Spokane Journal of Business

Fixed index annuities are option in inflationary era

Payouts can keep pace with rising cost of living

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Fixed indexed annuities—and their ability to guarantee zero market losses while providing a guaranteed life income—are to small business owners and the private sector what defined benefit pension plans are to government employees in the public sectors. But on steroids.

Having guaranteed income in retirement is like having a job you love where you can never be fired, and each year, you’re eligible for pay raises that get locked in.

However, while pensions are still standard if you are retiring from a public school district or law enforcement agency, many companies have opted out of guaranteed pensions in exchange for 401(k) retirement plans, which have two distinct disadvantages: The first is putting your money at risk in the market. Everyone remembers when the S&P 500 lost 38.49% in 2008. The second is the risk of running out of money in your retirement years, due to ever-improving longevity.

As we get older in retirement, challenges become exacerbated. Inflation can erode our spending power, so we need more and more money just to keep up. As we need to withdraw more money, the market may also be down, forcing us to liquidate even more shares out of our 401(k)s or individual retirement accounts at the worst possible time, depleting them even faster.

Pensions and annuities, on the other hand, both provide a guaranteed life income without ever having to worry about the market tanking.

Small business owners and self-employed professionals often erroneously believe guaranteed pensions are only for people retiring from the government or a large company. They often falsely think their only options are being at the mercy of the market with 401(k)s, IRAs, stocks, bonds, and mutual funds, or possibly real estate rentals.

Real estate isn’t a sure thing either. Tenants can be a total pain, and you are responsible for all the repairs and upkeep as well as covering the taxes.

Where pensions are typically partially guaranteed by the federal Pension Benefit Guaranty Corp., annuities are protected and backed by the strength, security, assets, and reserves of life insurance and annuity companies. For this reason, it’s important to go with a strong, older, established company with a proven track record and A+ ratings for financial strength and claims-paying ability through the major rating sources such as AM Best, Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings. In addition, each insurance company wanting to do business in a state be approved by each state’s insurance commissioner.

Fixed index annuities have incorporated many value-added features over the years, such as liquidity and access to your account value—something pension plans do not have. Annuities, which are similar to cash-value life insurance, such as whole life or universal life, also can provide helpful death benefits to beneficiaries. Unlike those products, this type of annuity has the added advantage of no medical underwriting being required, which can help those with health issues who might not qualify for life insurance.

One of the downsides to government pensions is they are typically fixed and sometimes don’t keep pace with inflation. Some pensions do have cost-of-living adjustment options that increase monthly benefits over time, but this feature is generally very expensive, forcing you to take a greatly reduced monthly benefit, so most people opt not to do it. Conversely, an advantage with annuities, particularly the fixed index variety, is they often have a feature whereby if a stock index they are tied to, such as the S&P 500, goes up, your guaranteed income also goes up—and gets locked in.

The money to fund an annuity can come from many sources. It can come from the sale of a business or the liquidating of investments such as savings, CDs, stocks, bonds, mutual funds, or real estate. It can also come from transferring an IRA or rolling a 401(k) into an annuity IRA or Roth IRA. It can come from an accident or legal settlement. It also can come from the cash value of a permanent life insurance policy.

With annuities, guaranteed life income can start on inception, or they can be allowed to “cook,” growing over time, either tax-deferred or tax-free if a Roth IRA, until you are ready to retire. Typically, the longer you postpone your monthly benefits, they higher they will be when you retire.

An additional advantage for business owners using annuities and cash value life insurance is their ability to choose who they have a plan on, such as only themselves or their best key people, in contrast participating in a 401(k) where everyone must be eligible, regardless of merit.

The bottom line: If you are a self-employed small business owner or someone in the private sector, you owe it to yourself to investigate it. Not all annuities are created equal, and they can be complicated with many moving parts to understand. So meet with someone who specializes in them to help you explore your options.

Todd Radwickprincipal of Radwick Financial Group LLC, of Winthrop, Washington, is an insurance and financial adviser. He can be reached at 509.679.4814.

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