Should We Ever Consider An Annuity?

After outlining some of the pros and cons of annuities a few weeks back, the question I’ve received is, “given those pros and cons, should we ever consider using an annuity?”

After outlining some of the pros and cons of annuities a few weeks back, the question I’ve received is, “given those pros and cons, should we ever consider using an annuity?”

Before addressing situations which I believe are an inappropriate uses of annuities (which are large in number), I thought I’d provide you with a few examples of situations where annuities might be appropriate for you as long as you do your proper research before signing on the dotted line.


To quickly review, annuitizing means turning your savings into monthly income for a stated period of time, typically for life.

  • Covering a Specific Expense: If social security is your only source of guaranteed monthly income, and you have a specific bill that must be paid each and every month, you may want to consider funding an immediate annuity. Structure the amount of the payment to you to cover that expense for the period of time the expense exists, i.e. a mortgage.
  • Medicaid Planning: It would be impossible to cover all the issues concerning qualifying for Medicaid in this issue. However, in the big picture, if you have assets above a very minimal level, you will not qualify for Medicaid assistance to pay for your care. One strategy used by many elder law practitioners is to move current assets into an immediate annuity.
  • In the eyes of the federal government, the asset no longer exists. Only the income from that asset which significantly increases your chances of qualifying for Medicaid assistance.
  • However, the same warning that I’ve raised still applies here. Remember that when you annuitize, you give up access to your money other than receiving your monthly income. When you and/or your beneficiary pass away, the insurance company keeps the money.
  • Guaranteed Income: If you want some portion of your monthly income guaranteed, an immediate annuity can accomplish this.
  • Two caveats come with this, however. The first I just alluded to which is to remember that once you annuitize, your asset is turned over to the insurance company.
  • The second is inflation. With most annuities, the payment is guaranteed for a certain period of time, typically for life. However, there is no cost of living increase each year to keep pace with inflation. So, if your monthly payment is $2,000 per month, 10 and 20 years down the road, you’re still going to receive $2,000 per month even if inflation has decreased the value of that $2,000.
Tax Deferral

If you have funds outside of your IRA, Roth IRA, and/or employer sponsored retirement plans that currently earn interest, dividends, and/or capital gains that you’re not currently spending, you may want to consider using an annuity to defer income taxes until you need the money to spend.

There are three potential benefits of doing this:

  1. Deferring the Tax: You control ‘when’ you pay the tax. By doing so, you can benefit from compound interest on the balances that would have gone to taxes if held outside of the annuity.

  2. Taxes on Social Security Income: The amount of tax you pay on your social security income is in direct relation to the amount of income you receive in addition to social security. The lower the amount of your other “provisional” income, the less of your social security income that is subject to tax.

  3. If you currently have interest, dividends, and/or capital gains coming from investments which you’re not spending, using an annuity to defer the taxes on those items not only reduces your taxes on that interest, but it may also reduce the amount of tax you must pay on your social security income.

  4. Medicare Part B Premiums: Your Medicare Part B premiums you pay are based on the amount of income on your 1040 tax return the prior year. Like the example above, if you reduce your taxable income, you may qualify to pay a lower Medicare Part B premium. One tool to reduce your taxable interest, dividend, and capital gain income is a tax deferred annuity.

Tax Free Exchange From Life Insurance

If you currently own whole life insurance (that you no longer need) with significant cash value, you may have a tax problem when/if you cash in your policy.

To the extent that your cash value is greater than the premiums you’ve paid over the years, you will owe ordinary income taxes.

In other words, if you have a policy with a cash value of $100,000 and over the years, you’ve paid a total of $60,000 in premiums, when you surrender your policy, you will owe ordinary income taxes on the difference, i.e. $40,000.

A way of deferring this tax burden is to directly exchange your life insurance policy’s cash value into a tax deferred annuity.

By doing this, there’s no tax burden at the time of the exchange and you get to continue tax deferred growth on your funds until you choose to withdraw funds.

As I mentioned a few weeks back, I don’t believe annuities themselves are bad in and of themselves. As I just illustrated, used correctly, they can potentially solve real problems.

However, I do believe that most of the situations where annuities are recommended and sold need to be seriously called into question.

In next week’s Strategy, I’m going to reveal some of those instances to you so you can avoid falling prey to their sales tactics.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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