These days, many people dream of an early retirement. Sometimes, early retirement is planned and, sometimes, it's not. Some workers are enticed by an early retirement incentive from their employer; while others are forced into the situation by a layoff or disability.
For whatever the reason, advisors are seeing more and more clients who retire from their job before reaching the normal Social Security retirement age. Many of these retirees choose to receive their Social Security benefit early even though it means a reduced monthly income.
Social Security reduces benefits by 1/180 for each month an individual retires before the normal Social Security retirement age. For example, if someone with a Social Security retirement age of 67 retires and begins receiving Social Security payments at age 62 (60 months early), his or her monthly Social Security benefit is reduced by 33%–significant reduction in retirement income. Depending on what other retirement assets a person may have available, the situation can adversely affect one's lifestyle during retirement.
Bridging The Gap
You may want to suggest to some of your clients who find themselves in the early retirement scenario to find another source of income to meet their needs until they reach normal Social Security retirement age. An immediate annuity can serve as a way to accomplish this in a simple and efficient way because you can design it to begin paying when your client retires and end when the Social Security benefits commence. Knowing that their Social Security payments will continue for life, your clients can retire when they choose–without the risk of running out of money later in life.
For example, suppose your client retires early from his full-time job at age 61, even though his normal retirement age for purposes of Social Security is 66. He decides to work part-time in a position outside of his original profession. Instead of taking Social Security benefits early and receiving reduced benefits for the rest of his life, you suggest your client consider an immediate annuity to fill the income gap until his normal retirement age.
Together, you determine after his part-time employment income, he needs an additional $20,000 annually before taxes to sustain his lifestyle for the next five years. He is in a 25% tax bracket. If he uses non-qualified funds to purchase the immediate annuity, he will benefit from the exclusion ratio and, therefore, will not need to generate the full $20,000. The exclusion ratio allows your client to exclude the amount of the annuity payment that represents a return of principal from his taxable income.
In this case, if your client purchases an immediate annuity for $75,000, he can generate an annual income of $15,972 for the next 5 years. The exclusion ratio for his annuity is 93%. This means 93% of the payments he receives will not be subject to income tax. Since the $15,972 is roughly equal to $20,000 before taxes, the annuity income will meet his needs for the next 5 years–without permanently reducing his Social Security payments–and in a tax-efficient manner.
