There are pros and cons to generating cash flow through single-premium fixed immediate annuities versus systematic withdrawals from an investment portfolio.
- It provides the maximum cash flow per level of risk, particularly with fixed annuities in the near term. If structured for life (lives), the annuitant cannot outlive the income.
- May be useful in estate planning to enhance income to the survivor but decrease estate tax liability.
- This strategy can presume average life expectancy, i.e., an insurer must account for a shorter life expectancy that is based on pooled averages rather than in a systematic withdrawal plan which must assume potential life expectancy.
- This approach is simple – the owner just receives checks without the burden of administrative logistics and decision-making.
- Provides a solid base of retirement income and may allow some clients to invest in other growth assets more confidently.
- It usually provides limited or no benefit for heirs.
- A guaranteed inflation hedge is provided only at additional cost with a fixed annuity.
- It lacks flexibility. Changes are difficult or “impossible.”
- Annuities are usually not an attractive option if life expectancy(ies) is/are very short, although they can be underwritten to reflect a decreased life expectancy.
- If assets used to purchase the annuity are held personally versus in a tax-deferred account, the sale of the assets may result in taxable gains.
- There is usually no access to funds (liquidity feature, at least without additional cost).
- Income payments above the annuity’s tax basis, if any, are taxed at ordinary income tax rates.
- There is a risk of purchasing in a low interest rate environment. This can possibly be somewhat mitigated by laddering a series of annuities.
Income planning may dictate a greater need for income than the capital retention method can prudently produce. A mix of income from an investment portfolio and annuities can resolve clients’ concerns and meet multiple objectives.
In many cases, a combination of fixed immediate annuities and withdrawals from an investment portfolio is an optimal solution that provides not only a guaranteed lifetime income but also a possible retention of capital for unseen events or bequest to heirs or charities.