I am the beneficiary of some non-qualified, variable, deferred annuities; is there a way to put a "floor under the market" to protect against a downturn in the stock market?
I am the beneficiary of some non-qualified, variable, deferred annuities. The owner passed away in February 2018. The total value is $1 million. I have six options, varying from lump sum to annuitization. I think I want to annuitize. I would like to leave my beneficiary with guaranteed income, and preserve as much of the current value of the policy. Is there a way to put a "floor under the market" to protect against a downturn in the stock market?
Annuitizing with a joint and survivor feature accomplishes your goals of putting a "floor under the market" and allowing the income to continue for your beneficiary. Once annuitized, the account is no longer subject to market value fluctuations and the dollar amount you annuitize is locked-in to determine your guaranteed income stream. I would also suggest adding a cash refund feature, so that if something happens to both you and your beneficiary that someone else gets the remainder of the annuity's value. Otherwise, the insurance company gets to keep your money.
If you opted against annuitization, bear in mind that variable annuities usually have a fixed interest rate option that will protect the principal from market losses. Do not choose the money market subaccount for principal protection because the variable annuity fees are typically higher than the interest earnings, therefore, your account value will slowly erode.
For more helpful tips about annuities and other options to consider, you can learn more by reading about it here.
Be careful asking this question in this forum because you will get annuity agents coming out of the woodwork to roll over your variable annuity to an "indexed" annuity where you supposedly get "most of the upside but none of the downside." While it is true that you will get none of the downside, you won't get most of the upside either. They are expensive and have long surrender penalties. It will lock in your money and the expenses will significantly eat away at the gains, which by the way will have caps or monthly averaging etc... all designed to reduce the return to low single digit.
There are actually annuities out there with no commissions or sales charges where you can put the money in one day and take it out the next if you are not happy. You don't hear about these because they do not generate big commissions and thus have no surrender penalties. And you can get professional money managers to help chose between over 200 funds - both long and short equity, commodities, bonds long and short, and even guaranteed funds or any combination thereof. This can significantly help offset market volatility and drawdown risks. Over a time period you will be far better off in my opinion. Now, I am an active manager so have a biased, but also have my insurance license and I do not sell indexed annuities. This is on the investment or "accumulation" phase, not the annuitization phase (see below).
If you are talking about annuitization, once you annuitize you are giving away the asset (1 million) for an income stream. In the simplest form based upon your life expectancy, you would receive in income for life. But if you get hit by a bus tomorrow, the remaining million minus any payments already made, even if only a couple, go the insurance company. You can also get an income stream for a "sum certain" time period, or even over your lifetime but with a minimum time period certain payments are made.
So if you do intend to annuitize, you should definitely get a couple of competitive bids from 3 to 4 different carries based upon whatever type(s) of preferred income stream(s). This way you can compare apples to apples & ensure you are getting the best deal because you can always roll these current assets to another insurance carrier's annuity via a 1035 like-kind exchange with no tax consequences (until you begin taking distributions). I know this can be complicated, but it is all about the time value of money. The insurance companies must make a profit on the group as a whole, so on average, they must build in their costs based upon life expectancies, payments made, their expected investment returns, profit margin etc.. So in order for you to "win," you must live at least 4-5 years past your life expectancy on a plain vanilla annuitization. But it is a competitive business, and that is why you should put it out to bid and do not rely on one agent where the annuity currently resides. Once you make the annuitization decision, it is irrevocable.
I know all this was complicated but I wanted to give you the various options so it will stimulate your thinking and provide you with the right questions to ask. And read all contracts carefully.
Hope this helps and best of luck, Dan Stewart CFA®
Quite frankly if you are annuitizing you are taking any market risk or reward out of the picture. Instead you are basically making a deal with the insurance company to forfeit the million dollars in return for some life time or period certain payment plan. However if choosing a different option annuities certainly have all sorts of features that may do exactly what you are suggesting. In essence an annuity is an investment with an insurance company. Being as such many of them offer insurance like protections on your investments. Before I take any option I would HIGHLY suggest speaking with an expert as this is a lot of money and your decision to annuitize is a irreversable one. In my humble opinion too big a decision not to fully understand what option is best for you. The fact you are asking this question on a chat room is concerning as anyone that answers doesn't fully understand your situation and I fear you making an ill informed decision without fully comprehending all the options along with what is the best option for you. Happy to answer anything else but that is my best thinking.
Assuming you are not the spouse of the deceased, you are liable for the earnings of the annuity for which you are beneficiary. If you take the lump sum, the full tax amount will be due and it will be at ordinary income tax rates, not capital gains rates. If you annuitize, the taxes will be payable over the annuitization period. Without knowing the terms of the annuities, it's not possible to know what's needed to provide your own beneficiary with guaranteed income.
For protection against market weakness, you would want to redeploy into subaccounts that emphasize short-term fixed income and limit or avoid equities.
This is a very good question. As a Certified Financial Planner with 23 years experience, my recommendation would be to conduct a 1035 exchange into a Fixed Indexed Annuity that would allow you to do a "non-qualified" stretch distribution. A handful of insurance companies allow for this "non-qualified" stretch distribution if the annuity that you are inheriting names you as the beneficiary versus a trust. The fixed indexed annuity would allow you to participate in a percentage of the upside in an index or multiple indexes and still protect your principal in a down market. Most also have a fixed interest option as well. The key is to find out what the "cost basis" is in the current annuity that you are inheriting to determine if this would be in your best interest. By implementing this strategy you are giving yourself flexibility in the future in case you want to distribute more that the required minimum distribution set forth in the "stretch" distribution schedule. If you annuitize you take that flexibility away. As I once heard from someone annuitizing an annuity contract is like committing "annuicide". It dooms you into that distribution schedule for the rest of your life with no flexibility. Not many advisors are aware that certain insurance companies allow for a 1035 tax free exchange into an inherited non-qualified annuity contract. You must begin your first distribution prior to the anniversary date of the date of death of the prior annuity owner. So time is of the essence.