A straight life annuity might not be the first financial product that comes to mind when planning for retirement. A 401(k) or IRA and Social Security benefits are the most common types of retirement income we think of when budgeting for the future. However, there are several reasons why a straight life annuity deserves a closer look as a valuable part of your portfolio.
In this article, we’ll explain straight life annuities and their benefits, plus outline the pros and cons of various straight life annuity alternatives to help you decide if this type of insurance product is right for you and your budget.
STRAIGHT LIFE ANNUITY DEFINITION
A straight life annuity is an insurance product that provides guaranteed retirement income for life. Unlike permanent life insurance, straight life annuities don’t offer a death benefit for your beneficiaries. They payout until you die, and then the payments stop. In other words, a straight life annuity provides predictable income you can’t outlive. You don’t have to worry that you’ve saved too little or too much. The longer you live, the more you get paid from your annuity.
Because straight life annuities only offer living benefits, they’re often more affordable than other retirement alternatives. They also provide a higher monthly payout. In fact, they can provide the highest amount of income of any type of retirement account. If you outlive the number of years paid into your annuity, it continues to pay out — guaranteed — for life.
A straight life annuity is a type of fixed annuity. It’s guaranteed to earn a fixed rate of return. Funds in the annuity continue to earn this rate of return, minus payouts, over the lifetime of the annuity. Straight life annuities are considered very safe retirement products as you cannot lose money like you can with stocks, mutual funds or other qualified retirement plans.
HOW IT WORKS
When you decide to purchase a straight life annuity, you can pay for it over a series of payments or you can purchase your annuity in one lump sum. Typically, if you’re near retirement or already retired, it makes sense to purchase your annuity upfront so you can start taking payouts as retirement income as soon as possible. If retirement is still several years down the road, paying for your annuity over a series of payments may be less strain on your budget. Most unretired individuals purchase straight life annuities between the ages of 45 and 55.
Regardless of the payment option you choose, the benefit to you is the same. If you’re concerned about inflation costs, you can add a Cost of Living Adjustment (COLA) to your straight life annuity at time of purchase. This increases your benefit by 3% each year, compounded annually.
There are multiple ways you can fund a straight life annuity:
- Cash or savings
- Transfer funds from a qualified retirement plan (401(k) or IRA)
- Transfer cash value of permanent life insurance via a 1035 exchange
- Sell stocks, mutual funds, or other publicly traded funds
If your annuity is funded with pre-tax dollars, like with funds transferred from a qualified retirement plan, you’ll pay taxes on your annuity payouts. However, if your annuity is funded with after-tax dollars, like from your personal savings, you won’t owe taxes on annuity payouts unless you live beyond your life expectancy. For example, if your annuity premiums are spread to cover payouts for 20 years, starting at age 65, any payouts after age 85 will be considered taxable income.
IS A STRAIGHT LIFE ANNUITY RIGHT FOR ME?
“A key component to any financial strategy is understanding how it works. You need to know why you have it and what you hope to accomplish with it.”Bryan McCloskey, Wealth Strategist
Straight life annuities are best for people who don’t have beneficiaries that rely on you for financial support. A straight life annuity might be the right choice for you if:
- You’re single
- You’re married but your spouse has their own income stream
- You don’t have children
- You don’t wish to pass down generational wealth
- You have children but already have other assets set aside for them
- You’re looking to diversify your retirement portfolio
It’s also important to consider all sources of retirement income and see if your financial needs are being met. Use this chart to determine your fixed expenses and see if an annuity might be beneficial to you:
Source: American National Insurance Company
STRAIGHT LIFE ANNUITY ALTERNATIVES
If your family’s needs call for something other than a straight life annuity, you have other options for guaranteed retirement income.
Cash Refund Rider
Technically not an alternative to a straight life annuity, a cash refund rider is a way to customize your annuity so it still can pay a benefit to a loved one when you pass away. Payouts are subtracted from premiums paid and any balance is given to your beneficiary. It helps you hedge against longevity by ensuring no premiums go to waste, however your beneficiary may be subject to taxes on their portion of the payout.
Period Certain Annuity
Similar to a cash refund rider, a period certain annuity may distribute any remaining funds to your beneficiaries if you pass away unexpectedly. The annuity is issued for a predetermined period (usually 10-20 years), during which your beneficiaries are eligible for benefits. If you outlive this period, no benefit is distributed. If you’re well into retirement or have certain health conditions that limit your longevity, this can make sense, as your life expectancy may be significantly shorter. Note that beneficiaries may owe taxes on payouts.
Life Plus Period Certain Annuity
A life plus period certain annuity combines the lifetime payout benefit of a straight life annuity with the option to pass down unused premium payments to a beneficiary offered with a period certain annuity. It’s a hybrid product and will payout for a specific period (usually 10-20 years) or the annuitant’s lifetime, whichever is longer. Tax implications vary.
If your spouse doesn’t have an additional income stream, a joint-to-survivor annuity pays out until both of you pass away, regardless of who dies first. This solves the dilemma of leaving a spouse without retirement income or financial assistance after one of you is gone. It can be a great option for couples who don’t have financially dependent children, don’t care about passing down generational wealth, or who have other assets set aside for their beneficiaries.
When you purchase a joint-to-survivor annuity, you may have the option of structuring payouts to be 25-50% larger while both you and your spouse are living and reduce the payout after one of you passes away. This helps optimize your annuity. Additionally, some insurance companies may offer greater benefits when the survivor is a spouse compared to another beneficiary relationship.
Whole Life Insurance
If passing down generational wealth or providing for dependents are primary financial goals, properly structured whole life insurance through a mutual insurance company not only provides a guaranteed death benefit, it also provides a guaranteed rate of return and potential dividends. These earnings can be accessed for tax-free retirement income or put to use in a variety of other ways. Of all the types of permanent life insurance, this offers the most guarantees and least amount of volatility.
The following table outlines examples of these annuity options and more. Options vary by insurance carrier.
Source: American National Insurance Company
BENEFITS OF ANNUITIES & INSURANCE PRODUCTS
Any of the options above can be used to generate guaranteed income in retirement, but the benefits don’t end there:
- Annuities can be used to create monthly cash flow without having to tap into assets.
- Annuities and cash value in whole life insurance provide increased liquidity.
- Annuities and whole life insurance reduce market volatility and can help qualified retirement assets (401(k) or IRA) rebound after a market downturn by providing non-correlated income.
- Annuities and whole life insurance allow business owners, entrepreneurs, and gig workers to create their own pension plans.
- Annuities and whole life insurance can provide income for early retirees, often without penalties, and help defer Social Security payouts for maximum benefits later in life.
PURCHASING AN ANNUITY OR INSURANCE
The decision of which annuity or other life insurance product to choose should be based on your retirement goals, family needs, and budget. The expert Wealth Strategists at Paradigm Life can help you decide which option is best for you, as well as provide illustrations from various insurance companies to help you compare costs and benefits. Not only can we answer all of your annuities and insurance questions, our expert Customer Experience team will help you in every step of the process and continue to assist you as your financial needs evolve down the road.
We work with the nation’s top-rated insurance companies to provide financial products you can trust to help you accomplish your retirement and wealth-building goals. If you’re interested in an annuity or using whole life insurance for additional income in retirement, schedule a complimentary consultation with a Wealth Strategist today.