EDU Articles

Retained Earnings in Accounting and What They Can Tell You

In the vast landscape of financial accounting, retained earnings stand as a testament to a company's financial health and strategic decisions. They represent the cumulative net earnings or profits of a company after accounting for dividend payments. In simpler terms, they are the earnings that a company has chosen to keep and reinvest in the business rather than distribute to shareholders as dividends. This article delves into the intricacies of retained earnings and how they intertwine with annuities, offering insights into what they can reveal about a company.

Understanding Retained Earnings

At its core, retained earnings (RE) are the amount of net income left over for the business after it has paid out dividends to its shareholders. The term "retained" signifies that these earnings were not distributed but were kept by the company. Their fluctuation can be attributed to two main factors: the company's profit or loss and its dividend payments. When a company incurs losses or pays dividends, its retained earnings decrease. Conversely, when a company generates profit, its retained earnings increase.

The Strategic Importance of Retained Earnings

The decision to retain earnings or distribute them is a strategic one, usually left to company management. A company focused on growth might opt not to pay dividends or only dispense minimal amounts. Such a company would prefer to use its retained earnings to finance expansion activities, such as increasing production capacity, hiring more sales representatives, or launching a new product. On the other hand, a company with substantial retained earnings might engage in share buybacks or distribute them to shareholders.

Retained earnings serve as a critical metric for assessing a company's financial health. They provide a snapshot of the net income a company has saved over time, indicating its capacity to reinvest in the business or distribute to shareholders.

Annuities and Their Connection to Retained Earnings

Annuities, often guaranteed by insurance companies, provide various payout options based on an investor's preference. One can convert the entire balance of an annuity into a pension-like income stream for life or jointly on two lives. Interestingly, the payout from annuities tends to be higher than the safe withdrawal rate investors might use in an investment account, offering guarantees where they might not otherwise exist.

Annuities offer flexibility. For instance, with variable and fixed annuities, one can convert only a portion of the balance into an income stream, allowing the account to remain partially liquid. This is crucial since annuities become highly illiquid once income payments commence.

Several beneficiary options exist, such as "life with period certain" which guarantees income for a set number of years, even if the annuitant passes away. Other options include Life with Cash Refund or Life with Installment Refund, ensuring beneficiaries receive the remaining principal balance if the annuitant doesn't outlive it.

One of the most intriguing features of annuities is the legal transfer of the lump sum from the annuitant once exchanged for an income stream. This can serve as an asset protection strategy, shielding assets from lawsuits, Medicaid eligibility considerations, and other scenarios.

Retained earnings and annuities, though distinct, both offer insights into financial health and strategic decision-making. While retained earnings provide a window into a company's financial decisions and its ability to grow and reward shareholders, annuities offer individuals a range of options to secure their financial future.

In essence, understanding retained earnings and the nuances of annuities can empower both businesses and individuals to make informed financial decisions, ensuring growth, security, and prosperity in the long run.

Summary:

Payout options in the realm of annuities tend to be guaranteed by the insurance company providing the annuity and may come in many forms depending on the investor’s preference.

Annuities can pay income to the annuitant in a few ways. One of the ways is to turn the entire balance of the annuity into a pension-like income stream for life, or jointly on two lives.

The payout tends to be higher than the safe withdrawal rate that investors can use in an investment account, and it provides guarantees and surety where it wouldn’t exist otherwise. You can also elect to have these payments start off slightly lower, and then increase at a guaranteed rate, to keep up with the cost of living.

Another option, which can be present in variable annuities and fixed annuities, is to turn only a portion of the balance into an income stream, whether now or in the future, and thereby allow the account to be partially liquid to the owner since annuities are very illiquid once income payments start.

If on a joint life, you could elect to have the survivor paid a percentage of the original monthly benefit. Or, you can elect a “life with period certain” option, to guarantee that income is provided for a certain number of years, even if the annuitant has died.

The other options for beneficiaries include Life with Cash Refund, or Life with Installment Refund, both of which will pay the remaining principal balance to your beneficiaries if you do not outlast it.

There is also the Life Only option, which has the highest payout, because it releases the insurer from any further payments or obligations once the annuitant has died, even if it is right after the income payments have started.

On period income annuities, you can elect to take the balance as a series of payments for a set number of years, which depletes the principal amount in the account and any interest credited to it.

One of the interesting features of annuity contracts is that the lump sum no longer belongs to the annuitant, legally, once it has been exchanged for a stream of income. This can be an asset protection and preservation strategy to those seeking to keep assets out of consideration for lawsuits, Medicaid eligibility, and other situations.

Another option would be to take the entire accumulation amount out of the annuity as a lump sum, and either roll it into another annuity product or pay taxes on the gains.

Lastly, it is also common to take random, non-recurring withdrawals from the accumulated balance in the account, but it is worth remembering that non-periodic withdrawals are taxed on the gains first, in a Last-in first-out (LIFO) methodology.

What is the “Period Income” Option on Annuities?
What is the “Life Only” Option on Annuities?