In the world of small businesses, annuities often fly under the radar. That’s right, those are the things you might associate with your grandparents’ retirement plans. As a business owner, however, you’re missing out by not considering them. In addition to serving as retirement vehicles, they’re versatile tools that can make it easier for you to reach your financial goals and secure the future of your business.
First things first, what exactly is an annuity?
Think of it this way: you are making a deal with an insurance company. In return for a lump sum or regular payments, they promise to give you a steady income stream. With this plan, you can set up your own private pension with much greater flexibility.
Okay, that sounds good. But how can this actually benefit my small business?
Great question. Let’s explore some real-world examples.
Creating a retirement safety net.
As a business owner, you probably work long hours and wear many hats. Although retirement might seem far away, it’s crucial to plan ahead. As an income guarantee, annuities complement other retirement savings accounts, like 401(k)s or IRAs.
Think about it this way: you’ve poured your heart and soul into your business. When you retire, you might not want to sell it. With an annuity, you can leave it to your children or a trusted employee and still receive a reliable income. It’s like eating your cake and having it too.
Attracting and retaining top talent.
We all know how tough it is to compete with large corporations for the best employees. However, you can stand out by offering unique benefits. With pensions virtually extinct, offering an annuity as part of your benefits package can be a game-changer.
If you tell a potential employee, “Not only do we offer competitive pay, but we’ll help you build a secure retirement with an annuity, ” you’re sending a powerful message.
Funding buy-sell agreements.
If you have business partners, you need a plan for what happens if one retires, becomes disabled, or dies. This is where buy-sell agreements come in. These agreements can be funded with annuities, ensuring that if a partner needs to sell his or her share, there will be enough money.
Let’s say you and your partner own a successful bakery. If one of you suddenly passes away, the other needs to be able to buy the other’s share without disrupting the business. An annuity provides the necessary funds, ensuring a smooth transition. Furthermore, structuring these agreements with annuities has some tax advantages, which your financial advisor can explain.
Key person insurance.
How would your business cope if your top salesperson or tech whiz suddenly got sick? With key person insurance, you can protect yourself against the financial consequences of losing a significant employee.
There is the possibility of accumulating cash value within these policies through annuities. This way, a safety net can be provided to cover the replacement cost or keep the business afloat during difficult times.
Decoding the Annuity Alphabet Soup: Types You Need to Know
Okay, so you’re intrigued. But with all the different types of annuities, where do you start? Well, let’s break it down.
Fixed annuities. Predictability is your friend.
Imagine knowing how much money you’ll earn in advance. Fixed annuities are like that. In addition to giving you a predictable income, it guarantees an interest rate for a specific period.
Suppose you invest $100,000 in a fixed annuity that promises a 3% annual return. Regardless of market fluctuations, you know exactly what you’ll earn each year.
Variable annuities: Ride the market wave (carefully).
Like mutual funds, variable annuities let you invest in subaccounts if you feel comfortable with some risk.
For example, you may invest in a variable annuity tied to the stock market. The value of your annuity grows; in a bad market, it declines.
Indexed annuities: A blend of growth and protection.
Indexed annuities guarantee returns, but they are tied to a market index like the S&P 500.
For example, your annuity tracks the S&P 500, but you will not lose your principal even if the market crashes. Aside from upside protection, you also get downside protection.
Immediate annuities: Income now, please.
Do you need income right away? You can start receiving regular payments immediately with an immediate annuity.
Let’s say you sell your business and want a steady income. As soon as you invest the proceeds, you receive payments from the immediate annuity.
Deferred annuities: Grow your wealth over time.
In these annuities, your money grows tax-deferred until you start taking withdrawals.
For example, you could invest in a deferred annuity while your business thrives, letting your money grow tax-free.
Why Annuities Are a Business Owner’s Best Friend
Business owners face unique financial challenges. But annuities might be the secret weapon you’ve been looking for:
Asset protection: Shielding your wealth.
The assets of annuities are generally protected against lawsuits and creditors in many states. Even if your business faces legal challenges, your personal wealth is protected.
Let’s say you are threatened by a lawsuit. An annuity protects your personal assets, providing peace of mind.
Tax advantages: Growing your money efficiently.
You do not have to pay taxes on earnings until you withdraw them since annuities offer tax-deferred growth. As a result, your money will grow faster.
Your investments grow tax-free within the annuity, allowing you to reinvest all earnings and compound your wealth over time.
Retirement security: Your personalized pension.
There is a possibility that a business owner doesn’t have a traditional pension. But, it is possible to create your own retirement plan with an annuity, which provides you with a stable income during retirement.
Suppose you set up a deferred annuity, which will ensure you will have a reliable income when you retire, regardless of market conditions.
Diversification: Spreading the risk.
In addition to diversifying your portfolio, annuities reduce the impact of market volatility.
For instance, combining annuities with stocks, bonds, and real estate can create a balanced portfolio that can withstand economic fluctuations.
Finding the Right Annuity: It’s All About You
When it comes to choosing the right annuity, it’s like looking for the perfect business partner. Here are some things to keep in mind;
- Liquidity needs: How much access do you need? Early withdrawals from some annuities are subject to surrender charges. Consider how much access you need.
- Risk tolerance: How comfortable are you with risk? Fixed annuities have a lower risk, whereas variable annuities have a higher risk.
- Time horizon: When do you need the income? An immediate annuity provides income immediately, whereas a deferred annuity provides income over a long period of time.
- Tax implications: Maximize your benefits. If you consult a tax professional, annuities can be a good addition to your overall tax strategy.
Annuities and Business Succession: Planning for the Future
In business succession planning, annuities can play a vital role, such as;
- Funding for a Buy-Sell Agreement. Annuities can provide funds for the purchase of a partner’s shares.
- Income replacement. If you sell your business, an annuity is a great way to replace your income.
- Legacy planning. You can pass wealth tax efficiently to your heirs with annuities with death benefits.
Busting Annuity Myths: Setting the Record Straight
There are a few common misconceptions that need to be clarified;
- “Annuities are too expensive.” Several low-cost options are available, including fixed annuities and immediate annuities.
- “I lose control of my money.” Annuities often allow flexible withdrawals.
- “Annuities are only for retirees.” Annuities can benefit anyone, regardless of age.
Partnering With the Pros: Getting Expert Advice
Choosing annuities can be complicated, so consulting a financial advisor is essential. You can ask them the following;
- Which annuity types align with my goals?
- How does this fit into my financial plan?
- What are the fees and risks?
- Are there any penalties for early withdrawal?
Your Financial Fortress: Building a Secure Future
Business owners can benefit from annuities because they offer asset protection, tax advantages, and retirement security. Understanding the different types and working with a financial professional is key to creating a secure financial future.
FAQs
What is an annuity?
An annuity is a contract between you (or your business) and an insurance company.
In return for either a lump-sum payment or a series of payments, the insurance company promises to make periodic payments to you, either immediately or in the future.
Can a business own an annuity?
The answer is yes. Businesses, including corporations, partnerships, and trusts, can own annuities. Individuals, however, face different tax implications.
How are annuities taxed when owned by a business?
Unlike individuals, businesses cannot usually defer taxes on annuity growth. Any gain on an annuity owned by a business is generally taxed as ordinary income in the year it is earned. This is a critical distinction compared to annuities owned by individuals.
What are some potential uses of annuities for businesses?
Businesses can use annuities for a variety of purposes, including;
- Funding buy-sell agreements. In some cases, annuities can be used to buy out the shares in a business that a partner owns.
- Key person insurance. It is possible to use annuities to offset financial losses resulting from the death or disability of a key employee.
- Providing deferred compensation. Annuities can be used to fund executive deferred compensation plans.
- Retirement planning. Business owners can use annuities as part of their overall retirement income strategy.
What should business owners consider before purchasing an annuity?
Business owners should consider the following points;
- Financial goals. What are you trying to achieve with the annuity?
- Risk tolerance. How comfortable are you with market fluctuations?
- Tax implications. How will the annuity affect your business taxes?
- Fees and expenses. Annuities can be paid with surrender charges, mortality, expense risk charges, or administrative fees.
- Financial strength of the insurance company. It is important to ensure the company you will work with is financially sound and reputable.
Are annuities suitable for all businesses?
No. It depends on the business’s specific circumstances whether an annuity is suitable. To determine if an annuity is right for your company, consult a qualified financial advisor and tax professional.
Image Credit: Craig Adderley; Pexels
