While tax-free bonds can be a popular source of tax-free income, some retirees are not aware that they can receive a potentially higher source of cash flow from insurance companies using an immediate fixed annuity.
In exchange for the premium payment, the insurance company pays the annuity owner a cash payment for life or for a term of years. Each of these payments is comprised of interest and principal as determined by an actuarial calculation set forth in Section 72 of the federal tax code. The principal portion is not subject to income taxation. Once the owner has recovered his or her investment, the remaining payments will be taxed as ordinary income.|
Let's take a look at the hypothetical case of Mr. Jones, age 70 with a $500,000 portfolio of municipal bonds, earning 4.17% tax free. He receives $20,850 of annual tax free income (4.17% x $500,000).
He decides to cash in his tax-free bonds and pay a premium to an insurance company of $500,000 for an immediate fixed annuity. With the immediate annuity, his yearly cash payment from the annuity would be $48,000 per year of which 65% is tax free (the tax free portion of an immediate annuity is the part the IRS considers return of your principal and is based on your life expectancy and the expected return). After taxes, he will have $43,800 to spend. His spendable cash increases by $22,950 annually ($43,800-20,850) over the tax free bonds.
You can see how much you could obtain form an immediate fixed annuity using the immediate annuity calculator.
So in this particular example, the yearly cash flow has increased by using the fixed immediate annuity. Of course, your results will vary based (among other things) upon your age, health, and premium payment. The payments in the example shown above are calculated on the life expectancy of the annuitant and the spot interest rates effective for the month of purchase under the contract. The spot interest rates can vary from month to month. The payments shown above are not subject to mortality fees, administrative charges, or other expenses. However, actuarial calculations, life expectancy assumptions, and interests rates can vary from insurer to insurer. Therefore, your results will likely vary from the examples shown above.
An immediate fixed annuity will usually not leave anything for your heirs unless you purchase from a company that offers a refund feature. This refund feature will typically reduce the size of the monthly annuity payments. The amount of the refund could also be reduced by surrender charges in some cases. Therefore, the fixed immediate annuity is generally better suited for people who place more importance upon increasing lifetime cash flow rather than leaving an estate to heirs.
Of course, an immediate fixed annuity or tax free bonds would only be a portion of a retirement portfolio and resources in the retirement planning center can help you plan your entire portfolio.
ProspectMatch helps financial advisors meet prospects for annuities
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Making a plan for retirement is very important. I will follow your advice.
Very useful information. Fixed annuities rather than tax-free bonds provide a better income but what would happen if the policyholder were to die shortly after the plan started, would the family receive any funds?
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I spent some time playing with the annuity calculator and that stuff is pretty impressive 😀
Very useful information. Fixed annuities rather than tax-free bonds provide a better income but what would happen if the policyholder were to die shortly after the plan started, would the family receive any funds?