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You are here: Home / Blog / Options for Creating a Fixed Income Stream in Divorce or Retirement

Options for Creating a Fixed Income Stream in Divorce or Retirement

October 29, 2010 By CDTx Staff - tcgi Leave a Comment

This post is from Steve Walker, principal at Steve Walker, CPA, based in Frisco. He has over 30 years accounting, tax, valuation, and forensic accounting experience. His practice focuses exclusively on family law matters in the areas of collaborative divorce, mediation, litigation support and professional training. He is a member of the American Institute of Certified Public Accountants, The Collaborative Law Institute of Texas and the International Academy of Collaborative Professionals.

Years ago, most retirees could expect a fixed pension from an employer to cover a large part of their retirement expenses. The employer would send a check for the same amount every month or quarter. Sadly, those defined benefit retirement plans have largely disappeared, and retirees are on their own for funding retirement.

One option to consider as a replacement is an annuity. Putting part of a retirement nest egg into an annuity provides a fixed and relatively safe lifetime income. Beaten down by the bear markets of the past decade, people increasingly are less likely to reach for equity returns, and are looking for a combination of safety and income. Furthermore, if interest rates rise as expected, annuities may be a useful divorce planning tool.

Beyond the basic features, annuities come with many different names and have a range of different features. Even so, it can be fairly easy to classify the annuities and compare them. Despite all the bells and whistles, a commercial annuity can usually be put into one of three main categories or some combination of the two of them: variable, fixed or immediate.

An immediate annuity, also called an “income annuity”, a “fixed immediate annuity” or a “single premium immediate annuity,” is a purchased insurance product, not an investment. The annuity is a contractual obligation of an insurance company to pay the quoted amount for the quoted term. The quoted amount is determined by the insurance company at the time of purchase, based on age, current interest rates, costs and other factors. The money paid to the insurance company becomes the property of the insurance company after the annuity contract is issued. A lifelong immediate annuity promises payments over the life of the purchaser.

How risky are annuities? If the insurance company that issues the annuity becomes financially distressed or goes out of business, the promised monthly stream of income is at risk. However, there are two things to keep in mind. One, insurance company regulation lessens the likelihood of insolvencies. Second, when insolvency does occur, state guaranty funds can come into play. Nevertheless, it is wise to purchase annuities from the strongest insurers.
Another consideration with life annuities is whether they are priced to provide your money’s worth. In addition to charging selling and administrative costs, the insurance company wants to make money with your money. If a life annuity monthly payment is too small, many people feel they can do better by taking the risk of investing. But the entire purpose of a life annuity is to avoid the risk of running out of money. The balance, of course, is payout versus risk.

Some financial advisors will attack this problem head on. One approach is to split the money into two pots, keeping some of it in stocks that would be expected to grow over time. The other pot can be put into an annuity or peeled off, approximating three to five years of spending money and building a portfolio of Treasury bonds and CDs with it. This portfolio is stretched out over that time period, with some of the bonds being very short term, and some being longer term maturities within the time horizon of three to five years. When those first bonds mature, in six months or a year, the owner can use the proceeds in part as spending money. The non-spending part of the short term maturities are put into the longer bonds thereby getting the highest possible safe returns for the longest amount of time. The strategy achieves a safe income stream that can be stretched out to cover long time periods and avoids the costs incurred with owning an annuity. Of course, the returns are not guaranteed (promised) as with annuities.

Purchasing an income stream or building one or a combination of both can be useful tools in retirement and divorce planning.

About CDTx Staff - tcgi

Filed Under: Blog, Divorce and Finance, Financial Professional Perspective on Collaborative Divorce

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