New Wrinkles For Annuities

By Anne Tergesen July 23, 2006

This article appears at the following website: businessweek.com

Immediate fixed annuities convert a lump-sum payment into guaranteed monthly income for life, something that should make them attractive to retirees worried they'll outlive their money. But they're not as popular as you might think, since many retirees also worry about the reverse: that they'll die before they collect much of the money, effectively making the insurance company, not their children, the heir.

That's why insurers are coming up with features to make them more palatable. One allows your heirs to receive years of income if you don't live to collect it. Another boosts payments to keep up with inflation. If you need cash, some companies allow you to withdraw part of the value of your account at certain times. New York Life, for example, lets you take back as much as 30% of future payments at five-year intervals or in case of losses because of a fire, flood, or other natural disaster. You can lock in lifetime payments that start at a future date -- say, when you're 85 -- for a fraction of the cost of an annuity that starts paying immediately.

"We're designing products to help people get more comfortable with annuities," says Ted Mathas, chief operating officer at New York Life. The "cost" of many of these benefits: You get less monthly income than you would otherwise for the same up-front payment.

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Is it worth giving up income for features designed to protect you or your heirs? The answer depends on your priorities, your investment mix, and whether you can buy other products with similar features for less. Here are some of the options:

Death Benefits

If you buy an annuity today and die tomorrow, your money is gone. To protect your heirs, you can get an annuity that continues monthly payments after you die for whatever remains of your contract's first 5 to 20 years. (You pick a period.) New York Life also has a product that guarantees your heirs the difference between what you paid up front and what you received in income by the time of your death. Another pays a death benefit regardless of when you die. Is this worthwhile? You may be better off with a regular annuity plus a life insurance policy for your heirs, says Shane Chalke, CEO of Finetre Corp., which processes sales orders for annuities. For example, if a 65-year-old New York man puts $500,000 into an annuity with 10 years of guaranteed income, he'd pocket $41,328 a year for life, vs. $42,996 with a regular annuity.

Suppose the man takes the higher amount and plows the after-tax difference between the two (about $1,168 for someone in the 30% marginal tax bracket) into a 10-year term life policy. Then he could buy $212,000 in coverage, all of which will go to his heirs free of income tax. With the income-protected annuity, his heirs would receive a maximum of 10 years of income, or $413,280, paid out in annual installments of $41,328. The potential payout would decline by $41,328 for each year the man lives. So if he dies in year five, the heirs would get $41,328 a year for the five remaining years, or $206,640 in total. Because the man is relatively young, combining a regular annuity and a life insurance policy is likely to prove the better deal.

Inflation Protection

To keep rising prices from eroding your purchasing power, you can elect to receive an annual raise of 2%, 3%, or more. With Vanguard Group's Lifetime Income Program, you can choose to have your income adjusted once a year for inflation. But to get a 3% annual raise, the 65-year-old above would receive $31,780 the first year, vs. more than $42,000 with a regular annuity. It's only if he lives beyond his life expectancy of 82 that he will come out ahead by choosing the 3% raise, says Hersh Stern, publisher of Annuity Shopper magazine.

If you opt against inflation protection, make sure your portfolio contains assets, such as stocks, that typically grow faster than inflation, advises Ellen Rinaldi, principal at Vanguard. To make sure your portfolio has adequate diversification and liquidity, put no more than 30% into annuities, she adds.

Interest Rate Protection

The higher rates are when you buy an annuity, the higher your payments will be. If you think rates are heading up, consider putting some money to work now and more later. You can also buy a New York Life product that provides a one-time, 20% step-up in income on the policy's fifth anniversary if 10-year rates are two percentage points or more above where they were when you bought the annuity. To get this, you'll sacrifice 2% of your monthly income.

Longevity Protection

Suppose you're confident you have enough money for your 60s and 70s, but are worried about your 80s and 90s. You can buy "longevity" insurance by paying now for an annuity that starts payments years from now when you really need it. Sure, you may never collect -- but you're not putting out a huge sum, either. To get an annual income of $42,000 from age 85 on, a 65-year-old man would put down just $47,575 today, vs. $500,000 for an annuity that starts paying $42,000 now. Moreover, knowing how much income will kick in at 85, a person can spend more money during the next 20 years.

If you're worried about dying before your benefits start, MetLife (MET) offers a version that refunds heirs your investment plus annual earnings of 3%. But a 65-year-old man who puts down $100,000 would get just $49,080 a year starting at age 85, vs. $84,000 without the death benefit.