Which is better, lump sum or pension (Fidelity)

Lump sum or monthly pension?

What you need to know about monthly and lump sum pension offers.

• FIDELITY VIEWPOINTS 
• – 12/19/2014

 

Faced with mounting pension costs and greater volatility, companies are increasingly offering their current and former employees a critical choice: Take a lump sum now or hold on to their pension.

“Companies are offering these buyouts as a way to shrink the size of their pension plans, which ultimately reduces the impact of that pension plan on the company’s financials,” says John Beck, senior vice president for benefits consulting at Fidelity Investments. “From an employee’s perspective, the decision comes down to a trade-off between an income stream and a pile of money that’s made available to him or her today.”

Pension buyouts can be offered to any current or former employee of a firm. You may be already receiving benefits as a retiree with an accrued (vested) benefit, or you may have a vested benefit from a former employer, or your current company may be offering you a pension lump sum buyout long before you retire.

Whatever the case, here’s how a pension lump sum offer typically works: Your employer issues a notice that by a certain date, eligible employees must decide whether to exchange a monthly benefit payment in the future for a one-time lump sum. If you opt for the lump sum, you’ll receive a check from the company’s pension fund for that amount, and the company’s pension (or defined benefit) obligation to you will end. Alternatively, if you opt to keep your monthly benefits, nothing will change, except the option to take a lump sum will be removed.

Some employers are also considering buying annuities for those who do not opt for the lump sum offer. In this case, your benefits will not change, except that the insurance company’s name will be on the checks you receive in retirement, and the guaranteed income will be provided by the insurance company.1 (As with offering lump sums, companies that switch to an annuity provided by an insurance company can remove the pension liability from their books.)

The process is relatively simple, but the decision about which option to take can be complex. Here are the pros and cons of each option:

Keeping the monthly payment

Pension plans typically provide a payment of a set amount every month from your retirement date through the rest of your life. You may also choose to receive lifetime payments that continue to your spouse after you die.

These monthly payments do have drawbacks, however:

• If you’re not working for the company making the offer, your benefit amount typically will not increase between now and your retirement date. During retirement, your life annuity payments typically do not come with inflation protection, so your monthly benefits are likely to lose purchasing power over time. An annual inflation rate of 3%, the average since 1926, will cut the value of your benefit in half in 24 years.
• Taking your pension benefit as a life annuity means you may not have access to enough money to fund a large, unexpected expense.
• Your ability to collect your payments depends in part on your company’s ability to make them. If your company retains the pension and can’t make the payments, a federal agency called the Pension Benefit Guaranty Corporation (PBGC) will pay a portion of them up to a legally defined limit. The maximum benefit guaranteed by the PBGC in 2014 is $4,943 per month for most people retiring at age 65. The monthly guarantee is lower for retirees before age 65 and larger for retirees age 65 or older. If responsibility for your payments shifts to an insurance company, it will be the insurance company and not the pension plan that is responsible for your guarantees.2

Taking the lump sum

A lump sum may seem attractive: You give up the right to receive future monthly benefit payments in exchange for a large cash payment now—typically, the actuarial net present value of your age-65 benefit, discounted to today. Taking the money up front gives you flexibility: You can invest it yourself, and if you have assets remaining at your death, you can leave them to your heirs.

However, keep in mind the following cautionary factors:

• You are responsible for making the funds last throughout your retirement.
• Your investments may be subject to market fluctuation, which could increase or reduce the value of your assets and the income you can generate from them.
• If you don’t roll the proceeds directly into an IRA or an employer qualified plan like a 401(k) or an 403(b), the distribution will be taxed as ordinary income and may push you into a higher tax bracket. If you take the distribution before age 59½, you may also owe a 10% early withdrawal tax penalty.
• You can use some or all of the lump sum to purchase annuity—typically, an immediate
  annuity—which could provide a monthly income stream as well as inflation protection or other features. But as an individual buyer, you may not be able to negotiate as good a deal with the insurance provider as the benefit you would have received by taking the pension plan annuity, so the annuity may or may not replicate the monthly pension payment you would have received from your employer. You also need to select your annuity provider carefully, paying special attention to a company's credit ratings, and make sure you read and understand the terms and conditions of the annuity.

Making your choice

Whether it’s best to take a lump sum or keep your pension depends on your personal circumstances. You’ll need to assess a number of factors, including those mentioned above and the following:

• Your retirement income and essential expenses. Guaranteed income, like Social Security, a pension, and fixed annuities, simply means something you can count on every month or year and that doesn’t vary with market and investment returns. If your guaranteed retirement income (including your income from the pension plan) and your essential expenses, such as food, housing, and health insurance, are roughly equivalent, the best choice may be to keep the monthly payments, because they play a critical role in meeting your essential retirement income needs. If your guaranteed income exceeds your essential expenses, you might consider taking the lump sum: You can use a portion of it to cover your monthly expenses, and invest the rest for growth.
  
  These comparisons may be relatively easy if you’re already retired, but developing an accurate picture of your retirement income and expenses can be difficult if you’re still working. Beware of the temptation to use the lump sum to pay down credit card debt or handle other current expenses—and not just because of the large tax bill you’re likely to face. “Lump sum distributions come from a pool of money that is developed specifically for retirement,” explains Beck. “To access those funds for another reason puts the quality of your retirement at risk.”
• Longevity. Both your monthly benefits payment and the lump sum amount were calculated using actuarial calculations that take into account your current age, mortality tables, and interest rates set forth by the IRS. But these estimates don’t take into account your personal health history or the longevity of your parents, grandparents, or siblings. If you expect to have an above-average life span, you may want the predictability of regular payments. Having a payment stream that is guaranteed to last throughout your lifetime can be comforting. However, if you expect to have a shorter-than-average life span because of personal reasons or your family medical history, the lump sum could be more beneficial.
• Wealth transfer plans. After you’ve considered retirement income and expenses, and have planned an adequate cushion for inflation, longevity, and investment risk, it’s appropriate to take wealth transfer plans into consideration. With pension plans, you often don’t have the ability to transfer the benefit to children or grandchildren. If wealth transfer is an important factor, a lump sum may be a better option.

Moving forward

A pension buyout should be evaluated within the context of your overal retirement picture. If you are presented with this option, consult an expert who can give you unbiased advice about your choices. Finally, be aware that more corporations continue to consider discharging their pension obligations, so it’s a good idea to stay in touch with old employers. “If you’ve left a pension behind at a former employer, sometime in the coming years you’re very likely to be offered a lump sum,” says Beck. “Keep your former employer’s administrator up to date on your current address, because you can miss this opportunity if your employer can’t find you.”

Next steps

• First and foremost, make sure you know whether you have any pension benefit at your current or former employers, and keep your contact information with those companies up to date. You cannot even consider an offer if you don’t know it exists.
• Second, make sure you have a plan for retirement. If you understand your needs, you will be better prepared to understand which option is right for you if you do receive a lump sum offer. Because these offers usually have a limited window for election, it will be more difficult to make an educated and informed decision without knowing, in advance, your total retirement financial picture. Using Fidelity Income Strategy Evaluator® (login required) and Retirement Income Planner can get you started.
• If you decide to take a lump sum in lieu of monthly pension payments, you may want to consider rolling it over to an IRA. A direct rollover from your employer's plan to your IRA provider (trustee to trustee) will not be subject to immediate taxation and may be the best way to preserve the tax-deferred status of this money. You should consult your tax adviser.

If you do receive an offer, review it with a trusted financial adviser. Everyone’s circumstances are different. What is right for your friend, neighbor, coworker, or relative may not be right for you.

Getting the Maximum Social Security Benefit (New York Times)

November 15, 2013

The Payoff in Waiting to Collect Social Security

By TARA SIEGEL BERNARD

If an insurance salesman offered a product with a guaranteed income of nearly 7 percent for life, it would be foolish not to question whether it was too good to be true.

But the fact is, such a product exists. And it’s “on sale” right now, for many people 62 and older, at the Social Security Administration.

Some people nearing or on the cusp of retirement consider buying immediate annuities from insurance companies: they hand over a big pile of cash to an insurance company in exchange for a guaranteed monthly income payment for life. But you can also “buy” an annuity, so to speak, from Social Security, and it’s a far better deal.

Think about it this way. If you delay collecting your benefits, which can be claimed anywhere from age 62 to 70, the money you leave on the table each year is basically a payment for a much higher stream of lifetime income. And that money will buy significantly more income, perhaps 50 percent more for a couple, than buying an annuity through a commercial insurer.

“It’s almost a no-brainer,” said Steven A. Sass, program director of the Financial Security Project at the Center for Retirement Research at Boston College, who analyzed the numbers. “Depending on how long you delay, you will get an income equal to about 6 percent or more of the savings used to produce that income. You will get that income, rising with inflation, with no risk, sent to you by the U.S. government.”

Delaying benefits requires leaving sizable sums of money on the table, which, for many sixty-somethings, could be too difficult — psychologically or financially. Some want to start collecting what they’re owed, while others simply need the money to live on. And individuals who aren’t healthy should clearly start collecting benefits as soon as they’re eligible.

But for people who are yearning for more sources of guaranteed income, this strategy — buying more income from Social Security — is especially attractive now when interest rates are low. Commercial insurers cannot compete on price, experts said, and they also have overhead that the federal agency does not. “Annuities look particularly horrible right now because the insurers must invest in bonds,” Mr. Sass added, “and bond interest rates are brutally low.”

Consider a couple with a 65-year-old husband and a 62-year-old wife who decide to buy an immediate annuity — one where payments would keep pace with inflation, and that would continue to pay out as long as either spouse was alive. If they paid $100,000 to an insurer, they would receive in exchange guaranteed lifetime income of about $3,840 per year, according to a quote from Vanguard. That translates into a guaranteed income stream of 3.8 percent a year on the money they used to buy the annuity.

Next, consider what sort of income stream they could “buy” from Social Security by waiting to collect benefits. Assume the husband, who is eligible to collect $12,000 at age 65, delays claiming until he is 66. By waiting the extra year, he would get a benefit increase of $860, for a total of $12,860.

But if he had to buy that extra $860 annual income, he would have to pay about $22,500 to an insurer. A much cheaper way of getting the extra income would be to wait an extra year for his benefits, and dip into his savings for the $12,860 he is not collecting from Social Security. (Or he could potentially work an extra year and not dip into his savings.) 

By doing this, he receives a guaranteed income of 6.7 percent when he “buys” the income from Social Security, according to Mr. Sass’s calculations, compared to an income of 3.8 percent he would receive from an insurer. 

“You will not get anything close to that anywhere else,” Mr. Sass added.

Now let’s imagine the retiree could afford to wait until he was 70 to collect benefits. By waiting those five extra years, his annual benefit would increase to $17,000 — $5,000 more than the $12,000 he could get at 65. 

But if he had gone to an insurer to purchase that extra $5,000 in annual income, it would cost more than $130,000, according to Mr. Sass’s calculations. The less expensive route would be to delay benefits, leave the $60,000 on the table, and also eat into his savings. That means he would be getting a 5.9 percent income if he “bought” the income from Social Security versus the 3.8 percent he would receive from an insurer.

These income rates also compare rather favorably to the income you can generate by a diversified portfolio of stocks and bonds. “Given the volatility of such a portfolio, there is a lot of debate and ongoing research about how much you can safely withdraw without outliving your savings,” Mr. Sass said. Some research has found that the conventional wisdom — taking out 4 percent annually — could be too high. But for argument’s sake, let’s say it’s somewhere between 3 and 4 percent of the portfolio, and rises each year with inflation. That means you could initially pull out somewhere between $3,000 and $4,000 for every $100,00 invested.

Delaying Social Security is a bit more attractive for married couples because you’re also getting something free that you would have to pay for in the commercial market: the survivor’s benefit. If the higher-earning spouse dies first, the survivor will continue to receive that benefit for the rest of his or her life. How much does it cost if you had to buy it? If we revisit the couple with a 65-year-old husband and 62-year-old wife, a survivor benefit for the wife reduces benefits by nearly a third, according to annuity pricing quotes from Vanguard. (You’ll also pay extra for an immediate annuity whose payments rise with inflation.)

“If you have a traditional couple where one worked a great deal and another didn’t work, by delaying claiming you can improve the survivor benefit substantially,” said Olivia S. Mitchell, an economics and public policy professor at the Wharton School of the University of Pennsylvania. “If you care about your wife or husband, that might also help them in old age.”

The benefits rise so that you will receive the same amount over your lifetime, regardless of when you begin collecting, if you live to average life expectancy. But if you are reasonably healthy, the payoff can be substantial. If the higher earner — or any worker — can hold off until they turn 70, the benefits collected will be at least 76 percent more than if payments started at 62.

Take those who are set to receive $1,000 a month at their full retirement age, which is 66 for people born 1943 to 1954, though it rises to 67 for younger people. A retiree who signs up for benefits at age 62 will collect only $750 a month. The extra credit earned by waiting until age 70 would increase that payment to $1,320 a month.

Your benefits generally rise by 8 percent each year you wait to collect beyond your full retirement age.

“There is this enormous payoff to waiting,” said Alicia Munnell, director of the Center for Retirement Research at Boston College. “And nobody knows that.”

Well, some people do. Of the 1.4 million men and nearly 1.3 million women who began collecting benefits in 2012, about 1 percent of the men and nearly 2 percent of women were at least 70.

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How to Create a Paycheck in Retirement (moneywatch)

By

Steve Vernon /

MoneyWatch/ October 22, 2012, 6:45 AM

3 ways to turn your IRA and 401(k) into a lifetime retirement paycheck

     

(MoneyWatch) I recently offered an overall financial strategy to help you avoid going broke in your retirement years: Don't spend your retirement savings!
Instead, you should think of your savings as "retirement income generators," or RIGs, that deliver a monthly paycheck that lasts for the rest of your life. The goal then becomes to spend no more than the amount of your monthly paycheck.
There are essentially only three ways to generate a monthly paycheck from your retirement savings:

• Invest your savings and spend just the investment earnings, which typically consist of interest and dividends. Don't touch the principal.
• Invest your savings, and draw down the principal cautiously so you don't outlive your assets. (In this post and future posts, I'll call this method "systematic withdrawals.")
• Buy an "immediate annuity" from an insurance company and live off the monthly benefit the insurance company pays you.

These methods are all designed to generate a lifetime retirement income, no matter how long you live. Achieving this goal will help you relax and enjoy your retirement. These methods might also provide protection against inflation, another important goal for many people.

Although these represent the three basic approaches to ensuring steady retirement income, each method has many variations. Here are just a few examples:

• If you decide to invest your money and only spend your investment earnings, you can invest in a variety of mutual funds, bank accounts, individual stocks and bonds, real estate investment trusts, or rental real estate.
• If you decide to use the systematic withdrawal method, you can invest your savings on your own and decide how much to draw down, or you can use a managed payout fund that does the investing and withdrawing for you.
• If you decide to purchase an immediate annuity, you have options. For example, you can buy an annuity that's fixed in dollar amounts, one that's adjusted for inflation, or a variable annuity that's adjusted according to an underlying portfolio of stocks and bonds. You can also buy an annuity that starts at a later age, or you can purchase a hybrid annuity that includes some of the features of systematic withdrawals.

These RIGS each have their advantages and disadvantages; there's not one magic bullet that works best for everybody. Most important, each type of RIG generates a different amount of retirement income:

• RIG #1, interest and dividends, typically pays an annual income ranging from 2 percent to 3.5 percent of your savings, depending on the specific investments you select and the allocation between stocks, bonds, cash and real estate investments.
• RIG #2, systematic withdrawals, typically pays an annual income from 3.5 percent to 5 percent of your savings, depending on your investments and how worried you are about exhausting your savings before you die.
• RIG #3, immediate annuities, can range from 4 percent to 6.5 percent of your savings, depending on the type of annuity you buy and your age, sex and whether you continue income to a beneficiary after your death.

You don't need to use just one type of RIG to generate the income you need. In fact, it might be best to use a combination of a few different types. In addition, there can be good reasons to change your RIGs as you get older. And some financial institutions have been introducing hybrid products and solutions that combine features of two or more of these basic RIGs.
 

© 2012 CBS Interactive Inc.. All Rights Reserved.

The Best Annuities (Barrons)

MAY 28, 2012 Top 50 Annuities
By KAREN HUBE | MORE ARTICLES BY AUTHOR

Americans are eager to lock in steady retirement income. We pick the best annuities from a dizzying array of choices.

Top 50 Annuities
By KAREN HUBE | MORE ARTICLES BY AUTHOR



When wealth manager Peter D'Arruda talks about the "old days" for annuities, he isn't talking about the Roman Empire, where these income-generating insurance products were invented and payments were calculated with an abacus. He's talking about last year, when guaranteed payouts and benefits on all kinds of annuities were far more generous. For example, he helped a 45-year-old investor find a fixed index annuity with guaranteed annual appreciation of 8.2% for 30 years and no risk to principal.

Today an investor that age likely wouldn't even qualify for an index annuity with income guarantees. "And that rate? It doesn't exist anymore," says D'Arruda, president of Capital Financial in Cary, N.C. "A lot has changed. There are still some good products out there, but it's hard to find the whipped cream on the sundae."


Annuities, which are insurance contracts, come in many shapes and sizes. They include fixed-rate, in which the principal compounds at a pre-set rate; variable, in which the principal appreciates based on the performance of an underlying mix of stocks and bonds; deferred, which require an upfront investment with payouts down the road, and immediate, which turn a lump sum, upon purchase, into guaranteed monthly payments for life. One attractive feature of annuities is that, as with most individual retirement accounts, or IRAs, balances grow tax-deferred until withdrawals begin. Even more important these days, annuities help remove investors' worst fears: losing principal and running out of money in retirement.

Variable annuities also resemble an IRA because withdrawals can begin after you turn 59½. But there the similarity ends. Given a dizzying number of features and restrictions, contracts for some annuities -- variable and otherwise -- can run 300 pages or more. And because each comes with its own small twists, these products can be very difficult to compare.

LOW BOND YIELDS and a sagging stock market have forced big insurers to re-evaluate their annuities strategies in recent years, and some major providers, including Hartford Financial (ticker: HIG), John Hancock, ING (ING), Genworth Financial (GNW) and Sun Life Financial (SLF), have opted to exit the business or scale back. Most of the remaining companies have cut back benefits significantly on new contracts.

"We've seen investment options in variable annuities diminished, guarantees brought down substantially and fees going up," says Nigel Dally, an analyst at Morgan Stanley. "Protracted low interest rates and high volatility in the stock market have made it far more expensive for annuity companies to support their products."

For investors, however, all is not lost. There are still competitive products that provide significant assurances for a reasonable price. Barron's has combed through hundreds of annuities to come up with a list of 50 best-in-class investments.

The tables below list highly competitive contracts in five annuity categories: deferred variable, fixed index, fixed deferred, immediate, and longevity insurance, which is geared toward 55-to 65-year old investors who won't begin collecting until they turn 80 or 85.






."Longevity insurance removes the big challenge in retirement planning: knowing when you're going to die," says Adam Rolewicz, director of Opus Advisory Group in Purchase, N.Y. "Knowing you'll have an income at a later age makes it easier to plan how to invest the rest of your money."

WHILE LOW INTEREST RATES have impacted all types of annuities, the category that has been hit the hardest is also the biggest: variable annuities. Of the $231.1 billion investors poured into annuities last year, 67% went into variable annuities, according to the Insured Retirement Institute.

Since the stock market crash of 2008, insurance companies have tried to one-up each other with increasingly generous living-benefit riders, guaranteeing a withdrawal rate for life, even if you live to 100 and the assets in your account are depleted. Demand for such products has been strong: Almost nine out of 10 variable annuities sold in 2011 had such a rider.

But many providers apparently promised more than they could afford. "Insurers try to cover the risk of offering generous lifetime guarantees by buying Treasuries and long-term swaps, but this doesn't work well when interest rates are so low," says Tamiko Toland, managing director at Strategic Insights, a market-research firm.

To compensate, annual withdrawal guarantees have been reduced -- to around 4.5% for a 65-year-old from 6% a year ago. And the annual costs for these add-ons have gone up about 25%, to more than 1% of assets.

Another way many insurance companies, including MetLife (MET), RiverSource and AXA Equitable, are trying to bring down the cost of operating variable annuities is by restricting investment options. Lincoln National (LNC), one of the country's highest-rated insurers, added five asset allocation models to its regular line-up of mutual fund investment options in its American Legacy and ChoicePlus variable annuities, and investors are given incentives to select them. For example, those who choose an asset allocation model may get a 5% lifetime withdrawal rate at age 60 instead of 4% for investors who choose to invest among the mutual funds. "This reduces the cost of hedging…and allows us to offer a sustainable product," says Brian Kroll, Lincoln's head of annuity solutions.

Investors slowly may be catching on to these changes. While variable-annuity sales rose 12% last year, to $155.5 billion -- the highest level since the 2007 peak of $183 billion -- they slumped 7% in the first quarter of 2012.

If there is a positive spin for investors from the recent shake-out in the variable- annuity market, it's that some of the stronger companies, including Jackson National, Ohio National, Guardian, AXA Equitable, Nationwide and Pacific Life, are likely to keep coming out with competitive and unique products to set themselves apart from their peers, says Scott DeMonte, co-owner of VA Edge, an annuity-oriented consulting firm.


DESPITE VARIABLE ANNUITIES' overwhelming popularity, some advisors say most variable annuities should be avoided because they are too expensive. The average variable annuity charges a 1.34% fee for insurance and administrative expenses on top of fees for the underlying investment, which average almost 1%. All in, that's an average of almost 2.3%, compared with 1.2% for the average mutual fund, according to Morningstar.

Most annuities also have surrender charges, or fees for withdrawing your money. Fees typically begin at 7% or 8% in the first two years after purchase, and decline each year thereafter before expiring after seven to nine years.

Fixed index annuities, a variation on fixed annuities, have been gaining attention lately. Most of the portfolio grows at a fixed rate, but a variable component is pegged to an index, typically the S&P 500.

While fixed annuities usually beat the rate you would get on a certificate of deposit or a money-market account, their rates have been only between 1.5% and 2.5% these days. Investors have been choosing fixed index annuities as a better-paying alternative. Sales of indexed annuities rose 14% in the first quarter of this year, the only annuity category whose numbers grew.



With these hybrids, your money is invested in investment-grade bonds and Treasuries. The insurer uses the interest generated by these investments to buy options on an index. If those options pay off, investors get the appreciation of the index–although participation typically is capped at around 6%, meaning that if the stock market goes up 10% or 20%, you earn 6%. In exchange, if the market declines, you are guaranteed to have no negative return. The account value usually is reset periodically to reflect and guarantee appreciation.

A fresh and popular wrinkle in these indexed annuities is a so-called income rider, which guarantees investors a minimum annual payment for life at various ages. If you begin withdrawals at 65, for example, your payment will be lower than if you begin at 66 (see the accompanying tables).

In these and other fixed annuities, the pricing is built into the payout rates, so the only sound way to size them up is by comparing what you ultimately pocket if you go with one contract over another.

THE MOST BARE-BONES KIND OF ANNUITY is an immediate annuity, and it is the type most favored by financial advisors to address investors' concerns about outliving their money. Quite simply, you give an insurance company a lump sum, and based on formulas that crunch life-expectancy data, interest rates, insurance fees, and other factors, the insurer guarantees you a certain income, usually for life.

For example, a healthy 65-year-old woman who buys an immediate annuity with $300,000 can expect to get a monthly income stream, starting right away, of about $1,600, or $19,200 annually, no matter how long she lives. By age 88, her life expectancy, she will have been paid out $441,600.

If you die before your principal is paid out, the insurance company keeps your assets. But there are a number of variations on this simple annuity to appeal to investor concerns. For example, you can arrange the annuity to cover the lives of both spouses, adjust for inflation, or be guaranteed to pay for a certain period even if you die within that period.

The costs of guarantees are reflected in the payout. The table "Best in Class" shows how payments can vary.

The variation that's best for you comes down to your income needs and how long you think you will live. For example, an inflation rider could make sense for an investor with expectations of a very long life. But the embedded costs of the inflation rider will result in lower initial payments. "It can take 12 to 15 years before the payment grows to what the initial amount would be without the inflation rider," says Debi Dieterich, senior annuity analyst at AnnuityAdvantage.com. If you have a long life, eventually your total payout will be greater with the inflation rider, but in the first decade or more "you lose the use of that money," Dieterich says.

Even with all the guarantees, some investors aren't willing to live within the strictures of annuities. Indeed, there's a chance they will do better: While a $200,000 investment in a group of high-quality blue-chip stocks paying 2.5% will provide income of only $5,000 in the first year, the payout may grow faster than inflation over time as companies lift their dividends. And if you look at the investment as a deferred annuity and reinvest all of the dividends for 10 or 15 years, the yield on your original investment will be significantly higher, and the principal likely will be, too.

But you take the risk of a bear market, which can be especially painful if it occurs early in your retirement. And experts say it is hard to beat the so-called mortality benefit you get from pooling your assets with other annuity investors. Quite simply, people who live long get subsidized by those who don't.

ONE OF THE MORE INTERESTING NEW PRODUCTS in the annuity industry is a form of a deferred income annuity called longevity insurance. This is geared toward folks in their 50s and 60s who are grappling with one of the most variable factors in retirement planning: how long you will live.

Longevity insurance provides a income starting late in life, say, at age 80 or 85. "The reason it's so attractive is that you have such leverage when go out that far -- 50% of the population dies between 65 and 85 -- [as] you get the money from people who died, and compounding based on a very long bond rate," says Matt Grove, vice president in charge of the annuity business at New York Life.

When used properly, annuities can remove concerns about longevity, and lower overall investment risk. This can make investors more comfortable allocating assets to riskier investments, ultimately increasing overall returns.

.E-mail: editors@barrons.com

Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved
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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.

The Best Annuities (Barrons)

Barron's Cover | SATURDAY, JUNE 18, 2011
Best Annuities
By KAREN HUBE

Special Report -- Retirement: With their steady income payments, annuities are suddenly hot.

Shortly after George Altmeyer of Bucks County, Pa., retired from his senior-management job at a large industrial company, half his stock portfolio vanished. It was wiped out by the stock-market crash of 2008. But Altmeyer, 67, never lost a night's sleep, and he doesn't worry about whether he will run out of retirement income. His secret? He bought two kinds of annuities in 2007. "They give this blanket of security—it doesn't matter what the stock market does, really," he says.

Annuities, maligned for years as expensive gimmicks, are now shining in a big way. The basic features that critics used to blast as too costly—downside protection and guaranteed payouts—have paid off spectacularly for folks like Altmeyer through the stock-market collapse and the subsequent volatility.

Now, as baby boomers approach retirement with fresh memories of big market losses, many sharp financial advisors are recommending an annuity as an important part of an income plan. "We've come from thinking that stocks and bonds were the answer to everything, to worrying about how to arrange for monthly income to age 80 and beyond," says Fred Reish, a lawyer who specializes in retirement issues at Drinker Biddle & Reath in Los Angeles. "Annuities can take away that worry."


Little wonder that annuities are getting a fresh look. Though the effective returns are hardly eye-popping—often just a shade above those of certificates of deposit—annuities offer some real comfort to retirees.

With that in mind, Barron's has identified what we think are the 25 best annuities. As you can see in the table nearby, we've picked five annuities from each of five categories. We sized up the field mostly by returns, costs and strength of the insurance companies behind the products. As of last week, each of the annuities on our list was doing well by all three measures.

IN ITS MOST basic form, an annuity is a contract with an insurance company that converts your lump sum into a stream of guaranteed income, for either a set period or for your lifetime. Its primary purpose is to hedge against longevity risk—the risk that you outlive your income. While annuities date back centuries, longevity risk is a growing modern concern. Consider: In 1930, retirement lasted three to seven years, with people dying at an average age of 60. As life expectancies grew longer over subsequent years, most workers could depend on a company pension to carry them through retirement.

Now, retirements last a quarter century or more, and pensions are a dying breed, so investors are left to their own devices to arrange for income to supplement Social Security payments. At age 65, the average life expectancy is 85 for a man and 88 for a woman. But what haunts folks planning for retirement are the odds of living much longer. There's a 25% chance of living past 90, and for a couple, there's a 25% chance that one spouse will live to age 95.

While that is a risk annuities can address, they traditionally have introduced other problems in the process. The biggest: Once you hand over a lump sum, you could never get the money back, and if you died prematurely, the insurance company, rather than your heirs, got what was left of your money.

But over the past decade, insurers have become much more flexible, offering long menus of riders and options to give investors liquidity, exit opportunities and certainty that their heirs are first in line for the assets, not the insurer.

The number of different annuities has mushroomed: There are now 1,600 iterations of the product. These include both variable annuities, whose growth fluctuates based on underlying stock and bond investments, and fixed annuities, which are pegged to an interest rate, similar to a certificate of deposit or a bond. The payouts can be either immediate—starting right now—or deferred, starting at a specified later date.

The most popular of all is the deferred variable annuity, the last of the five categories shown on our list. It accounted for 63% of the annuity industry's $221 billion in sales last year, with investors choosing from a range of underlying stock- and bond-fund investment options. Money in these products grows tax-deferred, an advantage over a mutual fund. On the date you specify, the value is "annuitized," or turned into steady payouts. The better the underlying investments have done, the higher the payouts. The payouts are taxed as ordinary income.

In a plain-vanilla deferred variable annuity, negative returns are possible, but the industry has created various options to put investors at ease, such as riders that guarantee certain levels of income upon retirement. "Eighty percent of the time people buy an income rider," says Robert E. Sollmann, executive vice president of retirement products at MetLife.

Also popular are guaranteed minimum death benefits. Almost all deferred variable annuities sold include the basic kind: a guarantee that, if the account value has lost value when the investor dies, heirs will get the full amount initially invested. Death benefits can get a lot fancier, such as guarantees that heirs get the highest value the account hit on one of its anniversaries. Between 2001 and 2003, variable annuity beneficiaries received $2.8 billion more than the account value when policy holders died earlier than expected, according to the Insured Retirement Institute.


Despite the popularity of deferred variable annuities, they aren't necessarily the best choice, financial advisors caution. Many are sold aggressively by sales agents to folks who only vaguely understand the costs and features. In fact, the fee structure can encourage unscrupulous practices.

Average fees on variable annuities are 2.33%, compared with mutual funds' 1.32%, but they can top 4%, including death-benefit fees, administrative fees and underlying mutual fund expenses.

Michael Zhuang, an advisor at MZ Capital in Washington, D.C., said an investor recently asked him to look over his variable annuity contract. "The investor thought he was paying 2% in expenses, but it was double that, " Zhuang says. "His contract was about 100 pages. Various expenses were on different pages."

However, it's entirely possible to find a lower-cost variable annuity, such as those offered by Vanguard, Fidelity, Charles Schwab or Pacific Life Insurance Co., among others, advisors say. And for investors who have maxed out contributions to a 401(k), IRA or other tax-favored savings plans, a variable deferred annuity could make sense, some advisors say.

THE PUREST OF ALL annuity products—favored most widely by advisors—is an immediate annuity. You give the insurance company a chunk of money, and it converts it right away into fixed regular payments for life or a specified period.

Some economists say they are baffled by the low level of participation in these products, given their benefits. Aside from guaranteed income, lifetime annuities actually give retirees higher regular payments than they would get if they self-managed their income stream. "Annuities provide what we economists call a mortality premium, which is basically an extra rate of return over and above what one can get from a non-annuitized asset," says Jeffrey R. Brown, a finance professor at the University of Illinois and associate director of the National Bureau of Economic Research's Center for Retirement Research.

With a basic lifetime immediate annuity, you give up assets to the insurance company if you die early. "If you live long, you win but if you don't, you lose. But you're dead," says Jean Fullerton, an advisor at WJM Financial in Bedford, N.H. But many insurers, such as New York Life and Aviva, offer guarantees that they will continue to pay the annuity for five to 25 years. If you die within this period, the payments go to your heirs.

Special features always cost extra, and with immediate annuities, the costs take the form of lower monthly payouts. For example, a 65-year-old man who puts $100,000 into an immediate annuity with lifetime payment at Pacific Life Insurance Co. would get a monthly lifetime payout of $602, according to Cannex, which tracks annuity data. If he opted for a 10-year guarantee, meaning the insurer continues to pay heirs for 10 years even if he dies before that, the monthly payment would be $590.

Rosemary Caligiuri, a financial advisor at Harvest Group Financial Services, says she likes to use immediate annuities in combination with fixed deferred annuities for her clients in retirement. In a fixed deferred annuity, assets are paid out later and grow based on underlying interest rates. The rates can be reset based on insurers' underlying investments. Or, investors can choose a fixed rate for a certain period.

You might also consider index-linked annuities, says Caligiuri, who ladders annuities to secure income in phases and diversify across insurers. These cushion the downside—you'll never have a return below zero, even in a year like 2008. On the upside, returns on these are pegged to an index, but are usually capped.

Jack Marrion, president of Advantage Compendium, which tracks indexed annuities, says over many historical periods they have proven to be better choices than either CDs or the stock market. Over the past five years through September 2010, 36 annuities offered by 19 insurers had an average annual return of 3.9%, compared with a one-year CD's 2.8%, a five-year CD's 3.8% and the S&P 500 index's return of 0.65%, according to a study by Marrion.

Periodically, usually each year, an insurer can reset its caps or other terms. "If a company won't give you its renewal history, don't do business with them," he says. Also consider the financial-strength ratings by A.M. Best, Standard & Poor's and other agencies.

If you choose wisely, you'll end up with a nice income flow, relatively low fees and minimal risk of problems with the provider. That's saying a lot in these uncertain times.

.E-mail: editors@barrons.com

Copyright 2011 Dow Jones & Company, Inc.

Why You Should Wait: Fixed Annuity Rates are Still Too Low (Morningstar)

The Error-Proof Portfolio:

For Annuities, Timing Is Key

By Christine Benz | 04-12-10

Many investors' hackles go up when you say the word "annuity." They immediately think of variable annuities, many of which are pricey and often sold, not bought. (When the TV program Dateline is using hidden cameras to catch salespeople in the act of peddling inappropriate products to unwitting seniors, it's fair to say that an industry has an image problem.)


But plain-vanilla single-premium immediate annuities deserve more respect. The concept is as simple as it can be: You give the insurance company a slice of your retirement portfolio, and the insurer, in turn, sends you back a stream of income for the rest of your life. You can layer on additional bells and whistles--such as survivor benefits in case you die early in the life of the contract--but they will dramatically decrease the payout you'll receive.


The Value Proposition
The idea of using annuities as a slice of retiree portfolios has been gaining traction in the financial-planning community and among mainstream investors during the last few years. Against the backdrop of a rocky stock market and a shrinking number of defined-benefit plans, annuities' promise of a certain payout holds a lot of appeal. And with bond yields still exceptionally low right now, annuities are also attractive in that they generally deliver a higher payout than what a retiree would receive via a traditional high-quality fixed-income investment.


Annuities also help address the more basic problem that--regardless of the market environment--we're all planning for an unknowable time horizon. None of us knows how long we'll live. And increasing life spans increase the risk that a portfolio of stocks and bonds (that is, one without an annuity) might not last throughout a retiree's lifetime, thereby burnishing annuities' appeal.


Problematic Timing
For all of these reasons, it's become conventional wisdom that SPIAs should be part of retirees' toolkits. Unfortunately, fixed annuities are catching on at what could, in hindsight, be the worst possible time. That's because the payout you receive from an annuity is based on two key factors: 1) the expected life spans of other annuityholders and the likelihood that some of them will die before actuarial tables would suggest; and 2) the interest rate that the insurance company can expect to earn on your money.


The first factor--in essence, the fact that some unlucky people in the annuity pool will die before their time--is why annuities can provide a higher payout than fixed-rate investments. In a pool of hundreds of people, the statisticians know that at least some of the folks who should live into their 80s and 90s will expire in their 60s and 70s instead. Those early decedents will have paid more into the annuity than they've gotten out. Other annuitants, meanwhile, will live well beyond what the actuarial tables would suggest, enabling them to receive more than they've put into their retirement.


The wrinkle is that people are living longer, and insurance companies are having to spread the money in the annuity pool over more and more very long lives, so increasing longevity will have the side effect of shrinking the payouts for everyone. (As a side note, an interesting body of research indicates that annuity pools include significant adverse selection--that is, the people who are most likely to buy an annuity are also likely to live much longer than actuarial tables would suggest. That may be because those most attracted to annuities may have longevity in their families, or perhaps there's a correlation with wealth and better health care.)


That trend will provide a long-term headwind for annuities, but it shouldn't have a significant impact on the timing of when you buy an annuity. The other component of annuity payouts--the interest rate the insurance company can expect to earn on your money--is more problematic. If you buy an annuity today, the currently ultra-low interest-rate environment will depress the payout you receive. (It's not a perfect analogy, but it's somewhat akin to buying a long-term bond with a very low coupon. Rates may go up in the future, but you'll be stuck with your low payout.) The average fixed annuity rate plunged from 5.55% to 3.94% between December 2008 and December 2009, according to National Underwriter.

What to Do?
For those who like the concept of an annuity but are concerned about the effect of low interest rates on payouts, one possibility is to ladder your investments, essentially dollar-cost averaging in to mitigate the risk of buying an annuity when interest rates are at a secular low. If, for example, you were planning to put $100,000 into an annuity overall, you could invest $20,000 into five annuities during 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.


Alternatively, a prospective annuity purchaser could simply wait until fixed-income interest rates head back up toward historical norms. While fixed-income yields have recently begun to climb, they're still extremely low relative to historic norms.

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