Bonds vs. annuities

Posted: Monday, May 03, 2010

Several years ago, Dan saw an interview with TV great Andy Griffith. Griffith said something like, “After year five of the Andy Griffith Show, Don Knotts quit to make movies. Three years later I quit because it just wasn’t the same without him. For the next 20 years, neither of us could find jobs we liked nearly as well.”

After 29 plus years of consulting retirees and pre-retirees (people within five years of retirement), we are convinced of one basic truth: Never quit your career until you can answer, “What’s next?” If “What’s next” is fishing Virginia trout streams with your granddaughter, or finally starting that second career as an actor, or helping out at a soup kitchen, the happy retirees can always answer, “What’s next?” And while we can’t answer that question for you, we can at least help you keep the money part of your life straight. Now for this month’s question:

 

“Dear Senior Money Matters: I am interested in protecting my principal and I now have government inflation bonds. I’ve heard that annuities are a better alternative. What are your thoughts? Walter H., Harrisburg, Pa.”

 

Dear Walter: Before investing at all, you need to know the purpose and time horizon for your assets. Do you need this money to live on or is it money being saved for a rainy day?

 

If you want your principal to be protected and you need current income, government or highly rated bonds may be options to consider. However, if sold before maturity, they can lose money especially in a rising interest rate environment. Also, bonds carry additional risks of inflation, reducing their value and changes to the credit rating of the issuing company (The U.S. Government guarantees Government bonds and T-Bills and, if held to maturity, they offer both a fixed rate of return and principal value).

Alternately, tax-deferred fixed annuities provide a stable interest rate (FDIC does not insure annuities). Fixed annuity rates vary with maturity and any guarantees are backed by the claims-paying ability of the issuer. Furthermore, most of these products allow monthly withdrawals that can be used to supplement your income.

It is important to know the limitations of specific annuities products before investing. For income purposes, you should consider how much can be taken annually without incurring an early surrender charge. Also consider that withdrawals from annuities are taxed as income, and withdrawals made prior to age 59½ are subject to penalties.

 

Finally, if the annuity is within an IRA, or other tax-qualified registration, and you’re 70½ or over, check that the annuity is “RMD friendly.” In other words, if your RMD exceeds the normal free withdrawal amount, will the early surrender fee be waived? Investing in an annuity within a tax-deferred account will not provide any additional tax savings.

 

If current income is not a concern, consider an equity-linked annuity. These products vary, but generally speaking, they will give you a percentage of an Index return during “up years” and guarantee your principal plus a fixed rate of return in “down years.” These products are not designed for income, or for the short-term, since they are not liquid, and for best results should be left to grow for five years or longer. Many equity index annuities (EIAs) have long vesting periods and growth may not be realized prior to fulfillment of the vesting period. Guarantees are based on the claims paying ability of the issuing company. Indices are unmanaged measures of market conditions that cannot be invested in directly.

Finally, while government inflation bonds and fixed annuities are widely divergent investments with almost completely separate qualities, both are used for investment income. If you don’t fully understand your options in this area, find a qualified financial planner to help you explore your options. Until next time, your money matters so treat it wisely.

 

Dan Searles and John Stohlman, owners of Medallion Financial Group, are CFP®’s, financial planners and Registered Representatives with over 25 years of experience in the financial services industry, offering securities and advisory services through National Planning Corpor-ation (NPC), member FINRA/SIPC, a Registered Investment Adviser. Medallion Financial Group and NPC are separate and unrelated companies. For further info, questions or comments regarding this article, Dan and John can be reached at 301-990-9704 or
1-800-878-9704 or Dan.Searles@natplan.com.

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