Insuring Lifetime Income Sufficiency with a Split Annuity

Alfred Hargrave |

Annuities have provided retirees with a safe and secure retirement solution for generations.  Deferred annuities have been a solid way to accumulate retirement assets on a tax deferred basis, and immediate annuities are still considered to be the soundest way to generate a dependable, guaranteed income for life, or for a specified period.  On their own, each can play a key part of an overall retirement planning strategy. When combined into a single strategy, their unique benefits can be substantially enhanced to provide an even larger amount of income with greater tax advantages.  

The strategy of a combining a deferred annuity with an immediate annuity is called a Split Annuity.  A split annuity is not a single annuity product, rather is a strategy that combines a deferred annuity with an immediate to generate a higher level of tax-advantaged income than would be generated by the use of an immediate annuity alone.

How a Split Annuity Works

A split annuity involves the simultaneous lump sum purchase of a deferred annuity and an immediate annuity. The objective of the split annuity is to deplete the income from the immediate annuity over a specified period and then restore the original lump sum of the immediate annuity with the lump sum that has accumulated within the deferred annuity over the same period.  At that point, the lump sum from the deferred annuity is deposited into a new immediate annuity to start the process all over again.  This process can be repeated as many times as needed to maintain the stream of income.

The advantage of employing the split annuity strategy over simply purchasing an immediate annuity is that it can produce a dependable stream of income with greater tax benefits.  Here is an example of how the income benefits of a split annuity can work towards that end:

A 65 year old male with $100,000 to put towards a retirement income would invest $41,500 into an immediate annuity with a fixed payment period of 10 years that would generate $5,100 of annual income, of which 80% would be excluded from taxes.  The balance of $58,500 is invested in a deferred annuity and left to accumulate for 10 years.  Assuming a hypothetical interest rate of 5%, the values would grow to $100,000, the original total investment, which can then be split again to repeat the strategy.  

Split Annuity Advantages as an Income Strategy

The advantages of a split annuity strategy over other income producing alternatives are many. Among them:

Dependable income – The income from the immediate annuity is guaranteed and fixed so it is predictable and not subject to fluctuations of the markets.

Tax advantages – In addition to a large portion of the income being exclude from taxes, annuity income is not included in the Social Security tax calculation. The earnings that accumulate in the deferred annuity are deferred until they are eventually received as income when they are annuitized.

Flexibility – The split annuity strategy provides for greater flexibility if additional funds are needed at any time.  Funds can be withdrawn from the deferred annuity, up to 10% of the accumulated value, free of charge.  If your income needs change, you can change the strategy after 10 years rather than being locked into a lifetime strategy.

Benefits for heirs – With the use of annuities for the retirement strategy, your heirs are protected in a couple of ways. First, as named beneficiaries of the annuities, they would receive the death benefit proceeds of the deferred annuity outside of probate and they could receive the on-going payments from the immediate annuity.  

Capital preservation - A split annuity is a strategy designed to preserve your capital while maximizing your after tax income.  By allowing a portion of your investment to accumulate tax-deferred inside a deferred annuity, you will be able to enjoy your income while your capital grows back to the original amount invested.

Summary

A split annuity strategy can be somewhat complex as it involves two different types of annuities, which, in and of themselves, are somewhat complex.  The amount of lump sum deposits in each need to be calculated using several factors and each of the annuities will need to be structured in the right way in terms of options.  It is strongly recommended that you seek the guidance of a financial professional who has specific experience with split annuities. When structured properly, split annuities can provide the ultimate retirement income solution.

*There is a surrender charge imposed generally during the first 5 to 7 years that you own the contract. Withdrawals prior to age 59 ½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. The guarantee of the annuity is backed by the financial strength of the underlying insurance company. Investment sub-account values will fluctuate with changes in market conditions.

*Investors should consider the investment objectives, risks and charges and expenses of the variable annuity carefully before investing. An investment in a variable annuity involves investment risk, including possible loss of principal. Variable annuities are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable annuities are subject to insurance-related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying sub-accounts. The prospectus contains this and other information about the variable annuity. Contact your local office to obtain a prospectus, which should be read carefully before investing or sending money.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.