods allow you to withdraw part of your money every year after the first year with no surrender penalty. Contracts vary. Some life/annuity companies have eliminated the once-customary 10 ­percent free withdrawal allowance in fixed deferred annuities in order to sweeten other benefits in the contract. Others allow withdrawals only of annual interest. Remember that withdrawals from qualified annuities before age 59½ may be subject to a 10 percent tax penalty. Liquidity (access to your money) problems generally don’t crop up if you put no more than half of your investable assets into an annuity and avoid putting money into an annuity too early in life.

Using nursing-home waivers If you’re concerned that you may need money for medical emergencies, many annuity contracts will waive withdrawal charges for a contract owner who goes into a nursing home, is disabled, or is diagnosed with a fatal illness. Read the prospectus and the contract closely to find out what conditions must be met. In some contracts, the restrictions limit your rights to medically related withdrawals. For example, you may have to

»» Be younger than 75 when you buy the annuity. »» Be confined to a nursing home for at least 90 days. »» Have a serious illness that’s usually fatal within two years or has an 80 percent mortality rate.


PART 4 Getting the Most out of Your Annuity

Other restrictions may apply. If you’re over age 75 and you think you may need the money for family medical expenses, don’t buy an annuity with a surrender charge period.

Using the period certain of an income annuity If you’re reluctant to buy a single premium immediate annuity (SPIA), perhaps because you’re afraid you might die before you’ve gotten your money back, there’s an easy remedy. Just add one of the following options to your contract:

»» Period-certain option: A period-certain option lets you specify that your

annuity payments must last for as long as you live, but for at least ten years. If you were to die during those first ten years, your beneficiaries (such as your children) would receive the remaining payments.

»» Joint-and-survivor option: A joint-and-survivor option means, in most cases, that a married couple co-owns the contract. If one owner dies, the surviving spouse would receive annuity payments until they die.

These options let you avoid the scary sense of finality that comes when you buy a single-life-only income annuity, where annuity payments end at the death of a single owner. The good news is that, if you buy your contract while you’re still in your 60s, a life-with-ten-years-certain income annuity contract will cost about the same as a life-only contract. In April 2023, for a $200,000 joint-life immediate income annuity contract for a 65-year-old male/female couple, the difference was only $7 ($1,069 versus $1,062).

Choosing a lifetime benefit over annuitization If you’re looking for lifetime income and liquidity, you can use a guaranteed lifetime withdrawal benefit (GLWB) option. As Chapter  10 shows, these riders are intended to let you have your cake and eat it, too. They guarantee you income for life without putting your money out of reach. You can put an income rider on several types of annuity contracts. There’s a cost to that feature, however. The annual fee for a GLWB rider is usually 1 percent of the benefit base or more, and those riders don’t deliver as much

CHAPTER 19 Recognizing Annuity Exit Ramps


income in retirement as SPIAs do, especially when interest rates are relatively high. Consider these two scenarios for a $500,000 contract in April 2023:

»» Given a joint-and-survivor SPIA owned by spouses (regardless of gender), both 70 years old, the fixed monthly payment would be $2,960 a month or $35,520 a year for a $500,000 premium. That’s a guaranteed lifelong annual payout rate of 7.1 percent.

»» Given a joint-and-survivor deferred variable annuity owned by spouses (again, regardless of gender), both 70 years old, the guaranteed income would be limited to $5,000 a month or $25,000 a year when the benefit base is $500,000. That’s a guaranteed lifelong annual payout rate of 5 percent. (Note: The benefit base may be different from the cash value of the contract. See guaranteed benefit base in Appendix A.)

If you use a GLWB rider to provide guaranteed income for life:

»» You always have access to all the cash value of your contract, though surrender charges may apply.

»» Your beneficiaries will receive your unspent savings. »» If you withdraw more money in a single year than the GLWB rider allows (5 percent of the benefit base, for instance), the withdrawal will reduce your benefit base and your guaranteed monthly income payment.

Eluding the federal penalty — legally If you own a qualified annuity and you’re still younger than 59½, you may be subject to a 10 percent federal penalty (excise tax) on the taxable portion of any withdrawals you take. A qualified annuity is one purchased with money from an IRA or employer-sponsored retirement savings plan. Fortunately, the U.S. tax code offers a few exceptions to the penalty. If you meet certain requirements before age 59½ or convert your money to an income stream by annuitizing it, for instance, then you won’t be penalized for your withdrawals. Generally, the following types of withdrawals aren’t penalized:

»» Withdrawals taken as an income annuity. »» Distributions taken as part of a series of “substantially equal periodic

payments.” The payments must be annual or more frequent, made for the


PART 4 Getting the Most out of Your Annuity

life or life expectancy of the owner, and for at least five years or until the owner reaches age 59½, whichever is the longer period.

»» Distributions forced by the death of the owner or annuitant. »» Withdrawals taken as a consequence of total, permanent disability. Be careful about interpreting these rules without the help of a tax expert.

Swapping Annuities: 1035 Exchanges Every year, many annuity owners transfer their money from one deferred annuity to another in a process known as a tax-free 1035 exchange. These exchanges have long accounted for most of the new sales of traditional deferred variable annuities. Certain rules govern these swaps, however:

»» You can exchange any kind of deferred annuity for any other kind. For

instance, you can exchange a fixed deferred annuity for a variable deferred and a deferred annuity for an immediate annuity.

»» You can’t exchange an immediate annuity or any annuity that’s been annuitized into a deferred annuity.

»» You can exchange a cash-value life insurance policy into an annuity, but you can’t exchange an annuity into life insurance.

Insurance agents have been known to try to persuade annuity owners to exchange annuities. The exchange would mean a new contract and a commission for the agent. But the swap isn’t always good for the customer, who may have to pay surrender charges on the old annuity and then start a whole new surrender charge period with the new contract. Still, the 1035 exchange can be your ally. The money you can save on annual fees by switching from a high-cost annuity to a low-cost annuity may even make that surrender charge worth your while. You can chalk up the loss to experience. The regulators now require that 1035 exchanges be advantageous for the contract owners. Before swapping one annuity contract for another, you’ll need to fill out a suitability form. An officer at a brokerage firm or at the annuity issuer should review your suitability form and your application to make sure you’re doing the right thing. It’s possible that your application for a 1035 exchange will be rejected on the grounds that you don’t have much to gain from one.

CHAPTER 19 Recognizing Annuity Exit Ramps


QUESTIONS TO ASK BEFORE YOU SWAP ANNUITIES The Financial Industry Regulatory Authority (FINRA), the watchdog group by which the securities industry polices itself, advises consumers to quiz any broker or agent who tries to sell them on swapping one annuity for another through a 1035 exchange. Important questions are

• What is my total cost for this exchange? • What does the change in the surrender period or other terms mean for me? • What are the new features? Why do I need or want those features? • Are those features worth the increased cost? • Will you be paid a commission for the exchange, and if so, how much is it?

SELLING A PERIOD-CERTAIN ANNUITY A number of Wall Street firms raise money to buy period-certain income streams from the small number of people who have received them as part of the settlements of personal injury lawsuits. If you ever find yourself in that position — and I hope you don’t — one of those firms may offer to buy your income stream. It would then sell the income stream, or portions of it, to people looking for a future source of retirement income. For example, imagine that a hypothetical 59-year-old woman receives $1,900 a month from a period-certain income annuity that she received in a settlement for a wrongful injury. The annuity will make 360 monthly payments over a period of 30 years. But the woman needs a large sum today to pay her child’s college tuition. To raise that money, she decides to sell the first 120 of her 360 payments to a financial firm. The 120 payments would have equaled $228,000 over ten years. Let’s assume that the present value of those annuity payments is $180,000. (That’s the price of a ten-year, $1,900-a-month period-certain annuity in 2023.) An investment firm buys her income stream for $145,000. The woman will start receiving her $1,900-a-month payments again in ten years. The purchasing firm may then resell the income stream to a retiree for perhaps $160,000. The retiree, in effect, buys a ten-year income stream for $20,000 less than its present value ($180,000), leaving $15,000 ($160,000 – $145,000). The purchasing firm will keep what’s left of the $15,000 after it pays its lenders and other middlemen.


PART 4 Getting the Most out of Your Annuity

Annuity death benefits (the amount paid to your beneficiary if you die) aren’t transferable from contract to contract. If you decide to exchange annuities, you’ll lose whatever death benefit you had in the original contract. Be careful when you sell an annuity for cash. Such Transactions (which require complex calculations to determine an accurate present value) are fertile ground for scams. It will be hard for you to tell whether you’re getting a fair price for your annuity. If a stranger approaches you and suggests that you sell or replace your annuity, call your state insurance commission. Such a sale also has tax implications. If you retain ownership of the annuity after a finance company buys part of your income stream, the IRS will hold you responsible for income taxes on distributions.

Converting an Annuity to Life Insurance Some people with deferred variable annuities may decide to leave the assets in the contract to their children. In that case, their financial planner may recommend that they turn the contract into life insurance. The life insurance death benefit may be higher than the annuity benefit. It’s also tax free for the beneficiary. Suppose you and your spouse are each 75 years old and have a deferred variable annuity that cost $100,000 but is now worth $200,000. If you’d like to leave the money to your children (they’re already the beneficiaries on the contract), what are your options? You can

»» Do nothing and let your children receive the death benefit from the

contract after you and your spouse die. They may pay income tax ($30,000) on the $100,000 gain, so they’ll net $170,000.

»» Cash out the annuity, pay the income tax, and apply the $170,000 to a

second-to-die variable life insurance policy that will pay your children about $250,000 after you and your spouse die. Thanks to a woman’s longer life expectancy, second-to-die insurance is much less expensive than insurance for a man or for the first-to-die, because a woman’s longer life expectancy allows the life insurer to hold the premium longer.

»» Keep the annuity, withdraw $20,000 every year, and apply it to the

purchase of a $250,000 second-to-die life insurance policy. At your death, your children will receive $250,000 plus the remainder of the variable annuity. (The first $100,000 you withdraw from the annuity is fully taxable; the second $100,000 is a tax-free return of your original investment.)

CHAPTER 19 Recognizing Annuity Exit Ramps


»» Convert the variable annuity to a lifelong income stream and apply the

payments each year to renew a $250,000 life insurance policy on you and your spouse. Only part of each payment is subject to income tax. (The exclusion ratio makes part of every payment from a nonqualified annuity tax free; see Chapter 18.) Your children receive the tax-free $250,000 and the partially taxable death benefit of the variable annuity. This strategy has an advantage over the previous one because your income stream continues to pay the life insurance premiums for as long as you live. You can’t exhaust your ability to pay them.

In these examples, the life insurance strategy looks like a no-brainer — as long as you and your spouse don’t need the money for living expenses or nursing-home expenses. But the choice may not always be simple. For example, as elderly people, you and your spouse may not qualify for affordable life insurance. And if your children are in the 15 percent tax bracket, their tax bite on the annuity death benefit (see the first bullet in the preceding list) may be modest. No two situations are alike, and potential variables are almost limitless. Talk to an experienced tax or insurance specialist before you try this one at home.


PART 4 Getting the Most out of Your Annuity


»» Naming the people performing the two major roles in an annuity »» Naming the people who’ll get your annuity contract if you die »» Deciding how much of a death benefit you want your beneficiaries to get



Structuring Your Annuity Correctly


hen you buy an annuity contract, you need to name an owner, annuitant, and beneficiaries. There’s a name for this process: It’s called structuring your contract. Structuring is not a big deal — unless you do

it wrong.

If you or the annuitant dies unexpectedly, a mistake in the structure can come back to haunt you. You can boil down the information in this chapter to a simple prescription: Make sure that the owner and the annuitant are the same person. As the owner of the annuity, you can change your designations later if necessary. Your insurance agent or your financial adviser should help you structure your contract correctly. But families change, and people change advisers, so you should be prepared to act on your own. Anyone who has ever named beneficiaries on an individual retirement account (IRA) or 401(k) may find this process familiar. But annuity contracts throw a couple of curveballs at you. I’ll show you how to create and maintain a structure that is in sync with your wishes.

CHAPTER 20 Structuring Your Annuity Correctly


Don’t confuse the process of structuring a deferred annuity with the process of choosing an annuity payout option for an income annuity, which I discuss in Chapter 7:

»» Structuring establishes the owner, annuitant, and beneficiaries of a deferred annuity.

»» Choosing a payout option means deciding what type of income stream the owner of an income annuity will receive.

You may remember that a deferred annuity is generally a tool for saving for retirement on a tax-deferred basis with full or partial protection against loss. An income annuity is a tool for turning those years of savings into income during retirement.

Naming Owners and Annuitants Every participant — that usually means you and your family members — plays a specific role. Structuring an annuity contract is almost like writing a last will and testament. There’s potentially a lot of money at stake, it’s all legally binding, and errors can lead to litigation. The first step toward structuring an annuity is to name the key participants in your contract (I also describe the participants in Chapter 3). Here’s a brief review of the two major roles:

»» Contract owner: The owners are the captains of the Good Ship Annuity. They

typically write the checks for the purchase and get to name all the other players. There may also be a joint contract owner, who is usually the owner’s spouse.

»» Annuitant (same as contract owner, ideally): When you buy an immediate

income annuity or convert a deferred annuity to a retirement income stream, the annuitant’s age when income begins, among other factors, determines the monthly payment. You must name an annuitant even if you don’t expect ever to convert your contract to a guaranteed lifetime income stream.

Here’s how you can prevent structure problems. Assuming that you purchased your deferred annuity for yourself and your spouse, and assuming that you want the surviving spouse to control the annuity if either of you dies, do one of the following:


PART 4 Getting the Most out of Your Annuity

»» Name the same person as owner and annuitant. »» Name one spouse as the owner and the other as the annuitant; then designate each as the other’s beneficiary.

»» Name two spouses as joint owners or joint annuitants. (Some authorities

discourage the use of this structure, however, because it can cause ambiguities and unintended consequences.)

Table 20-1 describes structures where the surviving spouse will control the assets regardless of which spouse dies first. These structures also maximize the surviving spouse’s flexibility in timing taxable withdrawals, and they apply equally well to owner-driven or annuitant-driven contracts.

TABLE 20-1

Structures Where the Surviving Spouse Receives the Assets


Owner’s Beneficiary


Annuitant’s Beneficiary

Spouse A

Spouse B

Spouse B

Spouse A

If spouse A dies, spouse B can continue the contract in their name or take a death benefit. If spouse B dies, spouse A continues the contract and names a new annuitant.

Spouse A


Spouse A

Spouse B

If spouse A dies, spouse B continues the contract or, as annuitant’s beneficiary, claims a death benefit. If spouse B dies, spouse A continues the contract.

Spouse A and spouse B


Spouse B

Spouse A

If spouse A dies, spouse B continues as the owner and annuitant. If spouse B dies, spouse A continues as the owner or claims a death benefit.

Spouse A and spouse B

Spouse A and spouse B



If spouse A or spouse B dies, the surviving spouse continues as the owner and annuitant.


Annuities can be either owner-driven or annuitant-driven. The difference can determine who receives money or who controls the contract if either the owner or the annuitant dies. When couples buy annuities together, and intend the surviving widow or widower to continue the contract when one of them dies, they can prevent unintended consequences by making sure that the owners and annuitants are the same people (themselves).

CHAPTER 20 Structuring Your Annuity Correctly


Naming Beneficiaries Your contract will also require you to name beneficiaries to whom the contract will pass in case the contract owners and annuitants die. You must choose

»» Contract owner’s beneficiary: This person receives the accumulated value of the contract if the owner dies before converting the contract to income.

»» Annuitant’s beneficiary: This person receives the death benefit (which may or may not be different from the accumulated value) if the annuitant dies before the contract is converted to an income stream.

Beneficiaries can also name contingent beneficiaries to receive bequests if the primary beneficiary dies or doesn’t want the bequest. A beneficiary’s options, upon receiving a bequest, depend on three issues:

»» Whether the beneficiary was the spouse of the deceased. »» Whether the beneficiary is an eligible designated beneficiary (EDB). That includes minors, the chronically ill, the disabled, or beneficiaries with ages within ten years of the age of the original account holder. This applies only to annuities owned by IRAs or qualified plans.

»» Whether the contract was initially funded with pretax traditional IRA money or after-tax money.

Generally, a beneficiary (who is also a human being) has these options:

»» Assume ownership of the contract (spouse of deceased owner only). If

the owner’s beneficiary is also the owner’s spouse, they can choose to become the new owner and simply continue the account. The spouse is the only one who can do this.

»» Withdraw all the money in a lump sum. The beneficiary can get a check for the contract value (or death benefit if higher) after sending a copy of a death certificate to the insurance company.

»» Withdraw the money over five years. If the beneficiary of the deceased

owner of a nonqualified annuity is not the surviving spouse, federal income tax rules generally require payments of amounts under the contract to be made within five years of an owner’s death. Beneficiaries can take money out as needed or schedule regular withdrawals.

»» Distribute the money over the life expectancy of the beneficiary (for nonqualified annuities). Minors, the chronically ill, the disabled, and


PART 4 Getting the Most out of Your Annuity

beneficiaries with ages within ten years of the age of the original account holder can use this option. In 2019, Congress did away with the “stretch” option that allowed other beneficiaries of qualified annuity assets to spread distributions (and the tax bills that go with them) over their life expectancies. If your beneficiary receives the annuity assets as a lump sum or in occasional withdrawals over five years, they will owe income tax on the withdrawals until only the original after-tax premium remains. The rest of the money can be withdrawn tax free. For example, if you purchased a contract for $100,000 with money outside a taxqualified retirement plan and it’s worth $150,000 today, the first $50,000 you withdraw will be taxed as income. You can then withdraw your original $100,000 tax free. If the beneficiary converts the assets to a lifelong income stream, they pay tax on a fraction of each regular payment. The fraction is determined by the exclusion ratio or the exclusion amount. For a discussion of the exclusion ratio, see Chapter 18.

“THIRTY HEADS” ARE BETTER THAN ONE In 18th-century France, the king raised money from his subjects by selling them annuities. Older French men or women could fund their retirements this way. For instance, they could lend 1,000 livres to the French government and receive a percentage of that amount, based on their age, every year for the rest of their lives. Starting in 1757, the cash-starved French monarchy raised huge sums selling annuities that paid out a flat 10 percent per year instead of age-based percentages. That would be considered a very generous offer today. A man would have to be age 75 or older to receive a guaranteed 10 percent annual payout from a single-life income annuity today. Speculators bought up these high-yield contracts and resold them. Swiss bankers based in Paris added a twist. To lengthen the payout period of the annuities, they named upper-class Geneva schoolgirls as the annuitants. Then they packaged the annuities into bundles (like mortgage-backed securities today), sliced them into bonds, and sold the bonds to French retirees or investors at a profit. That bundling strategy helped diversify the risk that an annuitant would die and the income would stop. By bundling together as many as 30 or more individual annuities and securitizing them, 30 young lives would back the Geneva bankers’ annuity-based bonds. The scheme blew up in 1793, when Louis XVI defaulted on his debts, died by guillotine, and the Ancien Régime ended with the French Revolution.

CHAPTER 20 Structuring Your Annuity Correctly


If you forget or neglect to designate beneficiaries, the value of your contract may end up in your estate when you die. Your intended beneficiaries may receive the money eventually, but the transfer will take longer. Talk to a tax specialist before you name a trust as the owner or beneficiary of a deferred annuity. (An annuitant, by definition, has to be a living person with a life expectancy.)

Choosing a Death Benefit The amount paid to your beneficiaries at your death will vary, depending on the death benefit options that your annuity contract gives you and which one you choose. The death benefit may be the current value of the contract, the amount you originally spent on the contract (the premium), or some other amount (such as the highest value of the annuity on any anniversary of the purchase of the contract). Its grim name notwithstanding, the death benefit is a standard insurance feature of deferred annuities. Here are a few examples of the types of death benefits that annuity contracts offer:

»» A standard death benefit: This benefit is generally available at no cost above the contract’s mortality and expense risk fee. It offers your beneficiary the current value of the contract, which

• May be fixed on the day the insurance company receives proof of the owner’s or annuitant’s death

• May fluctuate until a beneficiary files a claim in the case of a deferred variable annuity (VA)

»» Return of premium death benefit: Some contracts offer the beneficiary one of the following (whichever is greater) at no additional charge:

• The contract’s current market value • The sum of all contributions minus any withdrawals and fees Other contracts offer this benefit for about 0.05 percent a year ($50 per $100,000).

»» Stepped-up death benefit rider: For a small additional fee, the insurance company will give your beneficiary your contract’s highest value on an anniversary of the purchase date, adjusted for your withdrawals and additional contributions.


PART 4 Getting the Most out of Your Annuity

»» Enhanced death benefits: For an additional fee, some carriers enhance the death benefit with bonuses. The method of calculating the bonus may vary from carrier to carrier. The prospectus will explain it in detail.

Certain death benefits may not be available to contract owners who are over certain advanced ages. In the past, con men tried to swindle carriers by purchasing annuities with greater-than-premium death benefits for strangers in nursing homes who were near death. They would even offer cash incentives to obtain the necessary signatures. If you withdraw money from a deferred annuity before your death, an enhanced death benefit may be reduced on a proportional basis or dollar-for-dollar basis. It’s the same mechanism by which withdrawals from a VA may reduce the value of a living benefit, such as a guaranteed lifetime withdrawal benefit (GLWB) that provides income for life. Suppose, for instance, that you paid for a stepped-up death benefit rider on a variable deferred annuity that you originally paid $100,000 into. And suppose that the death benefit had grown to $125,000 while the investments in the annuity had grown to $150,000. If you withdraw $15,000 from the contract, your death benefit will drop to $110,000 from $125,000 on a dollar-for-dollar basis. Using the proportional basis, your withdrawal was 10 percent of your $150,000 account value, so your death benefit will drop by only 10 percent, to $112,500 from $125,000. On the other hand, if your death benefit was $125,000 and the account value was only $120,000, the calculation would be different. A $15,000 withdrawal would reduce your death benefit to $110,000 on a dollar-for-dollar basis. On a proportional basis, the $125,000 death benefit would be reduced by 12.5 percent of $125,000 ($15,625) to $109,375. For tax reasons, deferred annuities are not recommended as estate planning tools. In fact, they are poor vehicles for bequests. That’s because your beneficiary inherits your unfulfilled obligation to pay income tax on the difference between what you paid for your non-qualified annuity (the premium) and its value when you die. If you reach a lofty age and know you won’t need the money in your VA for living expenses or long-term care, consider cashing out of the contract, paying the income tax, and using the remainder to buy life insurance on yourself. Life insurance payouts are tax free.

CHAPTER 20 Structuring Your Annuity Correctly


ANNUITIES AND SAME-SEX MARRIAGES The U.S. Supreme Court’s 2015 decision in Obergefell v. Hodges requires all 50 states, the District of Columbia, and the insular areas to perform and recognize the marriages of same-sex couples on the same terms and conditions as the marriages of opposite-sex couples, with all the accompanying rights and responsibilities. That includes the rights of spouses to continue annuity contracts as their own.

It’s time for a brief Latin lesson. You may have an opportunity to decide if you want the death benefit of your annuity paid to your beneficiaries per capita or per stirpes. If you have five grown children, for instance, you can designate that each of them receives 20 percent of your death benefit. With a per capita designation, if one of those five children has died, the other children would divide their sibling’s share. With a per stirpes designation, the deceased child’s children (your grandchildren), would share the 20 percent due to their parent. (Stirpes is Latin for “branch.”)


PART 4 Getting the Most out of Your Annuity


»» Dodging common annuity problems »» Recognizing errors with income annuities »» Previewing the pitfalls of deferred variable annuities »» Avoiding simple mistakes



Avoiding Annuity Pitfalls


lying a small airplane isn’t more dangerous than other sports, someone once said  — it’s just less forgiving. You could say the same about annuities. Mistakes can be irrevocable and expensive. Much better not to make them in the first place. In this chapter, I identify some of the most common errors that people make when shopping for and buying annuities. Some are errors of commission, like buying an indexed annuity with a longer-than-appropriate surrender period. Others are errors of omission, like not price-shopping for an income annuity before you buy. Any of them can lead to buyer’s remorse. All are avoidable. After reading this chapter, you’ll be able to spot the worst of the booby traps before they snare you. The biggest mistake of all would be to give up in frustration and avoid the world of annuities entirely. Their purpose, after all, is to make your retirement more secure, not riskier. Piloted correctly, they can take you where you need to go.

CHAPTER 21 Avoiding Annuity Pitfalls


Watching Out for Common Annuity Missteps The four dumbest mistakes you can make when buying an annuity are locking up too much of your savings, overlooking the impact of fees, failing to understand the surrender period, and not thinking clearly when you name your beneficiaries. But you can easily avoid those fates by following the advice in this section.

Forgetting about fees Most people are willing to go an extra mile to save 10 cents on a gallon of gasoline. So, why do so many investors allow themselves to be snookered into paying outrageously high fees when they buy financial products and services? It’s a mystery. This overpayment problem is not unique to annuities. You can pay excessive sales loads, investment management fees, and marketing costs when buying mutual funds. You can pay excessive fees to trade stocks or bonds. An extra 1 percent in fees may seem small — until you look at it as a percentage of your annual gains. When buying a variable annuity, read the expense page of the prospectus, which the Securities and Exchange Commission requires issuers of variable annuities to publish. You can find that page in the table of contents. Remember that if your investments are earning 9 percent before fees and you’re paying 3 percent in fees, your net return is 6 percent. Your fees, in effect, are 33 percent of your gain.

Surrendering to a long surrender period Surrender periods are a necessary evil. When you buy an annuity, the insurance company is making a long-term commitment; it wants you to do the same. As a result, it penalizes you for early withdrawal in order to recover the cost — including the broker’s commission — of setting up the annuity. Deferred annuities generally have surrender periods that last from three to ten or more years. In many cases, the penalty in the first year is equal to the number of years in the surrender period. That is, if the surrender period is seven years long, the first year’s penalty is 7 percent.

Mis-structuring your contract Did you hear the one about the man who mistakenly left his entire fortune to his ex-wife, leaving his widow and children bereft? It’s not very funny. But it can happen to people who structure their annuity contracts wrong.


PART 4 Getting the Most out of Your Annuity

When you buy a deferred annuity, you must designate an owner, an annuitant and one or more beneficiaries. If you make these designations carelessly, there may be unintended consequences. For tips on proper contract structure, see Chapter 20.

Heading Off Income Annuity Errors When you buy a car, what do you do? You shop around and compare prices. You try to buy only the options you really want. You wait until the end of the year, when the dealers are desperate to meet their sales goals. If you’re concerned about mileage and gas consumption, you don’t buy the V6. You need to apply the same common-sense principles when you buy an income annuity. The worst mistakes you can make, as I explain in this section, are not shopping around and not understanding your options.

Trying to “time” an income annuity purchase There is no perfect interest rate environment for buying an income annuity. Some advisers warn clients not to buy income annuities when interest rates are extremely low, as they were much of the time from 2008 to 2022. All else being equal, income annuity payout rates are higher when interest rates are higher. Others have said that it makes more sense to buy income annuities instead of bonds when rates are low, because income annuities offer longevity risk pooling that delivers a survivorship credit in addition to a bond yield. To get the survivorship credit, however, you must buy an annuity whose payments stop when you die. Many people prefer income annuity contracts with a ten-year period certain or a cash refund, features that reduce the survivorship credit. When the Federal Reserve changes interest rates, the values of all your assets, including your home, may change. Those changes may affect your decision about when to buy an annuity. Some people deal with the interest rate dilemma by purchasing a series of small deferred income annuities over several years before retirement instead of buying a big one all at once at retirement. If you’re creating a retirement income plan, you need to make sure that your annuity delivers the right amount of income when you need it. That’s more important than trying to wait for the right interest rate climate. Trying to “time the market” is rarely the best strategy.

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Ignoring the period-certain and refund options Many people refuse to consider an income annuity because they’re concerned that the insurance company, and not their beneficiaries, will get their money if they die too soon. But if that’s your fear, you can easily prevent it from happening. By using the joint-and-survivor, period-certain, or refund options available on virtually every income annuity contract, you can make sure your money doesn’t just revert to the carrier if you die when your annuity contract is in force. Bear in mind, however, that these options may reduce your income payments. The following are brief explanations of each:

»» Joint-and-survivor option: This option ensures that annuity payments keep coming as long as either of two spouses is living.

»» Period-certain option: With this option, you can keep payments coming for no less than a specific number of years. If you die, your beneficiaries will receive the remaining payments.

»» Refund option: This option, paid either in cash or monthly installments,

ensures that your heirs receive the difference between your original payment for the annuity and what you received before you died, if any.

An alternative solution to the bequest motive problem (the reluctance to buy an annuity because you want your money to go your heirs) is to buy a smaller annuity and set aside the difference for your heirs. Instead of converting 40 percent of your savings to guaranteed income, for instance, convert 30 percent and apply the difference to a bequest. Talking about these topics can be gruesome; many people are repelled by income annuities because, as one expert put it, “Annuities have the smell of death.” On the contrary, an income annuity is a wager that you’re going to live a long life and have enough income to finance it.

Getting only one or two quotes In exchange for $100,000, one life/annuity company may offer you $650 a month while another offers $618 and another offers $688. If $70 a month for the rest of your life matters to you (it amounts to about $8,200 over ten years), then be sure to shop around before you decide on a SPIA. As a consumer, you have no way of knowing how a carrier determines its rates or quotes on a given day. Many factors affect the offer, and those factors change by the hour.


PART 4 Getting the Most out of Your Annuity

The company that offers the highest SPIA rate today may offer the lowest rate tomorrow. If you’ve set your heart on buying an annuity from a certain carrier and you don’t investigate further, you’ll never know whether you’ve picked a good day or a bad one (or frankly, a good SPIA or a bad one). Executives at Hueler Investment Services, a consumer-oriented company in Eden Prairie, Minnesota, decided a few years ago to offer an alternative to this roulette of annuity shopping. They set up a website,, where people near retirement age can submit requests for SPIA quotes to several insurance companies at once. The near-retirees receive the quotes through the website and pick the most attractive choice. Back in the late 1990s, annuity scholars found SPIA payout rates to be utterly unpredictable. At any given time, a 65-year-old man wanting to pay a premium of $100,000 for lifetime income could receive quotes ranging from as much as $872 to as little as $725 a month. That’s a difference of about $1,800 per year. During retirement, that could buy quite a few rounds of golf. So, how do you make sure you don’t buy a SPIA with the lowest rate in town? You can

»» Visit lots of insurance company websites and get lots of quotes from their online SPIA calculators.

»» Go to a website that offers comparative rates. »» Consult a financial adviser who subscribes to a professional SPIA database that tracks the latest prices, like

»» Shop at a SPIA supermarket like Fidelity Investments (, where you can compare SPIAs from five different carriers.

Choosing the Wrong Assumed Interest Rate If you happen to decide to convert a deferred annuity to an immediate income annuity and choose a variable instead of a fixed payout rate, you will have an opportunity to choose an assumed interest rate (AIR). You may be able to choose between 3.5 percent and 5 percent, for example.

CHAPTER 21 Avoiding Annuity Pitfalls


The life/annuity company needs this number in order to calculate your first income payment. Payments after that (or after the first year) will fluctuate with the market value of your underlying investments. If you ever need to choose an AIR, remember that the lower rate (3.5 percent, in this example) will produce a lower starting payment but a greater chance for higher payments in the future, while the higher rate (5 percent) will produce a higher starting payment but less chance for higher payments in the future.

Deflecting Deferred Variable Annuity Problems Few, if any, annuity products are more complicated than variable annuities with guaranteed lifetime withdrawal benefits. Buried deep inside the prospectuses, printed in a legal font too small to be read by anyone over 40, are dense paragraphs of information that you won’t understand even after you don your trifocals.

Tripping over step-up fees Always be alert for hidden fees. By law, the prospectus must disclose them, but they aren’t always easy to find. For instance, in some deferred variable annuities, the insurance carrier offers to step up (raise) your benefit base (the amount that determines your guaranteed income payments) on your contract anniversary to the current value of your investments (if higher than the existing benefit base). Sounds good. But in some cases, this offer causes your rider fee to go up. Suppose you invest $100,000 in a variable annuity that guarantees 5 percent withdrawals for life. Your withdrawals start at $5,000 and can never fall below $5,000. But then your account grows to $120,000. Two events may occur:

»» If you bought a step-up rider, you now have the right to increase your base to $120,000 and thereby increase your annual payment to $6,000.

»» If you exercise the rider, the company may exercise its right to raise the step-up rider fee. Your net gain? Negligible.

Moral of the story? Check the fine print!


PART 4 Getting the Most out of Your Annuity

Confusing the account value with the benefit base Variable annuities with lifetime income benefits can be very useful. They protect you against the risk of outliving your savings and allow you access to your savings during a financial emergency. But they can also be complex and confusing. What’s confusing about them? They define money in several different ways. When reading a variable annuity prospectus, you’ll find four or five definitions for what you thought was a discrete stack of money sitting somewhere with your name on it. It’s important to keep the meanings straight. Otherwise, you won’t know how much money you’re actually entitled to. Know how to recognize

»» Account value: The current market value of the subaccounts (similar to

mutual funds) where your money is invested. Think of it as the value of your annuity contract. This is real money.

»» Bonus value: The value of your original investment plus any bonus that the

insurance company may have tacked on to your account value to reward you for buying its annuity. The bonus may disappear if you break the terms of the contract or, in some cases, if you don’t annuitize the contract.

»» Guaranteed benefit base: The figure that your future income payments will be

based on. Your contract may specify that you’ll receive 5 percent of your guaranteed benefit base every year from age 65 on, and that your benefit base will grow at a certain rate each year until then, even if your account value doesn’t grow. Here’s an example: You buy your contract with a purchase payment of $100,000 at age 55. This particular contract guarantees that your benefit base will be at least $200,000 when you reach age 65 and that you can receive 5 percent of it ($10,000) each year for life. Meanwhile, your account value moves up and down with the markets. At age 65, it may be $180,000 or it may be $235,000. At age 65, you have a choice between your account value (whatever it may be) and $10,000 a year for life. Do not make the mistake of thinking that you can choose between your account value and $200,000. There is no $200,000. The benefit base is just the number on which your guaranteed 5 percent payout is calculated under the terms of your contract.

»» Guaranteed death benefit: The amount your beneficiaries will receive if you, as the owner, die while the contract is in force. Depending on whether you have a standard, enhanced, or super-enhanced death benefit, your heirs may receive different sums:

• Standard benefit: They receive your account balance. • Enhanced benefit: They receive your original premium (the amount you

originally put into the annuity) or your account balance, whichever is more.

CHAPTER 21 Avoiding Annuity Pitfalls


• Super-enhanced benefit: They receive the account balance’s highest value on any anniversary of the purchase date.

»» Step-up value: Your account value on the day you’re eligible to raise or “step up” your guaranteed benefit base to your account value (assuming that the account value is higher than the benefit base on the that day).

Suppose that at age 65, your account value was $191,000 but your guaranteed benefit base was $200,000. You chose to begin receiving $10,000 a year for life — 5 percent of the benefit base. But what if your account value later exceeds $200,000? On the anniversary of your contract, you may be allowed to “step up” your benefit base to your account value. On that day, your account value is called your “step-up” value. If, in the same example, your account value was $214,000 on your contract anniversary, you could increase your benefit base to $214,000. From then on (until the next step-up opportunity), you’d receive 5 percent of $214,000 per year, or $10,700.

»» Surrender value: The amount you receive if you cancel the contract during the surrender period. It will equal your original contribution minus any surrender charges you were required to pay. If you received an up-front bonus, you’ll forfeit the bonus.

The account value is your money. You can withdraw as much of it as you want at any time. All the other terms mentioned in this section describe amounts to which you may be entitled in certain situations. Read the fine print. You may be dazzled by the promise that your guaranteed withdrawal benefit base will at least double in ten years. But you aren’t entitled to the benefit base itself — only to a small percentage of its value each year.

Preventing Silly Mistakes Why is Homer Simpson so popular? Is it possible that we recognize something of ourselves in him? Homer would commit any and all the following violations of everyday common sense. You don’t have to.

Buying an indexed annuity that you don’t understand As I mention in Chapter 8, most people don’t understand how indexed annuities work — and, unfortunately, neither do many agents. If you don’t fully comprehend indexed annuities, you should probably stay away from them.


PART 4 Getting the Most out of Your Annuity

Indexed annuities are creatures that evolved for a specific environment  — the ultra-low interest rate environment and dodgy stock market climate in the four to five years after the dot-com crash of 2000. They offered a small, risk-free return with a chance to benefit from an increase in stock prices at a time when stocks and bonds seemed to offer only risk and no return.

Falling for an annuity postcard come-on A company in Ohio used to send out tens of thousands of postcards each year to older people throughout the United States to trick them into calling a toll-free number. The company’s goal was to get an insurance agent into their homes and convince these folks to swap their existing annuity for a new indexed annuity or to buy other insurance products. A few trusting souls always got snared. If you receive such a postcard, don’t call the toll-free number. Instead, call your state insurance commissioner’s toll-free fraud hotline. It’s illegal to send a postcard through the mail for the purpose of finding out what investments a person holds. This type of abuse, which helps give annuities a bad name, belongs to the category of senior scams. Such schemes target older people, taking advantage of their isolation, age, or infirmities to separate them from their savings.

Underestimating your own (or your spouse’s) longevity Boomers try to stay healthy in so many ways: by wearing jogging shoes, hydrating with green tea, and slathering themselves with sunblock. You’d think they’d realize how much longer they’ll live as a result of it. But no. Surveys in the United States and England show that

»» People tend to underestimate their own life expectancies by about five years. »» Baby boomers think of themselves as 14.5 years younger than their true chronological age.

But no one knows the effect these collective delusions will have on their individual longevity. What’s the reality?

CHAPTER 21 Avoiding Annuity Pitfalls


According to the Society of Actuaries, among American couples who reach age 65 together

»» The chance that at least one spouse will reach age 85 is 75.9 percent. »» The chance that one will reach age 90 is 50.3 percent. »» The chance that one will reach age 95 is 22.1 percent. In other words, if you’re married, you and your spouse are only a coin flip away from living to age 90. Unless you have a traditional pension, you’ll need to ration your savings or put aside a chunk of money in the event that you enjoy extreme longevity. This is called self-insuring. Or, you can buy longevity insurance (see Chapter 11). With this type of annuity, you pay an insurance company about 10 percent of your savings in return for its guarantee that you and your spouse will receive an income starting at age 85 or 90. Because many people don’t live to claim these benefits (just like many people don’t receive benefits from fire or flood insurance on their homes), longevity insurance tends to be inexpensive compared to the potential benefit.

Ignoring the impact of inflation When the wind is at your back, you can forget how hard it’s blowing. Inflation is like that. As long as you work and your salary rises with inflation, you don’t notice its effect. But when you retire, and your income levels off, inflation is in your face. That’s when it stings. To make sure that your retirement income keeps up with inflation, you need to prepare. There’s no simple way to keep up with inflation. If you add an inflation adjustment rider to an income annuity, you may reduce the amount of your initial payments substantially. Some people invest in stocks as a way to keep up with inflation, but stocks don’t always go up. The best strategy may be to buy a small additional income annuity every five or ten years to increase your income and preserve your purchasing power.

Avoiding annuities entirely In the past, annuities (mainly deferred annuities) have often been sold to the wrong people for the wrong reasons. Mistakes have been made. This fact, coupled with so much potential for error, leads too many people away from annuities. But that decision may be the biggest mistake of all. Today’s annuities  — incomeproducing annuities — have the potential to help millions of people finance their retirement.


PART 4 Getting the Most out of Your Annuity


The Part of Tens


Browse a mini-library of books on annuities, written by America’s top annuity and retirement planning experts. Ask ten essential questions of your agent, broker, or adviser when you meet. Surf the web and listen to podcasts that talk straight about annuities (and learn how to recognize those that don’t).


»» Finding useful books about annuities and income planning »» Extending your knowledge of annuities



Ten Great Books about Annuities


undreds if not thousands of books have been written about investing and retirement planning. There’s a lot of demand for them. A few of them are probably sitting on bookshelves in your home or office right now.

Books that focus specifically on annuities and retirement income planning are not quite as common. Here are ten books that have taught me a lot. Some are new and some are old. All are still available on the internet. Their authors include financial advisers, insurance company executives or agents, professors of finance, actuaries, and pension consultants.

The Annuity Stanifesto, by Stan G. Haithcock “Stan the Annuity Man” Haithcock has produced numerous books, articles, and podcasts about annuities. Famous for saying that he “hates” most annuities, he insists on the use of annuities in their purest form  — for personal guaranteed income in retirement — and not as insured investments.

CHAPTER 22 Ten Great Books about Annuities


Are You a Stock or a Bond?: Identify Your Own Human Capital for a Secure Financial Future, by Moshe Milevsky A professor of finance at York University in Toronto, Milevsky is known both for his deep understanding of the mathematics that underlie annuities and for his lively writing style. A much-in-demand conference speaker and corporate consultant, he has written at least ten books. He has a special interest in the tontine, an 18th-century annuity that is making a comeback today (see Chapter 1 for more on tontines).

Don’t Go Broke in Retirement: A Simple Plan to Build Lifetime Retirement Income, by Steve Vernon A lifelong actuary, Vernon is a consultant to the Stanford Center on Longevity. He is also active in the retirement research efforts of the Society of Actuaries. He likes to share what he has learned while planning for his own retirement.

Income Strategies: How to Create a TaxEfficient Withdrawal Strategy to Generate Retirement Income, by William Reichenstein A professor of investment management at Baylor University, Reichenstein shows readers how to minimize income taxes when drawing down income from taxfavored accounts such as individual retirement accounts (IRAs) and defined contribution plans. He and colleague William Meyer are also the renowned creators of software that helps advisers and individuals identify the most efficient way to claim Social Security benefits.


PART 5 The Part of Tens

Lifetime Income to Retire with Strength, by Bruno Caron Caron is an actuary with a self-described “passion for longevity risk.” A former senior analyst at AM Best, the rating agency, Caron is currently a principal at TELUS Health, a corporate benefits consulting firm in Montréal. His experience spans the life and annuity industry: consulting, life insurance companies, start-up companies, equity research, and credit rating.

Retirement Income Redesigned: Master Plans for Distribution, by Harold Evensky and Deena B. Katz Just as valid and valuable today as when it first appeared in 2006, this book’s chapters were written by some of North America’s most admired financial advisers and retirement experts. Evensky and Katz are cofounders of an advisory firm, Evensky & Katz/Foldes Wealth Management. Evensky is a retired professor of practice in the Texas Tech University Personal Financial Planning Department.

Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success, by Wade Pfau This comprehensive book covers all the bases. Since the early 2010s, Pfau has established himself as an authority on the optimization of retirement security through combinations of investments and annuities. He’s what I call an “ambidextrous adviser.” Pfau provides the analytics that many advisers and investors crave: precise mathematical and statistical projections that support their investment and annuity recommendations and decisions. A former director of the Retirement Income Certified Professional designation program at The American College of Financial Services, he has since created the and Retirement Income Style Awareness ( websites.

CHAPTER 22 Ten Great Books about Annuities


Risk Less and Prosper: Your Guide to Safer Investing, by Zvi Bodie and Rachelle Taqqu Bodie is a widely respected economist and pension consultant. He is also a professor emeritus at Boston University, as well as a friend of and collaborator with Nobel Prize–winning economists Robert Merton and the late Paul Samuelson. The author of many academic books, Bodie’s book for investors focuses on reducing investment risks in retirement, with an emphasis on reducing inflation risk. Taqqu is a retired financial industry executive.

Unveiling the Retirement Myth: Advanced Retirement Planning Based on Market History, by Jim Otar A truly independent voice in the world of financial advice, the now-retired Otar is a former engineer who focused his powers of analysis on the problem of investing and retirement planning. He has recorded his ideas in several self-published books. Otar created a green-yellow-red “zone” system to help near-retirees determine if they’re candidates for annuities.

Another Day in Paradise: The Handbook of Retirement Income, by Jeff Dellinger Dellinger’s book benefits from his experience as a pioneering annuity product designer and as someone planning his own retirement. The book assesses the pros and cons of various retirement income generation methods. It should appeal to anyone, regardless of the size of their nest egg, who is on the verge of retirement and needs sound advice.


PART 5 The Part of Tens

RECOMMENDED BOOKS FOR PROFESSIONALS I recommend the following books specifically for financial advisers:

• The Advisor’s Guide to Annuities, 6th Edition, by John L. Olsen and Michael

E. Kitces: For a book to undergo six editions, readers must rely on it. This book is written by two authorities in the field of investments and insurance. Michael Kitces is widely known to financial advisers through his blog, “Nerd’s Eye View” (www., as well as through his work as an adviser, conference speaker, and author of “The Kitces Report.” John Olsen is president of Olsen Annuity Education.

• Annuity Markets and Pension Reform, by George A. (Sandy) Mackenzie: Sandy

Mackenzie has been an economist at the International Monetary Fund (IMF) and was the founding editor of The Journal of Retirement. At the IMF, he led missions on public pension reform and social expenditure and safety net issues in South America, Central Europe, and Africa.

• Unlocking the Annuity Mystery: Practical Advice for Every Advisor, by Scott Stolz:

In a long career in financial services, Stolz has been a senior life insurance company executive, president of the insurance group at Raymond James, and head of insurance strategy at SIMON Markets, a structured products distributor. He is currently a managing director at iCapital, an internet platform where wealth managers shop for alternate investments such as private equity and private debt. Stolz brings his extensive expertise to bear on this book for agents, brokers, and advisers who recommend and sell annuities.

CHAPTER 22 Ten Great Books about Annuities



»» Determining your risk tolerance »» Assessing the fees »» Identifying the exit strategy



Ten Questions to Ask Before You Sign a Contract


uitability is one of the annuity world’s favorite buzzwords. State and federal regulators like to remind annuity marketers not to pressure their clients into buying annuities that aren’t “suitable” for them. If you buy an annuity, you’ll probably have to read and sign a formal suitability statement. But instead of relying entirely on the agent’s questionnaire (which is designed mainly to protect the seller’s posterior, so to speak), you should plan to prepare a few questions of your own. Here are some questions to ask the agent or broker — and yourself — before buying an annuity.

How Will This Annuity Reduce My Risks? When you buy an annuity, you shift risk from yourself to an insurance company. Which financial risks bother you enough to make you call “1-800-GOT-RISK” and pay an insurer to haul them away?

CHAPTER 23 Ten Questions to Ask Before You Sign a Contract


Maybe you’re worried about living longer than you expected and possibly running low on money. Or maybe you’re worried that a bear market will strike just when you need to tap your portfolio for income in retirement. Or maybe you want to avoid over- or underspending your savings during retirement. By identifying your risks, you can better determine which annuity you should buy, when to buy it, and how much money to assign to the contract. Bear in mind that annuities are a form of financial insurance — a desirable good that’s worth paying for in the right situation.

What Are My Risk Tolerance and Risk Capacity? Along with your unique genetic code, you have a unique risk profile. Some ­retirees aren’t bothered by the threat of a drop in the stock market. Others can’t sleep at night unless their investments are immune from loss. Knowing your risk tolerance (how much risk you can handle and still sleep soundly at night), as well as your risk capacity (how much you can afford to lose in the financial markets), will help you figure out which annuity, if any, is the right risk-reducer for you. Risk tolerance means more than just the ability to stay composed when stock prices plummet. In Chapter 2, I note the three main types of risk in retirement:

»» Longevity risk: All the hazards of living longer than you planned for »» Investment risk: The many financial uncertainties that go with owning securities and drawing down savings

»» Planning risk: The risk that you’ll make a serious blunder with your money Having a sharp sense of your risk capacity is as important as knowing your risk tolerance. If you don’t have enough savings to cover your expenses past age 82, your capacity for longevity risk is low. All the tolerance in the world can’t make up for low capacity.


PART 5 The Part of Tens

How Much of My Assets Should I Put into an Annuity? Without knowing the type of annuity you’re considering, or your purpose for ­buying it, that’s a difficult question to answer. The conventional wisdom is that you should put only about 30 percent of your savings into an annuity. The answer will depend on how much money you can afford to lock up in an annuity for a few years and still have enough for short-term expenses and emergencies. It will also depend on how much guaranteed income you need the annuity to produce. Beware of anyone who tries to pressure you into putting all your retirement savings in any type of annuity. They may try to describe the annuity as an “umbrella in the rain and a parasol in the sunshine” and argue that it will solve all your problems. Putting all your money into an annuity is rarely a good idea.

What Are the Strength and Integrity of the Issuer? Buy an annuity contract only from an insurance company whose financial strength has received a high rating from the agencies that rate insurance companies (for example, Standard & Poor’s, Fitch Ratings, and AM Best). The rating indicates the company’s ability to pay claims, fulfill guarantees, and meet its obligations to policyholders. An A rating indicates the greatest strength, but each rating agency uses a slightly different alphabetical rating system. The rating shouldn’t be your only consideration, though. A B+ rating may be acceptable if you want the highest-yielding short-term fixed deferred annuity. The longer you expect to own your contract, the stronger you’ll want the issuer to be. Comdex Rankings, which are numerical composites of the ratings prepared by Ebix, are offered to advisers through a proprietary service called VitalSigns. Many insurance agents or agencies publish the latest Comdex Rankings on their websites.

CHAPTER 23 Ten Questions to Ask Before You Sign a Contract


To determine the integrity of a specific company, search the web to check for civil, criminal, or administrative actions against it. Your state insurance commissioner, your state attorney general, or the Financial Industry Regulatory Authority (FINRA) may have records of such actions.

What Are the Fees? Don’t let the benefits of an annuity beguile you into overlooking the fees. Sometimes the fees are readily visible. At other times, annuities appear not to have any fees — but they always do. All or most of the fees associated with fixed-rate, fixed indexed, or fixed income annuities are built into the interest rates, crediting formulas, or monthly payout rates, respectively, of those types of contracts. They may be invisible to you, but they are there. With variable deferred annuities, some fees are not easy to interpret. For instance, variable annuity issuers charge annual fees to recover the commissions they pay to the adviser. Those fees may not be labeled as such. (See Chapter 10 for more information on variable annuities.) Annuity fees can go up unexpectedly. A fixed indexed annuity issuer can change the crediting formulas of a contract after any year in a multiyear contract. Variable annuities with GLWBs that allow you to “step up” your income base after a bull market may charge extra for the step-up. Variable annuity contract charges and investment fees may go up over time. Competitive pressures naturally discourage life insurers from abusing the­ privilege of raising fees. But they may raise fees if their own costs or risks rise significantly. Like parents who should put on their own oxygen masks before putting on their child’s, life insurers must protect themselves in order to ­protect you.

What’s My Upside Potential? All annuities are part insurance, part investment, so find out how much growth you can expect from your contract. The answer will depend on the type of annuity you intend to buy:


PART 5 The Part of Tens

»» MYGA: The seller will disclose your annual rate of return before you buy, and the rate won’t change until the contract term ends. You can’t lose money in these contracts unless you break the contract early and suffer a surrender charge or have to pay market value adjustment.

»» Variable annuity: Your returns will depend on the performance of your

portfolio of mutual fund–like investments, minus the fees, during the period when you’re invested. You can lose money in these contracts in down markets. You can often fine-tune the range of your returns by deciding how much to apportion to stock funds.

»» Fixed indexed annuity (FIA): You can’t lose principal in this product if you

keep your money in for the entire surrender charge period, which may range from three to ten years. As for upside potential, FIAs have been known to outperform certificates of deposit (CDs) when interest rates are low, and to outperform bonds during bull markets in stocks. (For more on FIAs, see Chapter 8.)

»» Registered index-linked annuity (RILA): Also known as structured variable

annuities, these contracts are known for higher yields than FIAs but at the risk of suffering an annual loss up to a “floor” percentage or in excess of a “buffer” percentage. (For more on RILAs, see Chapter 9).

How Do I Get My Money Out? Annuities are Crock-Pots for growing money, not pressure cookers. Don’t put money into one if you don’t think you can leave it there for a while. What’s a “while”? It may be as little as three years, if you buy a short-term fixed deferred annuity. It may be the rest of your life, if you buy an immediate income annuity. That said, deferred annuities (fixed and variable) usually offer some flexibility regarding withdrawals. Historically, you could withdraw up to 10 percent of your money in a single year from a deferred annuity with a surrender charge period. But a life insurer may reduce that to 5 percent or even zero in order to boost some other contract benefit. If you buy a no-commission annuity, you face little or no penalty for early withdrawals. Beware of “two-tiered” FIAs that offer bonuses without clear warning that the bonuses are contingent on your never taking your money out, except as a monthly or quarterly income stream in retirement. Remember that, especially if the surrender charge period is over, it’s possible to move money from one annuity contract to another. (See Chapter 19 for more on this topic.)

CHAPTER 23 Ten Questions to Ask Before You Sign a Contract


Many annuities are more liquid than you think. For instance, some people think that when they buy an income annuity or annuitize a deferred annuity, they have no access to their cash other than a monthly check. Not necessarily. Some income annuity contracts allow at least one lump-sum withdrawal during the life of the contract.

Where Can I Get More Information about This Annuity? Even after listening to a broker’s explanation of an annuity product, you may not immediately understand how the product works. Brokers and agents themselves don’t always understand the latest annuity products. Try asking for a copy of the contract prospectus, where you’ll find all the details. By law, you must receive (and read, ideally) a full prospectus or a summary prospectus before buying a variable annuity. Fixed annuities don’t have prospectuses because they’re contracts and don’t involve the purchase of securities. But the application should tell you everything you need to know. Prospectuses  — especially those for variable annuities with guaranteed living benefits — are notoriously confusing. They can lead you on endlessly circular and futile searches for the explanations and definitions that you need. But the prospectus is your best source of information about a variable annuity. You won’t have time to read any prospectus cover to cover. But don’t miss the fee section or the income rider section. Pay attention to text that’s in boldface type.

Am I Better Off Exchanging My Annuity for Another One? If you change financial advisers, which is not uncommon, your new adviser may recommend that you cancel or exchange an annuity contract that a previous adviser sold you. Use the suitability questionnaire on the application for a new annuity to help determine if switching to the new annuity would be in your best interest.


PART 5 The Part of Tens

What Are the Tax Implications? Nonqualified annuities, which are purchased with after-tax money, can be a ­double-edged tax sword. On the one hand, they let you defer taxes on your ­investment gains. On the other hand, you eventually owe ordinary income tax on your gains instead of long-term capital gains tax. Depending on your income and your marginal tax rate, that trade-off may or may not be to your advantage. (See Chapter 18 for details.) In retirement, you must withdraw all the gains that build up over time inside a nonqualified deferred annuity before you can withdraw the principal (what you paid for the contract). After you’ve withdrawn all the gains and paid income tax on them, you can start withdrawing the principal. Because the principal was taxed before you used it to buy the annuity, it won’t be taxed again.

CHAPTER 23 Ten Questions to Ask Before You Sign a Contract



»» Connecting with the smartest people in the room »» Identifying annuity regulators and rescuers »» Getting acquainted with annuity advocates



Ten Annuity Checkpoints on the Information Highway


f you search the web for annuities, you’ll net about 110 million web addresses. That keyword summoned a mere 14 million addresses when the first edition of Annuities For Dummies appeared in 2008. Smartphones and the arrival of financial technology (fintech for short) have reconfigured the annuity world since then. In this chapter, I point you to ten useful sources of information on annuities and their roles in retirement planning. This chapter serves as a supplement to the roundup of commercial annuity websites that I provide in Chapter 15. It introduces you to annuity researchers, regulators, educators, and lobbyists. This is obviously only a tiny sampling of what’s out there. The topics of annuities, pensions, and Social Security systems get a massive amount of attention today from financial advisers, academics, government agencies, think tanks, and corporations. They flood the internet with research, policy recommendations, and retirement planning advice. But the resources in this chapter are a great place to start.

CHAPTER 24 Ten Annuity Checkpoints on the Information Highway


Moshe A. Milevsky Anyone who takes more than a casual interest in retirement financing should know the name of Moshe Milevsky (, a professor of finance at York University in Toronto. In his many books, technical papers, and articles for the general public, he has brought wit, depth, and clarity to the topic of annuities. Through the pages of Pensionize Your Nest Egg (Wiley), Are You a Stock or a Bond? (FT Press), and The 7 Most Important Equations for Your Retirement (Wiley), Milevsky does more than share important practical information for retirees and pre-­ retirees. Like a Carl Sagan of the retirement universe, he awakens readers to the infinite historical and mathematical wonders of a topic mistakenly thought of as tedious and obscure.

Center for Retirement Research at Boston College One of the most quoted retirement financing experts in the United States is Alicia Munnell, PhD, who directs the think tank called the Center for Retirement Research at Boston College ( On this website, you’ll find lots of highly readable, four- or five-page working papers and briefs on Social Security, state and local pensions, health and long-term care, retirement ­financing, and the status of older workers. The center maintains a National Retirement Risk Index to indicate the percentage of Americans prepared or unprepared for retirement. The site also includes the Squared Away Blog, which contains content of direct interest to consumers, ­investors, and retirees. It translates recent research articles into useful reading for non-academics.

Society of Actuaries ( In the retirement industry, the smartest people in the room are very often the actuaries at life/annuity companies. Actuaries predict how long groups of life insurance policyholders and annuitants are likely to live. Their professional society, the Society of Actuaries (, hosts an information-rich website.


PART 5 The Part of Tens

In January 2023, the SOA published a 104-page “Primer on Retirement Income Strategy Design and Evaluation” ( It covers the rocket-science side of ­retirement planning. The SOA also sponsors a Longevity Illustrator at www.longevityillustrator. org. Answer a few questions, and find out how likely you are to reach age 85, 90, 95, and 100.

Financial Industry Regulatory Authority The Financial Industry Regulatory Authority (FINRA) is the securities industry’s self-policing agency. Prior to June 2007, FINRA was known as the National ­Association of Securities Dealers (NASD). The Securities and Exchange Commission (SEC) relies on FINRA, a government-authorized not-for-profit resource, to monitor the more than 600,000 people who are licensed to sell and give advice on the sales of securities in the United States. Because you can lose money owning them, traditional variable annuities and ­registered index-linked annuities (RILAs) are classified as securities and come under FINRA’s purview. FINRA has also weighed in on fixed indexed annuities, even though they aren’t securities. FINRA’s website ( has information on annuities, but you have to dig for it a bit. You can use the search tool to look for reports with the keyword annuity. That will bring you to a list of annuity-related publications called “Investor Insights.” Or you can click the For Investors drop-down menu, click Personal Finance, and then click the Learn More link under “Manage Your Retirement Income.”

Securities and Exchange Commission If you own a traditional variable annuity or a RILA, your money is invested in securities and you bear the risk of loss. For that reason, both types of annuities are regulated by the SEC, the independent agency that oversees the U.S. securities markets and enforces securities laws.

CHAPTER 24 Ten Annuity Checkpoints on the Information Highway


The SEC was created in response to the stock market crash of 1929 and the Great Depression that followed. It replaced state-by-state regulation of securities trading. The SEC has five commissioners, including a chairman appointed by the president. Within the SEC website (, there’s an website where you can find calculators for estimating required minimum distributions (RMDs) and finding out how much a given investment would grow at a given rate of interest. If you enter the term annuities in the search tool, you’ll find a list of reports related to annuities. The SEC had a tiff with the annuity industry in 2007. Amid a spike in national media coverage of alleged predatory sales tactics by agents selling equity indexed annuities, or EIAs, as fixed indexed annuities were called at the time, then–SEC Commissioner Christopher Cox moved to reclassify EIAs as securities on the grounds that their returns could vary. His action would have made insurance agents without securities licenses ineligible to sell EIAs. The life/annuity industry and the insurance agents’ trade associations fought back. They argued that because owners of EIAs couldn’t lose principal, EIAs were state-regulated insurance products, not federally regulated securities. A federal appeals court ruled in favor of the industry. EIA marketers subsequently changed the name of the product to fixed indexed annuity. Insurance agents agreed not to promote the product as a safe alternative to stocks.

National Association of Insurance Commissioners The National Association of Insurance Commissioners (NAIC) is the umbrella organization for the 50 state insurance commissioners. It was set up in 1871  in response to the need for nationwide consistency and standardization in the laws and regulations governing the business of insurance. States can follow the NAIC’s “model laws” but aren’t bound by them. The NAIC isn’t a regulator per se. It has no enforcement power. Because fees from insurance companies help fund it, it reflects their concerns. On the NAIC website (, hover your mouse over the Resource Center tab and you see a link to the Center for Insurance Policy and Research. Click that link, then click Insurance Topics, and scroll down until you find the A-to-Z topics list; a link to Annuities is near the top.


PART 5 The Part of Tens

National Organization of Life & Health Insurance Guaranty Associations Insurance agents are forbidden to mention this organization as part of a sales presentation. Regulators don’t want agents suggesting to prospective clients that the National Organization of Life & Health Insurance Guaranty Associations ­(NOLHGA) safety net takes all the risk out of buying insurance products. NOLHGA is an umbrella organization for 50 state guaranty associations. When an insurer licensed in more than one state is declared insolvent — when its investments are worth less than its obligations to policyholders — NOLHGA creates a task force of state guaranty association officials. This task force tries to expedite the resolution of insolvencies so you can get the money you were promised more quickly. A healthy insurance company may step in to buy the assets and liabilities of the failed company. If there isn’t enough money to pay all the claims, the state guaranty associations can call on the insurers in their states to make up the difference. An FAQ page on the NOLHGA website ( explains the extent of protection for each type of annuity. Each state sets limits on the amount it will pay to the failed company’s annuity contract owners. (See Appendix B for a state-bystate list of limits.)

Alliance for Lifetime Income Twenty-one of the largest life/annuity companies and investment companies in the United States collaborated to create and finance the Alliance for Lifetime Income, a nonprofit educational organization that promotes the use of annuities as deliverers of “protected income” before and during retirement. Many of the top variable annuity issuers are represented here. The group promotes both products that offer guarantees and products that reduce financial risk without providing full guarantees. Along with its educational component, the organization has a research arm, the Retirement Income Institute. On the website (, you can find the useful Retirement Income Security Evaluation (RISE), a free calculator. Based on your inputs about your savings, your expected sources of income in retirement, and your estimated retirement expenses, the calculator can reveal gaps between your foreseeable inflows and outflows.

CHAPTER 24 Ten Annuity Checkpoints on the Information Highway


Insured Retirement Institute The Insured Retirement Institute (IRI) lobbies Congress on behalf of the life/ annuity companies, investment companies, and other firms that comprise the retirement income industry in the United States. It is distinct from the American Retirement Association, which advocates on behalf of employer-sponsored plan providers. Much of the research on the IRI website ( is ­available only to members, but the site also has downloadable documents of IRI’s positions on current public policy issues related to retirement financing.

American Council of Life Insurers The American Council of Life Insurers (ACLI) lobbies Congress on behalf of the hundreds of U.S. companies that provide life insurance, health insurance, and annuities to Americans and that support American industry and business by ­lending them trillions of dollars through the purchase of corporate bonds. On the annuities section of the ACLI website (, you can find general information about annuities. On the main ACLI home page (www., hover your mouse over the News & Analysis tab, and click the Publications and Research link. That page has a link to the ACLI Life Insurers Fact Book. Click that link, and you can read the chapter on annuities.


PART 5 The Part of Tens




Find definitions to annuity-related terms. Get a breakdown of annuity benefits by state or territory.




accumulated value: The sum of the premium and the earnings in an annuity contract, minus fees charged to the contract and withdrawals from the contract. accumulation period: The period during which the owner of a deferred annuity makes payments into the contract and accumulates assets. Also known as savings period. accumulation unit value (AUV): A variable annuity subaccount’s unit of m ­ easure, similar to a mutual fund’s net asset value (NAV). During the accumulation period, the AUV fluctuates daily with a change in the value of the subaccount (similar to a mutual fund). See also subaccounts. AIR: See assumed interest rate (AIR). annuitant: The person (or persons) whose life expectancy is used to calculate the value of annuity payments. The contract owner and the annuitant are often, but not always, the same person. annuitization: The conversion of the accumulated value of the contract into a stream of monthly, quarterly, or semiannual payments, for as long as one or two persons is living or for a specific number of years. annuity commencement date: The date when income payments begin. Also known as the annuity starting date. annuity contract: The legal agreement between the annuity contract owner and the insurance company that issues the contract. annuity payout period: The period of time, starting on the annuity commencement date, during which the insurance company makes annuity payments. See also annuity commencement date. annuity starting date: See annuity commencement date.



annuity unit value: The measurement used to determine the amount of each annuity payment to the owner of a variable income annuity. The number of units is established when the annuity is first converted to an income stream or purchased. The annuity unit value fluctuates with the value of the underlying investments. A-share variable annuities: Variable annuity contracts whose purchaser pays a sales charge or load at the time of purchase. A-share contracts have no surrender charges or surrender periods, and may have lower insurance charges than other types of contract share classes. A-share contracts are far less common than B-share contracts. See also B-share variable annuities. asset allocation: The method, based on Modern Portfolio Theory, of diversifying away some of the risk in a portfolio by holding uncorrelated investment classes. “Uncorrelated” means the prices of the asset classes tend not to move in the same direction at the same time. For instance, a moderate asset allocation might include 60 percent stocks, 25 percent bonds, 5 percent real estate, 5 percent international stocks or bonds, and 5 percent metals or Treasury bonds. By adjusting the proportions, the investor can theoretically modulate the risk of the portfolio and influence long-term returns. See also Modern Portfolio Theory. asset allocation funds: Mutual funds that offer the investor a pre-established asset allocation. Someone who invests in a deferred variable annuity with guaranteed living benefits may be required to put their assets in any of several asset allocation subaccounts. See also subaccounts. assumed interest rate (AIR): The hypothetical growth rate, typically ranging from 3 percent to 5 percent, that life/annuity companies use when calculating the first payment of an immediate variable income annuity. If the underlying assets grow at a rate higher than the AIR in a year, the following year’s payments may be higher. If the underlying assets grow at a rate lower than the AIR, payments may be lower. AUV: See accumulation unit value (AUV). beneficiary: The person designated by the contract owner to receive any payments that may be due if the contract owner or the annuitant dies. benefit: Payments that insurers are contractually obligated to pay in response to a valid claim. See also distributions. B-share variable annuities: Variable annuity (VA) contracts where the issuer of the contract (a life/annuity company) pays an adviser an up-front commission for selling a contract and then gradually recovers that expense from the contract owners by deducting annual fees from their contracts. B-share VAs have surrender periods of up to seven years. Surrender charges allow the life/annuity company to recover the commission even if the contract owner cancels (surrenders) the contract soon after buying it. B-share contracts are the most common form of annuity contracts sold. See also surrender charges. cash surrender value: The amount that can be withdrawn from the contract after any surrender charge, if any is subtracted from the accumulated value. Also called the cash value. See also accumulated value. cash value: See cash surrender value.


PART 6 Appendixes

CDA: See contingent deferred annuity (CDA). CDSC: See contingent deferred sales charge (CDSC). charitable gift annuity: An annuity in which an individual transfers cash, securities, or property to a charitable organization and the individual (or two people) receives a regular income from the organization for life. contingent deferred annuity (CDA): An a la carte living benefit, unbundled from a variable deferred annuity. Advisers can attach them to their own balanced mutual fund portfolios to give their clients guaranteed lifetime withdrawal benefits (GLWBs) without using the menu of investments that typically come packaged into variable annuities. CDAs were once known as stand-alone living benefits (SALBs). See also guaranteed lifetime withdrawal benefit (GLWB) rider. contingent deferred sales charge (CDSC): If you withdraw money from a B-share variable annuity contract before the issuer has recovered an amount equal to the sales commission that it paid your agent or adviser, you may be assessed a CDSC. The CDSC is a percentage of the amount you withdraw, net of any allowed withdrawal amount. The percentage diminishes year-by-year over the CDSC period. Also called back-end loads, they may start at 5 percent to 7 percent of the contract value and decline by 1 percent per year until reaching zero. See also surrender charge. contract date: The date an annuity contract becomes effective. Each contract year begins and ends on an anniversary of the contract date. Annuity owners need to be conscious of their contract anniversaries, because they represent milestones, opportunities, or deadlines that can affect the value of the contract and may require a timely decision on the owner’s part. See also contract year. contract owner: The person who owns all rights to an annuity contract. It is often but not always the person who buys the annuity. The owner can make withdrawals, make investment decisions, surrender the contract, change the beneficiary, and convert a deferred contract to an income stream. contract year: The period from one contract anniversary to the next. See also contract date. C-share variable annuity: Contracts with no up-front or contingent deferred sales charges. Also known as no-surrender-charge annuities, they do not penalize any withdrawals. For that reason, their annual fees may be higher than those of B-share VAs. See also contingent deferred sales charge (CDSC). death benefit: The payment made to the beneficiary if a contract owner or annuitant dies during the accumulation period. The death benefit may be greater than the cash value of the contract, depending on the rider chosen by the contract owner. Contracts may include standard death benefit riders without added fees and enhanced death benefits with added fees. deferred annuity: An annuity contract purchased to help save for retirement. The contract can be paid for with a single premium, multiple occasional premiums, or regular contributions. The contract owner determines whether or when to convert the accumulated value to retirement income. See also annuitization.



defined benefit plan: An employer-sponsored pension plan that qualifies for special tax treatment under the Internal Revenue Code. A retiree covered by the plan receives lifetime payments based on salary, years of service, and age at retirement. The employer bears all investment risk. See also Internal Revenue Code. defined contribution plan: An employer-sponsored pension plan in which the employee channels part of their income into the plan. In 2023, contributions are tax deductible up to $22,500 ($28,000 for those over age 50). The employer may match a percentage of the employee’s annual contribution, but the employee bears all investment risk. distributions: Life/annuity industry jargon for their payments to owners of deferred annuity contracts, either as withdrawals or benefits. See also benefits. dollar cost averaging: A program for investing a fixed amount of money in mutual funds at set intervals so that more shares are purchased when prices are low and fewer shares are purchased when prices are high. Variable annuity (VA) contract owners can practice dollar cost averaging by arranging for regular, automatic transfers from a money-market subaccount or a fixed account to other subaccounts within the contract. See also subaccounts. ERISA: The Employee Retirement Income Security Act of 1974. It’s the foundational law governing pensions in the United States, including both traditional defined benefit pensions and defined contribution plans. exclusion ratio: The percentage of an annuity income payment that is not subject to income tax. It represents the tax-free return of the original investment, or principal. financial market risk: See market risk. fixed annuitization: Creation of a stream of guaranteed income payments based on a fixed rather than variable rate of return from an annuity contract in the payout phase. fixed income annuity: An income annuity that makes identical payments for the life of one person, two people, or a specific period. See also fixed annuitization and income annuity. fixed indexed annuity: An annuity whose gains are indirectly linked (through options) to the performance of a broad market index, such as the S&P 500, but that also guarantees no loss of principal due to poor market performance. fixed-rate annuity: A deferred annuity that guarantees that the contract owner will receive a stated rate of interest through the accumulation phase. See also deferred annuity. flexible-premium contract: A contract to which the owner can make additional payments after the initial contribution or premium. See also premium. free-look period: The ten or more days after the issue of a new contract during which the owner can cancel it. general account: All the assets of the insurance company not allocated to the separate accounts. When a fixed annuity is purchased, the premium goes into the general account.


PART 6 Appendixes

When a nonstructured deferred variable annuity is purchased, the premium goes into a separate account. GLWB: See guaranteed lifetime withdrawal benefit (GLWB) rider. guarantee period: The period during which the level of interest credited to a fixed annuity is guaranteed not to change. guaranteed benefit base: The notional amount, immune to market volatility, that the issuer of a variable annuity (VA) uses to calculate the monthly payout amount under a living benefit option. That is the monthly income benefit under a guaranteed lifetime withdrawal benefit (GLWB) rider. See also living benefits and guaranteed lifetime withdrawal benefit (GLWB) rider. guaranteed lifetime withdrawal benefit (GLWB) rider: An annuity rider or option, offered for a fee, promising contract owners that they can withdraw a percentage (4 percent to 7 percent, depending on their age when payments begin) of a guaranteed benefit base every year for life, regardless of the current value of their annuity. GLWBs can be found on fixed-rate, fixed indexed, variable, and registered index-linked annuities. HECMs: See home equity conversion mortgages (HECMs). home equity conversion mortgages (HECMs): See reverse mortgages. immediate annuity: An annuity contract, purchased with a single premium, that begins paying an income within 13 months after purchase. The payments can be variable or fixed. The fixed version is also known as a single premium immediate annuity (SPIA). The less-common variable version is sometimes called a single premium immediate variable annuity (SPIVA). income annuity: An immediate annuity. income floor guarantee: A promise that variable income annuity payments will never be less than a specified percentage (such as 80 percent) of the first payment. income options: The different ways that an annuity owner can elect to have income paid out from an immediate annuity. Typical income options are life only, life and period certain, life and cash refund, and joint-and-survivor. individual retirement account (IRA): A tax-advantaged long-term savings account, regulated by the Internal Revenue Service, to which a saver can contribute either pretax or after-tax money and that grows on a tax-deferred or tax-free basis, depending on the type of IRA. in-plan annuities: Retirement annuity contracts offered to participants in 401(k) plans. Participants contribute to them while they are still in the plan. See also out-of-plan annuities. insurance charges: How you compensate the life/annuity company for the guarantees it provides you and the risks that you transfer to it. The fees are deducted from your contract value.



Internal Revenue Code: The body of federal tax laws. investment management fee: The fee paid to the professional fund managers who manage the money in variable annuity subaccounts. See also subaccounts. IRA: See individual retirement account (IRA). issuer: The life insurance company that issues the annuity. joint and survivor annuity: A life annuity in which there are two annuitants, usually spouses, whose life expectancies determine the payout rates. In the annuity payout period, the contract makes payments as long as either of the joint annuitants is living. See also life annuity and annuity payout period. level annuity payments: Annuity payments under a variable annuity contract that change only at the end of a specified period, such as 12 months, when they reset to reflect the actual performance of the investments during the period. life annuity: Annuity payments that are guaranteed to continue for the life of the annuitant. life/annuity company: A life insurance company that issues annuity contracts, as well as life insurance policies. living benefits: Deferred annuity contract riders, developed in the late 1990s, that offer contract owners guaranteed income for life without denying them access to or control over the annuity assets. Different living benefits can be used to set a floor under the value of monthly income in retirement, under the amount available to annuitize, or under the future cash value of the account. Living benefits are available on many types of annuities. longevity risk: The risk of living more years than average, and the risk that you will not have saved enough for a longer-than-expected life. L-share variable annuities: Variable annuity (VA) contracts that typically have shorter surrender periods, such as three or four years, but may have higher annual fees than other contracts. lump-sum option: The option to withdraw all the assets in the annuity in a single payment. market risk: The risk that an investment in stocks or bonds may lose value. Also called financial market risk. market value adjustment: A feature of some fixed-rate annuities that discourages contract owners from taking opportunistic withdrawals to buy competing products with higher yields. If prevailing interest rates have gone up since the contract was purchased, a withdrawal is adjusted down. If rates have gone down, the value of the withdrawal is adjusted upward. minimum credited interest rate: The minimum rate of interest that the owner of a fixed annuity is guaranteed to receive during a contract term.


PART 6 Appendixes

Modern Portfolio Theory: The concept, pioneered by economist Harry Markowitz in 1952, that an investor can optimize the balance of risk and return of an investment portfolio by holding a diversity of asset classes. Monte Carlo simulation: A computerized analytical model that considers thousands of possible market scenarios, using hypothetical inflation rates, interest rates, and market returns. It then presents the range of probabilities that various scenarios might occur. Monte Carlo simulations provide an alternative to historical returns for someone trying to estimate the probability of future market performance. moral hazard: The behavioral phenomenon by which the ownership of insurance tempts an insured person to take excessive covered risks. mortality and expense (M&E) risk charge: A fee, found in many B-share variable annuities (VAs), that compensates a life/annuity company for the risk it took by promising to annuitize contracts at specific minimum rates in the future without knowing the interest rate environment in the future. VA issuers are allowed to use the money for marketing or other purposes. mortality credit: The dividend associated with longevity risk pooling. Also known as survivorship credit. See also risk pooling. multiyear guaranteed annuity (MYGA): Fixed-rate annuities whose yields are guaranteed for the term of the contract. By contrast, the rates paid on fixed-rate annuities are subject to annual changes by the issuer. MYGA: See multiyear guaranteed annuity (MYGA). nonqualified annuity: An annuity that is purchased with savings that you have already paid taxes on, as opposed to savings taken from a tax-deferred retirement plan, such as a 401(k) or an individual retirement account (IRA). out-of-plan annuities: Annuities that a 401(k) plan sponsor may offer participants but that participants don’t contribute to until after they have “rolled over” their plan savings to a traditional IRA. See also in-plan annuities. partial withdrawal: The withdrawal of an amount less than the entire cash surrender value of the contract. Many contracts permit annual withdrawals of a certain amount (such as 5 percent or 10 percent) without a surrender charge. See also cash surrender value. payout options: See income options. payout period: See payout phase. payout phase: The period during which a life/annuity company distributes income benefits from an annuity. It follows the purchase of an immediate annuity, the annuitization of a deferred annuity, or the activation of a guaranteed lifetime withdrawal benefit (GLWB) rider. Also known as payout period. See also immediate annuity, premiums, and guaranteed lifetime withdrawal benefit (GLWB) rider.



period certain: The number of years, from 5 to 20 or more, that income annuity payments are guaranteed to last. There is no provision to pay for as long as the owner lives. If the owner dies before the end of the period certain, the owner’s beneficiary receives the remaining scheduled payments. portfolio rebalancing: A type of automatic asset allocation that periodically restores the relative proportion of the investments in a variable annuity (VA) to the contract owner’s desired allocation. Market fluctuations can, over time, change the original allocation and, therefore, change the portfolio’s risk level. premiums: The amounts of money paid into an annuity contract. Also known as purchase payments. purchase payments: See premiums. pure life annuity: An income annuity whose payments last for the annuitant’s lifetime, stopping with the death of the annuitant. In most cases, the owner and annuitant will be the same person. Also known as straight life annuity. qualified annuity: An annuity purchased with pretax dollars from a traditional individual retirement account (IRA), rollover IRA, or defined contribution retirement savings plan. refund feature: An optional annuity contract provision that guarantees that if the annuitant dies before a specific amount of premiums paid for the annuity are received as income, some or all of the premiums will be refunded to the beneficiary. There may be either a lump-sum cash payment or a series of installment payments. registered index-linked annuity: Registered securities that resemble fixed indexed annuities but have higher performance caps and the potential for investment loss. They can be sold only by brokers with securities licenses. Also known as structured variable annuity. reverse mortgages: Federally regulated loans made to retirees and secured by the equity in their homes. The borrowers can use the loan proceeds to fund life annuities, if they want. They can also establish HECM lines-of-credit at the beginning of retirement as a source of emergency cash or as a hedge against falling home prices. Also known as home equity conversion mortgages (HECMs). risk pooling: In income annuities, the sharing of longevity risk among a large group of individuals, some of whom will die relatively sooner (and forfeit their remaining assets to the pool) and others of whom will live relatively longer (and share the assets forfeited by those who died before them). See also mortality credit. rollover individual retirement account (IRA): A traditional IRA funded with pretax savings from a defined contribution savings plan. The money continues to be sheltered from tax while in the IRA. See also individual retirement account (IRA). rollover IRA: See rollover individual retirement account (IRA). savings period: See accumulation period.


PART 6 Appendixes

Section 1035 exchange: The tax-free exchange of part or all of one or more nonqualified deferred annuity contracts for a new annuity contract. The exchange must meet the requirements of Section 1035 of the Internal Revenue Code. See also Internal Revenue Code. separate account: An account, consisting of mutual fund–like subaccounts, that receives the money you invest in a variable annuity. The separate account is set apart from the insurer’s general account and is legally insulated from the insurer’s general creditors. single premium annuity: An annuity contract that is purchased with a single payment. All immediate annuities and some deferred nonqualified annuities are in this category. single premium immediate annuity (SPIA): See immediate annuity. SPIA: See single premium immediate annuity (SPIA). stepped-up death benefit: A death benefit that is increased regularly to lock in the account value’s investment gains. It is sometimes offered as an option in variable annuity contracts. See also death benefit. straight life annuity: See pure life annuity. structured variable annuity: See registered index-linked annuity. subaccounts: Variable insurance trusts, similar to mutual funds, that are offered in variable annuity (VA) contracts and variable life insurance policies and held by the insurer in a separate account rather than in the insurer’s general account. See also separate account and general account. surrender charge: The cost to a contract owner for excess withdrawals from a deferred annuity contract before the end of the surrender period. survivorship credit: See mortality credit. systematic withdrawal plan: A plan that allows owners of deferred variable annuity (VA) contracts to schedule regular withdrawals from the contract instead of converting the assets to a guaranteed income stream. tax-qualified retirement plan: An employer-sponsored retirement plan such as a 401(k) plan, or 403(b) plan. Contributions to such plans qualify for special tax treatment under federal law. transfer: The movement of assets from one variable annuity (VA) subaccount to another. transfer fee: The charge for transfers. Most issuers allow a certain number of free transfers and impose fees only on excessive transfers. unbundled contracts: Annuity contracts that permit purchasers to choose and pay for the optional features they want. See also contingent deferred annuity. VA: See variable annuity (VA).



variable annuitization: A stream of guaranteed income payments that vary based on the investment performance of the underlying subaccounts. See also subaccounts. variable annuity (VA): An annuity whose contract value or income payments vary based on the investment performance of the underlying subaccounts. See subaccounts. variable insurance trusts: See variable investment options. variable investment options: The investment choices that are available to a variable annuity (VA) contract owner. These choices typically include stock, bond, and moneymarket funds. Also known as variable insurance trusts. withdrawal fee: An administrative fee charged on withdrawals. withdrawals: Any distributions from an annuity other than scheduled annuity payments.


PART 6 Appendixes



State Guaranty Associations


nsolvency rarely occurs among large insurance companies. Rating agencies and regulators are responsible for spotting bankruptcy’s warning signs long before it happens. Troubled companies are often purchased by a stronger life insurer before they fail. Even so, it’s reassuring to know that a safety net exists for a bankrupt life­ insurer’s annuity policyholders. Every state, along with Puerto Rico and the District of Columbia, has a guaranty association that gives you some, most, or even all of your money back if your annuity issuer fails. They all belong to the National Organization of Life and Health Guaranty Associations (NOLHGA;

Because every state regulates the sale of insurance within its borders, every state establishes its own limits on the coverage it extends to annuity owners who are the casualties of insurer bankruptcy. Since 2008, many states have more than doubled their limits. Some states use one limit during an annuity’s growth or “accumulation” stage and another after lifetime payments start.

APPENDIX B State Guaranty Associations


All NOLHGA’s member guaranty associations offer resident policyholders up to at least $250,000  in coverage for lost annuity contract values. Some offer more. Some apply additional conditions for coverage. The guaranty association laws of some states limit the interest rate that may be covered by the association. The protection applies to individual annuity contracts or group annuity certificates, which are issued to and owned by an individual or under which the insurer guarantees annuity benefits to an individual under the contract. The protection is subject to applicable limits and exclusions on coverage, including an exclusion for portions of an annuity contract not guaranteed by the insurer or under which the risk is borne by the contract owner. Here’s a breakdown of annuity benefits by state or territory, as of 2022, according to NOLHGA:

»» Alabama: $250,000 »» Alaska: $250,000 »» Arizona: $250,000 »» Arkansas: $300,000 »» California: 80 percent of the annuity contract value, to $250,000 »» Colorado: $250,000 »» Connecticut: $500,000 »» Delaware: $250,000 »» District of Columbia: $300,000 »» Florida: $250,000 if the annuity is deferred; $300,000 if the annuity is in payout status

»» Georgia: $250,000 if the annuity is deferred; $300,000 if the annuity is in payout status

»» Hawaii: $250,000 »» Idaho: $250,000 »» Illinois: $250,000 »» Indiana: $250,000 »» Iowa: $250,000


PART 6 Appendixes

»» Kansas: $250,000 »» Kentucky: $250,000 »» Louisiana: $250,000 »» Maine: $250,000 »» Maryland: $250,000 »» Massachusetts: $250,000 »» Michigan: $250,000 »» Minnesota: $250,000; $410,000 for structured settlements and for annuities

that have been annuitized for not less than lifetime or for a period certain not less than ten years

»» Mississippi: $250,000 »» Missouri: $250,000 »» Montana: $250,000 »» Nebraska: $250,000 »» Nevada: $250,000 »» New Hampshire: $250,000 »» New Jersey: $500,000 if the annuity is in payout status; $100,000 if the annuity is deferred

»» New Mexico: $250,000 »» New York: $500,000 »» North Carolina: $300,000, except in the case of structured settlement annuities (SSAs), for which the limit is $1 million

»» North Dakota: $250,000 »» Ohio: $250,000 »» Oklahoma: $300,000 »» Oregon: $250,000 »» Pennsylvania: $250,000 »» Puerto Rico: $250,000 »» Rhode Island: $250,000

APPENDIX B State Guaranty Associations


»» South Carolina: $300,000 »» South Dakota: $250,000 »» Tennessee: $250,000 »» Texas: $250,000 »» Utah: $250,000 »» Vermont: $250,000 »» Virginia: $250,000 »» Washington: $500,000 »» West Virginia: $250,000 »» Wisconsin: $300,000 »» Wyoming: $250,000


PART 6 Appendixes

Index A

AARP, 221 account value, 291–292 accumulated unit values (AUVs), 37 accumulated value, 329 accumulation annuities, 245 accumulation period, 9, 17–18, 329 Advanced Retirement Planning (Otar), 225 adverse selection, 54–55, 65 The Advisor’s Guide to Annuities (Olcen and Kitces), 121, 123, 301 Aegon, 202 after-tax money, 101 age, 68–70 age-in-place annuities. See reverse mortgages AIG, 200 AI Powered Multi-Asset Index (AiMAX), 117 Alliance for Lifetime Income, 315 Allianz Life, 114, 130, 227 alternative asset managers, 200 AM Best, 16 American Advisors Group (AAG), 177, 186 American College of Financial Services, 208 American Council of Life Insurers (ACLI), 316 American Equity, 114, 227 American Equity Investment Life, 200, 201 American General Life, 141 American Institute of Certified Public Accountants, 226 Ameritas, 148 Anderson, Bryan, 222, 256 annual fees, 147 annual reset, 115 annuitants, 35–36, 88, 278–279, 319 annuities advantages of, 48–51 benefits of, 2–3, 14–15 books about, 297–301

candidates for, 59–71 competition, 55–58 contracts. See contracts converting to life insurance, 275–276 defined, 7 disadvantages of, 52–55 elements of, 37–40 examples, 10 exchanging, 308 fees, 42, 53 history of, 19–20, 281 life cycle of, 16–18 media description of, 9 other financial tools, compared with, 8 overview, 7–9 owner-driven versus annuitant-driven, 279 owners of, 71 same-sex marriages and, 284 swapping, 273–275 types of, 10–13 annuitization, 40, 146, 152–153, 271–272, 319 annuity commencement date, 319 AnnuityFYI (website), 114 The Annuity Man (website), 220–221 Annuity Market News, 1 Annuity Markets and Pension Reform (Mackenzie), 103, 301 annuity payout period, 319 The Annuity Stanifesto (Haithcock), 298 annuity starting date, 319 Annuity Straight Talk (website), 222–223, 256 annuity unit value, 320 Another Day in Paradise: The Handbook of Retirement Income (Dillinger), 300 Are You a Stock or a Bond? (Milevsky), 64, 298 A-share variable annuities, 320 asset allocation, 320 asset allocation funds, 320 assets, 305



assumed interest rate (AIR), 104, 320 assumptions, in this book, 3 Athene, 114, 196, 200, 227 at-the-money (ATM) call/put, 136

Brighthouse Financial Guaranteed Income Builder, 170–171 brokerage advisers, 209–210 brokerages, 206, 210

AXA Equitable, 130, 199, 202

broker-dealers, 210, 211


bucketing, 248

B-share variable annuities, 320 buffered ETF, 136

baby boomers, 199

buffers, 131, 132–133

back-testing, 127

buyout firms, 200

banded rates, 81 bank advisers, 209 banks, 206 base rate, 81 Belth, Joseph, 196 beneficiaries of annuitants, 280 of contract owners, 280 defined, 36, 320 of fixed annuities, 88 naming, 279–282 options, 280–281 protecting, 49–50 taxes, 53–54, 268 benefits, 320 Bengen, William, 94 Bermuda Triangle strategy, 202 best interest, 45–46, 217–218 biennial reset, 115 The Big Short (film), 193 Black, Laurence, 115 BlackRock LifePath Paycheck, 235–236 Blueprint Income (website), 170, 221 Bodie, Zvi (author), 98, 300 Bond Investing for Dummies (Wild), 80 bonus annuities, 81–82 bonuses, 120 bonus rate, 81 bonus value, 291 books about annuities, 297–301 book value fixed annuities, 80 Boomer couples, 60–61 Brighthouse Financial, 109, 130, 192, 196, 235


Annuities For Dummies


calculators, 225–-227, 246 Calculator Soup (website), 226 call spread, 118, 123, 136 Camdex score, 78–79 candidates for annuities affluent, 62–63 age of, 68–70 Boomer couples, 60–61 determining, 63–64 market bears and other pessimists, 67–68 middle class, 62–63 overview, 59–60 people without beneficiaries, 70 people with rugged genes, 65 retirees, 65 suitability questions for, 68–69 women, 61–62 cap, 117, 118, 131, 133 Capital Asset Pricing Model, 252 captive force, 197 captive insurance agents, 87, 209 career insurance agents, 209 Caron, Bruno (author), 299 cash refund, 98–99, 247 cash surrender value, 320 CD-type annuities. See multiyear guaranteed annuities (MYGAs) Center for Retirement Research, 23, 312 certificate of deposits (CDs), 11, 55–56, 75, 82–83 Certified Financial Planner (CFP), 212 charitable gift annuity, 321

charities, 15

Cox, Christopher, 314

Charles Schwab (website), 170, 221–222

crediting intervals, 115

Chartered Financial Consultant (ChFC), 212

creditworthiness, 180

Chartered Retirement Planning Counselor (CRPC), 208

C-share variable annuity, 321

Cheat Sheet (web site), 4

current rate, 81

Chen, Steve, 224 Cloke, Curtis (financial adviser), 63 closely held companies, 198 collateral, 181

CUNA Mutual, 196 customer service, 44


collateralized loan obligations, 201

Dai-ichi Life, 202

community spouse, 108

death benefits

compliance, 44

defined, 321

compound interest, 76

described, 38

Compound Interest Calculator (website), 227

enhanced, 283, 291

conflicts of interest, 214–215

fees, 42

Consumer Financial Protection Bureau (CFPB), 186

in fixed annuities, 77

contingent annuitants, 36

loss of, in exchange of annuities, 275

contingent deferred annuities (CDAs), 156, 263– 264, 321

return of premium, 282

contingent deferred sales charge (CDSC), 38, 77, 321

stepped-up, 282

contract date, 321

super-enhanced, 292

contract owners, 35, 71, 278–279, 321

types of, 282–283, 291–292


in VA/GLWB contracts, 147

anniversary, 39

standard, 282, 291

in variable annuities, 146

annuitants, 35–36

default counseling, 188

beneficiaries, 36

default risk, 78

cancelling, 37 death benefits, 38

deferred annuities, 10–11, 255–256, 259, 321. See also annuitization

defined, 319

deferred fixed annuities, 55–56

fees, 42

deferred income annuities (DIAs)

free-look periods, 37

buying, 170–172

issuer, 37

described, 10, 13

mis-structuring, 286–287

in 401(k) plans, 233

overview, 9

ideal users of, 166

questions to ask before signing, 303–309

longevity risk hedging with, 163–164

signing, 34

overview, 161–163

single versus flexible premium, 40

paying for, 172–173

surrender periods, 38–39

premiums, 39

variable annuity, 41–42

products, 170–172

contract year, 321

pros and cons of, 164–167

contributions, 49

versus single premium immediate annuities, 162–163

CoreBridge Financial, 114, 192, 196, 200, 227 core contract charges, 147

deferred variable annuities, 39, 54, 56–57, 290–292



defined benefit pension plan, 65, 231, 322

fixed indexed annuities (FIAs), 121

defined contribution plan, 322

forgetting about, 286

defined-outcome ETF, 136

investment, 42

Dellinger, Jeffrey (author), 104, 300

living benefit, 42

demutualization, 198

questions, 306

Department of Labor (DOL), 218, 236

rider, 42

derivatives, 123

step-up, 290

distributions, 18, 322

variable annuities, 42, 145–147

distributors, 206–207

Fidelity and Guaranty Life, 200, 227

Dodd-Frank Wall Street Reform and Consumer Protection Act, 203

Fidelity Investments (website), 221–222, 289

dollar cost averaging, 322

fiduciary standard, 217

Don’t Go Broke in Retirement (Vernon), 298 DPL Financial Partners (website), 128, 148, 211, 223 dually registered advisers, 211 Dynamic Accumulator RILA-type annuity, 141

Fidelity Retirement Score (website), 227 financial advisers, 16 Financial Freedom Senior Funding Corp., 177 Financial Industry Regulatory Authority (FINRA), 139–140, 145, 274, 313 financial intermediaries, 208


financial planners, 211

economic man, 27 Employee Benefits Security Administration (EBSA), 204, 226 Employee Retirement Income Security Act of 1974 (ERISA), 232, 322 employer-sponsored retirement plans, 207 enhanced death benefits, 283, 291 enhanced participation rates, 121 EquBot, 117

financial reporting, 44 Fitch Ratings, 16, 193 fixed annuities annuitants, 88 beneficiaries, 88 buying, 87–89 characteristics of, 77–78 contracts, 42–43 end of contract, 89

Equitable Financial, 130, 227, 235

fees, 86

equity-indexed annuities. See fixed indexed annuities (FIAs)

market value adjusted versus book value, 80 overview, 75–77

Evensky, Harold (author), 299

pros and cons of, 84–86

exclusion ratio, 276, 281, 322

risk protection, 78

expected return multiple, 262

types of, 43, 79–84 fixed annuitization, 322


fixed immediate annuities, 43

F&G Life, 114, 141 fee-based advisers, 211 fee-only planners, 211 fees annuities versus mutual funds, 53 contract, 42 death benefit, 42 fixed annuities, 86


Annuities For Dummies

fixed income annuities, 322 fixed indexed annuities (FIAs) advantages of, 112 agents, 113–114 bonuses, 120 buying, 113–119, 128 choosing and customizing, 114–119 contracts, 43 crediting formula for, choosing, 117–118, 123

defined, 43, 322

QDIA, 234

described, 112

qualified lifetime annuity contracts, 234–235

enhanced participation rates, 121

SECURE Act and, 229–230

explicit fees, 121

403(b) accounts, 60–61

FAQs, 122–123

Franklin, Ben, 164

life insurers, choosing, 114

fraud, 293

lifetime income riders, 119–120

free-look periods, 37, 322

market index, choosing, 115–116

Friedman, Milton (economist), 198

market-value adjustments, 121–122

Furey, Edward, 226

mountain climbing analogy for, 118–119 options-based, 12 options in, 112 overview, 111 private equity-linked life insurers and, 200–201 pros and cons of, 126–127 for protected growth, 30 reset interval, setting, 115 surrender charges, 121 term length, 115 tracking performance of, 125–126 upside potential, 307 volatility-controlled indexes and, 116 fixed index-linked annuity (FILA), 12 fixed rate, 11 fixed-rate annuities, 11, 43, 200–201, 322 fixed-rate deferred annuities, 30 flexible-premium contracts, 40, 78, 322 floating rates, 83 floors, 131, 132–133 Forethought, 196 Form ADV, 212 4 percent rule, 94 401(k) plans adding annuities to, 229–241 annuities in, 232–233 annuities in TDFs or managed accounts, 234 annuity products, 235–238 buying annuity with savings, 239–241 deferred contracts, 234–235 fixing flaw in, 230–231 history of, 231 immediate contracts, 234–235 in-plan versus out-of-plan annuities, 234 owners as candidates for annuities, 60–61


general account, 76, 322–323 Global Atlantic, 83, 114, 196, 200, 201, 227 Gober, Tom (forensic accountant), 194–195 Gray Zone, 64–65 Great Recession of 2008, 160 Green Zone, 64 guaranteed benefit base, 291, 323 guaranteed income riders, 146 guaranteed lifetime withdrawal benefit (GLWB) versus annuitization, 271–272 RILAs and, 133 target date funds (TDFs), 233–234 variable annuity with, 103, 149–155, 199 withdrawals, 263 women and, 62 guaranteed minimum accumulation benefit (GMAB), 160 guaranteed minimum income benefit (GMIB), 160 guaranteed minimum withdrawal benefit (GMWB), 3, 160 guaranteed yield, 81 guarantee period, 247, 323 Guardian, 196 Guardian SecureFuture Income Annuity, 171 GuidedChoice Retirement Income Planning, 237–238 Guttentag, Jack, 182, 226


Haithcock, Stan (author), 220–221, 297 The Handbook of Variable Income Annuities (Dillinger), 104 The Hartford, 196



health risk, 23

reasons why people avoid, 100

Healthview Services, Inc., 23–24

single-life, 96

hoarding, 28

single premium immediate annuity, 105–109

home equity, 250–251

versus systematic withdrawals, 57–58

Home Equity Conversion Mortgage Insurance Demonstration, 177

versus variable annuity with guaranteed lifetime withdrawal benefit, 103

home equity conversion mortgages (HECMs). See reverse mortgages

Income Annuity Calculator (website), 226

home equity line of credit (HELOC), 183

Income for Life Model software, 223

Homo economicus (economic man), 27 Housing and Community Development Act of 1987, 177

IncomeConductor (website), 224 income options, 323 Income Solutions (website), 222 income stage, 18 Income Strategies (Reichenstein), 298


Income Strategy (website), 224

immediate annuities, 10–11, 39, 323

income tax, 48, 53–54 (website), 114, 170, 220, 246

independent advisers, 210 independent insurance agents, 209

immediate fixed annuities, 233

Index Annuities (Marrion), 112

income annuities

index annuities, two-tiered, 123

versus 4 percent rule, 94

indexed rate, 11

versus annuities with GWLBs, 233–234

The Index Standard (website), 115

benefits of, 93

individual retirement account (IRA), 323

bridge annuity, 106

inflation, 26, 294

buying, 95–96, 99

inflation-protection riders, 98–99

cash refund, 98–99

information systems, 44

cash withdrawal options, 107–108

ING USA, 202

customizing, 96–99

in-plan annuities, 234, 323. See also 401(k) plans

defined, 323

installment refund, 98–99

described, 245

insurance agencies, 206

dividend-paying, 106

insurance agents, 201, 207

fixed versus variable income payments, 103–104

insurance charges, 323

income payments, 106–107

insurance guarantees, 3

inflation-protection riders, 97–98

Insured Retirement Institute (IRI), 316

installment refund, 98–99

Integrity IncomeSource Select Deferred Income Annuity, 172

joint and survivor, 96–97 Medicaid-compliant, 108 medically unwritten, 106 money worth ratio, 102 monthly payouts, 105 mutual, 106 overview, 91–92 paying for, 101 quotes, comparing, 104–105 reasons for buying, 100


Annuities For Dummies

interest rate risk, 68, 78 interest rates, 2, 289–290 intermediaries, 16 Internal Revenue Code, 324 Internal Revenue Service (IRS), 127, 169, 262 Investment Adviser Association, 213 investment advisers, 210 investment advisor representatives (IARs), 128, 145, 210

Investment and Wealth Institute, 208

rebranding of, 192

investment fees, 42

regulation of, 203–204

investment management fee, 324

solvency, 193

investment-only variable annuities (IOVAs), 149–155

stock life insurers, 198–200

investment risks

strength ratings of, 192–196, 305–306

annuities for, 30

surplus of, 194

defined, 304

types of, 195–202

inflation risk, 26

websites, 227–228

market risk, 25

life-contingent income annuity, 62

policy risk, 27

life cycle of annuities, 16–18

reducing, 49

life expectancies, 22–23

sequence-of-returns risk, 25–26

life insurance, converting annuities to, 275–276

tax risk, 26

Lifetime Income Calculator (website), 226

issuer, 37, 324. See also life/annuity companies

lifetime income riders, 119–120, 133 Lifetime Income to Retire with Strength (Caron), 299


Lincoln Financial Group, 130, 227

Jackson National Life, 123, 148, 202, 227 Jefferson National, 148 John Hancock, 196, 199 joint and survivor annuities, 96–97, 271, 288, 324 joint annuitants, 36 Journal of Medical Association, 23


Katz, Deena B. (author), 299 Keynes, Maynard (economist), 98 Kitces, Michael (author), 121, 123, 301


level annuity payment, 324 liabilities, 29 life annuities, 324 life/annuity companies annuity sales, 192 defined, 324 differences in, 18, 195–196 fixed indexed annuities and, 114 as issuer, 37 mutual life insurers, 196–197 overview, 191–192 private equity-linked, 200–202 ratings, 78–79

Lincoln National Life, 148, 193 line of credit (LOC), 177, 178–179, 185–186 liquidity, 53, 270 living benefit fees, 42, 147 living benefit riders, 147, 324 longevity insurance. See deferred income annuities (DIAs) longevity risks annuities for, 29 deferred income annuities and, 164 defined, 304, 324 health risk, 23 long-term-care risk, 24–25 losing a spouse, 23 outliving your savings, 22–23 pooling, 13–14, 51 women and, 61–62 long-term care (LTC) annuities, 84 insurance, 70 risk, 24–25 L-share variable annuities, 324 lump-sum option, 324


MacDonald, Bob, 113 Mackenzie, George (author), 103, 301 managed accounts, 234



margin, 119

MSCI Emerging Markets index, 132

market bears, 67–68

multiyear guaranteed annuities (MYGAs)

market indexes, 115–117, 132

versus certificates of deposit, 83

marketing, 44

defined, 325

market risk, 25, 324

described, 82

market value adjusted (MVA) annuities, 80

for protected growth, 30

market-value adjustments (MVAs), 121–122, 147, 324

retirement income and, 247

Marrion, Jack (author), 112, 116

upside potential, 307

MassMutual, 196, 197, 201, 227

yield, 43

Mass Mutual Ascend, 114

Munnell, Alicia, 312

MassMutual RetireEase Choice Flexible Premium Deferred Income Annuity, 171

mutual companies, 18

McCarran-Ferguson Act, 203

mutual life insurers, 196–197

Medicaid compliant annuities (MCAs), 108 medical expenses, 15 medically unwritten income annuities, 106 Medicare, 23–24

mutual funds, 56–57 Mutual of Omaha, 106, 184–185, 227


Medicare Advantage plans, 23–24

Nasdaq-100 Index, 113, 116, 132

Medigap, 23–24

National Association of Insurance Commissioners (NAIC), 140, 193, 203, 216–217, 239, 314

MetLife, 196, 199 MetLife Guaranteed Income Plan, 237 Meyer, William (author), 224 Midland National, 114, 122, 200, 227 Milevsky, Moshe (author), 64, 106, 312 298, 297 minimum credited interest rate, 324

National Association of Personal Financial Advisors (NAPFA), 211 National Association of Variable Annuities (NAVA), 160 National Life Insurance, 154–155 nationally recognized statistical rating organizations (NRSROs), 193

Modern Portfolio Theory, 128, 320, 325

National Organization of Life & Health Insurance Guaranty Associations (NOLHGA), 315, 329

modified tenure payment, 177. See also reverse mortgages

Nationwide Defined Protection Annuity, 141 Nationwide Financial, 114, 148, 196, 227

modified term payment, 177. See also reverse mortgages

Nationwide Lifetime Income Builder, 236

Moneychimp (website), 227

net asset values (NAVs), 37

minimum guaranteed surrender value (MGSV), 122

money worth ratio (MWR), 102 Monte Carlo simulation, 325 monthly point-to-point crediting method, 124 Moody’s, 16, 193 Moore, Sheryl (annuity expert), 121

negative dollar-cost averaging, 26 (website), 224 New York Life, 106, 107, 196, 197, 201, 227 New York Life Clear Income, 82 New York Life Future Mutual Income Annuity, 171

moral hazard, 54, 325

New York Life Guaranteed Future Income Annuity II, 172

mortality and expense (M&E) risk charge, 325

nonqualified annuities, 39, 266–267

mortality credits, 14, 51, 69, 325

nonqualified deferred annuities, 261–262

mortgage insurance premium (MIP), 181

nonqualified money, 15

Mortgage Professor (website), 182

North American Securities Administrators Association (NASAA), 212–213

MSCI EAFE index, 116, 132


Annuities For Dummies

Northwestern Mutual Life, 107, 196

choosing wrong assumed interest rate, 289–290

nursing-home waivers, 270–271

deferred variable annuities, 290–292 forgetting fees, 286


Obama, Barack, 236 Obergefell v. Hodges, 284 Olsen, John (author), 121, 123, 301 OneAmerica, 83 online distributors, 207 options, 130 options-based fixed indexed annuities, 12 origination counseling, 187 Otar, Jim (author), 64, 225, 300 Otar Retirement Calculator, 225 out-of-plan annuities, 234, 325. See also 401(k) plans out-of-the-money (OTM) call/put, 136 overspending, 28


Pacific Life, 106, 107, 148, 196, 227 Pacific Life Secure Income, 172 partial withdrawal, 325 participation rate, 117, 119 Paschenko, Svetlana (economist), 66–67 pass-through rates, 83 paycheck, replacing, 51 payout mutual fund, 233 payout phase, 325

getting only one or two quotes, 288–289 ignoring period certain and refund options, 288 indexed annuities, 292–293 inflation, 294 long surrender period, 286 mis-structuring contracts, 286–287 overview, 285 step-up fees, 290 trying to time income annuity purchases, 287 underestimating longevity, 293–294 planning risks annuities for, 30 decline in cognitive ability, 28–29 defined, 304 helping out family members, 28 hoarding, 28 income plan, lack of, 27–28 overspending, 28 plan participants, 232. See also 401(k) plans plan sponsors, 232. See also 401(k) plans policy risk, 27 portfolio rebalancing, 326 premium, 146, 326 present value, 107 Present Value of Annuity Calculator (website), 226 pretax money, 101

peace of mind, obtaining, 51

price return indexes, 132

Pennsylvania Company for Insurances on Lives and Granting Annuities, 20

principal, 309 Principal Financial Group, 141, 228

pension buyout, 239

Principal Pension Builder, 237

pension-like annuities, 11

private credit specialists, 200

Pension Protection Act, 83, 231

private equity firms, 200

pension risk transfer, 239

prospectus, 41, 308

performance trigger, 118

protected growth, 3, 15, 30

period-certain annuities, 107–108, 251, 271, 274, 288, 326

Protective Life, 148, 202

pessimists, 67–68

Prudential Annuities, 130

Pfau, Wade (author), 65, 122, 128, 164, 225, 299 pitfalls annuity postcards, 293 avoiding annuities, 294

Prudential, 196, 199, 202 Prudential Income Flex, 236 publicly traded companies, 198 purchase payments, 326



purchase stage, 16–17

refund option, 98–99, 288, 326

pure life annuities, 326

registered index-linked annuities (RILAs)

put options, 136

buffers, 132–133 buyers and sellers of, 137–139


cap, 133

qualified annuities, 39, 260, 326 qualified default investment alternative (QDIA), 234 qualified longevity annuity contracts (QLACs) buying, 170–172 in 401(k) plans, 233 as hedge against nursing-home costs, 169 ideal users of, 166 overview, 162 paying for, 172–173 products, 170–172 reporting to IRS, 169 required minimum distributions, postponing, 167–168 withdrawals, 263 questions to ask advisers, 215 assets, 305 conflicts of interest, 214–215 customized advice, 215–216 designations, 215 exchanging annuities, 308 fees, 306 issuer, 305–306 need for product or advice, 214

crediting rates, 136 customizing, 131–133 defined, 326 versus defined-outcome ETF, 136 described, 12 floors, 132–133 how it works, 135 lifetime income riders, 133 market index, choosing, 132 overview, 129–131 products, 140–141 for protected growth, 30 regulation of, 139–140 term length or segment length, 131 upside potential, 307 registered investment advisors (RIAs), 128, 145, 148, 206, 210–211 registered representatives, 210 Reichenstein, William (author), 224, 298 reinsurance, 194–195, 202 ReliaStar, 202 renewal rate, 81 Required Minimum Distribution Calculator (website), 226

overview, 213

required minimum distributions (RMDs), 162, 167–168, 230, 255

prospectus, 308

research and development, 44

risks, 303–304

reset interval, 115

before signing contract, 303–309

Retirement Clearinghouse, 241

before swapping annuities, 274

Retirement Funds Integrator Calculator (website), 226

taxes, 309

retirement income

upside potential, 306–307

assuring, 50–51

wealth level, 214

bucketing retirement savings, 248

withdrawals, 307–308

buying annuities for, 14 creating income plan, 252–256 examples, 249, 253–254, 257


rating agencies, 16 ratings, 78–79 Red Zone, 64


Annuities For Dummies

overview, 245–246 pairing home equity with annuity, 250–251 Social Security with annuity, 246–247 Retirement Income Certified Professional (RICP), 208

Retirement Income Institute, 315

types of, 176

Retirement Income Journal, 1, 202

rider fees, 42

Retirement Income Redesigned: Master Plans for Distribution (Evensky and Katz), 299

Risk Less and Prosper (Bodie and Taqqu), 300

Retirement Income Security Evaluation (RISE) calculator, 315 retirement income specialists, 208 Retirement Management Analyst (RMA), 208 Retirement Optimizer (website), 225 Retirement Planning Guidebook (Pfau), 122, 128, 164, 225, 299 Retirement Researcher (website), 225 retirement risks annuities for, 29–31 countering, 21–29 investment risks, 24–27 longevity-related, 22–25 overview, 21–22 planning risks, 27–29 underestimating, 31 RetireOne (website), 148, 223 return period, 131 reverse mortgages calculator, 184–185 changing payment methods, 178 crisis, 188 deciding what to do with the money, 178–179 default counseling, 188 defined, 176–177, 326 described, 13 drawdown methods, 177 fixed rate versus adjustable-rate, 179 HECM counselors, 187–188 home equity, releasing, 177–182 line of credit, 178–179, 185–186

risk(s) budgeting, 30 capacity, 304 default, 78 interest, 78 management, 44 reducing, 303–304 retirement. See retirement risks tolerance, 304 robo-advisers IncomeConductor, 224 Income Strategy, 224 NewRetirement, 224 overview, 223 Retirement Optimizer, 225 Retirement Researcher, 225 rollover, 232 rollover individual retirement account, 88, 326 Runnymede Capital, 125 Russell 2000 index, 116, 132


S&P 500 Index, 113, 116, 130, 132 same-sex marriages, 284 savings account annuities, 11 Savings Distribution Calculator (website), 226, 256 scams, 293 secondary market annuities (SMAs), 109 Section 1035 exchanges, 268, 273, 327 SECURE Act, 39, 168, 169, 229–230

loan amount, 180

Securities and Exchange Commission (SEC), 123, 139, 145, 209, 313–314

origination counseling, 187

Security Benefit, 200, 228

overview, 175–176

segment length, 131

paying for, 181–182

self-insuring, 52, 294

property as collateral, 181

senior seminars, 207

pros and cons of, 182–184

separate accounts, 327

reasons for, 15

sequence-of-returns risk, 25–26, 67, 250

rules, 179–180, 183

Series 63 exam, 213



Series 65 exam, 213

step-up value, 292

Series 66 exam, 213

stock life insurers, 198–200

Series 7 exam, 213

Stolz, Scott (author), 301

Shakespeare, William, 19

straight life annuities, 326

Sharpe, Bill (economist), 252

Structured Capital Strategies PLUS contract, 134–135

single-life annuities, 96

structuring annuities

single premium annuities, 39, 78, 327

death benefits, 282–283

single premium immediate annuities (SPIAs)

naming beneficiaries, 279

bridge annuity, 106 cash withdrawal options, 107

naming owners and annuitants, 278–279 overview, 277–278

versus deferred income annuities, 162

subaccounts, 11, 327

defined, 327

suitability, 45–46, 216–217

described, 10

Sumitomo Life, 202

dividend-payment mutual income annuities, 107

summary prospectuses, 41

income payment acceleration, 106–107

super-enhanced death benefits, 292

innovations in, 105–108

surrender charges, 77, 121, 147, 327

Medicaid compliant annuities, 108

surrender fees, 43

medically underwritten income annuities, 106

surrender periods, 77, 146, 270

pricing, 67

surrender value, 292

single premium immediate variable annuities (SPIVAs), 103–104

survivorship credits, 14, 51, 69–70

single-year guarantee fixed annuities, 81

systematic withdrawal plans (SWPs), 57–58, 327

Social Security, 52–53, 247–248 Social Security Strategies (Reichenstein/Meyer), 224 Society of Actuaries (website), 294, 312–313

Symetra Financial, 202, 228


solvency, 193

Taqqu, Rachelle (author), 300

split annuities, 250

target date funds (TDFs)

spousal impoverishment, 108

annuities in, 234


described, 232

community, 108

with guaranteed lifetime withdrawal benefits, 233

longevity, 293–294

tax breaks, 3

risk of losing, 23

tax deferral, 3, 8–9, 15, 48, 259, 264–266

surviving, 23, 279

tax-deferred CDs. See multiyear guaranteed annuities (MYGAs)

spread, 118, 119 SSM – Population Health, 23 stacker cap, 141 Standard & Poor’s (S&P), 16, 193 state guaranty associations, 329–332 state insurance commissioners, 140 State Street Global Advisors IncomeWise, 238 state taxes, 267 stepped-up death benefits, 282, 327 step-up fees, 290


Annuities For Dummies

taxes 1035 exchanges, 268 beneficiaries, 268 deferred annuities, 259 fixed indexed annuities, 127 implications, 309 income, 53–54 nonqualified annuities, 266–267 nonqualified deferred annuities, 261–262

overview, 259 qualified annuities, 260 rates, 265 spreading out burden, 70 state, 267 tax-free 1035 exchange, 40 tax-qualified retirement plans, 327 Tax Reform Act of 1986, 160 tax risk, 26 Teachers Insurance and Annuity Association (TIAA), 19 tenure payment, 177, 251 term length, 43, 131 term payment, 177 360 Degrees of Financial Literacy (website), 256 Thrivent, 196, 202, 228 TIAA Life, 148, 228 TIAA Secure Income Account, 238 time segmentation, 224, 248 timing risk, 25 tipping points, 21 tontines, 19 training, 44 Transamerica, 148, 202 transfer, 327 transfer fees, 327 transparency, surplus, and riskier assets (TSR) ratio, 194–195

U.S. Department of Housing and Urban Development (HUD), 176 U. S. Treasury Department, 203


variable annuities (VAs) account value, 150 average annual premium, 145 benefit base, 150 contracts, 41–42 defined, 144, 327 elements of, 145–146 fees, 42, 145–147 with GLWB, 103, 120, 147, 149–155, 199–200 history of, 159 with income riders, 149–155 investment-only, 148–149 lifetime income riders, 120 nonqualified, 159 overview, 12, 143–144 Perspective II, 154–155 pros and cons of, 156–158 stock life insurers and, 199–200 top-selling contracts, 153 types, 143–144 upside potential, 307 withdrawals, 159

triennial reset, 115

variable annuitization, 327

trustee-to-trustee transfer, 40

Variable Annuity Life Insurance Company (VALIC), 159

12b-1 marketing fees, 214

variable investment options, 327

two-tier contracts, 115, 124

variable rate, 11 Vernon, Steve (author), 297


volatility-controlled indexes (VCIs), 116

uncapped, 133


unbundled contracts, 327 United of Omaha Deferred Income Protector, 171 Unlocking the Annuity Mystery (Stolz), 301

Voya, 202


Unveiling the Retirement Myth (Otar), 300

annuities and, 63

upside potential, 306–307

income annuities and, 66–67

USAA, 107, 196, 228

levels, 214



Wealth2k (website), 223

Securities and Exchange Commission, 313–314


Society of Actuaries, 312–313

American Council of Life Insurers (ACLI), 316

360 Degrees of Financial Literacy (website), 256

The Annuity Man, 220–221

U. S. Treasury Department, 203

Annuity Straight Talk, 222–223, 256

Wealth2k, 223

Blueprint Income, 170, 221

Wells Fargo, 177

calculators, 225–-227, 315

wholesaling, 44

Center for Retirement Research, 312

widely held companies, 198

Charles Schwab, 170, 221–222

Wild, Russel (author), 80

Cheat Sheet, 4

Wink, Inc., 114, 145, 153

Department of Housing and Urban Development (HUD), 176–177

wirehouses, 206

DPL Financial Partners, 128, 148, 211, 223 fee-based advisers, 223 Fidelity, 82, 221–222, 289 FINRA, 313 Global Atlantic, 84, 170, 220, 246 IncomeConductor, 224 Income Solutions, 222 Income Strategy, 224 The Index Standard, 115 Insured Retirement Institute, 316 Internal Revenue Service, 262 Investment Adviser Association, 213 IRS Required Minimum Distribution Worksheet, 61 money worth ratio calculator, 102 Mortgage Professor, 182 National Association of Insurance Commissioners, 314 NewRetirement., 224 NOLHGA, 315, 329 Retirement Optimizer, 225

withdrawals annuitized annuities, 261 contingent deferred annuities, 263–264 deferred annuities, 261 defined, 327 fees, 327 guaranteed lifetime withdrawal benefits, 263 income annuities, 107–108 nonqualified deferred annuities, 261–262 penalty, avoiding, 272–273 qualified annuities, 260 qualified longevity annuity contracts, 263 questions to ask, 307 during surrender period, 270 systematic, 57–58 variable annuities, 159 women, longevity of, 15, 61–62


Yaari, Menachem (economist), 91 yield, 78–79

Retirement Researcher, 225 RetireOne, 148, 223 robo-advisers, 223–225 secondary market annuities, 109


Annuities For Dummies


Zagular, Matt (insurance agency owner), 194–195 Zone Strategy, 64–65

About the Author Kerry Pechter is the editor and publisher of Retirement Income Journal. Since 2009, RIJ has provided news coverage and analysis of the global retirement industry for professionals working in life/annuity companies, 401(k) service providers, advisory firms, insurance agencies, marketing organizations, actuarial firms, law firms, and academia. A recognized authority and thought leader on annuities, pensions, and retirement issues, he is regularly interviewed for podcasts and radio shows. Kerry worked for nine years in the retirement division at Vanguard and later served as senior editor at Annuity Market News in New York. He has studied retirement systems in Costa Rica, Spain, Israel, Iceland, and France. He received National Press Foundation fellowships in 2009 and 2010. His feature articles have appeared in The New York Times, The Wall Street Journal, the Los Angeles Times, and other national publications. For three years, he was a reporter at the Billings Gazette in Billings, Montana. He graduated from Kenyon College.

Dedication To my family — my loving spouse and first reader, Lisa Higgins; my three daughters, Hannah Summerhill, Ariel Pechter, and Mattea Pechter; my brother, David Pechter, and his wife, Jean Baxter; my sister, Carol Markowitz, and her husband, Andy; and my late parents, Allen and Dorothy Pechter.

Author’s Acknowledgments The best ideas in this book were gleaned from hundreds of conversations and interviews with many brilliant people over the past 25 years. For their insight and candor, I’m especially grateful to Bryan Anderson, Gary Baker, Zvi Bodie, Mark Fortier, Francois Gadenne, Kelli Hueler, Mark Iwry, Per Linnemann, David ­Macchia, George “Sandy” Mackenzie, Moshe Milevsky, Olivia Mitchell, Jim Otar, Wade Pfau, Bill Sharpe, and Scott Stolz. I’m grateful to all those who wrote for, subscribed to, or advertised in Retirement Income Journal over the past 14 years. The publication would not have been possible without years and years of unfailing technical support from Laura Chinnis. Thanks to my agent, Marilyn Allen; to Steve Hayes, executive editor at Wiley; and to my project editor, Elizabeth Kuball. I’d also like to thank Jesus Salas, Jeff Schell, and fellow For Dummies author, Russ Wild.

Publisher’s Acknowledgments Executive Editor: Steve Hayes

Production Editor: Saikarthick Kumarasamy

Editor: Elizabeth Kuball

Cover Image: © Dilok Klaisataporn/Shutterstock

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