plan for the future, but live in the present

By Darrel Richter

Investors are often concerned about being able to balance future investments with current livable income. This especially holds true in times of a shaky economy, such as the one we are currently in. Most investment options allow you to grow earnings in an account for your retirement or for a set period of time in the future. Yet one option allows you to take care of not only your future, but also the present: a split annuity.

An annuity is a contract with an insurance company in which you may opt to receive cash payments on an ongoing basis or tax-deferred retirement income. There are several types of annuities, including immediate annuities, tax-deferred annuities, split annuities, charitable gift annuities, and college gift annuities. Each annuity provides different benefits and features that will help in your own personal situation. You may be young and looking to invest for the future or you may be close to retirement and opt for immediate income.

A split annuity is really a combination of a single-premium immediate annuity and a single-premium deferred annuity. You receive the benefits of the immediate annuity in which the policy provides you a steady stream of cash that is consistent, safe, and guaranteed, regardless of market conditions. Your payments from the insurance company may be either quarterly, semiannually, or annually. The choice is yours. Taxes make up only a small percentage (around 18 percent, depending on your tax bracket) of this stream of cash. So, the taxes on the continued payments are minimal.

The other aspect of a split annuity is the tax advantage you receive, which is the tax-deferred annuity portion of the contract. You will be able to earn a tax-deferred growth on your earnings. The initial interest rate of return will be set for a defined period, such as one year or three years. After that period, a new time period is set.

“Split annuities simply pay out principal and interest for a time (perhaps a certain period) on a portion of the money, and then the rest grows at the rate the insurance company is willing to pay” said Meg Green, financial planner of Meg Green and Associates in Miami, Florida.

Another advantage is that your original principal is restored after the initial time period in the contract, with proper planning and configuration. This is only true for the immediate portion of the annuity, not the deferred portion. This allows you to start the process over at prevailing interest rates. You are restricted to receive immediate benefits (current stream of cash) for a period of three to 20 years. Funds in the deferred portion may be extracted, but there are limitations and you should check with your insurance company for more details.

For example, if you divide $100,000 evenly into the split annuity in which half is tax deferred and the other half is received immediately, you reap larger gains than if you place the funds into a single investment option, like a CD. The $50,000 is put into the immediate portion of the annuity at seven percent. You will be provided more than $6,000 (of interest and principal) every year for 10 years, which of course is significantly higher than the principal. The other $50,000 would be invested in the deferred portion of the annuity contract and grow back to the original $100,000, and the process can be started over. Talk this over with a professional first to ensure rates and time constrictions.

If you invest in a CD, you earn the interest rate on the total principal, but only the one single amount of after-tax income. You would be able to earn anywhere from 25 to 35 higher income over the course of the same time period.

Another advantage, which is common to all annuities, is the death benefit. If the primary policyholder passes on, his or her beneficiaries will continue to receive the rewards of the split annuity contract.

Some items to keep in mind when purchasing a split annuity are surrender charges, which are applied against the funds withdrawn if you are not of a certain age (59 ˝) or before the contract has matured. Also, annuities are not as liquid as CD’s. Finally, the federal government does not insure annuities as they do CD’s.

The other issue to keep in mind is the rate of return. If interest rates are low, you may have to choose an annuity that has a variable rate rather than a fixed annuity that has a guaranteed rate. You may be able to acquire a higher income, but the risk is greater because the rate is not guaranteed and may drop below that of a fixed rate annuity.

“The worry here is churning,” Green said. “Many people are in variable annuities which are doing poorly in these markets. If a broker puts them into a split annuity with a promise of income, they might be losing their insured amount in the variable one.”

But, as far as earning income in both the long and short terms, split annuities are a better option than CD’s and the like. Since they allow you to receive tax-deferrable benefits with very good rates of return as well as a regular stream of monthly income, consider split annuities for your next investment.