Financial planning in retirement usually has two primary goals: create a steady, dependable stream of income and preserve retirement savings. One idea which may assist in achieving these retirement objectives is the split annuity concept.
What is a Split Annuity?
An annuity is a contract purchased from an insurance company that can be used to accumulate money on a tax-deferred basis for retirement and/or to convert retirement assets into a stream of income. A split annuity isn’t really one annuity, but a combination of two or more annuities funded with a single sum of money. A portion of the money is placed in an immediate annuity that makes a fixed payment to you for a fixed period of time, such as ten years. The balance of the money is invested in a fixed-interest deferred annuity, which accrues sufficient interest to equal the beginning sum used to fund both annuities by the time the immediate annuity payments stop. The amount of income you receive depends on the amount of money paid into each annuity, and the terms and interest rates applicable to each contract.
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Example of Split Annuity $100,000 Investment
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Immediate Annuity |
Deferred Annuity |
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$41,457 generates annual payments of $5,136.76 for 10 years |
$58,543 at 5.50% per year will grow to $100,000 by the end of 10 years
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This example assumes a total initial investment of $100,000. This is a hypothetical illustration and does not reflect actual annuity products or performance. Withdrawals from an annuity prior to age 59½ may result in a 10% penalty tax imposed by the IRS. Guarantees are subject to the claims-paying ability of the issuer.
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Split Annuity Benefits
Fixed Income:
The immediate annuity makes fixed payments to you for a fixed period of time, regardless of changing interest rates or stock market fluctuations.
Possible Tax-Advantaged Payments:
The tax code treats payments received as an annuity as being divided into two parts: a nontaxable portion that represents the return of premiums paid into the annuity, and a taxable portion that corresponds to the earnings in the annuity. As a result, only a portion (i.e., the earnings) of each payment is included in your gross income. The remainder is a return of principal and not taxed.
Tax-Deferred Accumulations
The earnings on a fixed-interest deferred annuity (i.e., the interest earned on your money) are tax deferred until withdrawn. Unlike most taxable investments, you pay no taxes on your annuity earnings until you begin to take payments or receive income. Income tax deferral allows your money to potentially grow faster than in a taxable account, because earnings that otherwise would be subject to taxes are available for growth.
Flexibility
The fixed-interest deferred annuity can provide a new income stream at its maturity. Also, most fixed-interest deferred annuities allow you to withdraw a portion of the annuity’s cash value without penalty. This option provides you with access to additional money should you need it in addition to the immediate annuity payments.
Return of Principal
At the end of the immediate annuity payout period, the fixed-interest deferred annuity is worth the original amount of your investment in both annuities. At that time, you can use the money from the fixed-interest deferred annuity however you wish, including another split annuity.
Split Annuity Limitations
Surrender or Early Withdrawal Charges
The fixed-interest deferred annuity usually has early withdrawal or surrender charges. This assessment is often a percentage of a withdrawal exceeding any applicable penalty-free amount allowed in the annuity contract. Most fixed-interest deferred annuities include some exceptions to the withdrawal charge, including withdrawals due to disability, loss of employment, long-term care, and death of the annuity owner.
Fixed Annuity Payments
While knowing that you will receive a fixed payment for a fixed period of time may be comforting, it may also prove inconvenient if you need or want more income. Typically, immediate annuity payments are fixed once they’ve begun, although there are some exceptions (such as inflation adjustments and commuted payment options) that allow for withdrawals from the balance of the immediate annuity in addition to the fixed payments.
Lower Deferred Annuity Interest Rates
The appeal of the split annuity idea is knowing that at the end of the immediate annuity payout period, the fixed-interest deferred annuity will have earned enough interest to equal the principal amount used to fund both annuities. The growth of the fixed-interest deferred annuity portion of the split annuity is based on the interest rate paid by the annuity issuer. The immediate annuity payments are based, in part, on the amount apportioned to the immediate annuity. The more money allocated to the immediate annuity, the larger the income payments. If more money is allocated to the fixed-interest deferred annuity because of lower interest rates, then less money is allocated to the immediate annuity, decreasing the payments to you.
Split Annuity Uses
While the split annuity concept is not the only alternative for pursuing a particular financial objective, it may be useful in a number of situations.
Dependable Income and Savings
Many people, especially retirees, want a dependable income coupled with preservation of retirement funds. The split annuity concept may offer a means to both objectives. Not only does the immediate annuity pay a fixed income for a fixed period of time, but a portion of each payment received from the immediate annuity may not be subject to income tax because it is considered a return of premium. Immediate annuity payments are fixed and don’t fluctuate during the payout period, regardless of changing interest rates. Moreover, the deferred annuity part of the concept offers a fixed interest rate on that portion of the money allocated to it. Most deferred annuities also allow for a portion of the account value to be withdrawn without penalty, so if you need more money in addition to the immediate annuity payments, you can withdraw it from the deferred annuity.
For Retirement Plan Income
Say your only retirement income is Social Security. You have savings but you’re concerned that if you take out too much, you may run out too soon. The split annuity can provide a steady source of income without exhausting your principal. It’s also flexible enough that if you need more income, you can take some from the fixed-interest deferred annuity (subject to early withdrawal penalties). At the end of the fixed income period, you can reevaluate your finances and determine whether you need more, less, or the same income, and adjust accordingly.
Bridge the Gap Between Retirement and Social Security
You have some savings in the bank and you want to retire, but you don’t want to (or are too young to) apply for Social Security retirement benefits. The income payments from the immediate annuity part of the split annuity concept may provide the income you want between retirement and Social Security. The fixed-interest deferred annuity preserves your principal by earning interest on the money you apportion to it. When you’re ready to begin receiving Social Security retirement benefits, the fixed interest deferred annuity will have earned enough interest to equal your original principal investment.
The Split Annuity Can Help
With company pensions vanishing and the cost of living rising, you likely will have to rely on your own savings to provide the majority of your retirement income. The split annuity concept can be a useful part of your retirement income plan by supplying fixed income while preserving funds for later use. If you have questions or need assistance, contact the Experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
