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Federal Employees News Digest : Oct 28, 2013
This is the second of two columns discussing what federal employees should consider before buying a commercial annuity. The Oct. 21 column discussed what an annuity is and the costs associated with annuity ownership. This week's column discusses the types of commercial annuities. The different types of commercial annuities include: • Fixed annuities. A fixed annuity operates like a certificate of deposit (CD) except that the annuity owner pays tax on the accrued interest only when the interest is withdrawn from the annuity. An owner of a CD invested in a non-retirement account pays taxes each year on the accrued interest. Surrender charge periods can range from two to 15 years. The risk in owning a fixed annuity is tying up one's money at a fixed rate at a time of rising market interest rates. Potential buyers should also be wary of fixed annuities with par- ticularly high "introductory" interest rates which may last for a very short period, such as six months, at which time the annuity company resets the interest rate to a much lower market rate. • Single premium immediate annuities (SPIAs). SPIAs are the original annuity design and provide a lifetime income stream. Once an SPIA is "annuitized," the income stream starts. The income stream continues for the duration of the annuity contract; that is, for the annuity owner's lifetime, for the lifetime of the owner and someone else's lifetime, or for a specified period of time. Cost-of-living adjustment (COLA) riders can be added to the policy to annually increase the monthly income. A COLA rider will result in a lower initial payment compared to an SPIA without a COLA rider. • Longevity annuities. Longevity annuities are long-term deferred immediate annuities. Premiums are paid initially in a lump sum. Deferral periods range from two years to as long as 45 years. Commissions are built into the cost of buying the annuity. As with SPIAs, adding a COLA to the annuity will lower the initial payout amount. Longevity annuities do not have any attachment to the bond or stock markets and the death benefit is a set amount. • Fixed-indexed annuities. Also known as an equity- indexed annuity, a fixed-indexed annuity is an annuity in which the interest paid is tied to the performance of one or more of the major stock market indices. One important feature of an indexed annuity is that the principal is never at risk of losing value. Any investment gains are locked in. While annual expenses are minimal---total expenses range from 0.5 percent to 1.5 percent on average---expenses also depend on any addi- tional riders that are attached to the policy. Built-in commis- sions on fixed-indexed annuities tend to be large. •Variable annuities. A variable annuity is an investment contract made between the annuity owner and an insurance company. A variable annu- ity offers a range of investment options. The value of the investments will vary depending on the performance of the investment options chosen. The investment options for variable annuities are typically mutual funds that invest in stocks, bonds, money market instruments or some combination of the three. Variable annuities differ from mutual funds in three ways---variable annuities: (1) allow the annuity owner to receive income for life, or for the life of any person the annuity owner designates; (2) offer a death benefit---a beneficiary is guar- anteed to receive a specified amount, typically at least the amount invested; and (3) are tax-deferred, meaning that the income and investment gains are not taxed until withdrawn. The problem with most variable annuities are their high fees, particularly the fee for the death benefit (mortal- ity expense), administrative expense, and the somewhat high commissions paid to the selling agent. Additional riders such as a guaranteed minimum income benefit add additional expense. Other investment vehicles such as IRAs and the Thrift Savings Plan (TSP) or employer-sponsored 401(k) plans will provide account owners tax-deferred growth and tax advantages with less expense. Who is a candidate to buy an annuity? When a federal employee retires, the employee will be the recip- ient of a government-sponsored annuity, either the Civil Service Retirement System (CSRS) annuity or the Federal Employee Retirement System (FERS) annuity, which are both guaranteed lifetime income streams with some inflation protection. Most employees will receive Social Security lifetime monthly benefits in the form of an annuity with some inflation protection. It is therefore questionable whether federal employees need to buy commercial annuities. Instead, it would be more advan- tageous for employees to first maximize contributions their TSP accounts and their IRAs before purchasing a commercial annuity. Once they have maximized their TSP accounts and IRAs, employees may want to consider purchasing some type of commercial annuity, assuming that they have a goal in mind as to why they are buying an annuity, as well as having a full understanding of how the annuity operates and the costs associ- ated with annuity ownership. Moreover, like any other financial product, an annuity should be bought and not sold. Edward A. Zurndorfer is a Certified Financial Planner and Enrolled Agent in Silver Spring, MD. He is also a registered representative with FSC Securities Corporation, branch address: 833 Bromley St. - Suite A, Silver Spring, MD 20902. Phone: (301) 681-1652. Securities offered through FSC Securities Corporation,member FINRA/SIPC. EZ Accounting and Financial Services and FSC are independent companies. Informed Investor What to consider before buying an annuity: Part II October 28, 2013 Vol. 63, No. 15 8 Visit us on the Internet at www.FederalDaily.com
Oct 21, 2013
Nov 4, 2013