Whether you’re an entry-level professional or a corporate executive, chances are that retirement has crossed your mind at least once. From the age you wish to retire to all the amazing pursuits you hope to enjoy, everyone has a clear personal picture of what those well-deserved years would look like.
For many of us, however, doubts about retirement income can make this picture somewhat cloudy. Permanent employees may wonder if their pensions will withstand the test of inflation. Alternately, contracted employees and the self-employed may feel ill-equipped to meet the challenge of investing for retirement on their own.
“Fortunately, no matter your situation, a deferred-tax annuity is a viable and accessible investment mechanism to generate income to meet your retirement goals.”
Below we explore how deferred-tax annuities work particularly in Trinidad and Tobago, their pros and cons and how you can access this investment product to build the retirement of your dreams.
The concept behind income annuities is simple. You, the buyer deposit a lump sum or series of payments with an annuity provider. In return, the annuity provider guarantees to pay you a stream of income in the future.
Generally in a deferred annuity contract, monthly or yearly premiums accrue interest and grow to a future date – usually to the age you would like to retire. You can choose when your payments begin and most people choose lifetime payments starting at age 60 or older.
For deferred-tax annuities specifically, these products have the added advantage of growing tax-free until retirement.
Deferred-tax annuity contracts are usually structured into two phases namely the accumulation phase and the payout phase.
During the accumulation phase, interest accumulates on your premiums tax-free until the maturity of the contract. The method in which interest accumulates depends on whether a fixed, indexed or variable rate of interest is chosen.
i. Fixed annuities promise a specific, guaranteed rate of return, regardless of market conditions.
ii. Indexed annuities provide a return based on the performance of a particular market index.
iii. Variable annuities are based on the performance of a portfolio or mutual funds or sub accounts chosen by the annuity holder.
As the purpose of the deferred-tax annuity is to encourage long-term investment, individuals are discouraged from making withdrawals during the accumulation phase. Accordingly, withdrawals during this period may be subjected to surrender charges and taxes.
At maturity, the payout phase begins. From this point on, you’ll receive a regular monthly or yearly income, based on the value the plan accumulated. There may be a guarantee period during which payments would continue to be made even if you pass away.
For example, if you decide to purchase an annuity with a 15-year guarantee period and pass away after 8 years, payments will continue to be made to your chosen beneficiary for the next 7 years.
“Deferred-tax annuities offer considerable advantages as an investment vehicle for retirement planning. The most significant of which is its power to maximize returns on your investment through compound interest.”
Compounding occurs when interest is paid on previously earned interest. So, let’s suppose you have a certificate of deposit (CD) which is a bank account that allows you to save at a fixed interest for a period of time. If this CD paid an interest rate of 3.0%, all future interest will be compounded on the total of principal and accumulated interest.
But you’re not really getting 3.0%. For example, if you’re paying 25% in income tax, you’d actually be earning only 2.25% net.
With a deferred annuity, if you’re earning 3.0%, you may be able to keep it all for compounding*. By allowing your contributions to accumulate in your deferred annuity, your money may grow and compound faster than money in a taxable account earning the same before-tax rate. At 3.0%, compounded annually, contributions of $1,000 a month can grow to $139,741* in 10 years. At 2.25%, you’d have $134,431.
The higher your tax bracket and the longer you defer, the bigger the advantage.
The stealth power of tax deferral is one of several benefits that deferred-tax annuities have to offer.
Income during retirement:
Deferred-tax annuities allow individuals to take retirement planning into their own hands. By making flexible, discretionary contributions to a deferred annuity product, you can be guaranteed lifetime income and are insured against the risk of running out of money during your later years.
These annuities can serve as a supplement to national insurance and for those employees entitled to pensions. For those responsible for preparing for their own retirement, it is an investment that is easy to access and is professionally managed on your behalf.
Whether the annuity has a fixed or variable rate of interest, it protects the investor against losses and guarantees a stable, minimum monthly payment throughout retirement.
Flexibility and convenience:
Deferred-tax annuity products are passive investment vehicles that do not require any specialized investment knowledge to participate. They offer flexibility with respect to contribution amounts making them a viable option for a wide range of income brackets. Individuals may choose to make small or large contributions initially and also have the option of adjusting their payments throughout the life of the plan or making lump sums.
Deferred-tax annuities may be used as a tool to reduce an individual’s tax liability.
Additionally, since it is likely that you will be in a lower tax bracket upon retirement, you are taxed at a lower rate at the payout phase. This is an important benefit when it is time to withdraw the funds.
Limited Accessibility to Funds in Accumulation Phase:
Given the withdrawal penalties during the accumulation phase, having a deferred-tax annuity imposes discipline towards investing for retirement and minimizes the temptation to withdraw funds for other uses.
Deferred-tax annuities can have high maintenance fees, which may make them costly investments.
There may be annual fees, deposit fees, mutual fund management fees and insurance fees. The fees accumulate and may reduce the profits an investor gains from the annuity. If possible, shop around for an annuity with low-load or no-load agreements – where load or sales fees are low or are not charged – and other low fees before investing.
Limited Accessibility to Funds in Accumulation Phase:
Funds placed in a deferred-tax annuity are essentially locked up until retirement and large penalty fees are applied when withdrawing funds before maturity. If you need to withdraw funds early in the life of the annuity, there may not be enough funds because fees and penalties could deplete the account.
Ability to maximize the tax benefits on contributions:
An investor who has already exhausted his or her annual tax-deductible allowance will not enjoy the full benefits of a deferred annuity. However, for investors who have not exhausted this allowance, the advantage of tax deferred compounding can be attained.
Relative prospective returns:
If alternative investments provide superior returns to the deferred-tax annuity, the tax benefit may be offset.
Timeframe for Investment:
If you are close to retirement or should need funds from the annuity in the near future, this is not the right investment vehicle.
Locally, deferred-tax annuities are offered by Insurance Companies and Financial Institutions like Republic Bank Limited.
Deferred-tax retirement products offered by financial institutions such as banks facilitate the accumulation phase of the contract. At maturity, the bank would contact various insurance companies on your behalf to attain immediate annuity quotes for the payout phase.
Key features of deferred-tax annuities in Trinidad and Tobago are as follows:
At Republic Bank, these features and benefits are offered in our Tax Incentive Savings Plan.
The attractiveness of a deferred-tax annuity relative other investments is shaped by several personal and financial considerations. These include your timeframe for investment; your ability to maximize on the tax deductible benefit; and an analysis of the rates of return and maintenance costs across different investment products.
When compared to other non-tax deferred investment options with similar return profiles, these products are able to make higher dollar value returns with equivalent contributions.This can certainly be of value to all types of investors. Whatever your level of investment knowledge, deferred-tax annuities can provide you the financial security to retire as you please.
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