Annuity Riders Help to Preserve Wealth

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January 15, 2002

Physician's Money Digest

By Donald T. Cohen, CPA
Newman + Cohen Financial Management

An annuity is a contract between an insurance company and an individual that provides for periodic payments to the individual or a designated beneficiary in return for an investment. An annuity has two phases: accumulation and annuitization. In the accumulation phase, an investor gives money to an insurance company in a lump sum or over a period of time and earns a rate of return. In the annuitization phase, the investor makes regular withdrawals from the contract.

Contract Riders

The most intriguing reasons why physicians should consider variable annuities (as opposed to fixed) are contract riders that provide added benefits. When considering ways to hedge against a bear market, physicians should consider variable annuity contracts with a guaranteed minimum income benefit rider and a stepped-up basis rider.

A guaranteed minimum-income benefit guarantees that variable annuity buyers will receive a minimum monthly payment, even if an investment performs poorly. For example, some companies offer a benefit that guarantees monthly payments will never fall below 80 percent of the first annuity payment. If the first monthly payment was $800 and the owner's investment performs poorly, the monthly payment will not drop to less than $640 in the future.

Additionally, a stepped-up basis rider enables an investor to annuitize his/her investment based on the highest value of the portfolio, greatly diminishing the downside risk. For example, the annuity contract owner's portfolio may rise to $500,000 and fall in a bear market to under $400,000. With a stepped-up basis rider, the investor can annuitize $500,000.

A recent example of someone who could have benefited from one of these riders is the 55-year-old widow of a physician who inherited an annuity purchased in 1983. The variable annuity was invested in a growth equity sub account. In March 2000, the account was worth more than $440,000 but fell below $290,000 because of the bear market. With a guaranteed minimum-income benefit rider and a stepped-up basis rider, the widow would have been able to annuitize at $440,000 rather than the current value.

Other variable annuity riders can help provide long-term care benefits, lump-sum payments and guaranteed death benefits. Annual fees are significant and range from 1.15 to 1.85 percent per year. However, as steep as these fees may have seemed during the rush of the last bull market, annuity riders are an affordable hedge against major market downturns.

Several Concerns

Some investment advisors frown on them because they believe annuities lack liquidity, offer minimal investment options and charge high fees. Although variable annuities are not for everyone, they offer some distinct benefits to some physicians.

Regarding concerns about liquidity, it is important to understand that annuities are not short-term investments. If an investor makes an early withdrawal, he or she will pay penalties similar to those for an early withdrawal from an IRA or 401(k). In addition, the insurance industry becomes more sophisticated every year with its offerings, and most annuities now offer a variety of attractive investment alternatives.

The big issue for physicians is fees. Many physicians summarily believe that annuity fees are too high, but further analysis shows that the benefits can greatly outweigh the fees. Some examples include:

• Physicians with large office staffs can use annuities to save for retirement at a lower net cost than setting up a retirement plan such as a 401(k) for the staff.
• In some states, annuities are creditor protected, which provides an excellent benefit to any physician worried about malpractice lawsuits.
• Annuities offer protection to its owner's heirs and have valuable provisions if the owner becomes disabled or terminally ill.

New insurance products, such as these, can help physicians preserve their wealth despite an unpredictable market, alleviate financial concerns and plan for retirement.

Donald T. Cohen is a director and founder of Newman + Cohen Financial Management (www.newman-cohen.com). He has more than 20 years of experience in certified public accounting, advanced financial strategies and business management with physicians and high-net-worth individuals.

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