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.

How to get 7% Income (Barrons)

Barron's Cover | MONDAY, NOVEMBER 21, 2011 How to Get Safe Annual Payouts of 7%
By KAREN HUBE |
Despite rock-bottom interest rates, you can still earn investment income of 7%-plus per year. How to keep money flowing during retirement.
Not so long ago, you could build a reliable portfolio of income-producing investments with just a few simple steps: Buy some Treasuries, some corporate bonds and some munis, and then watch the money roll in. That kind of investing is a long-lost luxury. Yields on core bond holdings have been slim for three years in a row. And while 10-year Treasury yields, at 2%, are higher than they were a year ago, you aren't going to do much better any time soon. The Federal Reserve says it is going to hold rates low until mid-2013. Bottom line: Traditional fixed-income portfolios don't work anymore, and "if retirement investors don't start thinking differently, they're going to run out of money," says Erin Botsford, CEO of the Botsford Group, a Frisco, Texas-based financial advisory firm.

Thinking differently, however, raises new challenges for retirement. Yields of 5% and 7% are attainable, but you have to look globally and across asset classes that may seem unfamiliar, such as emerging-market bonds, global infrastructure stocks, master limited partnerships and mortgage real-estate investment trusts.

The hunt for higher yields requires vigilance. Some risks are obvious: Greek sovereign debt, now yielding over 100%, clearly is no way to finance a leisurely retirement. But more often risk is difficult to spot.

Take the Pimco High Income closed-end fund (ticker: PHK). The fund not only has a highly regarded brand name and widely respected manager, Bill Gross, but also an enticing 11.7% yield.

"But if you look at funds not to buy, this is the poster child," says Maury Fertig, chief investment officer at Relative Value Partners in Northbrook, Ill., who points out that the fund trades at a 67% premium to its net asset value. Investors who buy into the fund are paying far too much for a yield that isn't guaranteed, he says.

Then there's the risk of inaction. If you stick with the traditional income investments, you will be losing money in inflation-adjusted terms.

The 10-year Treasury, with its 2% yield, is a clear loser with today's 3%-plus inflation. Ditto for certificates of deposit and money-market funds.

"You may be preserving your principal, but you aren't going to keep up with inflation," says Malcolm Makin, an advisor at Professional Planning Group in Westerly, R.I. For example, you have to lock your money up in a CD for five years just to get an average 1.5% pretax return. "That isn't going to seem so safe in retrospect at age 70 or 75, when your money has dried up," Makin says.

To increase yield and balance the risks, income portfolios must be cobbled together with a number of investments, ranging from Treasuries to junk bonds. Some—those with the highest credit risk or illiquidity, for example—should make up 2% or less of a portfolio. But even at those levels they can add income and help diversify your holdings.

Here are 11 choices with attractive yields. If you haven't looked at these kinds of investments before, now is an excellent time to start.


Closed-End Corporate-Bond Funds

Regular corporate-bond mutual funds can give you an edge over Treasuries, with yields around 3%, but you can get much more from closed-end bond funds, which trade like stocks.

"There are funds available at substantial discounts to net asset value, and the fact that these funds employ leverage, and their cost of borrowing is very low, can provide additional yield," says Relative Value's Fertig, who recommends these as a piece of a diversified income portfolio.




Fertig likes AllianceBernstein Income fund (ACG), which specializes in investment-grade corporates, Treasuries and agency bonds—debt issued by the likes of Fannie Mae and Freddie Mac. The yield: 6%. "It's trading at a 10.7% discount to its net asset value," he points out.

BlackRock Credit Allocation Income Trust fund (BTZ) is another good prospect, trading at a 13% discount and with a yield of 7.7%. But it is a little more risky, with many AA-rated and BBB-rated bonds—still investment grade, but just barely.


Municipal Bonds

Municipal bonds offer a rare opportunity for investors because they yield more than their taxable-bond counterparts and provide tax breaks to boot. For individuals, leveraged closed-end muni funds are great choices. They are riskier because of their leverage, but that's limited by the Fed's pledge to keep rates low. With tax-free yields above 6%—and many muni funds selling at a discount to NAV—that's equivalent to a taxable yield over 9% for somebody in the 35% tax bracket. Two that look good are BlackRock Municipal Income Quality Trust (BAF), with a 6.3% yield, and Neuberger Berman Intermediate Municipal (NBH), yielding 5.6%. Those yields equate to 9.7% and 8.6%, respectively, for taxpayers in the top bracket.

Less risky, because it uses no leverage, is the Vanguard High Yield Tax Exempt fund (VWAHX), which yields 4.4%, equivalent to 6.8% for high earners.

High-Yield Bonds

Bonds that don't qualify as investment- grade—rated BB or lower—clearly come with more risk, "but you can pick up substantial yield if you look at BB ratings primarily," rather than lower-rated bonds, says Michael Persinski, managing director of U.S. Investment for Citi Private Bank. Yields on these issues are around 7.3%.

Investors have been flocking to high-yield, or junk, bonds lately because the difference between their yields and those of Treasuries widened significantly since April. The current spread is 7.2 percentage points. Valuations are still attractive, says Jamie Kramer, head of thematic advisory at J.P. Morgan. The market is pricing in default rates of around 8%, yet the current rate is 2%.

The best strategy for investing in junk bonds is through a fund or ETF, because they are broadly diversified and have low transaction costs. Eaton Vance Income Fund of Boston (EVIBX) yields 7.9%, and iShares iBoxx $ High Yield Corporate ETF (HYG) yields 7.5%


Emerging-Market Government Bonds

Compared with European sovereign debt, emerging-market government bonds look like safe bets. And with an average yield of 6%, they pay three times that of U.S. Treasuries. Once viewed as high risk, these bonds have become much sturdier amid the rapid growth of developing-world economies.

Emerging-market bond funds can minimize currency risk by using hedging strategies; or you can bet on currencies as well as yields. Funds with currency exposure can give added return when the dollar falls.

While emerging-market currencies are expected to strengthen over the long term, that is no steady trend. Lately, those currencies have declined about 20% relative to the dollar, making currency-exposed funds more volatile, says Michael Herbst, associate director of fund analysis at Morningstar. For currency diversification, he likes Pimco Emerging Local Bond (PELAX), yielding 6.8%. A solid fund that hedges currency risk is Fidelity New Markets Income (FNMIX), with a 5.4% yield.

If you want to leave it up to a manager whether or not to hedge currency risk, consider T. Rowe Price Emerging Markets Bond fund (PREMX), yielding 6.8%.

Dividend-Paying Stocks

Your grandfather may have scoffed at today's dividend yields, but don't pass them by. The average yield on Standard & Poor's 500 stocks that pay dividends, at 2.5%, is well below the historic average of 5.8%. But the last time the index had a higher yield than 10-year Treasuries was 1958. That means investors have an opportunity to capture capital appreciation as well as Treasury-beating yields. And payouts are likely to get stronger as the economy continues to recover, says Howard Silverblatt, senior index analyst at S&P.

By sector, telecom companies have the highest yields, at 6%, followed by utilities at 4.2% and health care at 3%.

For investors who like these yields but are concerned about the risk of investing in stocks, look for companies that have raised their dividends for the past 10 years and aren't straining to pay them, Silverblatt says.

He suggests making sure that companies' earnings are at least twice their payouts. Among those that make the cut: Chevron (CVX), which yields 3%; Johnson & Johnson (JNJ), 3.5%; and Northeast Utilities (NU), 3.2%.




Global Infrastructure Stocks

Companies that own and operate infrastructure such as sea ports, toll roads and utility lines not only are good for yield—expect about 5% from a basket of the stocks—but also tend to perform better than the market in downturns.

"These companies are rich on physical assets, and a lot of them have monopolies. For example, if a company builds a toll road, someone isn't going to build a toll road right next to it," says Mike Finnegan, chief investment officer of Principal Funds and manager of the Principal Global Diversified Income fund.

Among his funds' holdings are PPL (PPL), a utility with operations in the U.S. and Britain, and BCE (BCE), a Quebec-based telecom provider.


Master Limited Partnerships

Advisors like energy-related master limited partnerships not only for their solid dividend yields—often 6% or more—but because they are relatively stable investments and good for diversification.

MLPs are publicly traded limited partnerships. Because of their organizational structure, they don't pay corporate taxes and can pass much of their profits on to their investors. The safest bet is to stick with energy MLPs that own and operate oil and natural-gas pipelines, such as Kinder Morgan Energy Partners (KMP), yielding 6%, and Mark West Energy Partners (MWE), yielding 5.3%. These partnerships aren't closely correlated to stocks and aren't affected by the rise and fall in energy prices, because they collect fees for transporting oil and gas, no matter what happens to the prices.


REITs

Real-estate investment trusts have had strong returns in recent years, and right now they are paying respectable yields.

The apartment sector has been particularly strong, the result of millions of cash-strapped families deciding to rent instead of buy. David Campbell, a principal at Bingham Osborn & Scarborough in San Francisco, recommends two apartment REITs: Camden Properties Trust (CPT), yielding 3.3%, and AvalonBay Communities (AVB), yielding 2.9%.

Fidelity Real Estate Income fund (FRIFX), with a yield of 5.1%, and Vanguard REIT ETF (VNQ), 3.4%, each will give you a diversified basket of REITs.

But when it comes to income, mortgage REITs that invest in mortgage-backed securities issued by Fannie Mae and Freddie Mac may be your best bet. Since their portfolios are guaranteed by the federal government, there's very little credit risk. So the main risk is that the Fed raises interest rates, and it has told us that won't happen before 2013. Annaly Capital Management (NLY) is the biggest in the bunch, with $113 billion in assets and a whopping yield of 14.8%.


Equipment Leasing

When a company leases a piece of heavy equipment, such as an oil tanker or a railroad car, income investors stand to benefit.

Here's how: Independent firms buy up large quantities of leases with investors' pooled assets, "and then investors pick up the income stream from these leases," she says. Current yields are 7% to 8%.

Investors take on the risk of the leases, but Botsford thinks this risk is small.

"We're talking about low-tech equipment that doesn't get obsolete, and 20-year lease cycles," Botsford says. Companies leasing the equipment typically have long track records of making their lease payments. The default rate is minimal, and typically there are about 50 leases in an investment pool.

To participate you have to work through brokers or asset managers, whose firms ooften have access to specific pools, such as those managed by Icon Investments and Cyprus Financial.

The caveat: These lock up investors' money for five to seven years, so Botsford recommends keeping the allocation to about 2% of your portfolio.


Immediate Fixed Annuities

Major stock-market declines and wild volatility have increased the appeal of low-cost annuities. One of the most widely recommended types by advisors is the simplest kind: an immediate fixed annuity. You fund this annuity with a lump sum, and it immediately starts paying out a guaranteed income for life—or a term you specify.

Investors get a higher monthly payment than they could if they tried to create their own income stream from their investments. That's because of annuities' so-called "mortality credit," which is the benefit resulting from pooled assets of many investors. "Some investors are going to die early, and since the insurance company isn't going to have to make their payments, they use them to benefit those still living," says Steve Horan, head of private wealth at the CFA Institute.

With yields of 6% to 7%, a 65-year-old man in good health can turn a $200,000 annuity into monthly payments of $1,100 for life.


Longevity Insurance

If you knew you were going to live until, say, age 85, planning an income stream would be a lot easier. But what worries many retirees is their longevity risk—the chance that they will live a lot longer than they expect.

That's why insurers have recently come out with a new kind of annuity called longevity insurance. This is a kind of deferred annuity that you buy early on to secure an annuity stream five to 20 years down the line. At age 65, you can buy one to begin paying at age 85. "This fixes the time-horizon problem and makes planning a lot easier," Horan says. "These are cost efficient, and they transfer the longevity risk to the insurer," says Horan.

Solid longevity-insurance providers include New York Life Insurance and Metropolitan Life. Fees are embedded in the annuity calculation, but as with immediate fixed annuities, they are reasonable. Through NY Life, a 60-year-old healthy man who buys a $100,000 longevity insurance contract today can secure a $2,916-per-month annuity that begins at age 80 and pays out for life.

In all, our 11 investments offer solid income at a time when any income is hard to come by. In other words, yes, you can still retire comfortably.

.E-mail: editors@barrons.com

The GAO Report on Immediate Annuities

The Government Accountability Office endorses immediate annuities as a supplement to social security.

Report to the Chairman, Special
Committee on Aging, U.S. Senate
June 2011
RETIREMENT
INCOME
Ensuring Income
throughout
Retirement GAO-11-400

http://www.gao.gov/new.items/d11400.pdf

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.

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

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

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

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

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

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

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

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

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


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

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


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

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

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

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

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

Obama and Annuities (New York TImes)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Smart Ways to Get Cash from your Life Insurance (from Kiplingers)

A New Lease on Life Insurance
That term or cash-value policy you bought to protect your young family could cushion your retirement as well.

By Kimberly Lankford

From Kiplinger's Personal Finance magazine, September 2009

You're 53 or 56 or 61, the kids are out of the house,the mortgage is nearly paid off, and before long you'll be eligible to retire and take your pension -- and so will your better half. Life insurance? At 60, you can expect to live another 20 to 25 years, if you're in good health.

You'll have more than enough money, or at least your house will be worth a million. So surely you won't need to pay insurance premiums for much longer, right? Dropping your policy would be like getting a bonus worth hundreds or thousands of dollars a year.



Nice try. After the real estate collapse and the stock-market crash, the finances of preretirees are far more challenging. Your mortgage payments may now be more of a burden, you can't borrow against home equity, and your retirement accounts have shrunk so much that you hope to hang on to your job and continue to contribute until you're old enough to collect your full Social Security benefit. That's crucial because your pension isn't getting any bigger -- and it may in fact shrink if your company can't keep the plan solvent or the investments perform poorly.

Here's the unpleasant dilemma if you have a term-life-insurance policy that is about to expire: Renew the coverage and your premiums are almost certain to soar. Drop all coverage and your family could be in a financial bind if you die prematurely.

If you own permanent, or cash-value, life insurance, you have other decisions to make. Premiums may be level but high. You may be tempted to take out money to compensate for a smaller pension or a tighter budget, especially if you are forced into early retirement. Or you might cash it in altogether to be done with premiums. That could make sense----or it could be a major financial-planning error.

Term-life policies
Millions of Americans bought low-cost, multiyear term policies ten to 20 years ago when their kids were young, and they expected to drop the coverage when the term -- and low rates -- expired. But if you go without now, you could be missing some special opportunities to extend your coverage for less than you think and retain tax-free death benefits that will make up for the damage to your retirement funds and pension.
Dane and Susan Swenson of Gainesville, Va., both 58, thought they'd be finished with life insurance by now. Dane retired from the Army in 1998 and currently works as a civilian for the U.S. Department of Defense. He has life insurance through work until he retires, which he plans to do in the next few years. He has a military pension and will qualify for a small federal-employee pension. But if he were to die and Susan collected only reduced survivorUs benefits, sheUd be short of money to live on.

The couple originally thought their retirement savings would allow Susan to go without life-insurance benefits. "I planned to be self-insured, but then the market dropped," says Dane. His retirement accounts fell by as much as 40%, so he started to reconsider the idea of going without insurance.

Early in 2009, Dane bought a $200,000, 15-year term policy from Genworth for $600 a year. "The policy covers the difference between being self-insured and the decrease in our portfolio," he says.

That may sound like a low price for a policy that will cover Dane until he turns 73, but it's hardly unusual. Term-insurance rates have plummeted over the past 15 years because of intense competition and longer life expectancies. So you may actually pay less now for the same coverage even though you're older, or lock in a longer rate guarantee with little impact on your premiums.
In 1994, a healthy 40-year-old man would have paid at least $995 per year for a 20-year, fixed-rate term policy with a $500,000 death benefit. Today, the same man -- now age 55 -- could buy ten more years of comparable coverage for $880 a year, as long as he's still physically fit. (In most cases you'll be asked to answer a few questions about your health, provide the insurer with doctors' references, and agree to a brief physical exam at home.)



If you have health issues, find an agent who deals with several insurance companies and can help you present a strong case for a fair deal. Also, check whether the expiring policy has conversion features. Most term-insurance policies come with the option to convert to a permanent life-insurance policy so that you can be covered for the rest of your life, regardless of what happens to your health. The premiums will be high: They are based on your age at conversion, which means the older you are when you convert, the more you pay. But the rates will also reflect your medical condition when you originally signed up for the insurance -- and unless you're a marathon runner, you were probably lighter and healthier then. And, in case you didnUt look, term insurance gets very expensive in old age.

Cash-value policies
Cash-value life-insurance policies, such as whole-life and universal life, don't expire. They can lapse if you don't keep up the premiums; but as long as there's enough money in the policy, the insurance will live on with you through age 100. Cash-value insurance is often criticized because it's hard to follow where all your premiums go and how your value builds. But as you get older, you may find that this complexity translates into more ways to pull money out and still preserve your life-insurance coverage.

Tom Arenberg of Mequon, Wis., bought a whole-life policy from Northwestern Mutual when he was just 22 years old. In addition to its value as protection, says Arenberg, now 57, he "considered it savings that would be harder to get at than if the money were in a bank."

A whole-life policy involves trading higher out-of-pocket costs for some guarantees. You pay a fixed annual premium that depends on your age, health and the size of the policy, and in return you know what your minimum cash value and death benefit are worth every year. If the insurance company invests well (usually in bonds and mortgage securities) and controls other expenses, youUll receive policy dividends, which can further build up your cash value and death benefits. There's no guarantee that you'll receive a dividend every year, but you're not in the position of a stockholder who knows the company may cut cash payments if it so desires. Policyholders virtually always get something. If yours is a mutual insurance company, you're legally considered an owner of the company and share in its gains.

There are two ways to extract cash from a permanent life policy: a withdrawal or a policy loan. Both moves reduce your death benefit, but you don't have to forfeit your coverage.
Arenberg borrowed from his policy's cash value a few times in the early years, for what he calls "growing-up stuff," such as buying his first home. He quickly repaid the loans so he could restore the full death benefit. He had the option to increase the size of the death benefit every three years by paying more premiums, and did.

But now that the Arenbergs' three daughters are 19, 21 and 24, and Tom has retired after 34 years at Accenture, the couple's needs for the policy are gradually shifting from family protection to helping Tom and his wife, Diane, with retirement. "It's become a safe, low-maintenance investment," Arenberg says. "I didn't care if it had the best return -- I wanted to be the least unhappy guy in the room if there were a downturn," he says. Like everyone else's investments, his have taken a hit. But, he says, "We're hurting a lot less than others."

He uses some cash from the life-insurance policy to pay for long-term-care-insurance premiums, and he may use more of it, eventually, to pay for his daughters' graduate-school expenses and to donate to charity. He likens the policy to a chess piece in a commanding position -- there's no rush to make any moves except to ensure that the policy stays in force so his heirs can collect a death benefit tax-free.

How you access your cash value while you're alive matters in terms of your coverage and your tax bill. If you simply cash in the policy, which is known as surrender, you take back the cash value all at once, minus any outstanding loans. But that means you give up the death benefit and owe income tax on the policy's gains over and above the premiums you've paid. If you bought the policy at, say, age 25 and you're now 60, that's an enormous tax hit. It would be smarter to withdraw up to the amount you've paid in premiums, your basis, which you may do without paying tax.

If you need occasional cash, the best way to claim it is a policy loan. You reduce your death benefit by the amount of the loan plus interest (which is generally low, perhaps 6%), but you never have to pay it back. If the policy is still in force when you die, your heirs get the remaining reduced death benefit tax-free. The downside of a policy loan is that you need to be very careful not to let your policy lapse, or else you'll owe taxes on the loan, even though you've spent the money and may think you borrowed the cash from your own savings. Although you can have the interest deducted from the remaining cash value, that's dangerous. It's wise to at least pay the annual interest as it accumulates.

Another option is to make a tax-free conversion into an income annuity (see Guaranteed Income for Life). You'll give up the death benefit and owe taxes on a portion of each annuity payout. But in exchange for paying taxes, you stop paying premiums and can be assured of a steady stream of income for life or for a specified number of years.

--------------------------------------------------------------------------------

Morningstar Advisor on Immediate Annuities

Immediate Annuities: The Key to Retirement


by Judith A. Hasenauer | 04-02-09


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

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

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

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

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

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

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

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

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

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

//
from morningstar.com

Retirement Income without Dividends (N Y Times)

April 1, 2009
Planning a Retirement Without Dividends
By TARA SIEGEL BERNARD

Many retirees have certain ideas about how they will occupy their days and how they will pay for it. Dividends are often a part of those plans.

But relying solely on regular checks from dividend-paying stocks or funds for retirement income is an outdated strategy, with little chance of supporting someone for, say, 30-years. This would be the case, even if dividends were not been disappearing at a record pace (as they have in recent months).
For one thing, relying on dividend payers will probably result in a portfolio that’s too concentrated in areas like financial stocks, which paid the most in dividends until recently. Financial companies accounted for more than 30 percent of the Standard & Poor’s 500 Index’s dividend income in 2007, but now account for just 10.6 percent.
Overall, constituents of the S. & P. cut nearly $42 billion in quarterly dividends this year, or 16.9 percent of 2008 payouts. That unprecedented decline followed another, of $15.9 billion, in the fourth quarter. “You are going to see significantly worse numbers this year, and there’s more bad news in the pike,” said Howard Silverblatt, senior index analyst at S.&P.

Even more disconcerting, especially for retirees, is that the cuts have come from many stocks that were once viewed as blue-chip stalwarts: General Electric, Bank of America, J.P. Morgan. And not only have many of these companies cut their dividends, but their stock prices have also dwindled. So retirees who were relying on the stocks for income may be forced to sell at the worst possible time.
“There is extreme danger in counting on a dividend strategy right now,” said Joel Framson, a financial adviser in Los Angeles. “In fact, too many of the decimated portfolios we are seeing in our new clients were caused by people thinking they could capture high dividend yields without taking risk.”

Of course, in these unpredictable times, there are no easy answers. Even the most diversified portfolios have taken devastating hits. But there are ways to structure your retirement portfolio so that you won’t be forced to sell investments at the most inopportune moments, as well as ways to create a paycheck, of sorts, in retirement.

TOTAL RETURN First, instead of focusing solely on dividend-paying investments, financial planners said that retirees should look at a retirement portfolio holistically. In financial adviser speak, this is known as a total return strategy, which includes drawing upon a collection of dividends, interest and capital gains (when they eventually return). You should devise an asset allocation based on your time horizon and tolerance for risk, among other factors. And all diversified portfolios will see the benefits of dividends — historically, they’ve accounted for more than 40 percent of stock market returns over the long haul.

In retirement, you withdraw a set amount of money from your portfolio each year, typically around 4 percent, and increase the dollar amount withdrawn each year to adjust for inflation. To ride out these tough economic times, many planners advise forgoing the inflation adjustment, or even withdrawing less. This is especially true for people who are still in the early years of their retirement and worried about outliving their savings.

FIVE-YEAR PLAN In the current environment, this strategy stands out. In the 1980s, Harold Evensky, president of Evensky & Katz Wealth Management, came up with what he calls a five-year mantra. Mr. Evensky believes you should not invest any of the money you’ll need in the next five years — whether it’s for living expenses or a large purchase or another anticipated expense.

Take a couple with a $750,000 retirement portfolio who needs $30,000 a year. Using Mr. Evensky’s strategy, they would set up three separate accounts. The first account would hold two years of expenses, or $60,000. About half of that money would be in a money-market account, while the balance would be in a short-term, high-quality bond fund (like the Vanguard Short-Term Bond Index). Each month, $2,500 ($30,000 divided by 12 months) would be automatically transferred from the money market fund into a second account — a local checking account — to pay their expenses.

“Knowing where their grocery money is coming from makes it a little easier,” Mr. Evensky said. “When things get bad, they will know they can look at it, they can touch it and they know they haven’t lost a penny.”

The third account, the investment portfolio, would hold the remaining $690,000. This money would be diversified among stocks, bonds and other asset classes based on the couple’s stomach for risk, age and overall goals. But part of the allocation would include at least three years of expenses in short-term bonds. If there isn’t a good time to replenish the cash account, the couple can tap the short-term bonds (that way, they don’t have to sell their investments when the markets are down). Otherwise, the cash account can be replenished through rebalancing the investment portfolio.

Mr. Evensky said he tested how this method might work during a period similar to the 1970s, when both stocks and bonds were decimated and inflation was rampant. His portfolio lasted 24 years, whereas a portfolio invested in 50 percent stocks and 50 percent bonds ran out of money after 20 years, and an all-bond portfolio ran dry after 12 years.

IMMEDIATE ANNUITIES With this type of annuity, you give a pile of money to an insurance company, and it provides you with a paycheck until you die. For a 65-year-old male, the payout rate is about 8 percent. So for every $100,000 that man purchases, he will receive $8,000 annually, according to New York Life. Women receive slightly less because they live longer. The payout will be less if you choose to adjust your payments for inflation. Of course, you need to choose an insurer carefully — especially now.

“The promise to pay lifetime income is only as good as the insurance company can deliver,” said Karin Maloney Stifler, a certified financial planner in Hudson, Ohio. “Investors must realize that annuities entail credit or default risk by the insurer.”

You can spread your risk by buying a few annuities from a few top-rated insurers and only buy up to the amount that the state regulator will insure in the event of a default. Ms. Stifler said that $100,000 is typical. The big downside with annuities, of course, is that you cannot get your money back. And if you die shortly after you buy the annuity, your heirs will get nothing.

How much annuity do you need? Generally, you shouldn’t put all your nest egg into an annuity. One approach is to tally up your essential living expenses (housing, health care, groceries, etc). Then, figure out how much reliable income you have from Social Security, for instance, or a pension. If there’s a gap between the two, it may make sense to purchase an annuity to fund the difference, Ms. Stifler said.

PAYOUT FUNDS These mutual funds, which are intended to provide retirees with an income stream during retirement, have only hit the market in the past 18 months or so. There are generally two types of funds, though they’re all generally funds that invest in other funds. The first type operates much like a university endowment: it aims to generate a stable income stream — say, 3 or 5 percent — while either preserving or increasing the initial investment. Vanguard and Schwab offer funds in this mold. The second type of payout fund also aims to generate income, but only until a specified date in the future, when the remaining money, if any, is completely distributed. The Fidelity Income Replacement Funds use this methodology.

But when a fund performs poorly, the income generated will also fall. In some cases, the funds will begin to return your principal. That’s why some experts say these funds will more likely be used to cover discretionary expenses. Given the complexity of these funds, you really need to understand them fully — and the supporting role they should play in your portfolio — before jumping in.

“They are all interesting approaches, but they are unproven,” said Dan Culloton, associate director of fund analysis at Morningstar Inc. “You can lose money, and people have thus far. But they are an interesting proposal for someone who wants to turn their nest eggs into a stream of payments and have some control over the assets and the ability to take money out.”

Lock In Lifetime Income (Immediate Annuities) from WSJ

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

Lock in a Lifetime of Income

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

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


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

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

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

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

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

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

How much to annuitize?

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

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

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

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

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

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

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

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

Email: encore@wsj.com

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