Understanding annuities

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1 Wealth Management Americas Understanding annuities Rethinking the role they play in retirement income planning

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3 Helping to protect your retirement income security from life s uncertainties. The retirement landscape has evolved significantly and today s retirees face an entirely new set of risks. If you are near or in retirement, you may not be participating in an employer-sponsored defined benefit plan that provides a reliable source of monthly income. In addition, the stability of Social Security is in question so future recipients may receive a smaller income benefit once they become eligible making it a smaller percentage of their retirement income. With the advances in modern medicine, people are living longer lives and thus are spending more years in retirement. For investors, this means that retirement savings intended to last for 10 or 15 years may need to now last for 20 or 25 years or more. While not everything about retirement can be predicted with certainty, this much is clear: failure to reflect a changing retirement landscape in your planning may restrict your ability to fulfill your retirement goals. With the challenging market and economic environment of the past few years, it is critical to protect the wealth you have created with a guaranteed income stream in the future. There is no time like the present to prepare for and manage the complexity and risks involved. 1

4 Changing attitudes, better planning tools Managing your assets to generate the right level of sustainable income once you retire is a challenge. And if you re like many Americans, it may be one for which you feel somewhat unprepared. But be encouraged investing in annuities may be one way you can help ensure you can live the life you ve envisioned for yourself in retirement. Annuities can be very useful in adding flexibility and control in retirement planning. They can also help provide protection for your retirement assets from market volatility and the risk of outliving your assets. But it s important to acknowledge that annuities often are not well understood. They have features of both investments and insurance, which make them more complex and often more costly than investing in, for example, a family of mutual funds. UBS can help to remove some of the mystery surrounding annuities and the role they can play in retirement planning. Your UBS Financial Advisor can take you beyond this conversation and help you explore whether annuities have a place in your retirement plans. Why consider annuities? Ideally, you want to know your retirement assets will produce the income you need for as long as you live to support the retirement you envision. You also want to maintain the financial agility to deal with the unexpected. 2

5 Annuities offer a number of important benefits, some of which are optional and available for an additional fee including: Income for life if you choose, you can have the insurance company that issues your annuity guarantee* you (and, if you like, your spouse or someone else you designate) income payments for the rest of your life. In the case of a joint annuitant, payments will last for as long as the surviving annuitant lives. Tax-deferred investment growth contributions to an annuity, along with any earnings, grow tax deferred until you begin to receive annuity payments. Choice of and easy exchange among professionally managed investments typically, you may choose from an array of professionally managed portfolios (called sub-accounts) ranging from the most conservative investments, such as money market and government bond portfolios, to a variety of more aggressive equity investments. Death benefits usually equal to money left in the annuity contract, plus the interest accrued up until the annuitant s death. For all types of annuities, contract add-ons, called riders, can be purchased to increase the death benefit. Principal protection may be obtained by a living benefit rider that guarantees to return your entire principal in cash after a defined holding period (regardless of market performance). Some variable annuities offer the ability to invest your premiums in portfolios that allow for upside participation in market indices while offering some downside protection of your investment. * Guarantees based on the claim paying ability of the issuing insurance company. Because annuities can offer a unique combination of investment and protection features it s worth learning a bit about these instruments. There are a variety of options, benefits, and costs involved with annuities and it s important to carefully consider all of these before you invest. Your UBS Financial Advisor can help you (1) determine whether an annuity is right for you, and (2) choose the right annuity for your particular circumstances. First step: estimate your retirement income needs Everyone has a unique vision of retirement. Some people wish to work less and have more time to spend with grandchildren, pursue hobbies or travel the world. Others would rather change careers or start a new business. Whatever your vision, it s important to estimate your income needs and your potential sources of income as you transition to this new phase of your life. You may find it helpful to differentiate your anticipated spending in retirement, which can be typically categorized as follows: Needs: basic, nondiscretionary living expenses that must be met under all circumstances. This usually includes items such as food, shelter, utilities, clothing, taxes, medications, and similar types of expenses. Wants: these are nice to have expenditures beyond basic needs. These types of expenses define a desired lifestyle and can include items such as new cars, vacations, or a second home. Wishes: these are longer term aspirations such as leaving a legacy for your grandchildren or a bequest to your favorite charity. 3

6 You ll then want to consider the predictable sources of income you expect to receive to help meet your essential, non-negotiable needs. These may include Social Security income, your employer s pension, or in some cases, rental income. By matching retirement income needs with predictable sources of income, you re putting yourself on the right path to pursuing your vision of retirement. Minimizing risk, maintaining growth potential It s common to become more risk averse toward investing as you get older particularly after weathering a period of financial turmoil such as the 2008 financial crisis. It s natural to want to shift into less risky assets such as bonds and cash. However, today s annuities can offer upside potential through diversified portfolios, while also carrying the downside income protection that traditional investments may not provide. Converting a portion of your retirement assets into a guaranteed income stream via an annuity may, in combination with other reliable income sources, help assure that your basic, nondiscretionary spending needs will be covered. You can then have the ability to invest your remaining assets in other strategies designed to help provide growth and cash flows for wants and wishes. But what type of annuity should you choose? Let s review some of the basics of annuities and then look at a few of the most popular living benefit annuity riders that can help make planning for your retirement income more predictable. A few annuity fundamentals At the most basic level, an annuity is simply a long-term contract between you and an insurance company. In exchange for a premium or series of premiums, the insurance company agrees to make payments to you at some time in the future. Annuities are of two types: immediate or deferred. Immediate annuities are purchased with a lump-sum payment and payout distributions begin almost immediately that is, usually within the next year. You get to choose the term, or length of payments: It can be for your lifetime, for your and your spouse s lifetimes for a designated number of years, or for some combination of lifetime plus a minimum number of years. With deferred annuities, the money you contribute accumulates over time and you postpone to some future date the point in time at which you will begin to receive payments. The amount of your payout is determined by how much you put into the contract, its term, your age and your investment results. Deferred annuities may be invested one of two ways: fixed or variable. With a fixed annuity, the insurance company assumes the investment risk, guarantees the security of your principal, and provides a guaranteed rate of interest on your investment for a predetermined period of time. At the end of this time you are generally given the option of renewing the contract at a new rate based on current market conditions. With a variable annuity, you assume the investment risk, because you select the investment options. The value of your contract may go up or down, depending on the performance of the investments you choose. The issuing insurance company typically offers investment portfolios in several different asset classes and a choice of several portfolio managers, and generally, you re allowed to transfer among the different investment options available in the contract without tax implications. Thus, you have flexibility to change your asset allocation strategy over time as your objectives change. Recent innovations have produced variable annuities featuring minimum guarantees for lifetime income and withdrawals, as well as death benefit provisions. Deferred annuities typically have two phases: Accumulation and distribution. During the accumulation (sometimes called buildup) phase of the contract, you (the owner) make contributions to the annuity and build up the value of your account. During the distribution or annuitization phase, your earlier contributions plus any generated earnings are paid to you as an income stream, according to the terms of your contract. Your investment earnings are taxed as ordinary income when received. 4

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8 There is no additional tax-deferral benefit for annuity contracts purchased in an IRA or other tax-qualified plan, since these are already afforded tax-deferred status. Thus, you should only purchase an annuity within an IRA or qualified plan if you value some of the other features of the annuity and are willing to incur any additional costs associated with the annuity to receive those benefits. Annuities can be purchased with pre-tax dollars or after-tax dollars. An annuity purchased with pre-tax dollars (perhaps as part of an employer s retirement plan) is considered a qualified annuity, and IRS rules regarding qualified plans apply. This means that the amount you can contribute annually is limited, and that your withdrawals must begin at age 70½. A non-qualified annuity is purchased with after-tax dollars; there are no limits on the size of the contribution and most contracts allow you to defer distributions until age 85. Thus, individuals who have maximized their contributions to their 401(k)s and IRAs find non-qualified annuities appealing, because they provide a way to make additional contributions to investments with the potential to grow tax-deferred. Because of the tax deferral benefits offered by annuities, non-qualified contributions are subject to similar early withdrawal penalties as qualified accounts: pre-59 ½ withdrawals may be subject to a 10% penalty tax. A focus on living benefits Given the variety of risks that pre-retirees and retirees face (longevity risk, sequence of returns risk, and inflation risk) many retirees have expressed concerns about outliving their retirement assets. There are a number of variable annuities that offer optional living benefit riders that can help to address these concerns. For most variable annuities, you must elect a living benefit rider at the time you purchase the product. Some riders are not revocable, so once you ve chosen one it will apply for the life of your contract. Typically, you can t elect more than one living benefit per contract. These benefits usually come with a cost, which applies for the life of the contract and may impact long-term performance. All of these benefit options have specific guidelines. For example, living benefits may require you to invest in an asset allocation model or a guaranteed interest account, which could limit potential investment growth. Be sure you read the product prospectus and have a thorough understanding of how a rider works, its restrictions and costs before you decide to include it in a variable annuity. A few of the most common living benefit riders are: Guaranteed minimum income benefit (GMIB). This rider guarantees lifetime income, regardless of how your investments perform. Your annuity issuer guarantees a particular growth rate to your investment (for example, 5%); that becomes your benefit base. The benefit base has no cash value. It will determine the amount of your future guaranteed income payments. While the contract value is the actual value of the investments in your annuity s subaccounts, the benefit base is the figure your future guaranteed income payments will be based on. After a specified minimum number of years (often 10), you re allowed to enter the payout phase and receive lifetime payments through annuitization of either your benefit base or your annuity s account value whichever is greater. Even if your account value goes to zero, the insurance company guarantees to pay you the same income for your life. Guaranteed minimum withdrawal benefit (GMWB). This rider guarantees that you can withdraw a certain percentage of the benefit base or account value whichever is greater. Even if your account value goes to zero, you would have the right to continue to receive the same amount each year. With a lifetime rider, this benefit can sometimes be passed on to your spouse. Guaranteed minimum accumulation benefit (GMAB). This rider offers principal protection by guaranteeing to return your entire principal in cash after a defined holding period (usually five to ten years), even if your annuity s account value has fallen far below your total premiums paid. Sometimes these riders also lock in contract gains on certain anniversary dates (daily, monthly, quarterly, or annually). Your UBS Financial Advisor can help you select an appropriate living benefit rider that suits your particular needs. 6

9 How a living benefit works Accumulation phase Distribution phase Benefit base Reset to capture higher contract value Initial purchase payment Income start date During accumulation, some benefits periodically reset for up to 20 years During distribution, some benefits offer the opportunity to receive a payment increase without requiring the contract value to exceed the Benefit Base. Guaranteed rate before reset Guaranteed rate after reset Contract value Payment based on Benefit Base or contract value, whichever is greater 7

10 Annuity death benefit Under most annuity contracts, if you die before your payout phase begins, your beneficiary will receive either the current account value or some guaranteed minimum such as your paid-in premiums less withdrawals, whichever is greater. This benefit is usually provided at no additional cost. Some insurance companies offer enhanced death benefits for an additional fee. Because annuities are insurance contracts, their death benefits generally avoid the delay and expense of probate. Annuity considerations to keep in mind Although annuities offer a number of benefits not available in other investments, there are important factors to consider when deciding whether an annuity is right for you. Each supplemental benefit provided by a variable annuity is usually associated with a fee. Because these fees will reduce the total value of your account and the return on your investment, it is very important that you understand these charges thoroughly before you invest. With some annuities, guarantee options must be elected at the time of purchase. And some options are irrevocable. Often there are restrictions on the number of guarantee options you can have at any given time. And there are usually additional annual fees associated with guarantee options. If you need to access your funds early, you may incur surrender charges. Withdrawals from annuity contracts will be taxable as ordinary income and not as capital gains. If taken prior to age 59 ½, you may be subject to an additional 10% federal income tax penalty as well as a contractual withdrawal charge. Guarantees are backed only by the financial strength of the insurance company that issues the annuity. The costs and benefits associated with annuity contracts may vary greatly based on the type of annuity you may be considering. It is important to read each prospectus carefully and compare costs and quality before buying. 8

11 Choosing an annuity through UBS UBS offers a wide range of annuity products from some of the most established and well-respected insurance companies in the country. Your UBS Financial Advisor can review your specific retirement income needs and preferences with you to determine whether an annuity would make sense as part of your overall retirement plan. If so, we can help you choose from a broad selection of annuities that represent the most compelling opportunities to supplement your retirement income. Advice you can trust starts with a conversation. 9

12 Important Disclosures Annuity products are issued by unaffiliated third-party insurance companies and made available through insurance agency subsidiaries of UBS Financial Services Inc. Guarantees are based on the claims-paying ability of the issuing insurance company. Guarantees do not apply to the investment performance or safety of amounts held in the variable accounts. Variable annuity contracts and underlying investment options are not FDIC insured and have fluctuating returns so that proceeds when redeemed may be worth more or less than their original value. Past performance is no guarantee of future results. Annuities are long term investments designed for retirement purposes. Withdrawals or surrenders may be subject to surrender charges. For tax purposes, withdrawals are generally deemed to be earnings out first. Taxable amounts withdrawn will be subject to ordinary income tax, and if taken prior to age 59½, a 10% IRS penalty may also apply. Withdrawals have the effect of reducing the death benefit, optional benefit riders and the contract value. You should carefully consider the investment objective, risks, and charges and expenses of the variable annuity contract and its underlying investment options before investing. This and other information can be found in the prospectus for the variable annuity and the prospectuses for the underlying funds, which can be obtained from your investment representative or by calling the insurance carrier. Please read the prospectus carefully before you invest. There is no additional tax deferral benefit for contracts purchased in an IRA or other tax-qualified plan, since these are already afforded taxdeferred status. Thus, an annuity should only be purchased in an IRA or qualified plan if the client values some of the other features of the annuity and is willing to incur any additional costs associated with the annuity to receive such benefits. UBS Financial Services Inc., its affiliates, and its employees are not in the business of providing tax or legal advice. Clients should seek advice based on their particular circumstances from an independent tax advisor. UBS The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved. UBS Financial Services Inc. is a subsidiary of UBS AG. Member FINRA/SIPC

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