Chip Stapleton: Strategies To Get the Most Out of Annuities in Your Retirement Plan

Welcome to the Annuity.org podcast, your path to financial freedom through better understanding annuities, selling structured settlements, personal finance and retirement planning. I’m Terry Turner, and joining me on this episode is one of our expert contributors here at Annuity.org, Chip Stapleton, financial advisory manager at airCFO. Chip is a FINRA Series 7 and Series 88 license holder and a CFA Level II candidate. He has expertise in corporate finance, financial planning, investing, life insurance, strategic finance and technical analysis. He’s also reviewed several of the articles you’ll find here at Annuity.org, including some recent ones on money market rates and how interest rate increases affect savings accounts. Thanks for joining us, Chip.

Oh, it’s my pleasure.

What should people look for when they’re thinking about buying an annuity? What do they need to be aware of?

I think, first and foremost, when you are looking at annuities, for a potential fit into your financial world, it’s really a matter of what is your end goal and is an annuity the best part of that? Is your end goal creating the most growth possible? Then maybe annuities aren’t the best option, or probably not the best option. If your goal is growth with some downside protection or your growth is guaranteed income for life or guaranteed income for a certain amount of time, annuities could be a great fit inside your financial life – but it’s all about how everything fits together that really makes annuities work best.

So, annuities may not be the right type of investment for every investor. Who might be more inclined to add an annuity to their portfolio? Who would benefit from an annuity?

From a traditional annuity sense… So I got fixed annuity, that’s going to give you income for life. It’s going to be looking at retirees, or are people quickly approaching retirement, say within five years, to where they have assets already and they understand that Social Security likely isn’t going to be enough on a guaranteed income basis to pay for their needs. So there’s a strategy called income flooring where you figure out what are all the expenses that I absolutely have to have. So that’s housing, that’s medical cost, that’s food, those things that you absolutely have to do, month in, month out, and you develop a number.

So let’s say that number is $60,000, and you look at your Social Security and your combined Social Security between you and your partner is $40,000. You have a $20,000 income gap. And what you can do from that point is you can purchase an annuity to fill that $20,000 gap. So, however big that annuity is, we’ll say that’s $400,000 or whatever it ends up being, you use that amount of money to close that gap. So all of your needs, your basic needs, are taken care of on a guaranteed basis. And then anything above that you can use for your wants and your desires and hobbies and have fun in retirement.

What kind of things, like your financial goals, your level of risk aversion should you consider to decide whether an annuity is the right option for you?

Risk tolerance is a huge part of that. When you’re dealing with an annuity, it is, for the most part, it’s an insurance. It’s a guaranteed product. There are guarantees associated with it. So if you are a very risk-averse investor, having something like an annuity can provide you a lot of an escape from the stress of market volatility. If you are someone who is not wanting the stress of a stock market, then an annuity could be something that you could put in to help alleviate some of that.

You know, could also do that with something like bonds. But bonds also go up and down. I mean, we’re sitting at the beginning of 2023 where bonds got hammered in 2022. You saw a lot of volatility in bond prices. So, with all of those things combined, annuities can come and sit in and give you an escape valve, a release valve, if you will, for some of that market volatility by using their guarantees. You could do that on an income basis where you don’t have to worry about that interest performance on your investment portfolio to create income. That guaranteed income can come in, but also on an accumulation basis, there are annuities that can limit market downside and still provide some upside, whether that’s indexed annuities or even variable annuities that have some index components like a hybrid or structured annuity. There’s a way you can get some upside while limiting your downside.

Let’s talk about some tax considerations with annuities. What’s the difference between a qualified and a non-qualified annuity?

Yeah, so a qualified annuity is going to sit inside of an IRA or a 401(k); I think you even put annuities in there now too. So, with the qualified status, it will sit inside of there, you’re not going to have any taxable gain that happens. And then, when you take the income out, when you annuitize and get that income, it’s going to be taxed at your normal income rates. So if you’re in the income bracket and it’s like 22% and that’s your effective rate, that’s what you’ll be taxed at – that 22%. A non-qualified annuity is going to sit outside of an IRA. You’re still going to have tax advantage growth, where any growth that happens inside of the annuity, you’re not going to get a 1099 that you’re going to have to pay taxes on that year, either on an interest or capital gain basis.

When you take it, take the money out, however, so when you annuitize it, the taxation becomes a bit more complicated where there is going to be some taxes that are paid, but the IRS understands that there’s a massive amount of principle that you have in there. So if you put $100,000, you have a $100,000 in principal. The IRS understands that you’ve already been taxed on that money, so they’re not going to tax you again. So they developed something called the exclusion ratio, which will help limit the taxes that you pay. You’re still going to be taxed at your kind of regular income tax levels as opposed to capital gains, but the amount of income that you take out is going to be significant for that the IRS sees [it] and taxes are going to be significantly less.

So non-qualified annuities can have some pretty significant tax advantages in terms of you’re not taxed along the way, similar to like your IRA.

Right.

But also, when you take the money out, you have that exclusion ratio, which is going to limit how much of that income is taxable to you. So there are some benefits to that too. It’s very complicated. I would always recommend talking to your tax professional or CPA or accountant about that, to get all the details. I am not a CPA, I’m not a tax professional, so we always recommend talking to your respective tax professional.

Thanks for joining us, Chip.

Oh, it’s my pleasure, and thank you for having me.

That’s Chip Stapleton, one of our expert contributors here at Annuity.org, also the financial advisory manager at airCFO. And thank you for joining us on the Annuity.org podcast. For more information about annuities, personal finance, anything else we talk about here, check out Annuity.org, your path to financial freedom.

Editor Malori Malone contributed to this article.