Looking for shelter from the stormy stock market, older investors turn to insurance products. By Mary Beth Franklin, Senior Editor December 22, 2008 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. Advertisement 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. Advertisement 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. Advertisement Hedging your bets There's another type of annuity that you can use to accumulate money over time and provide income in retirement. Deferred annuities can be "fixed" when tied to a specific interest rate or "variable" when linked to stock market performance. Annuity distributions, except for the portion that represents a return on your investment, are taxed are your regular income tax rate, not the preferential capital gains rates. If you use money in your retirement account to buy an annuity, the distributions are fully taxable. Cortazzo says he usually recommends deferred variable annuities with an annual income guarantee for his clients in or near retirement. The details can vary greatly from one company to another, but he likes the kind that typically offers a 6% income guarantee. It works like this: If you invest $100,000, you could withdraw $6,000 a year without diminishing your $100,000 principal that you invest in variety of mutual-fund-like sub-accounts. If the market goes up, you can reset your account balance on the anniversary of your contract and base your annual withdrawal on the new, higher amount. So if your account balance rose to $120,000, your 6% guarantee will generate $7,200 in annual income, up from the original $6,000 a year. "It's an effective strategy for current retirees and clients within a few years of retirement who have taken a hit on their investments, but want to stay in the market,” says Cortazzo. Advertisement Once the surrender period ends -- which generally lasts from two to ten years -- you can continue taking guaranteed withdrawals or cash out your account balance as a lump sum. You might want to do that if the investments have performed well and in your balance has increased. But if your account balance declines due to poor investment performance, you can continue to take guaranteed withdrawals over your lifetime based on higher amount that you already locked in. However, if you want to take the money and run, you can only cash out the actual value of your account. Buyer beware In the hands of a trusted financial adviser, a deferred annuity can be an appropriate part of your retirement income plan. But these products are very complicated with lots of moving parts. Income guarantees and other options can be expensive, costing at least 3% a year or more. And your money might be tied up for years. Typically, an annuity with a seven-year surrender period might penalize you 7% of the value of the annuity if you break the contract during the first year, declining to 1% in the seventh year and disappearing after that. There have been many well-publicized examples of unscrupulous insurance brokers aggressively marketing annuities to elderly investors, sometimes tying their money up with long surrender periods that exceed their life expectancy. If you are considering purchasing an annuity, make sure you understand what you are buying. In a recent investor alert, FINRA, the Financial Industry Regulatory Authority (www.finra.org), suggests that you ask the following questions: • How long will my money be tied up? • Are there surrender charges or other penalties if I withdraw funds from the investment earlier than I anticipated? • Will you be paid a commission or receive any type of compensation for selling the variable annuity? How much? • What are the risks that my investment could decrease in value? • What are all the fees and expenses? Finally, if you are offered an annuity with a feature you like, such as an income guarantee, but it has a longer surrender period than you want, ask if a similar feature is available on a product with a shorter surrender period.