Exploring Immediate Annuities: A Comprehensive Guide for Duke Energy Employees to Navigate Retirement Income Options

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What Is an Immediate Annuity?

While there are many variations of immediate annuities, the basic terms are simple: you give a single lump-sum of money to an annuity issuer (an insurance company) which pays you a fixed income for a fixed period of time or for the rest of your life or for the joint lives of you and another. Immediate annuities appeal to those investors who want a guaranteed income they cannot outlive.

Caution:  Guarantees are based on the claims-paying ability of the annuity issuer.

Who Should Consider an Immediate Annuity?

An immediate annuity can be a useful financial tool. Duke Energy employees may want to speak to a financial professional about immediate annuities if:

• You want a stream of income you cannot outlive.
• You have a sum of money that you would like to turn into a regular source of income and aren't interested in leaving the money to your heirs. If you want to leave a portion of the money as a legacy, an immediate annuity may not be a good choice. However, the guaranteed income furnished by an immediate annuity may replace income provided by other assets, allowing those other assets to be left as a legacy.
• You are uncomfortable with investments that have a significant risk of loss. Financial professionals reason that with proper planning, most retirees can make their savings last until they die without buying an immediate annuity. However, to do this, you may have to invest at least some of your savings in equity investments. If subjecting your money to the risk of loss associated with investing in equities does not appeal to you, an immediate annuity provides a way to transfer that risk to an insurance company. While the income guaranteed by the immediate annuity is subject to the claims-paying ability of the annuity issuer, the immediate annuity payments are not subject to stock market risk.
• You expect to live for a long time. If you're healthy and have longevity in your family, an immediate annuity may be an appropriate choice for you.

Strengths

Some of the benefits of immediate annuities are:

• Security and safety. An immediate annuity can provide a guaranteed income stream you can never outlive. If lifetime income is needed for a specific duration, an immediate annuity can provide guaranteed income payments for a fixed period of time.
• Simplicity. You do not have to manage or worry about your investments, watch markets, report interest or dividends.
• Tax treatment. Due to the exclusion ratio applied to determine that portion of your income payments which you treat as ordinary income, a portion of the payments you receive are treated as a return of your investment and are not treated as ordinary income.

Caution:  Guarantees are subject to the claims-paying ability of the annuity issuer.

Tradeoffs

• If you chose a life-only payout option, you may not live long enough to receive a return on all of your investment. If payments end at your death, the lack of income could adversely affect your family.
• You relinquish control over the money you use to pay the immediate annuity premium. Should you need a large sum due to illness or another emergency, you may not be able to access it. Consider carefully the available immediate annuity options.

Tip:  Some annuity issuers allow you to accelerate payments due to poor health, or you may be able to receive a lump sum (commuted payment) during certain periods of time and for specified amounts. These options may be available for an additional charge depending on the issuer.

• Your immediate annuity payments may not keep up with your spending needs or inflation. Since immediate annuities are not designed for maximum investment return, you may find that alternative investments pay a potentially higher yield for the same investment, but have a proportionately higher risk.

Tip:  Duke Energy employees should c ompare the potential risk of loss to the alternative investment due to adverse market conditions against the guaranteed income paid from the immediate annuity, regardless of market conditions.

Caution:  Guarantees are subject to the claims-paying ability of the annuity issuer.

How Does an Immediate Annuity Work?

As the name implies, an immediate annuity begins to pay you a stream of income immediately. The amount of income you receive is based on a number of factors. First, immediate annuity payments are computed using actuarial tables. These tables take into account the annuitant's life expectancy. It's the annuitant’s life that determines the timing and amount of the payments. Often, the annuity owner is also the annuitant, but not always. In the case of joint and survivor annuity options, an actuarial table using both the annuitant's age and the designated survivor's age is applied to calculate the amount of the periodic payments.

Second, the payments are based on the underlying interest rate the annuity issuer pays on the premium. The higher the interest rate, the higher the annuity payment will be.

Third, immediate annuity payments are determined according to the distribution option you chose. Longer payout periods, such as payments for life, will usually yield smaller payments than shorter, fixed payout periods, such as five or ten years.

A Note About Variable Annuities

Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk including the possibility of loss of principal. Variable annuities contain fees and charges including, but not limited to mortality and expense risk charges, sales and surrender (early withdrawal) charges, administrative fees and charges for optional benefits and riders.

Caution:  Variable annuities are sold by prospectus. Duke Energy employees should consider the investment objectives, risk, charges and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity, can be obtained from the insurance company issuing the variable annuity, or from your financial professional. You should read the prospectus carefully before you invest.

Caution:  Certain riders and options relating to immediate annuities may be available for an additional fee or charge, depending on the issuer. Duke Energy employees should read the annuity's prospectus or contract for a description of the available options and associated fees and charges, if any.

Immediate Annuity Payout Options

Life Only Annuity Option

This option provides a guaranteed income for life. The income payments stop on the annuitant's death. While this option will generally yield larger payments, it is possible you may not live long enough to receive the return of all of your original investment.

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Installment Refund Annuity Option

If you are concerned about not living long enough to receive all of your investment back, this option provides an alternative. The annuity issuer not only guarantees payments for the annuitant’s life, but it also guarantees that the total of these payments will never be less than the premium you paid to the annuity issuer. If the annuitant dies before your original investment is repaid, the beneficiary you name in the annuity contract will continue to receive payments until the full amount of your investment is paid back.

Cash Refund Annuity Option

This option is very similar to the installment refund option except that if the total annuity payments received are less than the premium you paid, your beneficiary will receive the balance of your original premium in a lump sum (as opposed to periodic payments).

Life Annuity with Period Certain Option

With this option, the annuity issuer does not guarantee the return on your investment, rather it guarantees a minimum period of time during which payments will be made. If the annuitant dies prior to the end of the specified period you selected (usually between 5 and 50 years), the payments will continue to be made to your beneficiary for the remainder of the period, but no longer.

Joint and Survivor Annuity Options

This option provides a guaranteed income for as long as either joint annuitant is alive. When either annuitant dies, payments continue to be made for the life of the surviving annuitant. You can elect that these 'survivor' payments remain the same, or be reduced to a percentage of the original payment, such as two-thirds. The joint and survivor option can also be added to the life with period certain option. In this case, the annuity issuer will make payments until both annuitants have died or for the period of time you selected, whichever is longer.

Joint and Contingent Survivor Annuity Option

This option provides a guaranteed income for as long as you or your joint contingent annuitant lives. If you, the primary annuitant, die first, payments will continue. However, they will decrease to 50 percent of the original payment amount. If the joint contingent annuitant dies first, annuity payments will continue to be received, without reduction, but only for the remainder of your life.

Period Certain Annuity Option

Instead of making payments for the life(s) of the annuitant(s), this option provides a guaranteed payment for the period of time you specify (i.e., 5, 10, 15 or 20 years). If you die prior to the end of this period, your beneficiary will continue to receive payments for the remainder of the fixed period.

Other Immediate Annuity Options

Cost of Living Adjustment (Inflation) Rider

This rider reduces the initial payment you would receive from the immediate annuity without the rider, but payments increase by one to five percent annually thereafter. This rider is intended to offset the effects of inflation on the income payments received.

Impaired Risk (Medically Underwritten) Rider

This option may be added to an immediate annuity or it may be sold as a separate immediate annuity. If you have a medical condition that reduces your “actuarial” life expectancy, the impaired risk rider allows you to receive a larger income payment for the same premium or the same income payment for a lower premium payment, based on your older, “actuarial” age as opposed to your actual age.

Commuted Payout Rider

This rider allows you to withdraw a lump sum from your immediate annuity in addition to the payments already being received. This option usually is available for a limited period of time and may be limited to a maximum dollar amount and/or a maximum percentage of the premium you paid to the annuity issuer.

Variable Payments

This option allows you to withdraw a larger sum than your regular payment at certain times (for instance on the anniversary of your purchase).

Variable Immediate Annuity

Variable immediate annuities offer a variety of investment options, called subaccounts. Your immediate annuity payments can increase or decrease in value depending on the performance of these subaccounts.

Immediate Annuity Strategies

While most financial professionals suggest that you do not devote all of your savings to an immediate annuity, there are many strategies involving immediate annuities that may prove useful to you.

Fund Long-Term Care or Life Insurance Premiums

Many people have the need for long-term care and/or life insurance, although many of these same people will not purchase either type of insurance primarily because of its cost. For our clients from Duke Energy that have an asset, such as a CD, stock, or mutual fund, which they do not intend to use or spend, we suggest that Duke Energy client consider liquidating that asset and investing it in a single premium immediate annuity. You can use the annuity payments to pay the premium cost of long-term care insurance, life insurance, or both. The amount of the immediate annuity payments will be based on your age, the premium paid to purchase the immediate annuity, and the payment option you select. This strategy allows you to convert an unused asset to one which is needed.

Provide Income for a Child with Special Needs or a Spendthrift

Some families must care for a child with special needs. Providing financial support for the child after you die is very important. Investing some of your estate proceeds in an immediate annuity can ensure a steady flow of income for the child’s benefit for his/her entire lifetime.

What if you'd like to leave your child an inheritance comparable in value to your other children, but you fear that the child will squander or misuse his inheritance to his/her detriment? An immediate annuity can be used to control the flow of income to the spendthrift child.

In either case, you can direct in your will or trust that at your death, a specified amount of cash be used to purchase an immediate annuity for the benefit of your child. Frequently, the annuity income will be paid into a special type of trust, usually established at your death. This 'special needs trust' (or supplemental needs trust) is an estate planning tool that can help you provide for the needs of a disabled individual without jeopardizing his or her eligibility for government benefits. A spendthrift trust protects a trust beneficiary from creditors or other parties (e.g., a divorcing spouse). A spendthrift trust specifically prevents the beneficiary from transferring his or her interest which may eliminate the ability of a creditor from accessing the interest. Thus, immediate annuity payments within the trust are protected from most claims of the beneficiary's creditors. A qualified attorney can help you establish and administer these types of trust.

Caution:  Spendthrift trusts are not valid in all states.

The Split Annuity Strategy

This strategy is intended to provide a dependable income with principal preservation. It uses a lump sum of money, a portion of which is invested in a single premium fixed-term immediate annuity with the balance invested in a single premium deferred annuity. The immediate annuity pays you a fixed amount over a specified period of time. The deferred annuity grows on a fixed interest basis, with the goal being that by the time the immediate annuity payments end, the deferred annuity will be fully restored to your original starting principal. You can then restart the process with prevailing interest rates or re-evaluate your Duke Energy retirement and investment strategy as needed.

The split annuity concept is useful as an asset management tool when fixed or regular payments need to be made over a set period of time. For example, the immediate annuity payments of the split annuity can be used to make payments on a mortgage, while the deferred annuity is simultaneously growing back to the original amount of your total investment.

Also, a split-annuity strategy can be used in retirement to generate an immediate, steady income stream while preserving some retirement savings for the future. The deferred annuity is intended to grow to reach the original amount of your investment; however, if you need to dip into your principal, most deferred annuities allow some penalty-free withdrawals.

Tax Treatment of Immediate Annuities

Payments received from a non-qualified annuity are divided into two parts: a non-taxable portion that represents the return of capital and a taxable portion that represents the earnings on the annuity. It's important for Duke Energy employees to note that, as a result, only a portion (i.e., the portion representing premiums paid) is excluded from your gross income. The portion of each annuity payment that is excludable is determined by multiplying each payment by an exclusion ratio. The fixed annuity exclusion ratio equals:

your investment in the contract ÷ expected return = exclusion ratio.

Example: You have a fixed immediate annuity that pays you $200 a month for 20 years. Your expected return is $200/month x 20 years x 12 months/year = $48,000. If you have an investment in the contract of $24,000, your exclusion ratio is $24,000/$48,000 = 50 percent. As a result, 50 percent of each $200 payment ($100) is excludable from your gross income. The rest of the payment ($100) is treated as ordinary income.

Caution:  The rules are different for variable immediate annuities. Since variable immediate annuity payments fluctuate in value, it is impossible to estimate the expected return at the starting date of the annuity. Typically, the excludable portion is determined by dividing the amount you invested in the immediate annuity by the number of years over which it is anticipated the annuity will be paid. This calculation may vary depending on the annuitization option (i.e. life only, period certain, etc.) chosen.

Estate Taxation of Immediate Annuities

If you select a single life-only payment option, your annuity payments stop at your death. There are no estate tax implications because no part of the annuity is transferred.

If you buy a joint and survivor immediate annuity, at the death of one of the joint annuitants, payments will continue for the remaining life of the surviving annuitant. However, the value of the joint and survivor immediate annuity that the deceased annuitant paid for will be includable in the estate of the deceased annuitant. The amount included is the amount the same annuity issuer would charge the survivor for a single life annuity as of the date of the first annuitant’s death. If the joint annuitant is the surviving spouse, the interest qualifies for the marital deduction. In addition, the surviving joint annuitant receives an income tax deduction for any estate tax attributable to the annuity.

 

 

 

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