Annuities are insurance policies designed to protect retirement income by guaranteeing lifetime payments or payments for a set number of years. Because they are insurance products, they are regulated by each individual state, which includes the degree to which they're protected from lawsuits. Not all states treat annuities the same in this regard, and it could dramatically affect your retirement income.
People generally buy annuities to hold over a long period of time, during which they appreciate in value on a tax-deferred basis. Subject to certain conditions including age, the owner can annuitize the account at any time and turn it into a monthly income stream, either for life or for a fixed period of time. To varying degrees, states provide for the protection of annuities in both forms.
The benefit of the protections offered to annuities can be significant. For example, Florida exempts 100 percent of the cash value of annuities without exemption. If you live in this state, you cannot lose your annuity policy due to a lawsuit. This means you won't have to start over saving money for your retirement. In this sense, annuities are given protections very similar to 401k plans and other retirement accounts.
Not all states are as generous as Florida. For example, Pennsylvania only protects the first $100 of annuity income per month from lawsuits. Why the discrepancy? Insurance companies are regulated at the state level, not the federal government. Because of this, protections vary significantly from one state to the next, and some provide stronger protections for annuities. If you live in a state with weaker protections, though, you cannot do anything to protect your assets in an annuity once you are sued.
If you live in a state with weak protections for annuities, consider using a different type of retirement planning strategy. While you may never be sued, your assets will enjoy greater protection if they're kept in an IRA or a 401k plan, which are not insurance products but retirement savings programs which are shielded from creditor lawsuits by the federal Employee Retirement Income Security Act (ERISA). By diversifying your retirement savings, you may only expose a small portion of your assets to creditors while securing your own financial future.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007