Annuities: Getting the Most Income (Morningstar)

Improving Your Finances

Four Strategies for Combating Low Annuity Yields

By Christine Benz | 12-22-11 | 06:00 AM

To help avoid outliving their assets, more retirees should defer Social Security and consider income annuities, according to a report prepared by the General Accounting Office for the U.S. Senate's Special Committee on Aging.


Yet many retirees do just the opposite, according to data presented in the report. Between 1997 and 2005, roughly 43% of Social Security-eligible individuals began taking benefits within one month of turning 62, even though waiting until their full retirement age would've translated into a substantially higher payout.


Retirees also skimp on annuities, according to the study, even though several research papers, including one from Ibbotson Associates, have demonstrated that the products can help ensure that individuals don't outlive their savings. Between 2000 and 2006, just 6% of retirees with defined-contribution plans such as 401(k) and 403(b) plans chose to move their assets into an annuity upon retirement, according to the GAO study; nearly 40% of these folks left their money in their accounts following retirement, while another one third rolled the assets over into an IRA. (The GAO's data follows participant behavior shortly after individuals retired; the report acknowledges that these same retirees may have chosen a different strategy for their retirement savings at a later time.)


Why Are People Avoiding Them?
Academics and finance professionals specializing in retirement income have conducted research into why investors are so resistant to annuities. One key impediment is pretty straightforward: loss of control. In contrast with traditional investment assets that you can alter and tap whenever you see fit, a key premise behind annuities is that you fork over a lump sum in exchange for a stream of payments throughout your life. Those payments may ultimately add up to more than you'd be able to take out of a nest egg composed of stocks, bonds, and cash, particularly if you live a long time, but the irrevocability of the decision to purchase an annuity is a key psychological barrier.


Another woefully underdiscussed reason that so few retirees opt for annuities is that payouts from plain-vanilla, single-premium immediate annuities are painfully low. In mid-2010, the difference between fixed annuity payouts and five-year certificate of deposit rates actually dipped into negative territory. Although the situation for fixed-annuity buyers has improved somewhat recently, the payouts still aren't compelling: In early 2011, fixed-annuity rates, on average, were just 0.39% higher than five-year CD rates. Of course, immediate-annuity buyers are guaranteed their income for life, even if they live to be 115. But they're also giving up control of their assets.


Annuity payouts have been depressed in part by increasing longevity: With payouts being spread over very long lives and few purchasers dying prematurely, that has the net effect of shrinking payouts for everyone in the annuity pool. (There's also some evidence that those purchasing annuities tend to be healthier with the likelihood of living longer than the general population, which could serve to depress annuity payouts further.)


Those factors are likely to be long-term headwinds for annuities. But the other factor depressing annuity payouts is apt to be more temporal: rock-bottom interest rates. For an immediate annuity, your payout will consist of just a few key elements: whatever interest rate the insurer can safely earn on your money as well as any mortality credits (the amount the insurer expects to be able to reallocate from those who die prematurely to those who survive), less the insurance company's fees. With interest rates on very safe investments barely breaking into the black, it's no wonder that annuity payouts have sunk, too.


The current rate environment argues against plowing a lot of one's assets into an immediate annuity all in one go, but that doesn't mean that investors should completely dismiss annuities (and the promise of lifetime income they provide) out of hand.


Here are four strategies for playing it smart with an immediate-annuity purchase.


1. Consider Your Need
Fixed immediate annuities will tend to make more sense for some retirees than others. Those who have a substantial share of their lifetime living expenses accounted for via pension income or Social Security will likely want to diversify into investments over which they exert a higher level of control and have the opportunity to earn a higher rate of return, such as stocks. Those who don't have a substantial source of guaranteed retirement income, meanwhile, will find greater utility from annuity products.


2. Be Patient
Although the negative effects of longevity are unlikely to go away soon, rising interest rates will eventually translate into higher annuity payouts. Don't expect substantially higher payouts right out of the box, particularly given that the still-shaky economy is apt to keep a damper on interest rates, and in turn annuity payouts, in the near term. But interest rates don't have much more room to move down, and it's worth noting that as recently as a decade ago, annuity rates were nearly double what they are today.


3. Build Your Own Ladder
One of the key attractions of sinking a lump sum into an annuity is the ability to receive a no-maintenance, pensionlike stream of income, which is particularly appealing for retirees who don't have the time or inclination to manage their portfolios on an ongoing basis. However, a slightly higher-maintenance strategy of laddering multiple annuities can help mitigate the risk of sinking a sizable share of your portfolio into an annuity at what in hindsight could turn out to be an inopportune time. If, for example, you were planning to put $200,000 into an annuity overall, you could invest $40,000 into five annuities during each of the next five years. Such a program, while not particularly simple or streamlined, would also have a beneficial side effect in that it would give you the opportunity to diversify your investments across different insurance companies, thereby offsetting the risk that an insurance company would have difficulty meeting its obligations.


4. Consider More Flexible Options
Throughout this article, I've been focusing on the simplest of annuity types--fixed-rate immediate annuities. These vehicles are typically the cheapest and most transparent in the annuity world, but they're also the most beholden to whatever interest-rate environment prevails at the time the purchaser signs the contract. It's worth noting, however, that the annuity universe includes many products with more bells and whistles, including some that address the current yield-starved climate by allowing for an interest-rate adjustment if and when interest rates head back up. Such products offer an appealing safeguard to those concerned about buying an annuity with interest rates as low as they are now, but the trade-off is that the initial payout on such an annuity would tend to be lower than the payout on an annuity without such a feature. A key rule to remember when shopping for annuities is that as you layer on safety features, such as survivor benefits and the ability to participate in higher payout rates in the future, you'll likely increase your costs and reduce your monthly payout, at least at the outset of your contract.


A version of this article appeared July 14, 2011.

When is an annuity a good retirement strategy? SPIA advice (Forbes.com)

For Some Retirees, This Annuity Makes Sense
Mel Lindauer, 07.30.10, 12:00 PM ET

We've talked about a number of different types of annuities in our previous columns. We discussed nonqualified deferred variable annuities in the first and second columns in this series on annuities. We covered qualified deferred variable annuities in our third column, and in our fourth column we talked about fixed deferred annuities.

Based on these previous columns, you might be getting the feeling that Bogleheads are against all types of annuities, but you'd be wrong. We're against high-cost annuities that trap investors into substandard investments for long periods of time using often-hidden surrender periods and the associated high surrender fees. We're also against annuities that are sold by unscrupulous salespersons who sometimes "hoodwink" (often older) investors into investing with them by providing false or misleading information about the annuity products they're selling.

However, despite all the negatives and cautions we've mentioned in our previous columns, we do feel that annuities can be appropriate in certain situations. In earlier columns we listed some situations where a low-cost variable annuity may make sense in both non-qualified and qualified situations.

In this column, we'll talk about another type of annuity which could play a role in some retirees' overall investment planning, and that's a single premium immediate annuity or SPIA.

A single premium immediate annuity offers an income stream that will last as long as the annuitant (or joint annuitant, if that option is selected) lives or for a predetermined period, depending on the option selected at the time of purchase. The fixed immediate annuities include nominal, graded and inflation-adjusted payment options. There is also a variable option in which the payout is determined by the returns on the investments chosen by the investor.

In exchange for these payments, the annuitant surrenders a specific amount of money to the insurance company. These payments can be based on a single or joint life. Normally this purchase is irrevocable, and the money used to make the SPIA purchase is not available to one's heirs, even if the annuitant dies shortly after purchasing the annuity, unless a predetermined payment period was selected. However, selecting one of the available term-certain payment options will result in lower payments.

An SPIA is probably one of the easiest annuity products to understand. You give the insurance company a specific sum of money in exchange for an income stream that you can't outlive. The SPIA can offer peace of mind in bridging income shortages. For example, if a retired couple needs $4,000 per month to cover their living expenses, and Social Security and pensions provide $3,000 per month, they could purchase an SPIA that would pay out the needed $1,000 per month for as long as either one of them lived. However, they would need to keep in mind that most annuity payments aren't indexed for inflation, so over the long term, the spending power of that $1,000 would decrease.


Should the couple choose to purchase one of the few inflation-indexed SPIAs available, they'd have to either pay a higher premium or receive a lower initial payment. And since inflation-indexed annuities are only offered by a few insurance companies, there's not a lot of competition to help make those rates attractive for the annuitant. Finally, it's important to remember that the return of your principal is included in the promised payment stream.

An SPIA can also provide a "bridge" that could allow an investor to delay taking Social Security until later in life. Doing so could mean larger Social Security payments to both the recipient and his/her spouse. Boglehead Ron explained his use of an SPIA this way: "In our case, we used it as ‘SS gap insurance' since I retired at 59 but will not claim SS till age 70 (primarily for the benefit of my wife)."


Using a period-certain SPIA as a bridge to Social Security may be a valid strategy for some folks like Ron. However, for many relatively young retirees, the period-certain option is probably not the best choice. Remember, the insurance company has to plan to pay for the rest of your longer-expected life, so that means you'll receive lower payments. In addition, because of the longer expected payout period, you magnify default and inflation risks since the insurance company has to remain solvent for a very long period of time and inflation will almost surely erode the yield over those longer periods. As an alternative to taking the inflation-indexed option, consider purchasing TIPs at the Treasury auctions and holding them to maturity, since TIPS both preserve capital and protect against inflation.

In another recent Bogleheads.org forum post, author and forum leader Taylor Larimore listed a number of valid reasons why he and his wife, Pat, purchased an SPIA. He stated that "The primary reason we bought our lifetime annuities was so that we could give our heirs their inheritance while we're living. The annuities assure us (and them) that we will not run out of money no matter how long we live." Taylor then went on to list a number of other reasons that he and Pat considered important in their decision to annuitize a portion of their savings:

"Our annuities give us a guaranteed income of approximately 10% of premium (using interest and principal). This is more than we could get from any other safe investment.
"Our annuities immediately reduced our estate for tax purposes and offered protection from lawsuits.
"It was very comforting to have a steady income and protection of principal during the recent bear market.
"Our annuity income is only partially taxable.
"It will be much easier for survivors to not worry about this part of our portfolio." Here are some situations where an SPIA may make sense:

For someone who is in good health and has a family history of longevity.
For folks who are afraid of running out of money before running out of breath.
For investors who don't know how to properly manage their assets or who don't care to do so.
For an investor who is concerned about a surviving spouse who has no knowledge of, or interest in, investing.
For people who have no heirs or who have no desire to leave the funds used to purchase the annuity as part of their estate.

There is no one rule that covers every situation or every investor. However, if one or more of the above situations apply to you, then there's a good possibility that an SPIA may be appropriate for you

Obama and Annuities (New York TImes)

January 30, 2010
Your Money
The Unloved Annuity Gets a Hug From Obama
By RON LIEBER
Annuities: The official retirement vehicle of the Obama administration.

As slogans go, it’s hardly “Keep Hope Alive,” or even “Change We Can Believe In.”

But there were annuities, in a report from the administration’s Middle Class Task Force that came out this week. They are among the tools the administration is promoting as it tries to give Americans a better shot at a more secure retirement.At its simplest, which is how the White House seems to want to keep it, an annuity is something you buy with a large pile of cash in exchange for a monthly check for the rest of your life.

If the biggest risk in retirement is running out of money, an annuity can help guarantee that you won’t. In effect, it allows you to buy the pension that your employer has probably stopped offering, and it can help pick up where Social Security leaves off.

President Obama did not discuss annuities in his State of the Union address on Wednesday night, probably figuring that viewers had enough problems staying awake. But the mere mention of them by the task force was enough to send executives at the insurance companies that sell the products into paroxysms of glee.

“I never thought I’d have the president as a wholesaler for us,” said Christopher O. Blunt, executive vice president of retirement income security at the New York Life Insurance Company. “This is awesome. I’m trying to see if I can get him to do a big broker meeting for us.”

He’s unlikely to turn up for such an event just yet. After all, the announcement from the White House did make it clear that the administration was looking to promote “annuities and other forms of guaranteed lifetime income.” That suggests the administration is open to other solutions, though there are not many others that are as simple as the basic fixed immediate annuity (also known as a single premium immediate annuity) that delivers a regular check for life.

Still, all of this attention from the president is a stunning turn of events for a rather unloved product. Many consumers reflexively run in fear when salesmen turn up pitching high-cost and complex variable annuities, which evolved from their simpler siblings decades ago. Today, the Securities and Exchange Commission maintains an extensive warning document on its Web site for investors considering the variable variety.

Meanwhile, almost all employees on the precipice of retirement who have access to annuities as a payout option steer clear when their companies offer them. While various surveys show that roughly 15 to 25 percent of corporations offer annuities to workers who are retiring, including big employers like I.B.M., a 2009 Hewitt Associates study reported that just 1 percent of workers actually bought one.
“I joke sometimes that we’re the best ice hockey players in Ecuador,” said Mr. Blunt of New York Life, which sells more fixed annuities than any other company, according to Limra, a research firm that tracks the industry.

So what are these soon-to-be retirees so afraid of? And what makes the White House so sure it can change their minds?

Let’s start with the fears. Early on, the knock on annuities was that once you died, the money was gone. So let’s say a 65-year-old man in Illinois turned over $100,000 in exchange for $632 a month for life, a recent quote from immediateannuities.com. If he died at 67, his heirs would get nothing while he would have collected only about $15,000. (On the other hand, it would take him until age 78 to get $100,000 back, but that doesn’t take inflation into account.)

The industry solved this by coming up with variations on the policy, allowing people to include a spouse in the annuity or guarantee that payouts to beneficiaries would last at least 10 or 20 years. This costs extra, of course, meaning your monthly payment is lower.

Others worried about inflation, so now there are annuities whose payments rise a few percentage points each year or are pegged to the Consumer Price Index. These cost extra, too (often a lot extra).

You see the pattern here. Every time someone had an objection — the need for a bunch of payments at once, a lump sum in an emergency or concern about rising interest rates — the industry created a rider to add to policies to make the concern go away (and make the monthly payment smaller).

Besides, people need to have saved enough to purchase a decent monthly annuity payout in the first place. But plenty of retirees haven’t been saving in a 401(k) or individual retirement account long enough to have a good-size lump sum.

There are also stockbrokers and financial planners standing in the way. Once money goes into an annuity, they can’t earn commissions from trading it anymore and may not be able to charge fees for managing it. Financial advisers have a charming term for this phenomenon — annuicide. You insure, and their revenue dies. So, many of them will try to talk you out of it.

One reasonable point they might make is that insurance companies can die, leaving your annuity worthless. State guaranty agencies exist, but they may cover only $100,000 to $500,000. I’ve linked to a list of the agencies in the Web version of this column so you can see what they insure.

Even if you get over all these mental hurdles, however, the hardest one may be the difficulty of seeing a big number suddenly turn small.

“It’s the wealth illusion, the sense that my 401(k) account balance is the largest wad of dollars I’ll ever see in my lifetime, and I feel pretty good about having that,” said J. Mark Iwry, senior adviser to the secretary and deputy assistant secretary for retirement and health policy for the Treasury Department. “Meanwhile, I feel pretty bad about the seemingly small amount of annuity income that large balance would purchase and about the prospect of handing it over to an entity that will keep it all if I’m hit by the proverbial bus after walking out of their office.” So how might the Obama administration solve this? It could get behind a Senate bill that would require retirement plan administrators to give account holders an annual estimate of what sort of annuity check their savings would buy. That way, people would get used to thinking about their lump sum as a monthly stream.

Tax incentives could help, too. A recent House bill called for waiving 50 percent of the taxes on the first $10,000 in annuity payouts each year. “If this is behavior that the administration is trying to inspire, then it’s not that long of a leap to think that maybe they’ll start to promote some version of these bills,” said Craig Hemke, president of BuyaPension.com, which sells basic annuities (and offers some good educational material for people who are trying to learn about the products).

Mr. Iwry, who is one of the intellectual architects of the administration’s examination of annuities, wouldn’t say much about what might happen next. But one paper he co-wrote two years ago suggests a clue.

As the treatise suggests, the administration could nudge employers into automatically depositing, say, half of new retirees’ lump sums into a basic annuity or other lifetime income product, unless they opt out. Then, they could test the thing out for two years and see how that monthly paycheck felt. If they liked it, they could keep the annuity. If not, they could cancel it without penalty and get the rest of their money back.

Annuities won’t be right for everyone (people in poor health should probably steer clear). And they’re not right for everything because it rarely makes sense to put all of your money in a single product or investment.

You could, for instance, use an annuity to cover the basic expenses that your Social Security check doesn’t cover. You might also use the money to buy long-term care insurance, which would keep nursing home bills from becoming a budget-destroyer.

But the president has one thing right: The basic annuity is almost certainly underused. Sure, you may be able to arrange a better income stream on your own, but not without a lot of help from a financial planner or a lot of time managing it yourself. Then there’s the possibility, however small, that you’ll spend too much in spite of yourself or run into a once-in-a-generation market event that will cause you to run out of money sooner than you expected.

All of that makes basic annuities the ultimate test of risk aversion. If you buy some, you and your heirs may have less money than if you’d kept your retirement savings in investments. Then again, if you guarantee enough of your retirement income, you — and those same heirs — won’t have to worry about how you’re going to meet your basic needs.

A Fresh Look at Variable Annuities (from the Wall Street Journal)

JULY 22, 2009

Long Derided, This Investment Now Looks Wise

Thanks to Guarantees, Variable Annuities Paid Even When Stocks Didn’t
By LESLIE SCISM

One of the best investments of the past decade was one of the most derided: the variable annuity. But investors who want in on the action now are in for a shock, as the juiciest deals have disappeared from the market.

Variable annuities, a tax-advantaged investment account that holds a type of mutual fund, are sold by insurers, and most offer some form of investment guarantee for an additional fee. For years, they were attacked for being too expensive. Why pay for a guarantee to protect against a stock-market decline, the argument went, when stocks continued their inexorable march upward?

From Loathed To Loved
Guaranteed-minimum variable annuities have turned out to be a smart buy for many investors. Here are some key considerations:

The issuer is on the hook to make up for investment losses. Investors can’t withdraw the guaranteed amount in a lump sum. It is paid out over years.Investors should buy from insurers with high ratings.Then stocks plunged, and variable-annuity guarantees no longer looked expensive. In fact, insurers, in a move to build market share, had underpriced many of them. Suppose an investor owned a variable annuity that tanked in value last year. No matter. Under the most-generous contracts, insurers pledged to pay customers lifetime retirement income based on past market gains in their underlying funds, plus minimum annual increases in years the market is sluggish or down.

Because of such guarantees, many holders of variable annuities actually saw their accounts increase 6% or more in value last year, when the Standard & Poor’s 500-stock index dropped nearly 39%.

“When I watch friends bemoaning the market, I feel guilty saying anything, actually,” says Amy White, a 67-year-old retired accountant in Dallas. She and her late husband invested hundreds of thousands of dollars in variable annuities early this decade, and their funds rose as the market neared its 2007 peak. While they fell last year, the guaranteed amount—on which Ms. White’s retirement-income checks will be based—is still more than double the invested amount.

“I know that I’m doing quite well,” she says, while her friends are “experiencing real pain.”

An estimated $300 billion of these retirement-income guarantees are outstanding, compared with $3.7 trillion in stock mutual funds.

Variable annuities still have some notable drawbacks. Among the biggest: There is no lump-sum option for cashing out the guaranteed amount. Instead, the higher guaranteed amount is payable by the insurer over time, with 5%-a-year payouts common for those in their 60s when they start receiving checks. If you cash out all at once, you get only the shrunken sum that remains in your funds. Another concern: The insurers have to stay healthy enough to cut all those checks.

So far, though, it is the issuers’ stockholders who are getting the raw end of the deal. To meet their annuity obligations, the roughly two dozen insurers who dominate the field have boosted their claims reserves, which has hurt earnings, and have raised fresh capital, which dilutes existing shareholders. Hartford Financial Services Group Inc. and Lincoln National Corp., two big issuers of variable annuities, also have accepted money from the U.S. government’s Troubled Asset Relief Program.
Variable-annuity sales were down 27% in the first quarter, as stock investments of many sorts took a dive. Those buying typically are in their 60s, says Thomas Hamlin, a top broker at Raymond James Financial Inc., though 40- and 50-year-olds are increasingly interested. “People are sick of sliding back down to the base camp after they felt like they were about to put their flag in the top of the mountain,” Mr. Hamlin says, and the guarantees are the investment-world equivalent of “rope and ice spikes.”

The guarantees are no longer as sweet, yet what is still for sale is “better than the alternative: mutual funds with no downside protection,” says Mr. Hamlin.

In scaling back the products, many insurers are reducing the size of the minimum annual boosts to the guaranteed income base—or the value of the underlying investments combined with any investment gains and minimum annual boosts. For instance, the “Accumulator” variable annuity of AXA SA’s AXA Equitable Life Insurance Co., a year ago offered an income-base guarantee calculated with a 6.5% minimum annual-growth factor, while the new version uses 5%. Many also are reducing the annual withdrawal payouts by about one percentage point, while fees are up about a fifth of a percentage point, according to Milliman Inc.

Some formerly big players have suspended sales of guaranteed variable annuities entirely. Of those still available, MetLife, like AXA Equitable, promises to boost the income base by 5% a year in most states, if there aren’t investment gains greater than that on contract anniversary dates. Ohio National Life Insurance Co. also has an offering with a 5% minimum annual income-base boost, and 6% versions still for sale in some states.

Around since the 1950s, variable annuities originally were pitched for their tax-deferred buildup of investment earnings; they’re akin to 401(k) plans in that taxes are paid as the money is withdrawn. Insurers in the 1980s began tossing in a “death benefit”: If your underlying funds perform badly, your heirs will receive at least your original principal, less withdrawals.

Critics included Moshe Milevsky, a finance professor at the Schulich School of Business at York University in Toronto, who crunched data in the 1990s and concluded that consumers were being “grossly overcharged.” At the time, variable-annuity fees approached 3% of the account balance, more than twice that of a typical mutual fund.

His findings were widely circulated among consumer advocates, financial commentators, regulators and plaintiff lawyers. One of the big beefs has been that many insurers pay big commissions to salespeople, which may encourage them to push the products regardless of their suitability, including to many elderly people who would need access to their money during periods when surrender penalties apply.

In recent years, the landscape has shifted. In a bid to cash in on baby boomers’ fears of outliving their savings, insurers were adding “living benefits”—investment guarantees that kick in while the owner is still alive. So two and a half years ago, Prof. Milevsky updated his research, making an about-face: “Some insurance companies are not charging enough,” given the cost of risk-management instruments that insurers can buy to protect themselves, he wrote in 2007 in Research Magazine.

Some on Wall Street, seeing a bargain, bought annuities for their personal portfolios. Consider Colin Devine, an insurance-stock analyst at Citigroup Global Markets. He has been bearish on some insurers as stock investments because of the guarantees, even as he owns guaranteed variable annuities from MetLife Inc., Lincoln, ING Groep NV, Manulife Financial Corp.’s John Hancock Life Insurance Co. unit and Pacific Life Insurance Co.
Prof. Milevsky recommends that individuals who lack old-fashioned pensions put a portion of their savings into the products to create personal pension plans. Even with the cutbacks, “overall, I still believe that these products make sense for individuals approaching retirement,” he says.

Many in the industry are eager to see consumers’ response to John Hancock’s newly launched “AnnuityNote.” The investor’s money is invested in an indexed stock and bond portfolio. After five years, the contract guarantees a 5%-a-year lifetime withdrawal based on the total amount invested or the value of the fund investments at the fifth contract anniversary, whichever is higher. There is no automatic income-base boost in bad market years. Total annual fees: 1.74%.

Such streamlined guarantees are expected to proliferate. Just this week, MetLife introduced “Simple Solutions,” to be sold through banks, which similarly locks in investment gains annually but promises no minimum income-base boost.

Erin Botsford, president of Botsford Group in Frisco, Texas, used to be an “anti-variable-annuity person,” but became a convert after the tech-stock crash. Advisers often focus on performance and fees, she says, when the client really wants to know: “Where should I invest my hard-earned savings in order to ensure I can have a comfortable retirement that I cannot outlive?”

Write to Leslie Scism at leslie.scism@wsj.com

WSJ on Annuity Strategies for Retirement Income - Fixed, Variable, Deferred

APRIL 18, 2009

Getting Smart About Annuities These products can be loaded with traps and fees. But there are valuable ways to use them to build a pension -- and salvage your nest egg.
Article in Wall Street Journal Encore Section

By ANNE TERGESEN and LESLIE SCISM
For years, many retirees were content to act as their own pension managers, a complex task that involves making a nest egg last a lifetime. Now, reeling from the stock-market meltdown, many are calling it quits -- and buying annuities to do the job for them.

In recent months, sales of plain-vanilla immediate annuities -- essentially insurance contracts that convert a lump-sum payment into lifelong payouts -- have hit an all-time high.

That's a big change from a few years ago. Then, the hot products were variable annuities whose value fluctuates with an underlying investment portfolio. Many purchase these products with riders that protect against stock-market losses and guarantee a minimum paycheck for life.

Annuities in general have never been popular with many financial advisers. For the most part, the products don't offer the potential for outsized gains. And once you hand over your money to an insurer, you either can't get it back or can do so only by forfeiting at least some of the guarantee you've paid for. Variable annuities, in particular, can be ridiculously complex and loaded with fees and hidden traps.

But for those grappling with investment losses, annuities today have an undeniable appeal. At first glance, they offer a way to restore some financial security to what are supposed to be your golden years. There is even evidence that retirees with regular paychecks are happier than those who rely exclusively on 401(k)s to supplement their Social Security. The latter "are more prone to depression due to concern about running out of money," says Stan Panis, a director in Sherman Oaks, Calif., for Advanced Analytical Consulting Group of Wayland, Mass., and author of a study about annuities and retirement satisfaction.

The problem: While many investors have a general idea of what an annuity is, few understand the strategies available for making these products a part of their holdings. You have to figure out how much to buy, whether to put your money to work immediately or gradually, and how to invest what remains.


Here are some of the best ways to do that.

Immediate Gratification
The immediate annuity is relatively straightforward: It allows you to convert a payment into monthly, quarterly or annual income for life. Most immediate annuities are fixed, which simply means they pay an amount that's established at the outset.

Typically, immediate annuities provide a significantly higher level of sustainable income than you'd be able to produce from your investment portfolio, assuming you stick to the convention of withdrawing no more than 4% of your nest egg per year. For example, a 65-year-old man who buys an immediate annuity today will receive some 8.4% a year of the amount he invested in the annuity.

The extra income is the result of the requirement that you surrender your principal to the insurer. Each payment consists not just of interest, but also of a portion of your principal, prorated over your remaining life expectancy. The payments are guaranteed to continue for the rest of your life. But when you die, they stop -- regardless of whether you've recouped the amount you paid for the annuity.

If you are willing to settle for a lower income, you can buy features designed to overcome some of the drawbacks of a traditional annuity. With one, for instance, your heirs will receive a set number of years of income if you don't live to collect it. (First, though, check whether buying a life-insurance policy would be cheaper.) Another raises payments by 2% or more annually to keep up with inflation -- a key feature, given the way inflation can erode purchasing power.

How much should you put into an annuity? If Social Security plus any pension you receive won't cover your monthly budget, many economists recommend buying an annuity for an amount that bridges the gap.

But if you're worried about leaving something for your heirs, Jim Otar, a financial planner in Thornhill, Ontario, recommends this approach: Annuitize just enough to meet your income needs -- in conjunction with the 4% annual withdrawals from your investment portfolio that most investment advisers consider prudent.

Consider a 65-year-old man with $1 million of investments who anticipates spending $60,000 a year, in addition to Social Security. That amounts to 6% of his $1 million -- a level that exceeds the recommended 4% withdrawal level. To not risk depleting that nest egg, the man would have to pare spending to $40,000 a year, indexed to inflation. Alternatively, he could put about $720,000 into an immediate annuity that would produce some $60,000 a year for life.

Another option from Mr. Otar: Put $450,000 into an annuity, which would give the man a payout of nearly $38,000 a year for life. To produce the other $22,000 needed to cover his annual expenses, he could withdraw the recommended 4% from the $550,000 that remains of his initial $1 million.

Of course, if the $550,000 nest egg declines in value, the man's income will fall, too. If so, he may have to tighten his belt or purchase an additional annuity, Mr. Otar says. But if he dies tomorrow, such an arrangement ensures his heirs will receive much more -- $550,000 versus the $280,000 he would have with an annuity that produces the entire $60,000 in income.

Longevity Rider
Another way to preserve more for yourself or your heirs is to buy a deferred-income annuity with a longevity feature. Like a conventional immediate annuity, this one produces an income for life. But the payments typically don't kick in until the policyholder turns 80 or 85. For $71,300, a 65-year-old man can get a $60,000-a-year payout starting at age 85; that compares with $714,430 for an immediate annuity, according to insurer MetLife Inc., whose product is called longevity income guarantee.

Knowing that this safety net will be in place, you may be able to withdraw a greater percentage of your savings earlier in retirement than would otherwise be prudent -- some 5% to 6% a year, compared with the typical 4%, says Jason Scott, managing director of the Retiree Research Center at Financial Engines, a Palo Alto, Calif., firm that manages 401(k) accounts. Payments may be timed to kick in when you may need help with rising medical or long-term-care costs.

When should you buy an annuity with a longevity rider? "When you retire," says Mr. Scott. The longer you wait, the more you'll pay for a given level of benefits, simply because your chances of surviving to receive payouts improve as you age.

In contrast, with a conventional immediate annuity, economists are divided over whether it's best to buy at retirement, or after age 70. That's when an unpleasant reality sets in: Your peers start dying in big enough numbers that the financial benefits of joining them in an annuity pool start to outweigh the costs.

Wading In
One way to hedge your bets is to "ladder" your purchases -- by buying immediate annuities in bits and pieces over time.

Proponents say that by doing so you'll reduce the odds of buying at an inopportune time. For instance, when interest rates are low -- as is the case today -- insurers offer skimpier payouts because they stand to earn less on the corporate and government bonds that back their payments.

Another reason to stagger your purchases: It gives you some flexibility to adjust your annuity purchases if your circumstances change, says Benjamin Goodman, director of actuarial consulting services at TIAA-CREF, a New York-based provider of low-cost annuities.

How should you construct your ladder? Mr. Otar uses this rule of thumb: First, decide how many years to spread the purchases over. Those who feel they can afford to take some risk may want to spread purchases over as many as four years, he says.

Then, he says, "the amount of premium you pay in the first year should be twice as much as in the second year, and so on." Someone who wants to annuitize $300,000 over three years should commit roughly $170,000 in year one, $85,000 in year two, and $45,000 in year three. By advising clients to buy more upfront, Mr. Otar seeks to reduce the amount of money that an individual would have at risk in the event of a bear market. (Sample Mr. Otar's calculator, which costs $99.99, free of charge at www.retirementoptimizer.com.)

Of course, these days, trusting your future to an insurer -- even a top-rated one -- requires a leap of faith. But in the event of an insurer's insolvency, industry-funded associations provide at least $100,000 in coverage for the guaranteed portions of annuity contracts held at an insolvent company. Check the site of the National Organization of Life and Health Insurance Guaranty Associations (www.nolhga.com) for links to your state association's Web site, where, generally in the FAQs section, you can find the coverage limit.

So as not to exceed this limit, divide your purchases among highly rated carriers, says David Babbel, a professor of insurance and finance at the University of Pennsylvania's Wharton School.

When shopping, compare quotes from a number of insurers and mutual-fund companies. Web sites such as immediateannuties.com can help.

Upside Potential
While an immediate annuity will generate regular paychecks at once, it does nothing to help rebuild a depleted nest egg. That's where variable annuities with "living benefits" come in.

A variable annuity, in its simplest form, combines tax-deferred savings and, potentially, investment gains -- typically in mutual funds -- with insurance. So when you die, and even if the investments perform poorly, your heirs get a payout. Variable annuities with living benefits have investment-performance guarantees that kick in while the annuity owner is alive -- even if the investments tank.

The most popular form of a living-benefit rider sold in recent years provides a monthly income check from the date you elect benefits to start until you die, with benefits depending on your age at the start date. Some contracts also allow you to buy additional riders that let the income stream continue to a spouse.

These products give you the chance to benefit, after fees, from any market increases, and the insurer protects you on the downside. At a minimum, you get back your initial investment, spread out in monthly checks beginning at some point after you turn 59½, an age set by law. This is called the guaranteed-minimum-benefit base.

Under many living-benefit contracts, the buyer has two, and sometimes three, account balances to monitor. The first tracks the actual value of the stock-fund and bond-fund holdings. The others are different formulations of the guaranteed-minimum-benefit base. When you are ready to tap your income payments, the highest balance is used to calculate the payments.

Many contracts ratchet up the guaranteed base annually to incorporate investment gains in the underlying mutual funds, and many versions sold in recent years promise 5% to 7% compounded annual growth of the initial investment.

The bad news: The best deals are rapidly being pulled from the market. Insurers are trying to bring the guarantees in line with higher hedging costs and to meet stiff capital regulatory requirements showing they can make good on their promises.

So how are variable annuities best used, and who should buy them? In general, these are products for relatively well-off baby boomers, people whose investments total $500,000 to several million dollars. The most logical candidates are people in their 50s who don't need to convert investments into an income stream for at least five or 10 years. Those who need an income stream right away generally are better off buying immediate annuities.

A variable annuity with a guaranteed minimum benefit "gives you the fortitude to be in the market" if your inclination is to hunker down in safe but low-yielding investments as you enter the final stretch toward retirement, says Jerome Golden, president of Massachusetts Mutual Life Insurance Co.'s Income Management Strategies division.

Unlike immediate annuities, guaranteed-minimum variable annuities generally give buyers access to their principal should their plans change. But many contracts contain restrictions that make it costly to do so. Also, if the underlying investments perform badly and the payouts end up based on the higher guaranteed-minimum-benefit base, you must take the money in a stream of payments over years. There's no lump-sum payout of the guaranteed benefit base.

If you want all your money back, you will have to cash out the smaller sum that remains in your stock and bond funds, not the higher guaranteed amount.

Another caveat: If you withdraw more than the designated maximum annual amount, you could damage your minimum-payment guarantee. In such cases, the insurer has the right to reduce the amount it is obligated to pay out over your lifetime. The formulas for reduction vary from insurer to insurer.

What's Selling
For all their shortcomings, these guaranteed-minimum variable annuities appeal to many as a source of retirement income. The top seller is a type with a "guaranteed lifetime withdrawal benefit," under which owners can annually withdraw a specified maximum percentage of their fund account or guaranteed-benefit base, whichever is higher. Contracts sold in recent years generally allow 5%-a-year withdrawals for 60-year-olds, and 6% withdrawals for those in their 70s.

But in what has become a trend, Pacific Life Insurance Co., a top-10 variable-annuity seller, as of Jan. 1 reduced the withdrawal rate to 4%, from 5%, for new customers in their 60s in one of its popular offerings. Numerous other insurers have followed suit in making these reductions, and industry executives and consultants expect more announcements in coming weeks.

The other main type is a "guaranteed minimum income benefit" variable annuity. It generally requires you to annuitize to tap into the guaranteed-benefit base -- although thanks to the competitive frenzy, some contracts offer both withdrawal and annuitization features.

A word of warning: On the annuitization contracts, variable-annuity issuers often use life-expectancy estimates that are favorable to them in determining the level of annual payments. The result: Annual payments that could be significantly smaller than if you had the ability to shop around for the best deal.

Either way, annual fees typically total more than 3.5% of the account balance, and price increases now being pushed through by many companies are bringing costs to about 4%. The fees come out of the owner's fund account, which means they cut into the investment return.

All in all, the complexities of the contracts generally mean they need to be bought through financial advisers.

The Right Blend
In addition to protecting a portion of your nest egg, annuities can -- at least in theory -- help you rebuild the rest. The logic, says Moshe Milevsky, an associate professor of finance at the Schulich School of Business at York University in Toronto, is that with some income guaranteed, you may feel comfortable investing more of your portfolio in stocks. The big decision those in or near retirement face, he says, is "how much to allocate to regular stocks, bonds and mutual funds, versus" annuities with income guarantees.

To solve this puzzle, first figure out how much of your portfolio you'll need to annuitize. The percentage will depend on how much income you need as well as whether you use variable or immediate annuities.

For example, a 65-year-old man with a $1 million nest egg can generate $50,000 a year by putting about $600,000 into an immediate fixed annuity. Alternatively, he can get the same $50,000 with a variable annuity that allows for a 5%-a-year withdrawal -- but only if he puts the entire $1 million into the contract.

He also can use a combination of the two. For example, he might put $400,000 into an immediate annuity that produces $33,500 a year and $325,000 into a variable contract that plugs the $16,000 or so gap -- assuming it has a 5%-a-year withdrawal feature.

To figure out how to invest the $275,000 that remains of his $1 million, this individual would first have to figure out which bucket -- conservative or risky -- his annuities belong in.

With immediate fixed annuities, it's straightforward: "These are substitutes for bonds," says Tom Idzorek, chief investment officer at Ibbotson Associates, which designs portfolios of stocks, bonds and annuities. So, if the man above with the $1 million portfolio were to put $400,000 into immediate fixed annuities, he would effectively hold 40% in bonds.

Variable contracts with income guarantees, on the other hand, can be treated as either stocks or bonds -- and their classification may change over time. Such an annuity should be viewed as a bond substitute when the money invested substantially declines in value. That's because the insurer guarantees that, at the very least, you'll receive a bond-like 5% annual return on your initial deposit for the rest your life, says Prof. Milevsky. If, however, the investment fares well, you should treat it as part bond and part stock.

How much should be assigned to each? First, look at the way the money in the variable account is invested. Ideally, those who buy these products should pick the riskiest blend allowed -- say, 70% in stocks and 30% in bonds. (As insurers try to reduce their exposure to risk, many are requiring annuity buyers to put at least 30% into bond funds.)

But due to the guarantee, the variable annuity's actual risk profile is more conservative than it appears. Assuming an investment horizon of 20 or more years, a 70/30 investment mix would behave more like a 50/50 combination, says Mr. Idzorek.

As a result, a 65-year-old man who puts $325,000 into a variable-annuity contract for all practical purposes has 50% of the value, or $162,500, in stocks and 50% in bonds.

As a percentage of his $1 million portfolio, this translates into 16% in stocks and 16% in bonds. Combined with the $400,000, or 40%, he invested in immediate fixed annuities -- in the example above -- the man would have a total of 56% in bonds and 16% in stocks. If his goal is to achieve an overall portfolio mix of 40% in stocks and 60% in bonds, he ought to put the vast majority of the $275,000 that remains in his portfolio into stocks, says Mr. Idzorek.

—Ms. Tergesen is a staff reporter for The Wall Street Journal in New York. Ms. Scism is a news editor for the Journal in South Brunswick, N.J. They can be reached at encore@wsj.com.
Printed in The Wall Street Journal, page R1
Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

The New Build America Bonds (from Reuters)

Treasury unveils Build America Bonds
Thu Apr 9, 2009 3:35pm EDT
By Lisa Lambert and David Lawder

WASHINGTON (Reuters) - The U.S. Treasury said on Friday that states and municipalities using new "Build America Bonds" created under the economic stimulus law face limits on their use, with the deepest subsidies reserved for capital projects.

The bonds, a new type of debt aimed at overcoming obstacles presented by stressed municipal bond markets, pay interest that can be taxed, but offer a tax credit for the buyer, according to Treasury guidelines released Friday.

In place of the tax credit, issuers may opt to receive a direct payment from the federal government equivalent to 35 percent of the interest costs. Issuers who elect to take the subsidy are limited in how they can use the debt.

While the tax credit bonds can be used to finance the same kinds of expenditures as tax-exempt governmental bonds, those with the direct subsidy "generally may not be issued to refinance capital expenditures in 'refunding issues,'" the Treasury said.

Treasury is breaking with other federal programs that authorize states to issue debt, such as the one for mortgage bonds, by not setting constraints on how many bonds can be sold. In the same light, it is not capping the amount it will pay in subsidies. Time seems to be the major limit, as the bonds must be sold within the next two years.

The subsidy was included to entice buyers, such as foreign investors, who may not need the credit, Treasury said.

"As a result of this federal subsidy payment, state and local governments will have lower net borrowing costs and be able to reach more sources of borrowing than with more traditional tax-exempt and tax credit bonds," it said.If a state issued a bond at a 10 percent taxable interest rate, it would receive a subsidy equal to 3.5 percent of that interest and then would only pay 6.5 percent on the bond.

"What this does is provide the market with enough specificity for issuers to go forward, especially in direct pay Build America bonds," said Philip Fischer, municipal strategist at Bank of America Merrill Lynch.

The tax credit bonds would most likely be taken up by larger issuers, he added, and some mutual funds have already expressed interest in buying Build America Bonds.

"They did a good job," said Carol Lew, a Newport Beach, California, bond attorney, although questions remain about what happens to the bonds post-issuance. "This is a new animal, we're going to have to get used to it."

Lew, a former head of the National Association of Bond Lawyers, said the Treasury will need to explain if the bonds can be refunded or refinanced in the future, and whether issuers can make changes in their use.

"Are issuers at more of a risk of an IRS audit because they're now dealing directly with the IRS?" she said about the Internal Revenue Service.

"These bonds give state and local governments a new, direct injection of capital to jump-start infrastructure projects that will create jobs and improve our cities and towns," said House Ways and Means Committee Chairman Charles Rangel, the New York Democrat who helped draft the stimulus plan, in a statement.

Rangel also lauded the Treasury Department for quickly setting up the program. The IRS will begin making payments on the tax credits on July 1, Treasury said.

Treasury also announced the allocations of the $11 billion school construction bonds and the $1.4 billion Qualified Zone Academy Bonds, which can be used to retrofit school facilities, included in the stimulus law.

The bonds, which grant investors tax credits in lieu of interest payments, are allocated according to certain formulas and the construction bonds are granted to states and the 100 largest school districts based on current levels of federal school funding. California will receive the largest allotment, of $773.53 million, followed by Texas, which will be able to issue up to $53.59 million bonds.

Guidance on the stimulus law's Recovery Zone Economic Development Bonds will be released soon.

(Additional reporting by Michael Connor in Miami; Editing by Leslie Adler)


© Thomson Reuters 2009. All rights reserved. Users may download and print extracts of content from this website for their own personal and non-commercial use only

Morningstar Advisor on Immediate Annuities

Immediate Annuities: The Key to Retirement


by Judith A. Hasenauer | 04-02-09


We love the cartoon of the family gathered around the lawyer's office for the reading of the will with the lawyer stating the will's contents: "Being of sound mind, I spent it all." Unfortunately, this joke begs the question of how can we guarantee that we and our money expire at the same time? Or, at the very least to make sure that the money does not end before we do. Although we all would like to be able to leave some of our hard-earned nest egg to our children, our first obligation is to ensure that what we have gathered lasts us for the remainder of our lives once we retire--particularly with ever increasing longevity and the financial instability rampant in the world economy. After all, it is better to have "spent it all" rather than having to move in with our children because we outlived our assets.

For the very wealthy, longevity is usually not a problem. However, for the vast majority of people, even those we like to refer to as the "working affluent," outliving funds for retirement is a matter of great concern (some politicians and the news media like to refer to the "working affluent" as "rich," but the term "rich" is, in our opinion, very relative). At the time the Social Security system was initiated in 1937 the life expectancy of the average recipient was only a few short years. Today, increased longevity has everyone expecting many times the expected longevity of 1937. It is not unusual for a working person today to expect to spend longer in retirement than she did working! Thus, fewer years are available to garner assets than there will be to spend the same assets in retirement. The actuaries tell us that it is likely that a married couple, with a 10-year disparity in age, where one reaches age 65, have a probability that one of the two will still be alive in 30 years! Thus, the need for longevity planning.

We have all read about the problems faced by the under-funding of the Social Security system and the problems we will all face when the 77 million "baby boomers" retire. It should be obvious to any serious observer that everyone needs to plan for funding their own retirement rather than to expect that employers or the government will handle it for them--particularly not in view of ever-increasing longevity.

So, how do we handle the problem of increasing longevity? How do we ensure that we and our money end at the same time? The only sure answer is with a payout annuity.

Annuities take many forms. Variable annuities are designed to provide a hedge against inflation because of the vast choice of investment options that underlie them. Fixed annuities provide a certainty because of the guaranteed amount of regular annuity payments. Unfortunately, few provide inflation protection. Index annuities provide both the certainty of guarantees plus a potential hedge against inflation because of the availability of an index that can provide for investment growth. Annuities also take different forms relating to premium payment modes and relating to when payouts begin. We are all familiar with the deferred annuities that have become such an important element in the financial market in recent years. Payout annuities--often referred to as "immediate" annuities are less well known, but of great importance in longevity planning.

Virtually all commercial annuities offered by life insurance companies in the United States have annuity payout options that are guaranteed for so long as the annuitant lives. This is true whether the annuity is deferred or immediate. The basic payout option is simple. The insurer guarantees payments for the life of the annuitant and they stop with the payment immediately prior to death. This "straight life annuity" is rarely selected because it does not provide for hedged alternatives that are appealing to retirees. Thus, payout options often include payments for joint lives, or for life and a period certain with payments guaranteed to a beneficiary if the annuitant dies prior to a specified term of five, 10 or 20 years.

Generally speaking, payout annuities used in connection with qualified pension plans provide for payments for the joint lives of the retiree and his spouse. This is to ensure the spouse is not left destitute on the death of the retiree. Annuities used with qualified pension plans can take two forms: They can be "individual retirement annuities" that are treated similar to IRA Rollovers, or, if the pension plan permits, they can be regular annuities purchased by the retirement plan's trustees for the benefit of the retiree. Annuities should be an important component of any qualified retirement plan because most qualified retirement plans do not provide payments that are guaranteed for the life of the retiree. Instead, they merely distribute the proceeds from the retirement plan to the retiree and leave it to her to determine how to invest it and to plan for longevity. Without a payout annuity, there is a significant risk that retirees will outlive the funds they have accumulated for their retirement.

The federal government, in the legislation covering retirement plans, has dictated that distributions from such plans must be for life or for "life expectancy," as determined by the mortality tables published by the Internal Revenue Service. Unfortunately, "life expectancy" is not "life." There is no requirement that retirement plans guarantee that a retiree will not outlive her retirement funds. Moreover, even if a retiree establishes a payout scheme that makes payments for her IRS determined "life expectancy," there is still a better than 50/50 chance she will live longer than the life expectancy established by the IRS mortality tables. The IRS mortality tables state that, at the end of any life expectancy for any age group, half of the group will still be alive. This half will have outlived their retirement funds if they chose to take them for their life expectancies.

The IRS mortality tables also can mislead a retiree because they are based on the total American population--not just those of us fortunate enough to retire with a qualified pension plan. Thus, it is more likely that employed persons participating in a qualified retirement plan will, as a group, live longer than will the general American population that includes drug addicts, homeless persons and those with no employer-sponsored medical plans. This means that the likelihood if people retiring with qualified retirement plans have an even greater risk of outliving their retirement funds--unless they take distribution of some part of their retirement funds in the form of a payout annuity guaranteed for life.

The retirement crisis facing our country for the next 15 years is profound. The Social Security system is under great pressure, lifetime pensions guaranteed by employers have virtually disappeared from the landscape and it is up to everyone to ensure that their funds last for their lives. Immediate payout annuities are the easiest way to ensure that you and your retirement funds expire at the same time. The alternative is not a comfortable one to contemplate.

//
from morningstar.com

Lock In Lifetime Income (Immediate Annuities) from WSJ

MARCH 28, 2009, 11:19 P.M. ET

Lock in a Lifetime of Income

By TOM LAURICELLA
Tough times in the markets are renewing interest in an old, reliable investment for retirement: immediate annuities.

These insurance products convert your cash into a stream of income that can be guaranteed to last the rest of your life. With many retirees staring at double-digit losses on their portfolios, that kind of reassurance is attractive.


Unlike some annuities that are complicated and expensive, immediate annuities are usually fairly straightforward. However, comparison shopping among insurers is essential because their payouts vary.

An immediate annuity can function just like a pension, producing a predictable payout. As the "immediate" part of the name suggests, the distributions start shortly after the money is invested. The trade-off with an annuity is that in exchange for that guaranteed payout, an investor gives up control of the money.

Payouts largely depend on an investor's age -- the older the investor, the bigger the checks -- and on the level of interest rates. These annuities are worth considering for retirees who tap their portfolios to pay day-to-day expenses and stand a chance of using up their savings.

'Shifting the Risk'
"You're shifting the risk that you'll outlive your money over to the insurance company," says Scott Stolz of Raymond James Financial.

If you're relying on your portfolio for living expenses, financial planners typically suggest withdrawing no more than 4% a year, to limit the risk of outliving your funds; in contrast, with an annuity, you'll get a bigger starting payout.

For example, an immediate annuity offered by Vanguard Group would convert a $100,000 investment from a 65-year old couple in Pennsylvania into $604.69 a month for life. (This policy comes with 100% joint survivorship, which means that when one spouse dies, the survivor continues to receive the full payout. It's possible to get higher payouts for a lower survivor percentage.)

How much to annuitize?

One strategy is to get a big enough check to cover essential expenses. Mr. Stolz suggests waiting a year or so into retirement to be sure of how much money is needed on a continuing basis.

One problem with getting a fixed payout from an immediate annuity is that over the two or three decades that a retiree may live, inflation can eat into the value of that money. It takes more than $1,700 to buy today what it cost $1,000 to buy in 1989.

Inflation Protection
You can insure against that erosion of spending power by using an annuity that adjusts to inflation. This feature comes with a cost, however. The same Vanguard annuity with an inflation-adjustment rider pays out $151 less per month initially, $453.49.

That may sound like a big difference, but inflation could more than reverse that gap over the course of retirement. If the consumer-price index rises 3% a year, the monthly payout on that inflation-adjusted annuity would hit $609 in 10 years -- matching the quote on the non-inflation-adjusted annuity -- and reach $818 in 20 years.

Paula Hogan, a financial adviser in Milwaukee, notes that the current environment, in which the inflation rate is declining, raises an additional issue: Some inflation-adjusted annuities, such as Vanguard's, can lower payments if consumer prices fall and then increase them again if prices subsequently rise.

Add Annuities Over Time
As an alternative way to contend with the inflation challenge, Ms. Hogan recommends some clients annuitize portions of their portfolio over time. That allows them to increase their income stream as needed, as well as to diversify among different insurers.

How much do payouts vary among insurers? A recent sampling of eight major insurers done for Encore by Hueler Cos. -- a firm that has an online annuity quote service for advisers -- found a difference of $108 between the highest and lowest payouts on a $100,000 annuity for a 65-year-old couple.

"I can ask 10 companies for the same exact type of annuity and get 10 different quotes," says Kelli Hueler, chief executive of the firm.

Email: encore@wsj.com

Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

Retirement Rescue - Annuities (from Bankrate.com)

Check annuities for retirement rescue

By Melissa M. Ezarik • Bankrate.com


In a crowd of average Joes and Janes, you'll be hard-pressed to find anyone who knows a lot about annuities, but you'll likely find plenty with a generally negative feeling about them.

That connotation may be well-deserved, yet in today's volatile investment climate annuities might represent a safe haven.

Tom Warschauer, professor of finance at San Diego State University, says, "The insurance industry has not done a very good job recommending products that specifically fit their clients' needs. They look at what they want to sell and find a place for them in everyone's portfolio."

One big issue has been the lack of transparency about charges embedded in annuity products, and since it's difficult to decipher those costs, "There's a lot of room for abuse," says Warschauer, who's also a professor of finance and director of the Center for the Study of Personal Financial Planning at the university.

Beth Almeida, executive director of the National Institute on Retirement Security agrees. "The costs associated with the purchase of individual annuities eat away at the overall retirement nest egg. So a retiree may get a regular check, but their overall retirement income is diminished."

But in today's uncertain and volatile market, "retirees and near-retirees are likely seeking safe haven," says Almeida. And Warschauer agrees, annuities "have some very valuable uses in retirement planning" in this economic climate.

During your working years, return on investment is generally the primary focus. But in retirement, "the new ROI is 'reliability of income,'" says Robert E. Sollmann Jr., senior vice president of MetLife's Retirement Strategies Group.

"The painful lesson we are learning from today's market is that the conventional wisdom -- 'diversify' -- isn't cutting it. International, commodities, U.S. stocks are all down. The guarantees provided by annuities that can deliver regardless of market performance" are needed to balance a retirement plan, Sollmann says.

Think annuities may be worth a look? With so many annuity types, it's easy to get overwhelmed by possibilities. Here are some directions that experts say pre-retirees and retirees should consider.

Let's start with some basic definitions: Annuities are life insurance contracts sold by insurance companies, brokers and other financial institutions that provide a regular periodic payment to a policyholder for a specified period of time. They are paid for before retirement in exchange for lifetime payments after retirement and are intended to provide a regular level of retirement income to meet day-to-day living expenses.


They come in two general categories:


• Fixed annuity. The insurance company guarantees the principal pays a minimum rate of interest. As long as the company is financially sound, money in a fixed annuity will grow -- and not drop -- in value. The growth in value or benefits paid may be fixed at a dollar amount, at an interest rate, or by a specified formula. The interest rate usually starts out as a fixed percentage and is adjusted annually.
• Variable annuity. Your money is invested in a fund similar to a mutual fund -- but one open only to that insurance company's investors. The amount paid out depends on the performance of that fund.

"I'm a real advocate of fixed annuities," says Warschauer, who compares it to a fixed vs. variable mortgage rate. "It's obvious with a fixed mortgage you're more secure. When you're in your retirement years, you really want to be able to count on the cash in-flow, and the fixed annuity does that." Of course, the fact that it's fixed means it doesn't go up with inflation. His recommendation: Package a growth element within your IRA or 401(k), and then shift money out into immediate fixed annuities for daily living expenses.

On the variable annuity route, consider products that come with bonuses or guarantees such as living benefit riders, says Bayne Northern, a national sales manager for Penn Mutual Life's Annuity Distribution System. Variable annuities that include bonuses "may actually 'replace' what you have just lost in the market."

But guarantees as part of a variable annuity come at an added expense, cautions Peter Miralles, president of Atlanta Wealth Consultants. In addition, he says, "Generally the guarantees are diminished when withdrawals are made while the market value is down."

Shaun Golden of Golden Wealth Management in Riverhead, N.Y., concurs about living benefit riders, which can be found in today's variable annuity contracts, offering a "lifetime of guaranteed income regardless of financial market conditions." Golden, who has positioned a portion of his clients' assets into these types of annuities, says he's getting expressions of appreciation for protecting "the income which we count on each month."

Sollmann says variable annuities with an income rider are worth considering for those who are still saving for retirement who want the potential to grow assets along with income protection, even in down markets.






More annuity choices
Among the many other annuities available:

Immediate (or income) annuity. Available as fixed, variable or a combination of both, the immediate annuity is designed to produce a stream of income soon after its purchase. This option would generally appeal to someone age 60 or older. Deferred annuities can be annuitized to become immediate annuities. Warschauer believes fixed immediate annuities are what near-retirees and retirees should consider first.

Deferred annuity. You give the company a large sum upfront or make monthly payments until you reach retirement age. The money grows tax-free until you retire. This works best for someone who has a big chunk of change to put down and at least 20 years for the money to grow tax-free before setting up a schedule of lifetime payments that would start after retirement.

Lifetime income annuity. This product provides income for the remaining life of a person (or people, if a two-life annuity is purchased), according to the Insurance Information Institute. The amount paid depends on age, the amount paid into the annuity, and (if it's a fixed annuity) an interest rate set by the company. David F. Babbel, professor of insurance and finance at The Wharton School at the University of Pennsylvania, says lifetime income annuities should play a substantial role -- 40 percent to 80 percent of retirement assets -- in the retirement arrangements of most people.

Inflation-adjusted annuity. This feature is one that is added to lifetime income annuities that protects one's purchasing power, regardless of whether inflation or deflation occurs, Babbel says, adding that only a handful of insurers offer this feature. He also suggests seeking an annuity with a preset annual rate of increase, such as 1 percent to 6 percent per year. As an alternative to the inflation-adjusted annuity, he suggests having a fixed immediate annuity with a deferred, flexible premium annuity as a supplement. The flexible premium annuity can be activated as needed, "and if inflation really takes off, you can use the flexible premium feature to increase the size of your annuity," he says.

Seek stability
A final word of wisdom that's especially important in today's market: Be careful whom you do business with. "An insurance company can go out of business," points out Warschauer. "There is no guarantee that if a company goes out of business, they won't take the variable annuity or fixed annuity holders with them."

That's why it's worth taking the time to do some research to find out how solid a company you're thinking of buying from. Check out:

A.M. Best WWW.AMBEST.COM
Moody's Investors Service WWW.MOODYS.COM
Standard & Poor's WWW.STANDARDANDPOORS.COM
TheStreet.com Ratings (formerly Weiss Ratings) WWW.WEISSRATINGS.COM


According to Warschauer, Weiss has had a reputation for doing the best job in predicting failure in insurance companies, although users have to pay to access information. With national firms, he adds, a company being licensed in the State of New York is a good sign of stability, since their insurance commissioner's department is "probably the best known with being careful with regulations."

Regarding worries over financial stability, Warschauer points out that ordinarily the industry purchases each other's customers when a company goes under. "They will buy that package of annuities and take them over. But there have been cases where the annuities have simply failed." Conclusion: Annuities can be a rescue vehicle for many retirees -- just proceed with caution.

Melissa Ezarik is a Connecticut-based freelance writer.