Many people rely on their IRAs and 401(k) plans to help them pay for their retirement years — and for good reason, because IRAs and 401(k)s are excellent retirement-savings vehicles. But once you reach the point where you are contributing the maximum amount to your IRA and 401(k) each year, what else can you do to build resources for retirement? You might want to consider annuities and cash value insurance.
Fixed and variable annuities
When you buy a fixed annuity, the insurance company puts your funds into fixed income investments, such as bonds. Your principal is guaranteed, and the insurance company pays you an interest rate that is also guaranteed for a certain period of time. At the end of the guarantee period, the insurer adjusts the guaranteed interest rate upward or downward. These guarantees are backed by the claims paying ability of the issuing insurance companies.
If you'd like the potential to earn more than you can receive from a fixed annuity, you might want to consider a variable annuity. When you purchase a variable annuity, you place your money in various accounts that can be made up of stocks, bonds and other securities. You choose how to allocate your investment dollars, based on your risk tolerance and time horizon. Keep in mind, though, that this investment is called “variable” for a reason; your account balance will fluctuate along with the financial markets, and there’s no guarantee you will get back all your principal. Furthermore, fees are associated with each variable annuity benefit.
With either a fixed or variable annuity, you won’t pay taxes on your earnings until you begin taking withdrawals. Be aware though, that if you are younger than 59-1/2 when you start taking withdrawals, you will have to pay a 10 percent tax penalty in addition to ordinary income tax on the amount withdrawn.
Apart from tax deferral, annuities offer at least one other key benefit: flexibility in taking your payments. You can accept distributions as a lump sum, spread them out over a certain number of years or create an income stream for the rest of your life — or even your life and that of your spouse.
Cash value insurance
When you buy permanent insurance, also known as “cash value” insurance, part of your premium pays for the death benefit (the amount that goes to your beneficiary), but some of the payment goes to help build cash value — and this money grows on a tax-deferred basis, similar to annuities, your traditional IRA and your 401(k).
You can choose from a variety of cash-value insurance policies. In building cash value, some of these policies rely on variable investments, such as stocks. Consequently, your cash value will fluctuate over time, and, as is the case with variable annuities, you could lose some or all of your principal. However, you can also choose varieties of cash-value insurance, such as whole life or universal life, that typically pay guaranteed rates of return. The guarantees of these products are also backed only by the claims paying ability of the issuing insurance company.
To access your cash value, you can cancel or surrender your policy (although, if you surrender it within a few years of purchasing it, you may have to pay surrender charges) or you can borrow from your policy and either let the remaining cash value pay the interest or pay it back yourself.
Ultimately, you can provide a significant boost to your retirement savings by investing in annuities and cash value insurance. So, give them some consideration once you’ve hit the “ceiling” on your 401(k) and IRA.
Jeff Hupman is a financial advisor with Edward Jones in Rincon. He can be reached at 826-2694.