Seniors are being squeezed

Seniors are being squeezed
By Jason Parker

Seniors are being squeezed and I’m not talking about bear hugs from the grandkids. Higher property taxes along with inflation driving up the costs of gasoline, food, health care and insurance, coupled with a very volatile stock market, longer life expectancies and declining yield on fixed income investments and we have an especially alarming trend for folks who are retired.

Often times when people retire they shift from a strategy of accumulating assets and savings to more of a preservation, distribution and income strategy for the assets and savings they have accumulated. Certificates of Deposit (CD’s) seem to be a popular safe haven for many of these folks. While CD’s certainly offer a great deal of safety there may be a better alternative for those dollars.

After a quick visit to bankrate.com I noticed that the overnight national average yield on a 5 year CD is currently 3.24%. Assuming these are taxable dollars it would be prudent to calculate your yield after tax. So if you are in the 25% marginal tax bracket the after tax yield on your CD is only 2.43%. If we then factor in a conservative estimate of 3% for inflation you can start to see that inflation and taxes are taking a big bite out of your bottom line. Your principal is safe from market volatility but not from taxes and inflation.

One of the most common tax planning strategies is to defer income from the current year to later years. The underlying reason is that it’s better to pay taxes later rather than sooner due to the time value of money. The time value of money concept basically states that a dollar in hand today is worth more than a dollar that will be received in some future year. This concept is particularly important during inflationary times.

So what are the alternatives and how can you defer the tax on interest earned from your CD? The suggestion I am going to make may sound counterintuitive but could result in a significantly greater yield than the CD described above. One often overlooked and misunderstood savings vehicle is the tax deferred fixed rate annuity. One of the reasons tax deferred fixed rate annuities were created by insurance companies was to compete for the dollars currently invested in CD’s. These tax deferred fixed rate annuities work in much the same way as a CD works with respect to how they credit interest, but the annuities offer a few advantages not found in CD’s. First and probably the most obvious is they are tax deferred. So in other words you won’t receive a 1099 interest statement at the end of every year for the interest you earn in your Annuity, as long as the interest isn’t withdrawn from the annuity. Second the rates are currently considerably higher than the national average for CD’s. As of this morning I noticed an offering of 5.30% fixed for 5 years for deposits over $100,000. Remember these fixed rate annuities are tax deferred so the taxable equivalent needed by a CD would be 7.07%. Or in real dollars $100,000 invested in a 5 year CD at 3.24% in a 25% marginal tax bracket and assuming you are paying your taxes from the interest earned each year you would have a value of $112,755.01 at the end of 5 years. The tax deferred fixed rate annuity would have a value of $129,461.88 at the end of the same 5 year period. At the end of the 5 year annuity contract you can continue to defer your taxes out into the future by doing what is called a 1035 exchange to another fixed rate annuity and continue to defer the taxes out into the future. Unlike IRA’s you don’t have to begin taking a required minimum distributions at age 70 and a half. Unless of course you have an annuity inside your IRA then the IRA rules override the annuity rules.

Like CD’s you may pay a penalty for drawing funds out your annuity before the end of the 5 year period. Taxes can be deferred as long as you are alive and continue to 1035 exchange the contracts but when you start to take the money out of the annuity taxes will have to be paid at ordinary income tax rates. Annuities are offered by insurance companies so it’s important to know and understand the financial strength of the insurance company offering the Annuity.

If you invest in CD’s and don’t need the interest income for current living expenses, you may want to consider the benefits of a tax deferred fixed rate annuity as an alternative.

Jason Parker is the President of Parker Financial LLC a fee based registered investment advisory firm specializing in wealth management. His office is located at 9057 Washington Ave NW #104 in old town Silverdale. He holds the series 65 securities license as well as being licensed to offer life and health insurance in Washington State. For more information please contact Jason at 360-337-2701 or online at www.parker-financial.net. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Please consult with you financial planner and or tax professional before considering a CD or a tax deferred fixed rate annuity. Annuities unlike most CD’s are not covered by FDIC insurance.