Everywhere you turn, you see ads for deferred annuities: by banks, savings and loan associations, brokerage houses and, of course, insurance companies. The ads-—and the sales people—usually tout the tax advantages as the reason you should buy.
If you are thinking of investing in a deferred annuity, whether for yourself or some member of your family, what you are about to read will not only inform you but also make you richer. It all started with a phone call from Joe, a 30-year-old reader of this column. Joe, a successful successor to his dad’s business, wanted to fax two proposals from his broker for variable annuity plans. One proposal was for Joe, and the other was for his six-year-old son, Ben.
Along with the proposals came an article, which was written by the broker, explaining variable annuities and their advantages. The long article can be summarized by giving you the five reasons for choosing variable annuities for retirement savings:
- The main reason. Earnings accumulate tax deferred until you take them. The earnings are taxable when received. One warning—a 10 percent penalty may occur if earnings are withdrawn before age 59 1/2.
- Professional management. Your account may be switched among a large choice of investments, all professionally managed by a staff of experts.
- Liquidity. A certain percentage may be withdrawn each year (but can be subject to surrender charges or that 10 percent early withdrawal penalty).
- Flexibility. Unlike an IRA, there is no maximum $2,000 annual contribution limit, nor is earned income a requirement.
- Death Protection. There is a guaranteed death benefit to the beneficiary if the annuity owner dies.
Are deferred annuities (whether variable or fixed) a good idea? Yes, they are to the extent the income is deferred. But what if you could invest in a plan that gives you everything a deferred annuity gives you, plus the following three big additional advantages?
- All the earnings you take (distributions) are tax-free.
- Whether taken before or after age 591/2, distributions are never subject to any withdrawal penalties or charges. This feature allows tax-free distributions to be made for educational (usually college) purposes for your children or grandchildren.
- Fathers who want to set up a retirement plan and want life insurance, just in case they get hit by a bus, can accomplish both wants at the same time.
The plan just described is called a “Private Retirement Plan” (PRP). Essentially, a PRP is a special high-cash surrender value life insurance policy. Let’s summarize: The best tax bet in the law for setting up a retirement plan or an educational fund is a PRP.
Here’s why. Joe created a PRP for himself that will require total contributions of $340,000 ($20,000 for 17 years). Starting at age 60 he is projected to receive $150,000 per year to age 95. If he just makes it to age 90, his total benefits under the PRP are estimated at $6,132,841, all tax-free.
What about six-year-old Ben? His PRP was set up so that Joe would contribute $7,000 per year for 12 years, a total of $84,000. It is anticipated that Ben will receive three benefits: (1) $12,000 per year for a four-year college education: (2) $50,000 as a down payment on a house at age 32; and (3) $150,000 annual retirement benefit starting at age 60. If Ben lives to age 95, his total benefits are estimated at over $7.5 million; again it is all tax-free. All from only $84,000. It is a simple illustration of the power of compounding money in a tax-free environment.