Split Annuity Strategy

When financial markets become volatile, many investors express their frustration by abandoning the markets and seeking alternatives designed for stability.

For instance, in the first quarter of 2020, the S&P 500 dropped nearly 20%, wiping out over $5 trillion in value due to market volatility.

For those who prefer to step off Wall Street’s roller-coaster, annuities can provide an appealing alternative.

Annuities are contracts with insurance companies, either funded through a lump sum or regular payments, and are designed primarily for retirement. In exchange for premiums, the insurance company guarantees regular payments—either immediately or at a future date.

Moreover, the funds invested in the annuity grow tax-deferred. Unlike other retirement accounts, annuities don’t have contribution limits, and they can be structured in highly creative and efficient ways.

The Split Strategy

One strategy uses two different annuities to generate income and restore principal. Here’s how it works:

An investor purchases a fixed-period immediate annuity and a single-premium tax-deferred annuity simultaneously, dividing capital between the two. The combination provides tax-advantaged income for a set period while restoring the original principal at the end.

However, any withdrawals from the deferred annuity are taxed as ordinary income. Once the immediate annuity contract ends, the process can be repeated using the funds from the deferred annuity. It’s important to remember that an annuity’s guarantees depend on the issuing company’s claims-paying ability.

Diane’s Strategy

Diane splits $300,000 between two annuities: a deferred annuity with a 10-year term and an assumed 5% return, and an immediate annuity with a 10-year term and a hypothetical 3% return. She allocates $182,148 to the deferred annuity and $117,852 to the immediate annuity. Over the next 10 years, the immediate annuity is expected to provide $1,117 monthly, while the deferred annuity grows to approximately $296,700, effectively restoring her principal.

Key Considerations

Annuities come with contract limitations, fees, and charges, including administrative and account fees, investment management fees, and optional benefit charges. Most annuities impose surrender fees, especially in the early years of the contract. Withdrawals and income payments are taxed as ordinary income, and withdrawals made before age 59? may incur a 10% federal tax penalty unless an exception applies. Annuities are not guaranteed by the FDIC or any other government agency.

Variable annuities, in particular, are subject to market fluctuations, and their value may increase or decrease based on performance. Variable annuities are sold by prospectus, which provides important information about investment objectives, risks, and fees. Be sure to read the prospectus carefully before investing.

1.YCharts.com, 2024

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