An Annuity Could Protect Savings

By Sandra Block, USA TODAY November 23, 2001

This article appears at the following website: usatoday.com

Considering the alternative, most of us hope to live for many years after we retire.

There's a good chance you will. The average 65-year-old will live an additional 17.8 years. A healthy percentage of retirees will live much longer.

But as Americans are living longer, many worry they'll outlive their money. Events of the past year have stoked those fears. Many retirees have seen their stock investments savaged by the bear market. Those seeking sanctuary in money market funds and certificates of deposit have seen their income evaporate.

The financial services industry has a solution: immediate annuities. These products offer a way to ensure you'll receive a check every month for as long as you live. If you don't have an employer-provided pension plan, immediate annuities provide a way to create your own pension, using the money you've saved for retirement.

When you buy an immediate annuity, you give an insurance company a chunk of money in exchange for a guarantee that you'll receive a monthly check for the rest of your life or for a specific period. The amount of the check will depend on several factors, including your life expectancy and the expected rate of return on your investment.

Competition has led to more choices in immediate annuities and lower expenses. Still, the security of an immediate annuity comes at a cost. What you should consider before you buy:

Control of your money.

Even the biggest supporters of immediate annuities say you should only use them for a portion of your retirement savings. The reason: Once you hand over your money, you're locked into the agreed upon monthly payment. If you underestimated your expenses or need money to buy a new car, you're out of luck.

Some companies will let you cash out of your annuity during the early years, but you'll pay a surrender fee. For example, T. Rowe Price will let you withdraw some or all of your investment in its immediate variable annuity during the first 5 years. The surrender fee for the first year is 5% of the amount withdrawn, and it declines by 1% for each of the 4 remaining years.

Your heirs.

If you buy an immediate annuity that provides payments for the rest of your life, the payments will stop when you die. None of the money you invested will go to your heirs, even if you die shortly after buying the annuity. Many annuity owners don't understand this aspect of immediate annuities, says Andrew Keeler, a financial planner in Columbus, Ohio.

There are ways to ensure your annuity outlasts you. If you're married, you can buy a joint and last survivor annuity, which continues payments as long as you or your spouse is alive. You can also buy an annuity for a specific period, ranging from 10 to 30 years. If you die, your beneficiaries will continue to receive payments until the period expires.

The drawback: Your payments will be reduced. When you buy a joint and last survivor annuity, the payments will be based on the life expectancy of both you and your spouse.

Inflation.

Fixed immediate annuities provide the same monthly payment for the life of the annuity. That's fine if you expect your expenses to remain the same for the rest of your life. But if inflation boosts the price of groceries or utilities, your annuity benefits may fall short.

Many insurers now offer variable immediate annuities, which link their returns to the performance of stock mutual funds. Returns are based on the performance of the funds during the past month or the past year.

In return for greater returns, you accept more risk. During a stock market downturn, your income could plunge.

Some insurers let you have it both ways. For example, Fidelity Investments Life Insurance offers an immediate annuity that lets you allocate part of your money to a fixed portion, guaranteeing a specific amount of income each month, and invest the rest in a variable portion, says Farrell Dolan, senior vice president of the company. T. Rowe Price offers an immediate variable annuity with a floor: Your payment can never fall below 80% of your initial monthly payment. For example, if your initial monthly payment is $1,000, you can earn more if the stock market rises. But no matter how much your investments decline, you'll never receive less than $800, spokesman Steve Norwitz says.

Fees.

When you buy an immediate annuity, you'll pay what's known as a "mortality and expense" fee to the insurance company. You'll pay an investment management fee to cover the cost of managing the underlying investments. You may also pay an annual account maintenance fee.

These fees add up. The average fee for an immediate variable annuity is 2.12% vs. 1.4% for a stock mutual fund, according to fund-tracker Morningstar. Fixed annuities are less expensive because, like bond funds, they're less costly to manage.

Fortunately, this is an area where shopping around can save you money. Insurance arms of many no-load mutual fund groups now offer low-cost annuities. For example, annual fees on TIAA-CREF's immediate annuities range from 0.37% to 0.59%.

So who should buy an immediate annuity? Consider investing in one if:

1. You want a regular source of income and aren't interested in leaving money to your heirs. If you want to leave a legacy to your children, an immediate annuity isn't a good choice.

2. You're extremely risk-averse. With proper planning, financial planners say, most retirees can make their savings last until they die without buying an immediate annuity. But that usually means leaving at least some of your money in the stock market. If you can't bear the thought, an immediate annuity offers a way to transfer the risk to an insurance company, Norwitz says.

3. You expect to live for a long time. If you're healthy and come from a long line of octogenarians, a lifetime annuity may pay off.

If you're convinced an immediate annuity is right for you, do your homework. There are several Internet Web sites that let you get free quotes on monthly payments. One of the easiest to navigate is WebAnnuities.com (www.immediateannuities.com).

Before you hand over any money, make sure the insurance company is financially sound. A.M. Best, which rates financial services companies, provides ratings at its Internet site, www.ambest.com.