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Retirement Planning > Retirement Investing

Why you should use FIAs in retirement income planning

By Ed McCarthy, CFP, RICP

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Fixed index annuities (FIAs) are on track to approach last year’s record sales of $48 billion, according to LIMRA’s reports on this year’s first two quarters.

While advisors and FIA buyers often focus on the product’s features during the accumulation phase, FIAs can also play an important role in retirement income planning. 

Flexibility

Robert Klein, CPA, CFP, president of the Retirement Income Center in Newport Beach, California, finds several FIA features useful for retirement income planning. The first is the flexible withdrawal start date. That’s particularly valuable for clients who are several years from retirement, he said.

Those clients might not have an exact retirement date and even if they do, they might not need income from the FIA at that time because they have other sources. Deferring the start of withdrawals also allows the periodic payments to grow. “And, furthermore, there’s no requirement that you ever have to take income withdrawals, that you ever have to start those,” he noted.

“In most situations it wouldn’t make sense not to start them because typically there’s an income rider fee for having that feature and the whole purpose is to have income but once again, there’s no stipulation that you have to take the income.”

FIAs’ flexibility extends to the annuitization and 1035 exchange options, Klein added. “I buy the FIA with the income rider, let’s say, at age 50 and now I’m 65. Do I turn on the income or should I annuitize it or potentially do a 1035 exchange of it for an opportunity for greater income potentially? So, it gives you more flexibility and annuitization is a possibility.” 

Those options are lacking with other retirement income vehicles such as deferred income annuities (DIAs), he maintains. The timing of DIAs’ income start date is typically fixed, and while the contract may allow changes to that date, generally speaking the start date and the payout amount are fixed.  Eric Thomes, senior vice president, sales, with Allianz Life in Minneapolis, Minnesota, highlights the potential for increasing FIA distributions post-retirement as another benefit.

Some of Allianz’s contracts allow owners to choose either a level payment option or an increasing payment option for their distributions. The level option payments start at a higher amount than the increasing payment option’s amounts, but the increasing options’ payments can serve as an inflation hedge.

The increases are determined by the contract index’s performance with the same mechanics used in the accumulation phase. Increases are locked in for life, Thomes explained.

Drawbacks

All financial products require trade-offs and Thomes cites two for FIAs. The first is that FIAs’ rates of returns compare favorably to money market accounts or certificates of deposits but they aren’t meant to compete with equity market returns.

“You’re also giving up a little liquidity,” he adds. “Now, most annuity contracts have a 10 percent free withdrawal provision … where you can get 10 percent out but you can’t get access to all the money if you needed it tomorrow. They’re longer duration.”

FIA’s tax treatment is another drawback, Klein noted. DIAs held in nonqualified accounts can apply the exclusion ratio to distributions, which means that some part of the payments received will be treated as a nontaxable return of principal. FIA distributions, at least initially, are likely to be fully taxed as ordinary income under the last-in, first-out principal.

“That is an important factor, but I balance that against the advantages of using an FIA, particularly the flexibility of the income start date and the accumulation value which translates to an ongoing death benefit,” he said.

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