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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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.

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

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.