For products with surrender fees, those fees must be navigated. The products typically have provisions to keep required minimum distributions from triggering surrender fees but even when surrender fees are not incurred, withdrawals can adversely affect the performance of the product or undermine the very guarantees that were touted to make the sale. We have not found clients that need these extra hoops. The retirement withdrawal puzzle is complicated enough as it is.
With non-qualified money, the same issues with investment flexibility and added complexity is there too. However, in many cases, the annuity also serves to create something clients don’t need or want any more of—deferred income.
Many clients are converting money to Roth IRAs or taking retirement account distributions to reduce future taxation. Building an additional pool of deferred income makes little sense for these clients or others in modest tax brackets.
Even high-income clients can be bit by the tax bug if they aren’t careful. When they take money out, the deferred income comes out first and is taxable at ordinary income rates.
The deferred income in non-qualified annuities is income in respect of a decedent (IRD) and does not get a step up in basis at death. Someone will pay taxes on the earnings. In many cases, the net to surviving spouses or other heirs is hampered because the inheritor is in a higher tax bracket, or the IRD puts them in a higher bracket.
Options Strategies
Owning something that will increase in value precisely at the time the market dives sounds awesome, doesn’t it? Options contracts can do just that. They really are fascinating instruments. Options are the most direct and precise way to counter downside in the stock market of all the things I have written about today.
They are not, however, free. Unfortunately, to use them to great effect, you have to be right about which way the market is going to go, how far it will move and the time frame in which the move occurs. That is asking a lot. If the market goes the wrong way or not far enough or not in the right time frame, the options don’t help. In taxable accounts, it can be even harder to net a big enough profit because short-term gains and ordinary income is the usual result of a position that pays.
Options and the use of the other items I have mentioned all suffer from the same basic problem. The focus has turned away from a sound long-term plan and toward trying to lessen the effect of a market downturn as though downturns are something to fear rather than something to expect.
The whole exercise of finding “where to invest now” suggests market timing but some clients won’t see it that way. They aren’t bailing out to sit in cash. They are just adjusting. They don’t see the bet on market behavior their change implies.