Investors Embrace Annuities
Looking for shelter from the stormy stock market, older investors turn to insurance products.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
December 22, 2008
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The historic stock market meltdown has spooked investors of all ages, but those in and near retirement are the most vulnerable.
"Classic diversification strategies designed to shield investors from across-the-board losses are not working in this market," says Mark Cortazzo, senior partner of the Macro Consulting Group in Parsippany, NJ. "For retirees withdrawing money from a shrinking portfolio, their risk of failure -- the risk of outliving their money -- is dramatic."
Many older investors who have little time to recover from market losses are turning to insurance products such as immediate and deferred annuities to protect themselves from market volatility and to create guaranteed income in retirement.
Personal pensions
Immediate payout annuities, also called income annuities, are simple and straight forward. You give an insurance company a chunk of money and it promises to send you a monthly check for a certain period of time or for the rest of your life, no matter how long you live. It's like creating a personal pension.
Immediate fixed annuity payouts are based on your age and prevailing interest rates at the time of purchase and your gender. (Women get slightly lower payouts since they tend to live longer than men and receive checks for a longer period of time.) For example, a 65-year-old man who invests $100,000 would receive annuity payments of about $725 a month, about $50 more per month than a 65-year-old woman who invested the same amount, according to ImmediateAnnuities.com.
Retirees concerned about outliving their savings, particularly those who don't have a traditional pension, may want to consider using a portion of their nest egg to buy an immediate annuity. (But don't tie up all your money. You'll need some on hand for emergencies and you still need to invest for growth to protect against future inflation.)
You can estimate how much monthly income you could receive from an annuity by using the calculator at www.immediateannuities.com or how large a lump sum you would need to invest to generate a certain amount of monthly income.
Increased income
An immediate annuity can significantly boost your retirement income. Using the widely accepted rule of thumb that recommends you tap just 4% of your nest egg during the first year of retirement and increase your subsequent withdrawals by 3% a year to keep pace with inflation, you could withdraw $4,000 the first year from a $100,000 portfolio. In comparison, a 65-year-old man would receive about $8,700 a year if he bought a $100,000 immediate annuity.
But there are drawbacks. Buying an immediate annuity is an irrevocable decision. If you live a long time, it's a good deal for you. If you don't, the insurance company keeps the balance of your investment and uses it to the pay benefits to other policy holders.
You can purchase an annuity with a survivor benefits, but that decreases the payout amount. For example, a 65-year-old couple who buys an immediate income annuity with full survivor benefits would receive about $600 per month as long as either of them lived—about 20% less than the man would receive on his own.
Your fixed-annuity will loose buying power over time due to inflation, so you might want to add another annuity later. Or, you could buy an inflation-adjusted immediate annuity which offers a smaller payout initially but increases each year to keep pace with inflation.
Despite their potential value as a guaranteed source of retirement income, immediate payout annuities have not be very popular, representing only 5% of the annuity market, according to a recent study by the Congressional Research Service. That's largely due to their lack of flexibility and retirees' concern over having nothing left for heirs. But that trend may be changing. Sales of fixed immediate annuities increased 26% in the third quarter of 2008 compared to the same period a year earlier, according to LIMRA, an insurance industry research firm.
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Reader Comments (7)
Posted by: Bob at 12/22/2008 11:57:56 AM
Annuities again? What magical high return investments will they find that the rest of us can't? Despite the word guarantee being used over and over,the fine print will ALWAYS state there is NO GUARANTEE. If you want a guarantee, simply put your money into FDIC insured laddered 5 year CDs and have the monthly interest paid to your checking accounts. You may only make 4-5% but you will know exactly where your money is with no unexpected commissions,fees or penalties. Every year 1/5 of your CDs will mature and can be cashed in if needed. As my wife says you won't have to worry about being caught up in a Fonzi scheme.(Misspelling (of Fonzi intentional...)
Posted by: wkgrt at 12/22/2008 05:45:52 PM
...you bought the (insurance companies) salesman's pitch hook,line, & sinker. Annuities are the insurance agent's best friend. This only benefits the agent's retirement, not yours. I saw a different version of this same story here a few months ago. You guys keep reptiching the same article with a different spin.
Posted by: Fred at 12/22/2008 11:20:58 PM
If (Bob) thinks most people can retire and keep ahead of inflation with a ladder of cd's, he is clearly mistaken. Annuities should be a PART of the retirement picture for those folks who can't stand the income volatility but still are looking for stock market type returns over the long term. If you're looking to lower costs, then buy cheaper investments with the portion of your portfolio that you can afford to lose.
Posted by: RobMac at 01/22/2009 05:22:50 PM
The bottom line is that money has become worth much less and it takes an extreme amount to generate a reasonable income stream. You can no longer survive on CD/ fiancial investment dividends. Immediate Joint Tennant Annunites guarantee an income stream for life. Talking about inflation concerns.. How about losing 40% of your value in the stock market!!! How's that for risky.
Posted by: gfmucci at 02/08/2009 06:59:45 PM
I'm considering a combination of annuties including "fixed, indexed annuities" and "variable annuities." The order of priorities is 1) safety 2) income 3) at least some portion of market appreciation. Two or three percent fees to accomplish this is acceptable at age 63. However, something that you seldom hear about from annuity agents is DIVERSIFICATION. It is just as prudent to diversify into more than one annuity account, and even perhaps into more than one annuity firm (depending of the rules of your state's guarantee funds) as it is with stocks and mutual funds. Does anyone have any experience with this sort of annuity diversification?
Posted by: TFLY at 02/25/2009 09:23:42 AM
Gfmucci has the right idea. The guarantees on any annuities are only as good as the guarantor's ability to pay. Different insurers use a variety of methods to insure thier promises - hedging, reinsurance, setting aside reserves. 2008 has put a real strain on the companies who did not adequately cover their contractual guarantees well enough. Fixed and variable annuities would be my choices. The indexed annuities that I have seen give too much control to the insurance company over how much you can make. They use "spreads" and "caps" to limit your upside participation in the index. Thus you may be capped at 6% in a year when the S & P, for instance is up 18%. They can also change the caps and spreads from year to year and you are stuck with the contract by surrender penalties. In a raging bull market, you are essentially "on the sidelines".
Posted by: Curtis Cloke at 06/14/2009 08:42:01 AM
There is another way to create lifetime income with a ladder of single premium immediate income annuities (SPIA), single premium deferred income annuities (DIA) and longevity insurance. You can purchase “Designated Period Certain” income annuities that pay the designated guarantee of payments even if the owner of the contract dies before all contractual payments have been paid. This insures that the retiree and or their heirs receive the entire stream of payments that were designated. (DIA) contracts are not well know and are the reason that this strategy actually works without the negative of losing anything to the insurance company while generating competitive rates of return. Only three carriers currently offer the ability to purchase today and defer payment start dates from 2 – 50 years in the future. All other deferred annuity income annuities require a life contingent stream of payments thus requiring the uncertainty and loss of control. Because these (SPIA) and (DIA) contracts can be purchased with an inflation feature that allows the income annuity to increase up to 6.5% annually, this in fact creates authentic solutions for inflation adjusted retirement income. Because the (DIA) contracts can be purchased in a laddered format for each of the stops and starts, you can purchase them for segments of the retirement period. If non-qualified dollars are used to fund any portion of the income annuities, the payouts enjoy an exclusion ratio payout which means that your gains come out on a pro-rata of the basis and gains for each segment selected. The higher the tax bracket the greater the tax benefit. If the laddered annuities are purchased with a designated period guarantee to age 85 - 90, the retiree can buy something called a longevity insurance policy. These contracts can be purchased at any age and can be delayed as far out as age 95. In totality, this creates a true income for life strategy that can be purchased anytime before or at retirement. The (DIA) contracts generate competitive rates of return with rates as high as 7.3% since 1/2009. The longer you defer start date for (DIA) contracts, the higher the rates of return. No insurance deposits or gains are retained by the insurance company except for the longevity insurance proceeds if death happens prior to age 85 - 90. The key to laddering these annuity contracts while extracting the highest rates of return with maximum tax efficiency is the mission of Thrive Income Distribution System.