Is a Split Annuity Strategy Right for You?

Could a split annuity strategy potentially assist in achieving a balanced approach to retirement planning? Many individuals at or near retirement find themselves grappling with this question. On one hand, they seek to sustain their existing standard of living; on the other, they aim to safeguard their wealth for future generations. This equilibrium can prove challenging to maintain, particularly considering the potential duration of retirement spanning decades.

One potential avenue to strike this balance is through the utilization of a split annuity strategy. This approach aims to generate a current income stream while simultaneously safeguarding wealth for the future.

An annuity, in essence, is an investment contract typically offered by insurance companies or financial institutions, providing tax advantages. Investors contribute either a lump sum or periodic premiums, and in return, receive regular payments for a predetermined period or for the duration of their life.

For the purposes of the split annuity strategy elucidated below, the focus will be primarily on "fixed" annuities, which generally offer a guaranteed minimum rate of return. Other annuity variants include "variable" and "equity-indexed" annuities, which may present higher growth potential but also entail greater risk.

Annuities can be categorized as immediate or deferred. Immediate annuities commence payouts promptly, while deferred annuities initiate payments at a predetermined future date.

From a tax perspective, annuity earnings grow tax-deferred, meaning they accumulate without tax liability until disbursed. Upon payout, a portion of the earnings is subject to ordinary income tax, while another portion represents a tax-free return of the principal. This tax-deferral feature allows deferred annuities to accrue earnings more rapidly than many taxable accounts, offsetting their typically modest interest rates.

Annuities offer flexibility in terms of fund withdrawal or reallocation, albeit with potential surrender or early withdrawal charges depending on the amount and timing of withdrawals. Certain exceptions to these charges may apply under specific circumstances, such as disability, unemployment, or the annuity owner's demise. Additionally, withdrawals made before age 59½ may incur a 10% tax penalty.

The essence of a split annuity lies in its dual-component structure, typically comprising two or more annuities funded from a single investment. In a conventional split annuity strategy, a portion of the funds is allocated to purchase an immediate annuity, generating fixed payments for a specified term, while the remainder is invested in a deferred annuity set to commence payouts after the initial annuity period.

Ideally, by the conclusion of the immediate annuity term, the deferred annuity will have amassed sufficient earnings to match the original investment value. Effectively, when structured appropriately, a split annuity strategy can provide a fixed income stream for a predetermined period while safeguarding the principal sum.

Upon reaching the term's conclusion, various options become available for consideration. These may include commencing payments from the deferred annuity, withdrawing cash value, or reinvesting in another split annuity or alternative investment vehicle. While deferred annuities often permit penalty-free partial withdrawals, potential early withdrawal penalties or surrender charges may apply based on the withdrawal amount or reinvestment decisions.

For inquiries concerning the tax implications of split annuities, please contact us.