Take a balanced approach to retirement and estate planning using a split annuity

split annuity in retirement and estate planning

The biggest problem for those who are approaching or have already reached retirement is striking a balance between the necessity to maintain their standard of living and their desire to leave as much money as they can for their loved ones. Finding this balance can be challenging, especially because retirement might last for decades. Split annuity is one tactic to consider since it generates a present income stream while safeguarding money for the future.

ABCs of an annuity

An annuity is a tax-advantaged investment contract, usually with an insurance company or other financial services provider. In exchange for a one-time payment or yearly premiums, you receive recurring payments from the provider for a set number of years or the rest of your life.

We’ll concentrate on “fixed” annuities for the sake of the split annuity method described below because they often offer a guaranteed minimum rate of return. Variable and equity-indexed annuities are other options; they may have higher upside potential but also carry higher risk.

Annuities can be immediate or put off to a later date. An instant annuity pays off immediately, as the name implies. Still, a deferred annuity intends to have a later payout.

Annuity earnings are tax-deferred, which means they grow tax-free until there is a payment or withdrawal. Each payment consists of two parts:

  1. A component taxed as regular income
  2. A portion treated as a tax-free return of principle (premiums)

Deferred annuities can grow more quickly than equivalent taxable accounts. Because of the ability to accumulate earnings on a tax-deferred basis, it offsets their typically low interest rates.

If your situation changes, annuities give you some flexibility to withdraw or repurpose the money. But be aware that you can incur surrender or early withdrawal fees depending on how much money you withdraw and when.

Split annuity strategy

Although the term “split annuity” may suggest a single product, it refers to two (or more) annuities that are often funded with a single investment. An immediate annuity that pays you fixed payments for a set period is typically purchased using a portion of the assets in a split annuity approach (ten years, for example). The money left over goes toward a deferred annuity that starts paying out after the initial annuity period.

The delayed annuity should, in theory, have collected enough earnings by the conclusion of the immediate annuity term to equal the value of your initial investment. In other words, if the split annuity is of proper design, you will benefit from a fixed income stream for a set time while maintaining your principal.

At the end of the term, you can reconsider your alternatives, such as:

  • Begin receiving payments from the deferred annuity
  • Taking a cash value distribution of all or part of it
  • Reinvesting the money in another split annuity or another investment instrument

Please contact our RRBB accountants and advisors if you want to learn more about split annuities. We would be happy to assist you in determining whether this approach is appropriate for your circumstance.

© 2022


Get free tax planning and financial advice