Most of us don’t like the idea of the federal government and the politicians that run it being in control of our retirement funds. That’s why we put money into vehicles such as 401ks, Roth IRAs, IRAs, etc., to ensure that there will be cash available when we are too old to work. Unfortunately, there is some indication that some politicians would like to seize or take control of tax-deferred retirement plans [2] and divert the money to their pet projects.
Naturally, many of you are wondering if there are alternatives to 401ks, where you can stash money for retirement and keep it out of Uncle Sam’s hands. Fortunately, the answer is yes; there is at least one excellent alternative to 401k and IRA plans that Uncle Sam is not likely to touch.
Annuities
The best alternative to 401k accounts has actually been around for centuries. It’s called an annuity, and it is how people paid for retirement before social security and the widespread adoption of pension plans. Until the 1930s, a large percentage of older Americans relied on annuities for a large part of their income. The good thing about annuities is that they are fairly safe from government confiscation because they are controlled by major insurance companies.
An annuity [3] is a contract between an individual and an insurance company. Under the terms of the contract, the individual pays the insurer an amount of money. The contract then obligates the insurance company to make regular payments to a beneficiary, called an annuitant, for a period of time.
The advantage to this arrangement is that it guarantees income to a person; the insurer automatically makes the payments. A good annuity can put a cash payment in your bank account each month for the rest of your life. Because the arrangement is automatic, it can keep providing income even if a person becomes incapacitated and unable to manage his or her affairs.
As mentioned earlier, annuities are among the most secure retirement investments because they are issued by major insurance companies. The top insurance companies, such as New York Life, are among the oldest and most stable businesses in the United States. They’ve survived civil war, depressions, recessions, two world wars, the Cold War, the Great Financial Meltdown of 2008, and other upheavals, so there’s a good chance they’ll be around servicing annuities through the twenty-first century.
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More importantly, the insurance companies are rich and politically connected. Politicians are not going to even think of touching funds under their control. Even if they tried, the insurance industry has the money and influence to fight them off. Since many of the rich people in the United States (including politicians) own annuities, it is unlikely that politicians will try to seize them. After all, they don’t want to seize their own money or anger their paymasters.
The biggest advantage to annuities is that they are tax-deferred just like IRAs and 401ks. That means money placed in one doesn’t have to be declared on your income tax return, so they can reduce your tax rate. The IRS does regard annuity payments and funds taken out of annuities as taxable income however.
Annuities are actually a better deal than 401k plans because there is no limit to the amount of money you can put into one. In fact, annuities are the way that many rich people and executives save for their retirement. A person can use annuities to put a large amount of money away for retirement.
Individuals and couples that are working can take advantage of a deferred annuity. This plan works much like a retirement account—a person puts money in it while he or she is working. Then, when he or she retires or reaches a certain age, the plan starts paying him or her. A deferred annuity can be a good deal for a person with a regular job.
Persons with a lot of cash have another option, called an immediate annuity, which begins paying out as soon as it is purchased. Many self-employed people would be best leaving the cash in investments or savings until retirement and shifting it into an indexed annuity at some point.
There are some drawbacks to annuities that you should be aware of. The first is that the IRS will charge an additional 10 percent income tax on withdrawals from annuities made by persons who are under 59 ½ years of age. That tax is charged on top of the person’s normal income tax rate. That means it is usually not a good idea for persons under forty-five and people that might need to tap their nest eggs to invest in deferred annuities.
Another problem with annuities is inflation; a traditional annuity pays at a fixed rate like a savings account. As with savings accounts, this interest income can be quickly destroyed by inflation.
The insurance industry has solved this problem with a number of alternatives, such as indexed annuities, in which a portion of the funds is invested in a stock market index fund and variable annuities. In variable annuities, part of the funds are invested in subaccounts similar to mutual funds.
Another advantage to annuities is their variety. Modern indexed and variable annuities give investors many of the same choices as mutual funds. Persons can invest in stocks, bonds, and even precious metals through such vehicles.
You should take your time and do a lot of research first hand before investing in an annuity because any money put into one might be tied up for years to come. Cashing out or selling an annuity can be difficult, so make sure it’s a good fit before buying.
After-Market Annuities
An interesting investment that often pays a higher rate of return than bonds but offers a high degree of security is an aftermarket or secondary market annuity [5]. This is an annuity contract that somebody is trying to sell. The buyer gets the right to receive the payments.
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Most of the aftermarket annuities sold in the U.S. are from structured settlements for accident investments. To buy an aftermarket annuity you’ll have to have a lot of cash, and you will have to search carefully. Many of the aftermarket annuities on the market today are overpriced. There are some good deals available in aftermarket annuities, but there are only a few of them, and they go fast when they hit the market.
CD and Money Market Accounts
The best way to think of certificates of deposit (CD) and money market accounts is that they are modified savings accounts that pay a higher rate of interest. These accounts usually achieve this through investments in the bond market. The investor takes more risks than with a savings account but gets a higher rate of return.
The big advantage to CDs is the security; most of them are insured by the Federal Deposit Insurance Corporation (FDIC), so the money is fairly safe. The disadvantage is that the return is fairly low, and there are often restrictions on withdrawal. A person may not be able to withdraw funds until the CD matures.
Another advantage is that a CD or money market is a bank account. That means you can transfer funds to a checking account. Some accounts even come with a debit card so the account holder can make purchases or withdraw cash through an ATM.
Funds kept in a CD or money market account are viewed as taxable income by the IRS. That means the IRS may raise your tax bracket if you have a lot of money in one. The added taxes and low interest rates usually make CDs or money markets a bad deal for average people, but they are a good place to park money.
Finding Alternatives
There are alternatives to 401k and IRA plans out there if you are willing to look for them. Something to remember is that the investment industry will not tell you about many of the best retirement vehicles because it cannot make money off of them. Investment professionals are constantly bad-mouthing annuities because they offer a better deal than mutual funds. Investment salesmen prefer mutual funds because they can make more money off of them. Many mutual funds contain something called a load, which pays a portion of the plan directly to salesmen for several years after it is sold. Annuities are sold on a straight commission, so the salesperson only gets paid once.
Everybody needs to start thinking about these alternatives now and researching them because there is a strong possibility that Congress might change 401k and IRA plans. The most likely possibility is that it will repeal some of the tax breaks associated with the plans.
Another possibility is that our “leaders” might follow the lead of the Irish and Argentine governments and try to seize private pension accounts. If the federal government does this, it is unlikely to touch annuities because they are controlled by major insurance companies that are big campaign donors. More importantly, rich people like Congressmen will want to preserve some sort of private retirement funding for themselves and their families. If they do it will probably be annuities.
So a likely outcome is that many of us could lose the tax breaks associated with retirement savings we’ve enjoyed for a long time. That means it might be a good idea to put funds in a more flexible arrangement that offers fewer tax advantages, such as a savings account or a CD. For long-term retirement savings, annuities are probably the best deal for those who can afford them.
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