Annuities With Guaranteed Benefits
Annuities that promise minimum income sound great, but they can be complex and costly.
EDITOR'S NOTE: This article was originally published in the February 2009 issue of Kiplinger's Retirement Report. To subscribe, click here.Even in this tumultuous market, Tom Gilson of Jensen Beach, Fla., can withdraw 6% a year from his savings without worrying about running out of money. How?
The 68-year-old retiree has a variable annuity with a guaranteed minimum income benefit that lets him take out 6% of the highest value his investments ever reach, no matter what the market does after that. His investments are now worth only half of the balance that is used to calculate his guarantee. "Needless to say, that is pretty substantial," he says.
As the market continues to struggle, insurance companies are intensifying their marketing of annuities with guaranteed benefits. The target of this sales blitz: retirees who worry about outliving their dwindling nest eggs.
Generally, these annuities promise a benefit regardless of market performance. Still, they're not for everyone. There are so many moving parts that the products are difficult to compare. For instance, payouts vary enormously, and high fees can devour returns and the value of the guarantee. Surrender periods and charges also vary. Some annuities allow you to invest in low-cost index mutual funds, while others only offer expensive investments.
Also, some newer versions are not as generous as ones offered a few years ago, like the annuity Gilson has. After the stock market plummeted, some companies found it expensive to meet the guarantees based on higher market values. They're raising fees or reducing guarantees for new products.
Variable annuities let you invest in several mutual fund–like accounts, and the money grows tax-deferred until it's withdrawn. Most companies now let you pay extra to add on a guarantee, either a guaranteed minimum income benefit or a guaranteed minimum withdrawal benefit. The insurer charges 0.6% to 1% of your investment on top of the standard annuity fee of about 1.4%.
With a minimum withdrawal benefit, you can withdraw up to a certain amount each year from the initial investment for the rest of your life, no matter how the investments perform. A 5% to 6% annual payout is most common. Some products increase payouts if your investments increase.
Unlike immediate annuities, which also guarantee lifetime income, you can withdraw your account balance at any time. Many of these annuities levy a surrender charge of up to 7% if you cash out in the first year, but the penalty disappears after you hold the annuity for seven years or so.
With a minimum income benefit, you withdraw up to a certain amount each year -- 5% to 6% is also common -- until the account is worth next to nothing. At that point, you can convert your account to a lifetime stream of payments, called annuitization.
Those lifetime payments are based on at least the original investment and are usually higher than the initial 5% or 6% withdrawals. The older you are when you annuitize, the higher your payouts.
Gilson owns an Ohio National annuity with guaranteed minimum income benefits. His adviser, Mark Cortazzo, a certified financial planner at Macro Consulting Group in Parsippany, N.J., says he prefers this type of guarantee because "you can get higher cash flow" than with the withdrawal benefits. Depending on your age when you annuitize, the benefit could be 7% or more of your initial investment.
Gilson's payout rose as his investments increased in value. The payout locked in at the highest point -- 40% higher than his initial investment -- although the investments lost money after that. The benefit will be reset higher if the investments rise again.
Cortazzo prefers annuities with guarantees for people in their late fifties or sixties who plan to start taking withdrawals within the next three years. He says that an immediate annuity will generally provide older retirees with a bigger payout.
Gilson retired from a pharmaceutical company at age 57 in 1997. After the dot-com bust, he decided to get help managing his investments. "I wanted something that could provide the gains that the stock market might provide, but also the security of not having to worry about a big loss," he says. He bought his first annuity in 2001 and started taking withdrawals three years later.
Strategies to Maximize the Benefit
Another strategy is to buy the annuity at retirement but to delay withdrawals for about ten years. The money stays invested in the market and builds up higher guarantees, says Mark Ragusa, co-founder of AnnuityGrader.com, which lists the details of annuity guarantees from many companies.
Ragusa often builds a fixed-income portfolio to cover clients' expenses for ten years, including bonds, laddered CDs and sometimes an inflation-adjusted immediate annuity. After the ten years, the variable annuity will kick in, offering guarantees tied to the investments' highest point.
Ragusa prefers annuities with guaranteed minimum withdrawal benefits because the money can stay invested in the stock market for life but still provide guaranteed payouts. Right now, he likes Transamerica's version because of its low fees and low-cost Vanguard index funds.
Still, it's easy to make a mistake that could jeopardize the benefits. If you cash out the annuity, you may get only your actual balance in your account, even if it's much less than you originally invested. "People could be walking away from a tremendous guarantee," says Cortazzo.
Christopher Cordaro, chief investment officer with RegentAtlantic, in Morristown, N.J., doesn't believe it's the right time to buy these variable annuities. The best time, he says, is when the market is high and you want protection against a fall. With the market near its bottom, you're just guaranteeing a very low initial account value. "It's like buying flood insurance right after a 100-year flood," he says.
Instead, Cordaro prefers investing enough money to cover fixed retirement expenses in an immediate annuity. Then he invests the rest of a client's savings in a diversified, low-fee stock portfolio.
If you decide to buy a variable annuity with guarantees, make sure it's one that resets payouts to the highest investment values. Otherwise, the lifetime guarantee will be based on an initial investment of, say, $100,000, even if the investments end up growing to $500,000. You'll be spending a lot of money for a guarantee you'd never use.
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