Dr. Herbert Reynolds, age 60, is planning to retire at the end of this year. He will generate a retirement income from several sources: his IRA, 401(k), pension and profit sharing plan, brokerage account, tax-deferred annuity, and eventually Social Security benefits. Income generated from these sources will be taxable. Let's look at Dr. Reynolds' tax-deferred annuity, which will provide a source of annual retirement income, and the impact of taxes on that income.
Back in late 1988, Dr. Reynolds deposited $300,000 of after-tax monies into a fixed annuity that has yielded between 4% and 8% over the past 15 years. Since opening the annuity, he has made no further deposits. The current market value of the annuity is approximately $772,000. Since he is older than age 59 1/2, he can begin making withdrawals that are not subject to an IRS early withdrawal penalty.
There are several withdrawal options available to Dr. Reynolds. Because of the market's volatility in recent years, he elects a life and 20-year period certain payout option. In other words, the insurance company will guarantee him a monthly income for as long as he lives, for a period of no less than 20 years. Should he die within the 20-year timeframe, his designated bene- ficiary will be guaranteed a monthly income for the remaining years left on the option.
Under the life and 20-year period certain option, Dr. Reynolds will receive a monthly retirement income check from the life insurance company in the amount of $4362, or an annual income of $52,346. However, there are some taxes due on this amount. Of the amount he receives annually, about 30% will be excluded from taxes (that's assuming a 35% income tax bracket during his retirement years). This is because he has already paid taxes on the initial deposit of $300,000.
Income Tax Scenario
Dr. Reynolds will have to pay an estimated annual income tax of $13,071, and his after-tax annual retirement income from the annuity will be approximately $39,275. Should he live beyond the 20-year timeframe, Dr. Reynolds will continue to receive an annual income of $52,346. However, because his cost basis of $300,000 has been fully recovered, all income generated beyond the 20-year period certain option will be subject to income taxes.
Dr. Reynolds' estimated tax liability will no longer be $13,071. It will be approximately $18,321, or $52,346 x 35% (ie, his marginal tax bracket). Keep in mind that monthly retirement income is going to be a function of the following criteria: amount to be annuitized, annuity payout option selected, annuitant's age, current interest rate environment, annuitant's sex, state of residence, and the insurance company through which the annuity is purchased.
Regardless of these criteria, please note that once you have elected to begin receiving a monthly annuity payout, the contract between you, the annuitant, and the insurance company is "etched in stone." It may not be changed or altered in any way. In other words, once you have begun receiving payments, you do not have the flexibility to make changes to the annuity contact.
The bottom line:
Are annuities a good investment vehicle for physician-investors? Annuities offer many benefits, and in some states even offer the added benefit of creditor protection. The appropriateness of annuities as a supplemental source of retirement income must be explored on a case-by-case basis.
Thomas R. Kosky and his partner, Harris L. Kerker, are principals of the Asset Planning Group, Inc, in Miami, Fla. The company specializes in investment, retirement, and estate planning. Mr. Kosky also teaches corporate finance in the Saturday Executive and Health Care Executive MBA Programs at the University of Miami in Coral Gables, Fla. They welcome questions or comments at 800-953-5508, or visit www.assetplanning.net.