“Golf is the closest game to the game we call life. You get bad breaks from good shots; you get good breaks from bad shots – but you have to play the ball where it lies.” -Bobby Jones

They come in many varieties, have quite the stigma, are difficult to get out of, and come with a contract with lots of legalese.  But, what if you are stuck with an annuity?

The retirement income challenge is real and growing—and annuities are one of the only sources of guaranteed income that clients can’t outlive.  There are plenty of baby boomers and their parents who have these because of the guarantee.

In essence, annuities are contracts that clients make with an insurance carrier. How the funds are invested and how disbursements are made may vary. But the promise of a payout is guaranteed. For many clients, the only question is when. What are the consequences of turning on the income spigot at one particular time over another?

No One-Size-Fits-All Answer

What’s best for any client depends on a multitude of variables. What is the client’s income need? What other sources of income does the client have? How is the client’s health—and life expectancy?

Just as every client is unique, so is every annuity. An annuity’s income features are generally designed to be employed at age 65.

The Argument for Waiting

But it may be better for the client to wait until he or she is beyond 65 to take the income. Typically, it is not beneficial to wait unless the product has deferral credits. Deferral credits can increase the payout amount in certain annuities, which may make delaying taking income advantageous.”

For some annuities, payout amounts increase when the recipient “ages out of one age band and into a new one,” explains Woodland Hills’ Bryan Pinsky, at AIG, a leading annuity provider. “Payments for other annuities will grow over time—either by a guaranteed rate or by market- or index-based performance—and then may get locked in after a fixed number of years.”

Annuities with a guaranteed lifetime-income rider, for instance, often provide an income interest credit.  The longer you wait, the higher your income will be. However, with the unknown factor of life expectancy, you’ll never know how long you’ll be receiving that income.  If you want to keep up with inflation, or keep the income stream going for your spouse, or leave a benefit for family/charities you’ll be paying extra for each.  One of the reasons we seldom use these as financial planning tools.

And The Case for Not Waiting

Nevertheless, there can be some benefit to taking income sooner rather than later. An argument can be made to turn on the income as soon as possible typically after age 59 and a half, to avoid the 10% federal excise tax penalty for early withdrawals.

The insurance company does not pay out of its pocket until the client has depleted all of his or her own money from the annuity policy. Therefore, the longer one lives, and the sooner the contract value goes to zero, the more money will be received from the insurance company’s pocket.  Did you ever wonder why the tallest and most luxurious buildings in nearly every US city are insurance company buildings!

Like life insurance policies, annuities have payout rates typically tied to life-expectancy tables. Clients who live beyond their life expectancy benefit more from the lifetime income options that annuities provide.

Social Security

For most retirees, though, the primary income conundrum concerns Social Security. Many are tempted to start collecting Social Security at age 62, but waiting to age 70 can greatly increase payouts. That’s where an annuity, such as a single premium immediate annuity (SPIA), can be the right solution and one that many of our parents have taken advantage of. This is basically referring to the simple annuity contract in which clients pay an up-front premium for the promise of a guaranteed lifetime income thereafter.

Such an arrangement can help retirees manage the income gap while they’re waiting for Social Security benefits. Using an immediate annuity for income now and postponing Social Security until later allows clients to maximize their income benefits and generate significantly more guaranteed retirement income over their lifetime.  Can we do better with direct purchase of income producing assets like stock, bonds, and rental properties?  In our view…..YES!!


This scenario can be trickier, however, if an annuity is part of a retirement account such as an IRA.

Retirement accounts require a minimum distribution (RMD) at age 70 and a half. If the account contains a single premium immediate annuity, then the annuity assets are exempted from the RMD calculation. But if it’s a variable annuity, which invests in a mutual-fund-like subaccount, the impact on RMDs depends on whether or not the VA’s income stream has been turned on. Before the VA’s income stream is turned on, the annuity’s value is included when calculating RMDs. Once a VA starts generating income, its value will no longer be used to calculate RMDs.

Tax Implications for Heirs

Another consideration for annuities held in retirement accounts is the effect on heirs. Annuities do not share the advantage of a step-up in basis for heirs.

If an heir sells an inherited stock, the taxable gain is the difference between the current price and the price when inherited, not the price when the shares were originally purchased.  This is a great portion of the tax code.  So if it is sold right away, there is no capital gains tax at all. But this step-up in basis does not apply to annuities—unless they’re within a qualified retirement account.

Current law allows the heir to stretch out receipt of that IRA account over the heir’s life expectancy. This has the effect of pushing out taxes over a number of years. (Note: Congress is currently considering limiting that IRA stretch to 10 years.)

Distributions, however, are taxable. So, for heirs, when inheriting retirement accounts or annuities, taxes must be paid on any distributions.

Know Your Annuities

It goes without saying that advisors need to know their clients’ wishes and goals. What may be less obvious is that they also should be familiar with the intricacies of the annuities their clients hold or inherit. Advisors should be very clear about all of the pros and cons of annuities. We’re always careful to point out that while the bells and whistles of an annuity can be very attractive; there is usually a high price to pay for them.

Indeed, many VAs with a guaranteed lifetime income rider come with fees of 2% to 3.5% of their value. There is also a limit to how much you can take out without disrupting or reducing the income benefits. It’s kind of like when you purchase that really nice self-driving electric car only to find out that it won’t let you speed.  So if you need a large lump sum of cash in a hurry, then you could be stuck with high back-end fees or severely reduced benefits, which we’ve seen too many times.  This was supposed to be money that stayed in the family but instead is going to the insurance company and brokers.

Though we rarely recommend annuities because there are several ways to accomplish the same outcome with less downside, sometimes we have clients who have no choice because they are stuck with them.  They can be used to your advantage.  Get all the answers before making a decision.  It’s a big decision.  Give us a call for a consultation.


Blake Parrish, CFP®
Senior VP, Portfolio Manager
Phone: (503) 619-7237
E-mail: blake@bpfinancialassoc.com

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.”