Financial Services

Retirement Income Planning

Retirement Incoming Planning

Everyone wants a golden retirement. But saving for retirement is no easy task. The baby boomer generation is graying. More and more people are approaching retirement age. With Social Security's assets being consumed and the number of workers that will support it shrinking, we will have to rely more on our personal savings when it's time to retire.

Today, we have a myriad of options to help each of us prepare for the golden years. Yet, without a specific plan of action, many people find themselves falling short when it is time for them to live off of their life's work.

Some of the most powerful retirement strategies include:

  • Annuities
  • Modified Endowment Contracts
  • Roth IRA

Take the time to review your options, and ensure that you're prepared when it's your turn to retire. And when you're ready to speak with a professional about saving for retirement, call us at 847.268.3670. 


  • A myriad of options
  • Annuity flexibility
  • Choices to consider
  • Common benefits

Annuities are flexible insurance contracts designed to provide income and help you achieve long-term savings goals. Much like a CD is a contract between you and a bank, an annuity is a long-term contract between you and an insurance company. In essence, the same company that insures your home or protects your family may also help you save for retirement.

After making a single lump-sum premium payment or a series of periodic payments, individuals can then receive regular annuity payments from the insurance company. These payments can be made over a definite period of time, or they can last a lifetime.

Payments to the annuity owner can also be tailored to begin after the contract has been established for a number of years, or they can begin immediately after the first premium payment is made.

Annuity owners even have the option to choose between a fixed annuity or variable annuity. Over time, insurance companies have modified and enhanced both types of annuities; however, their basic premise has always remained the same. And because annuities are issued by insurance companies, Congress allows them to grow tax-deferred under current tax laws.

A Myriad of Options

Tax deferral is not the only reason why annuities have mushroomed in popularity. While they typically have maturity dates of five to seven years, annuities require no medical exams and can usually be opened by filling out a basic annuity contract.

Today, there are hundreds of annuities to choose from, designed for different retirement goals. When it comes to fixed annuities, insurance companies sometimes offer higher initial rates to attract would-be buyers, while other companies promise consistent interest rates throughout the life of the annuity contract. Rates, maturity periods and death benefits are just some of the options to look for in a fixed annuity.

With today's annuities, you can tailor your retirement account to meet your own individual needs.

Annuity Flexibility

Annuities are one of the most flexible savings vehicles today. You can use after-tax money to deposit into an annuity, or you can fund your annuity by rolling over qualified money.

For example, traditional IRA and 401(k) owners can transfer their accounts into a qualified annuity, which maintains their tax-preferred status. In some cases, annuities will offer fixed interest rates, added death benefits or other features from the insurance company that are not available in a qualified retirement plan. However, note that annuities will not provide additional tax deferral benefits in a qualified account and that the death benefits may come at an added cost.

Non-qualified (or "after-tax") annuities are just as popular. Because no rollover from another account is involved, non-qualified annuities often require less time to establish. In addition, when you withdraw funds, you'll only pay taxes on your accrued interest, since your principal was already taxed once before (when you earned it).

Up until this point, we've focused primarily on options available during the accumulation phase. But what about the payout phase, when the annuity returns its value to you? Fortunately, annuities can also provide incredible flexibility during the payout phase.

When the payout phase begins, you can opt to receive your annuity's value in one lump sum or in a steady stream of payments at regular intervals (e.g. monthly, quarterly, etc.).

If you opt for a regular stream of payments, many insurers will allow you to have annuity payments last for a set amount of time (such as 10 or 20 years). Many contracts also allow you to receive payments for as long as you and your spouse live. For many annuity owners, having indefinite payments for the rest of their lives provides a predictable source of income.

As a rule of thumb, the longer your payment period, the smaller your payments will be. These conditions are clearly spelled out in the terms of the annuity.

Want more flexibility? Some annuities are designed to be immediate. Immediate annuities have no accumulation phase whatsoever. They begin paying you in regular increments the moment you purchase the contract.

Choices to Consider

When shopping for an annuity, there are several considerations that must be weighed.

Immediate vs. Deferred Income

When it comes time to withdraw your money out of an annuity, you have a variety of payment options to choose from. The insurance company either can pay you in a lump sum, make periodic payments or guarantee you a lifetime of income on a tax-advantaged basis. Depending on the annuity contract you purchase, the choice is yours.

Qualified vs. Non-Qualified

Annuities can accommodate qualified or non-qualified money. For instance, suppose you are switching jobs and need to move over a 401(k). However, you already have an IRA and are looking to diversify your portfolio. You can reduce your portfolio exposure by rolling into an annuity and not be forced to lose your money's tax advantages.

In another scenario, suppose you receive an inheritance of $20,000. If you don't need the money right away and want to build a long-term nest egg, consider putting the inheritance into an annuity. You'll gain the advantage of tax deferral. Plus, when it comes time to withdraw from your non-qualified annuity, you'll only be taxed on the accumulated interest, not the principal itself.

Insurance Company

The quality of the insurance company is important, especially when purchasing a fixed annuity. Working with a respected, highly rated insurer can help eliminate default risk and ensure a retirement income when you need it most. Having a solid insurer is also vital if your annuity has any additional death benefits or rate guarantees. 

Common Benefits

All annuities share several common benefits. Here's a summary of what annuities can bring to your retirement portfolio:

  • Ideal for Estate Planning: Proceeds from annuities pass directly to your beneficiaries without the delay, expense and publicity of probate in most states. If you've ever had a loved one's estate go through this time-consuming legal process, you know just what kind of advantage this is.
  • The Power of Tax Deferral: Because you do not pay taxes on earnings every year, your annuity is able to work harder thanks to tax deferral. You will have to pay taxes on earnings when you withdraw your annuity's gains, but at least you can decide when that happens.
  • No Contribution Limits: Contributions to other retirement savings vehicles, like 401(k)s and individual retirement accounts, are strictly limited. Annuities, however, offer tremendous flexibility. You can contribute as much as you want -- up to the limits imposed by the insurer -- to take advantage of tax deferral or variable accounts inside the annuity. Plus, you can add to your annuity contract at any time.
  • Flexible Payment Options: Unlike 401(k)s and IRAs, which require that you begin making withdrawals at age 70 1/2, you may be able to wait much longer with annuities. When you do decide to begin receiving payments, you can usually select one of the following methods:
    • Lump-sum distribution (a one-time payment)
    • Periodic distributions (you can take money only when you need it)
    • Systematic distributions (a fixed or variable amount is sent to you at regular intervals)
    • Annuitization (fixed or variable payments, guaranteed for the rest of your life)

Different distribution methods behave differently when it comes to taxes; for instance, lump-sum, periodic and systematic distributions exhaust all earnings (which are taxable) before tapping principal. Under annuitization, each payment consists of both principal and interest, spreading your tax liability evenly among payments.

Through these distribution options, you have complete control over when you will pay taxes on your earnings.

  • Tax Control: The money inside your annuity is made up of two components — principal and earnings. Assuming your annuity was opened with after-tax dollars, you're only taxed on your earnings.

Annuities are not perfect when it comes to tax control. If you pass away while your annuity is accumulating, all deferred taxes on your growth will become due, reducing your annuity's value.

  • Easy to Start and Maintain: Usually, a simple application, a check and your signature begins your annuity. And, at the end of each year, you will not receive a 1099 for income earned within your annuity contract. That's one less thing to worry about when April 15th rolls around.
  • Other Features: Annuities also do not offset Social Security benefits like bonds, CDs and other investment income sources do.

Annuities are easy to establish and often come with a "free-look period." Your state of residence or the annuity contract will define a length of time (usually 30 days) when you can cancel your contract if you decide it's not right for you.

You can even exchange older, non-performing annuities into a newer fixed annuity with no tax consequences, thanks to Section 1035 of the Internal Revenue Code.

If you are a conservative investor looking for a consistent way to build your retirement savings, then fixed annuities may be the answer for you. However, if you are financially savvy and believe you can do better choosing your annuity's direction, we would be glad to describe the benefits that variable annuities may be able to provide for you. Please contact us for an individual discussion.

Modified Endowment Contracts (MECs)

For nearly two decades, tax-deferred annuities have enjoyed remarkable popularity. Most tax-deferred annuities require a single premium payment in the beginning, which then accumulates on a tax-deferred basis.

However, annuities are not perfect. For instance, if you pass away while your annuity is accumulating, all deferred taxes on your growth suddenly become due. Annuities with substantial growth could be reduced significantly, and your children and grandchildren could end up with a fraction of your annuity's value after taxes.

For retirement savers looking to preserve a little more wealth for their family, there may be a solution: a type of life insurance policy known as a modified endowment contract (MEC). In financial circles, MECs are often compared to annuities because of their similarities. In fact, MECs are technically life insurance contracts that have many of the benefits of accumulation found in annuities, but if anything happens to you, your loved ones will usually receive more than your initial premium, not less.

The Basics of MECs

The same insurance companies that issue annuities also underwrite modified endowment contracts. MECs are very similar to annuities in terms of tax-deferred accumulation of your initial premium.

However, the tax code is not very favorable, particularly if the owner passes away during the annuity's accumulation stage. If that happens, all deferred income taxes on growth become due. MECs are able to overcome this by including an insurance "rider" in the contract, designed to pass the entire account value to your beneficiaries income tax-free. While specific features will vary by company, MECs offer several distinct advantages over deferred annuities and other wealth-accumulation vehicles:

  • MECs avoid income taxes during the accumulation stage of your account;
  • MECs do not force you to make distributions by a particular age, like some IRAs and 401(k)s;
  • MECs allow you to make withdrawals or loans in cases of emergency;
  • MECs give you the flexibility to choose between fixed and variable account options;
  • MECs provide a lump sum payment to heirs that is tax-free;
  • Unlike annuities, MECs can be owned by certain types of trusts without losing their tax-advantaged status

MECs can provide a retirement income for you while preserving your legacy for your loved ones.

Reducing Taxes

The Internal Revenue Code provides tax advantages for MECs, regardless of whether you choose a fixed MEC or a variable MEC. Insurance products have always received very favorable treatment by Congress, and MECs are no exception.

Unlike stocks and mutual funds, which are taxed every year, any earnings within your MEC remain untaxed as long as they stay within the MEC account. You choose when to pay taxes, since income taxes on the growth of your MEC are due only upon withdrawal. Over the long haul, this tax-free accumulation can produce dramatic advantages.

Tax deferral provides this added value, because of the time value of money. Compare the accumulation of a jumbo CD and an MEC, and let's assume both are earning 7 percent. The CD is taxed on the earnings, reducing your net interest rate. If you're in the 27 percent tax bracket, you're actually earning 5.11 percent.

However, for the MEC, it's a different story. Since income taxes are deferred, the MEC is credited with the full 7 percent.

Of course, CDs have much shorter maturities than MECs, and they're offered by banks (not insurance companies). CDs are also FDIC-insured, while MECs are not. Plus, remember that when funds are finally withdrawn from the MEC, income taxes will be due. However, your MEC money will have worked harder for you, thanks to the time value of money on your side.

Long-Term Strategy

Tax deferral is wonderful, but there is a small price to be paid in terms of liquidity. MECs can grow without annual income taxes being paid, because they are designed for retirement.

Like annuities and traditional IRAs, money placed inside an MEC must remain there past age 59 1/2. If you make a withdrawal from the MEC before that age, the IRS will slap a 10 percent penalty on any withdrawals made. For this reason, they are not liquid and should remain in there until you're ready to draw money in the form of retirement income.

It's important to make a distinction between "liquidity" and "flexibility." Although MEC money must remain inside the retirement account past 59 1/2, that does not mean you don't have options.

To the contrary, many fixed MECs offer a wide variety of payout options to suit your needs.

Variable MECs go one step further, allowing you to choose from several variable accounts. These variable accounts are often run by the same professional money managers who run mutual funds. And if you have a favorite mutual fund, chances are the mutual fund manager also runs variable accounts for use in variable MECs.

Let's not forget that as long as your account is accumulating and no withdrawals are made, no Form 1099s reporting income will be generated. At the very least, this maintains a degree of privacy. And, in many states, MECs also offer asset protection from creditors. If anything happens to you, your MEC also avoids probate. Resembling annuities once more, MECs pass probate-free to your named heirs. This probate bypass will spare your family the time, expense and public exposure that probate can bring.

When purchasing an MEC, it's important to look at the quality of the issuer. If you were buying an annuity or life insurance policy, you'd want a highly rated insurance company behind your purchase. MECs are no different, since the same insurance companies that offer traditional life insurance and annuities also offer them.

If you're concerned about your MEC issuer's stability, there are many safeguards already in place by law. For instance, in a variable MEC, each variable account is in a separate custodial trust. Your money is invested with the separate portfolio managers and is not commingled with the issuer's general accounts.

Once you purchase an MEC, you don't have to keep it forever. Section 1035 of the Internal Revenue Code allows you to switch from one MEC to another without incurring taxes on the growth of your MEC. However, if you switch to another MEC before your guarantee or "maturity" period has expired, you may incur company-imposed surrender charges. Always check those charges carefully before choosing your MEC.

Plus, MECs usually have a death benefit higher than the actual cash value. This feature is especially useful for variable MECs, since your family may be guaranteed a death benefit greater than the payments you made, no matter what happens with the performance of your variable accounts.

Roth IRA

Roth IRAs, unlike traditional IRAs, have a simple premise: You pay income tax going in, rather than when you pull out. The Roth IRA represents an enhanced level of flexibility for people saving for their retirement.

The Roth IRA is a type of account that you establish through a qualified broker. Any contributions that you make to your Roth IRA are considered "after-tax" and cannot be deducted from your tax return. However, when it is time for you to draw money from your account, you will not pay income taxes on the growth of your account. If you're in a high tax bracket, that can amount to tremendous savings.

Just like a traditional IRA, Roth IRA accounts can hold stocks, mutual funds and other types of investments. Retirement-minded investors, looking to build their nest eggs, can open a Roth IRA brokerage account and invest it like they would any other account. However, unlike other types of brokerage accounts, your broker will usually ask you to pick a designated beneficiary for your Roth IRA funds, should you pass away with the account open.

People who are still working and are eligible to contribute more have to think about what kind of IRA they should contribute to. This is especially true if you have already accumulated a large IRA, perhaps from the rollover of a retirement plan, and if you want to know whether you should convert that pot of money into a Roth IRA.

If you have accumulated a large traditional IRA, you can elect to convert the entire account to a Roth IRA. Upon conversion, you must declare the entire IRA taxable balance as taxable income and pay taxes on it in the year of conversion. From that point on, the IRA is federal income tax-free during compounding, and federal income tax-free when you pull money from it (if you have held the Roth IRA for at least five years, you are age 59 1/2 or meet other requirements).

If you are a mature American with a large IRA, you have a big decision. Should you convert your nest egg to a Roth IRA? In many cases, it makes sense. If you qualify for a conversion, you may save thousands of dollars for both yourself and your heirs.

Better to Pay Now or Later?

Are you better off waiting to pay taxes or paying them now? For many, paying your taxes owed now is the smart thing to do. Forget the math — just know that politicians like to spend other people's money. After all, Uncle Sam could collect his pound of flesh later or just a few ounces now. Traditionally, the U.S. government prefers to collect its money now, even if the long-term goal is more reduction of the budget deficit.

In what circumstances should you not convert your existing IRA to a Roth IRA? One instance is if your tax bracket is higher now than your heirs' tax bracket will be when the money is spent. Also, be very careful if you aren't sure about falling under the $100,000 ceiling. Converting and then later discovering that your income was higher could blow up in your face, creating significant tax penalties.

From an estate planning standpoint, if your main goal is to accumulate as much as you can and leave it for your heirs, conversion can make a lot of sense. Traditional IRA owners must begin taking distributions by age 70 1/2. However, Roth IRAs require no minimum distributions each year during the life of the IRA owner, nor on the life of the IRA owner's spouse. If you want to keep your money growing on a tax-preferred basis longer, then the Roth IRA may hold your solution.

A Look at the Numbers

Suppose you own $20,000 of growth stocks in a qualified IRA, and you believe it will be worth $60,000 by the time you spend it.

For simplicity, you are in a 36 percent tax bracket now, and you expect to be in the same bracket in the future.

If your assumptions are correct and you leave your IRA alone, the IRA will grow to $60,000. After paying $21,600 in taxes, you will have $38,400 of spendable cash.

But suppose, in the beginning, you made the conversion to a Roth IRA. You convert, using $7,200 from the account itself to pay the immediate tax bill. The remaining $13,600 triples to $38,400.

The two outcomes are identical. In this scenario, there's no difference between the two, unless you were under age 59 1/2, in which case money taken from the Roth IRA account to pay tax would also be subject to a 10 percent early withdrawal penalty.

However, there is another option. Suppose you convert to a Roth IRA in the beginning and come up with the $7,200 in initial taxes from some other source of cash that would not have qualified for tax-deferred compounding.

Assuming the same growth rate, your Roth IRA would have tripled in value to $60,000 (a full $21,600 more). Best of all, the entire amount would be income tax-free when you needed to make withdrawals, plus, there would not have been a 10 percent tax penalty on money taken from the account if you were under age 59 1/2.

Sure, you're missing that $7,200 from your outside account, and that money could have grown. However, its growth would have been stunted by the fact you were paying taxes on the income all along.

Remember: In this case, the "time value of money" is definitely on your side. The Roth trade is a bad one for Uncle Sam and a good one for you.