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A Split-Annuity Strategy

ANNUITY word written on wooden blocks on wooden table.

One of the most challenging aspects of personal finance is turning a retirement investing program into a retirement income program.

Our clients have different priorities, concerns, and fears regarding retirement, so when we guide them through this transition, we want to better understand what’s “top of mind” before we explore a strategy or highlight some different approaches.

For some, having a predictable income is their top priority. They want a high level of certainty that a fixed amount of money will come in each month, regardless of what happens in the financial markets.

“Where no counsel is, the people fall: but in the multitude of counselors there is safety.” Proverbs 11:14

In this instance, one solution is a split-annuity strategy, which combines two different annuities to generate income and rebuild the principal. Here’s how it works:

An investor purchases two annuity contracts–one is an immediate annuity and the other is a deferred annuity. Both annuities would have a fixed time horizon. In the example below, we used a 10-year period. The combination is designed to generate a tax-advantaged income stream and restore principal at the end of the time frame.1,2

Strategy Session

Overview

In this illustration, the Smith family has decided to use a split-annuity strategy with $400,000 of their retirement portfolio.

The Smith’s have decided to place $268,000 in a deferred annuity with a 10-year term and a hypothetical 5% return. At the end of the 10 years, the deferred annuity is projected to increase to over $400,000.

The remaining $132,000 will be placed in an immediate annuity that is expected to generate $1,250 a month in income for 10 years.

Keep in mind that this is a simplified illustration, and the annuity choices are hypothetical and don’t represent any particular product. The concept is shown to highlight a potential retirement income strategy that may be appropriate in certain circumstances.

It’s important to understand that any guarantees with the annuity contract depend on the issuing company’s claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees and charges for optional benefits. Also, most annuities have surrender fees that can be highest if you take out the money in the initial years of the contract.

Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made before age 59½, a 10% federal income tax penalty may apply. There are exceptions to the tax-penalty rule.

When considering a retirement income strategy, many choices are available because there is no one-size-fits-all approach. When we develop a strategy, we help people define their goals, time horizon and risk tolerance so they can be comfortable evaluating their choices.

¹ SmartAssets.com, February 28, 2022

² RetirementPlans.Vanguard.com, 2023

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