Showing posts with label immediate annuities. Show all posts

Getting the Maximum Social Security Benefit (New York Times)

November 15, 2013

The Payoff in Waiting to Collect Social Security

By TARA SIEGEL BERNARD

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.

The Sleep at Night Portfolio: Make Your Own Pension (WSJ)

New ways to create a gold-plated pensionBY ELEANOR LAISE,
The Wall Street Journal
The Wall Street Journal — 10/30/10
The financial crisis has given some investors a case of pension envy. In an era of volatile markets, the idea of steady, guaranteed payments for life holds obvious appeal.
The problem, of course, is that investors are less likely than ever to get that kind of deal from their employer. Companies tend to be freezing their pensions or closing them entirely, rather than beefing them up. About a third of today's Fortune 100 companies have frozen or closed a pension plan since 1998, according to consulting firm Towers Watson.

But that doesn't mean investors can't set up their own. New tools are emerging to help investors fashion portfolios that mimic the steady payments generated by the pension plans of yore.

The trick: to focus more on constructing a portfolio to cover future expenses—not just maximize returns—and to rethink old retirement-planning rules of thumb, such as a "safe" portfolio withdrawal rate of 4% annually.

Financial firms and advisers are catering to the demand for pension-like portfolios. New bond-based products can be tailored to produce income to pay living expenses for a period of, say, five or 10 years, leaving a significant chunk of the portfolio to invest in higher-growth assets with long-term potential. Some target-date mutual funds, meanwhile, are aiming to match their investments to the expenses investors face in retirement.

The new strategies often mean heftier helpings of bonds and inflation-fighting investments like real estate and commodities. While bigger bond holdings can mean lower returns, the approach also can give investors the confidence to stick with the more volatile stock investments in other parts of their portfolio, advisers say—reducing the chance they will sell shares at a market bottom.

When investors know that a few years' worth of basic expenses are covered by safe, high-quality bonds, "they can sit back and worry a whole heck of a lot less" about stocks' ups and downs, says Joe Chrisman, director at wealth-management firm Lourd Capital Management, which uses a pension-style approach with clients.

The most painful part of the process may be simply saving more. Since the financial crisis, "there's been a much greater recognition that the markets are not going to rescue everyone," says Timothy Noonan, managing director at Russell Investments. Building a secure retirement "is not a function of going and finding higher returns."

The pension approach seems to work: Over the long term, defined-benefit pension plans have outperformed 401(k) plans by roughly 1 percentage point annually, according to Towers Watson.

Small investors can't—and shouldn't—invest exactly like pension plans, though. For a pension plan acting on behalf of many beneficiaries, with people entering and retiring each year, the age of an individual worker makes little difference. But a person investing on his own must tone down portfolio risk—and generally accept lower returns—as he approaches retirement.

Pension plans also can buy into some investments that most small investors can't access, such as hedge funds and private equity, and get better deals on fees.

That isn't to say pension plans have some magic formula. Many suffered big losses in 2008, for example, though overall they held up better than 401(k)s, according to Towers Watson.

Neither type of retirement plan provides the perfect answer, says Zvi Bodie, a finance and economics professor at Boston University School of Management. "We need to combine the best of both."

Annuities may seem the simplest solution for investors seeking a steady income stream. One approach: Buy an immediate annuity that provides for basic expenses, leaving other parts of the portfolio to cover nonessentials. A number of firms now are working to marry funds with annuities within 401(k) plans.

Still, many advisers suggest investors first consider the greater flexibility, and often lower costs, that can come with a do-it-yourself approach.

A homemade pension plan starts by acknowledging that people, like companies, have a balance sheet with both assets and liabilities, advisers say. The liabilities include the money you will spend on food, shelter, travel and other expenses. Yet advisers and money managers traditionally have focused mostly on the assets, trying to maximize investment returns for a given level of risk.

Pensions, by contrast, are more likely to employ liability-driven investing, choosing particular investments to match their future expenses. Investors can do this, too—by buying long-term bonds, for example, to match payments to be made decades from now.New tools can help people size up future expenses. At goalgami.com, a free calculator launched earlier this year by financial-planning technology firm Advisor Software Inc., people can enter information on their income, assets, debt and long-term goals like real-estate purchases. Taking a lifetime view of the "household balance sheet," rather than a single snapshot, the tool analyzes whether future sources of cash will pay the bills and cover other retirement costs.

Most people want to maintain their standard of living in retirement. So if you have just retired and live comfortably on $100,000 a year, you want that income to keep up with inflation as long as you live, says Tom Idzorek, chief investment officer at Morningstar Inc.'s Ibbotson Associates.

A "laddered" portfolio of Treasury inflation-protected securities, or TIPS, can help. Investors who buy TIPS that mature in each year of retirement ensure a steady income stream that rises with inflation and matches spending, Mr. Idzorek says.

Ibbotson in recent years has been designing target-date fund strategies with retirement liabilities in mind. It has built two sample portfolios—one using traditional asset allocation and one with a liability-focused approach—that have roughly the same allocations to stocks and bonds. But the liability-focused portfolio allocates roughly 28% to assets that can act as inflation hedges, including commodities and real estate, versus about 16% in the traditional portfolio.

Since people are likely to spend their retirement money in U.S. dollars, they also can more closely match their assets with their liabilities by investing more in U.S. stocks and bonds as they approach retirement, Mr. Idzorek says. In the sample portfolios, the liability-focused approach devotes only about 8% to non-U.S. holdings, versus about 18% in the traditional portfolio.

The liability-focused portfolio's expected return, 5.9%, is only slightly less than the 6.4% expected in the traditional portfolio, according to Ibbotson.

Of course, given the recent bond rally, it can be pricey to match many years' worth of retirement expenses with TIPS and other bond investments. Asset Dedication LLC, a Mill Valley, Calif., money-management firm, aims to address that by building custom bond portfolios to produce precisely the income to cover client expenses for a given number of years, leaving plenty to invest in higher-growth assets.

The firm's Defined Income product, launched this year, invests in certificates of deposit, TIPS and other high-quality bonds and holds them to maturity. Bulking up on fixed-income might seem counterintuitive right now. But by holding bonds to maturity and then rolling them over, the strategy can capitalize on higher yields later.
If a client wants to spend $50,000 in each of the next five years but also wants to buy a vacation home in year three, the account can help plan for that, says Mr. Chrisman of Lourd Capital, which uses the Asset Dedication program and other liability-driven strategies with clients.

Mickey Patrick, 57 years old, says his do-it-yourself pension allows him to stop worrying about short-term stock-market swings. Mr. Patrick, a technology manager in Houston, earlier this year started investing most of his individual retirement account in TIPS, CDs and other high-quality bond holdings. Though several financial advisers had told him to keep most of the money in stocks, Mr. Patrick determined that the account needed to cover only about one-fourth of his retirement spending, since a pension and Social Security would provide the rest—and therefore he didn't need to take that much risk.

"They said I was crazy," Mr. Patrick says. But while he used to check market moves daily, now "I don't worry at all about it," he says.

People who are focused on matching investment assets with retirement "liabilities" challenge some conventional retirement-planning wisdom. One rule of thumb says investors should have a stock allocation equal to 100 minus their age. (A 40-year-old, for example, would keep 60% in stocks.) But Boston University's Mr. Bodie says risk-averse investors, even younger ones, might want to put most of their money in safer assets.
Bob Kirchner, 63, a retired economist in Fort Washington, Md., has found that a liability-matching strategy reverses the traditional planning process. Instead of first deciding to put, say, 50% in stocks, he says, it's "let's get all this safe stuff lined up first," leaving stock decisions for later. He now has more than half of his portfolio in TIPS.

Liability-driven investing also involves rethinking the "safe" portfolio-withdrawal rate. Many advisers say retirees can withdraw 4% of their initial retirement balance a year, adjusting annually for inflation. But while the 4% spending rule is rigid, the investments tend not to be. Someone might automatically spend a preset amount, disregarding the fact that his portfolio has gained or lost, say, 30% over the past year. With the 4% rule, "there's a chance you'll wind up with nothing, and there's a bigger chance you'll leave quite a bit," says William Sharpe, a professor of finance, emeritus, at Stanford Graduate School of Business.

A bill introduced in Congress last year would require 401(k)s to show participants a projected monthly retirement income based on their current account balance, instead of just a simple lump sum. Russell Investments is developing tools to help financial advisers look at similar metrics for clients' portfolios, says Russell's Mr. Noonan.

If investors can look at their progress in terms of their personal goals rather than market events, Mr. Noonan says, "it's easier for them to remain invested when the market is doing scary gyrating things."
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Copyright © 2010 Dow Jones & Company, Inc. All Rights Reserv

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

Guaranteeing Lifetime Income (Yahoo.com , Forbes)

by Scott Woolley
Wednesday, May 13, 2009

If your assets are barely sufficient for your own needs, stiff your heirs. Put your money into an annuity.

As a purely financial matter, it's difficult to die at just the right time. Pop off unexpectedly young and you could rob your family of paychecks it was counting on. Hang on too long and you could exhaust your savings, impoverishing your family or consigning yourself to a decrepit retirement home.

One unexpected side effect of the recent financial crisis: a boom in sales of fixed immediate annuities, which dispense guaranteed income for life. Sales at New York Life, the largest issuer, hit $425 million in the first quarter, up 82% from last year.

For most clients those new annuities are likely to be a good deal. A 65-year-old man who pays New York Life $100,000 today will receive $650 a month for life. That's equal to taking out 7.8% of the total each year, which is double what long-term Treasurys yield. (Because of her longer life expectancy, a woman of the same age would receive $600, or 7.2%.) Wait longer to buy an annuity and the payout is, of course, higher (see table).

Part of the sales surge is because of the crash. Fixed-annuity buyers sailed peacefully through the recent market turmoil with monthly checks intact. Another factor: Many older Americans now find themselves planning for retirement with shrunken portfolios. Instead of living off dividends and leaving the principal to heirs, they need to consume the whole sum for their own needs.
Annuities offer the best way to lock in guaranteed lifetime income, argues Christopher Blunt, who runs New York Life's retirement division. Retirement income generated from a stock-and-bond portfolio requires keeping plenty of assets in reserve in case they're needed to fund a long life or contend with a nasty bear market. Blunt's pitch: Get the same retirement income as you could from a stock-and-bond portfolio, with 25% to 40% less principal.Annuities' ability to generate superior retirement income is conjured by pooling risk. The annuities transfer savings from people who don't need it (because they're dead) to those who do.

This ability to match assets to future liabilities sends academic hearts aflutter. Economists who study the retirement market have long been sold on the merits of annuities and frustrated by consumers' aversion to them. U.S. vendors sold a piddling $6 billion worth of immediate fixed annuities last year. The 2008 figure will likely be around $10 billion. This in a country with $2.7 trillion tucked away in 401(k)s.

One explanation for poor sales is that immediate fixed annuities aren't very profitable for the salesperson. A 70-year-old client who plunks down $500,000 for an annuity and cashes a $3,600 monthly check probably doesn't need much else.

Another impediment to sales has been crummy marketing by insurers. Fixed immediate annuities have gotten a bad rap in part for sharing an association with their deferred-annuity cousins. These are complex vehicles that promise a tax deferral but subject buyers to a multiyear "accumulation phase," during which assets are subjected to all manner of surrender penalties, commissions, fees and insurance charges, before paying out a dime. Most are great deals for the sales reps and lousy ones for clients.

Unlike fee-laden deferred annuities, immediate ones are likely to be a square deal for buyers. The typical buyer receives a string of payments worth (at discounted present value) 95 cents for every premium dollar he pays in. The obvious reason for the efficiency in the pricing is that prices are easy to compare. Someone with $1 million to put in gets quotes from several vendors and takes the best payout.

Insurers do the best they can to make the product more opaque and complicated. Responding to customers' fear that they'll get a really bad deal (by dying young and leaving heirs nothing), vendors offer such features as a guaranteed minimum payout. A 65-year-old man who buys an annuity with a "ten-year period certain" feature has the right to checks for ten years, even if his heirs are the ones to cash them. For this he cuts his annual payout from 7.8% to 7.5%. That might seem like a small price to pay, but the drop-off is so tiny only because the guarantee is unlikely to cost the insurer much. Almost all 65-year-olds live at least into their early seventies.

Assuming you're in good health and keep your product features simple, there aren't a lot of downsides to fixed immediate annuities. One to think about is the risk that the insurer will go bust in your lifetime. However, there are segregated asset pools as well as state-run guarantee funds to make a loss unlikely. In the bankruptcy of Executive Life, some annuity holders lost 20% of their payout. Try to buy from a company with a rating of double-a or better from A.M. Best. New York Life, tiaa and Northwestern Mutual qualify.
A bigger risk is inflation. New York Life offers a rider that increases payouts at a set rate of between 1% and 5% annually but is not pegged to actual price rises. More in keeping with the buy-it-and-forget-it philosophy are payouts linked to the Consumer Price Index, which are available from Lincoln Life Insurance and others. For a 65-year-old man an inflation-indexing feature would cut his initial annual payout from 8% to 5% of his original principal. If inflation averages 4%, the indexed payout would surpass the conventional one in year 12.

Do you want to protect a spouse? That will cost you. If our hypothetical 65-year-old man is married to a 60-year-old woman, he'll cut the annual payout to 6.3% if it has to last until they are both dead.

Immediate annuities aren't a great fit for everyone. If your annual retirement living expenses (including income taxes) come to less than 3% of your assets, you should be able to safely fund your lifestyle by owning a conservative mix of securities, without effectively handing over 7% to an insurer to cover your longevity risk. For everyone else the standard advice is to annuitize the portion of your nest egg you'll need to cover living expenses, including supplemental health insurance. The rest you can invest as you please.
One way or the other, an immediate annuity is an investment you're unlikely to regret buying. If it turns out that the insurer got the better deal, you won't be around to fret about it.

Income for Life

Buy a fixed annuity for $100,000 and what you get depends on your age and gender. Adding a guarantee of ten years of payments (even if you die tomorrow) is surprisingly cheap.

Plain annuity (life)/With 10-year guarantee/With cash refund
Buyer would receive Monthly Check ( Yield )

65-year-old man $650 (7.8%) / $629 (7.5%) / $601 (7.2%)
65-year-old woman 600 (7.2) / 592 (7.1) / 571 (6.9)
70-year-old man 723 (8.7) / 691 (8.3) / 654 (7.8)
70-year-old woman 667 (8.0) / 650 (7.8) / 619 (7.4)
80-year-old man 1,026 (12.3) / 858 (10.3) / 836 (10.0)
80-year-old woman 960 (11.5) / 818 (9.8) / 785 (9.4)

Source: New York Life.

Copyrighted, Forbes.com. All rights reserved.

Safer Strategies for Retirement Portfolios (NY Times)

June 20, 2009
Your Money
For Older Investors, Old Rules May Not Apply
By TARA SIEGEL BERNARD
The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less.

But what should you do right now with the money you have left? Should you wade back into the stock market, if you bailed out when the market was plunging? Or if you watched your investments drop and then recover a little in the last few months, should you just hold on? What happens if the market doesn’t fully recover for a long time? (That happened in Japan in the ’90s.)

This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.

The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.

But some people are no longer comfortable with that logic. There’s even a new study that contends holding stocks over long periods of time may be riskier than previously thought. Robert F. Stambaugh, a finance professor at the Wharton School at the University of Pennsylvania and a co-author of the report, said most investment research only accounted for the risk of short-term market swings around the stock market’s average gain over time. It doesn’t factor in the fact, he said, that the average itself is subject to change.

So what should retirees and pre-retirees make of all of this?

“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”

What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.
That’s a rather conservative recommendation, by many financial planners’ standards. In fact, Vanguard itself offers products that are more aggressive. Its target-date funds — whose investment mix grows more conservative as retirement nears — recommend that people retiring in 2010 (generally, people who are 65) should split their savings evenly between stock and bonds.

Charles Schwab, by contrast, has recently reduced the risk for its target-date funds. The company’s 2010 fund will allocate about 40 percent to stock funds next year, down from 50 percent in the past. “It’s a reflection that our clients’ appetite for risk has changed,” said Peter Crawford, a senior vice president at Charles Schwab Investment Management.

But you shouldn’t simply view your investments through the lens of how much you allocate to different investments (though you will need to come up with a plan). Instead, you should work your way backward. First, consider how much you will need to live when you’re retired and then figure out how you’ll pay for it.
Nearing Retirement

Ideally, you should have started to slowly shrink your stock position over your working career. But some financial planners have become more conservative about that. Before the market’s sharp downturn, Warren McIntyre, a financial planner in Troy, Mich., typically reduced his clients’ stock allocations by about 1 percent each year. Now, for older investors, he ratchets down their stocks by 2 percent each year once they reach 60. So a 65-year-old’s investments would be evenly split between stocks and bonds.
Other planners are taking even more defensive positions. “We are still very concerned about the status of the economic recovery and remain quite defensive as a result,” said Chip Addis, a financial planner in Wayne, Pa., who invests his clients’ portfolios in only 40 percent stocks.

Of course, there’s no one formula. Milo Benningfield, a fee-only planner in San Francisco, for instance, said he put a 61-year-old client in a portfolio with 60 percent in diversified stocks and alternatives (like real estate) and 40 percent in fixed-income (largely split among high-quality, short-term and intermediate-term bonds and cash). But this client can afford to take that risk — the client owns a house, rental property and has other holdings outside the portfolio.
The picture may change for pre-retirees who are 61 and close to meeting their savings goals, but can’t afford to lose any money. “We would ask ourselves to what degree, if any, can you afford equities,” Mr. Benningfield said. If inflation was their only concern, he might invest their money across a ladder of Treasury Inflation-Protected Securities, or TIPS, which are backed by the government and keep pace with inflation.

But since retirees generally spend money on entertainment, health care and food — whose costs often exceed the general rate of inflation — he said he might invest 40 to 50 percent of their money in a portfolio of diversified stock funds (with at least 30 percent of that in international stock funds). But, he added, “Cash is risky, stocks and bonds are risky, life is risky.”

As to those investors who got out of stocks, Mr. Bogle said it might be time for some of them to get back in. “But I would take two years to do it,” he said. “Maybe average in over eight quarters, and do an eighth each quarter. I am just not in favor of doing things in a hurry or emotionally.”

And then? “Don’t touch it,” he said, emphatically. “One of my rules is don’t do something. Just stand there.”

Retirement

Several planners recommended different variations on a similar strategy for retirees. Set aside anywhere from eight to 15 years of your expected expenses — that includes food, utilities, housing, insurance — in bonds and cash. That way, you’ll never have to tap your stock holdings at the worst possible moment.
“Once you have that in place, you feel like you can weather any economic storm,” said Chip Simon, a financial planner in Poughkeepsie, N.Y.

When you have figured out how much it costs to live each year, the next step is to see how much Social Security will cover. Whatever is left needs to be financed by your retirement portfolio. And the general rule of thumb is that you shouldn’t withdraw more than 4 percent of your portfolio (adjusted for inflation) each year. There are different ways to invest your cash and bond holdings.

Rick Rodgers, a financial planner in Lancaster, Pa., invests 10 years of annual expenses in a bond ladder, with an equal amount coming due every six months. The ladder can include high-quality corporate bonds, Treasury notes, certificates of deposit or municipal bonds, depending on the retiree’s tax bracket. Mr. Simon takes a similar approach using a 15-year ladder of zero-coupon bonds. He says that investors can start building the ladder in their 50s, with the first rung coming due the year they retire.

Some advisers also say you can guarantee you’ll be able to cover your basic expenses by purchasing an immediate annuity from an insurance company. The annuity pays you a stream of income until you die. “You can buy four small ones from four insurers if you are worried about insolvency risk,” said Dallas L. Salisbury, president of the Employee Benefit Research Institute. “And if you are just worried about inflation protection, you can do TIPS.”

But you should probably delay any annuity purchases because payouts rise with interest rates. With current rates so low, and the possibility of inflation later, advisers said it’s best to wait a few years. You can also research inflation-adjusted annuities, but you’ll receive lower payouts in the beginning, Mr. Benningfield said, adding: “Less than most people can stomach.”

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 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.”

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