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Cracking Open Your Nest Egg

03/26/01 11:21:54 PM PST
by David Penn

You've earned it. You've saved it. You've invested it. Now that you're retired, what do you do with it?

As if saving for decades for your retirement isn't work enough, planning just how you will spend your retirement nest egg once you've put your full-time work years behind you is a separate -- but no less important -- task all of its own. By now, many of us know that without careful planning, even the best-laid plans can leave you cash-poor in a few years, forcing you to scale back your standard of living sharply at a time when you should be enjoying the rewards of a lifetime of work and thrift. Worse, you might find yourself re-entering the full-time workforce just to make ends meet.

But assuming you've done (or are doing) the right thing in terms of putting money aside, deciding just how you want it back is crucial. Is a steady stream of income more important to you than leaving a sizable estate for your heirs? If you have been managing your own investments as a worker, would you be comfortable with an insurance company's annuity limiting your investment choices once you were a retiree? And how heavily will your hard-earned investment gains be taxed once they emerge from under the tax-deferred shelter of an Individual Retirement Account (IRA) plan? These are just a few of the questions you will want to answer when trying to determine how to have your retirement money distributed to you after your full-time working days are done.


One of the more common ways for people to receive their retirement money is through annuity payouts. Annuities offer one thing that most recent retirees want more than anything else: peace of mind. An annuity guarantees a monthly income for life in exchange for an investment in a set of securities offered through the annuity program. In fact, not only do annuities ensure an income stream for your lifetime, but some annuities also offer significant benefits for your heirs, as well.

Annuities come in a number of flavors. Deferred annuities are largely investment vehicles for those with some years before retirement and are available as either fixed or variable products. Fixed annuities pay a "fixed" interest rate for a period -- usually from a few months up to a year -- after which the payout rate changes at the discretion of the annuity seller, though there is usually a minimum rate. The returns from variable annuities are based on the performance of the stocks, bonds, or mutual funds in which the annuity is invested. Immediate annuities, unlike deferred annuities, begin paying usually within 30 days from the date of investment and continue paying until the death of the purchaser (or, in some cases, the death of the beneficiary as well).

Thus, annuities are often referred to by the way they administer income. The more common forms are listed below:

  • Straight-life -- Provides payment until the death of the annuity owner.
  • Installment-refund -- Pays annuity owner or beneficiary at least the amount of the original investment.
  • Period-certain life -- Guarantees payments to owner or beneficiary for at least a set number of years.
  • Joint and survivor -- Guarantees payments until the death of both the annuity owner and a beneficiary.
There are a number of factors that determine the actual payment amounts, from the type of annuity purchased to the age of the purchaser. Generally speaking, straight-life and shorter-term, period-certain annuities provide higher payments than joint and survivor and longer-term, period-certain annuities. But these are broad tendencies that vary from company to company (especially in periods of increased competition).

Insurance companies, brokerage firms, and banks all sell annuities -- which underscores both the advantages and disadvantages of annuity products. Capital gains and dividends from variable annuity investments are tax-deferred, providing some shelter for those, such as recent retirees, who are no longer eligible for traditional IRAs. In addition, the fact that annuities are available from a variety of sources means that annuity purchasers can afford to shop around for the annuity offering the best choices in mutual funds.

There are some downsides to annuities. It is important to note that once an annuity contract has been purchased, there is no going back. Your capital is now the engine that drives your annuity payments. This underscores the importance of learning just what investments your annuity will make (what funds, stocks, bonds, and so on). Unfortunately, as far as annuities invested in mutual funds are concerned, many of the mutual funds available to your annuity are not as good as mutual funds you might be able to select on your own. Often, the mutual funds available are those with some connection to the company or institution that is selling the annuity -- which can mean higher fees and lower returns (either because of the high fees or simply due to underperformance).

The issue of fees and annuities is especially important for recent retirees, who may prefer to have their annuities invested in conservative instruments such as money market funds. It is not uncommon for someone to actually pay more in fees than they receive in annuity income, through the cruel combination of high fees and low returns.


Annuities are by no means the only method of receiving your investment money after retirement. Many recent retirees prefer a single lump-sum distribution to annuities for many of the reasons mentioned above. Receiving a lump sum means that the whole of your investment capital becomes available to you and can be considered a part of your estate after death (unlike annuities, in which your investment capital is "exchanged" for the monthly annuity payments you receive). Estate preservation is one of the reasons why many prefer a lump-sum distribution upon retirement.

Others may choose a lump-sum distribution in order to reinvest the money in financial products that may yield higher returns than those provided through annuities. Given the fact that annuities do not always invest in the best-returning/lowest-fee instruments available, a recent retiree who has spent much of his or her working years managing his or her own investments may prefer to continue doing so in retirement. In a time of steeply rising inflation, for example, a retiree may look at a fixed, monthly annuity payment with some trepidation. Indeed, inflation is the sworn enemy of all fixed-income investing, and in this regard, annuities are no different. Even the monthly payments of a well-performing variable annuity product may not meet the income preferences of some retirees. For them, a lump-sum distribution and a self-managed income generation portfolio may better suit their needs.

Of course, the other "enemy" to watch out for is the tax bill. Once funds are withdrawn from the tax-deferred protection of an IRA, the IRS will be waiting for its share. This tax consideration is very significant for those looking to take their IRA distributions as a lump sum, and determining likely tax exposure with a specialist in retirement taxation is vital.

Further options can help lessen the tax blow. These range from rolling your money over into another IRA, such as a post-retirement Roth IRA, from which distributions can be taken under certain circumstances, to forward-averaging, which allows you to, in effect, treat the tax on the lump-sum distribution as if it were paid over time (instead of just once) and as if the distribution were your only source of income. Unfortunately, not everyone qualifies for post-retirement Roth IRA conversion, nor is everyone able to use forward-averaging; for example, IRAs, simplified employee pensions (SEPS), and 403(b) plans usually cannot use forward-averaging. Again, consult your tax professional and/or financial advisor to help determine your eligibility for either of these options.


Just as careful planning during your work years is key to a financially secure retirement, deciding which tool you will use to crack open your nest egg when you retire will go a long way toward making your retirement years free of money anxieties. And if you did play a moderately active role in your finances leading up to retirement -- even if all that meant was choosing the best mutual fund available in your company's 401(k) plan -- you will already have many of the skills needed to begin comparing annuities and discussing with a tax professional how best to meet your final set of financial goals. Whether you simply want to make sure you will have enough money to maintain your standard of living in retirement or you contemplate a sizable investment-based estate that you would like to leave behind, it is never too soon to begin educating yourself on what to do with your retirement money.

In our next issue, we will take a closer look at the post-retirement Roth IRA conversion, one tool that retirees can use to minimize their tax liability while continuing to appreciate investment capital. In addition, we will take a look at recent changes in tax laws and how they can affect the way you save and spend your retirement dollars.

David Penn can be reached at


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David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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