Are Annuities Right for You?

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By Martha M. Hamilton March 26, 2009

This article appears at the following website: aarp.org

In 2006 I took a buyout from the Washington Post. In addition to getting my full pension five years early, I got a lump sum equal to two years’ pay.

The question confronting me back then was whether to invest that money in the markets or to buy an annuity, which would provide monthly payments to the end of my life, augmenting my pension.

I took the annuity, and then asked a financial expert whether I had made the right choice. The answer was that it might have been too conservative, given the fact that I already had a future stream of predictable payments from my pension and eventually from Social Security. A better option for the money may have been the market, where I was likely to get a higher return.

But now—when we look at the markets and see more risk than reward—I’m feeling pretty happy with the choice I made.

And, based on a new Fidelity Investments survey of fee-for-services financial advisers, other investors also are starting to value predictable returns. According to the advisers surveyed, 83 percent of their investor clients ages 55 through 70 think guaranteed income is more important than above-average gains. After years when everyone was going for the smart money, we’re taking a shine to the safe money.

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The annuity I bought with my lump sum was a single-premium, fixed-payment annuity, a product designed to make sure I don’t outlive my savings. Basically, it’s similar to a traditional pension, except it’s the individual, not the employer, whose contribution buys a lifetime stream of monthly payments. However, there are some important distinctions.

Employer-funded pensions cover a pool of people, including some who will die young, leaving more money for those who survive. On the other hand, the market for commercial annuities for individuals, which typically are sold by insurance companies, tends to attract people who expect to live longer than average. As a result, commercial annuities tend to have lower payouts. And, while employer-provided annuities—in some cases, as at the Post, offered in addition to the traditional pension (itself an annuity) as an option for investing a lump sum—are required to be gender-neutral, commercial annuities pay women less because of their anticipated greater longevity. So if you’re a woman, an annuity offered by your employer is a better deal, but if you’re a man, you’ll get higher returns from a commercial annuity.

And, even though annuities may look attractive now that we’re in the market for security blankets, there’s a catch. This probably isn’t the best time to buy them. Payouts from annuities go up and down with interest rates at the time of purchase, and interest rates are about as low as they can go right now.

Still, says Olivia S. Mitchell, chair of the Insurance and Risk Management Department at the University of Pennsylvania’s Wharton School, “one solution to that is to not buy all at once.” Mitchell and Joan Bloom, executive vice president at Fidelity Investments Life Insurance Company, say investors might want to consider “laddering” investments in annuities, or investing in annuities at regular intervals, not all at once.

Bloom also says that while returns on annuities do tend to go up and down with interest rates, they don’t go up or down as much as the overall market.

Even so, “I think there is a sudden awareness of the downside of risk that has translated into more interest in fixed payouts,” Mitchell says. She says that buyers should make sure the insurance company providing the annuity is highly rated and strong. Mitchell also likes the idea of annuities that increase with inflation. Although few companies offer inflation-indexed annuities and they are more expensive, she says they keep your purchasing power intact for life.

Scott Hudson, chief investment officer for Seeman Holtz Financial, a national company headquartered in Hollywood, Fla., that advises investors age 65 and older, says Seeman Holtz uses annuities as part of an income plan for its clients. “Our message always has been: Let’s reassess your risk, and let’s get more conservative. When we speak to people about that message in this market and last year’s market, it’s been very well received.”

Some developments are under way in the annuities market that may increase their use, Mitchell says. Some employers are considering offering annuities as a choice in retirement savings plans such as 401(k) plans, which could allow workers to put aside a portion of their savings to create guaranteed income.

Some companies are also beginning to offer “longevity annuities.” Instead of the stream of payments beginning when you invest, the payments kick in when you reach an older age—for instance, 85. As a result, the payments are larger. Some countries, including the United Kingdom and Germany, mandate longevity annuities, Mitchell says, to protect the government from having to provide for retirees who run out of money. She adds that other new developments may include annuities that pay at one rate as long as you are healthy and at a higher rate if you require home care or nursing home care.

Shopping for annuities can be difficult, in part because the features are not standardized. Although this is less of a problem for single-premium, fixed-payment annuities than for products such as market-indexed annuities (which for some investors turn out to be a money-losing product), Mitchell says she would like to see more standardization.

Immediate Annuities.com compares prices from participating companies and can give you an idea how much in monthly payments an investment can buy. You can also find information online from insurance companies, such as Berkshire Hathaway and MetLife.

One advantage of having monthly income from an annuity has come home to me during the current crisis. Because I have that additional income, I don’t feel pressured to sell any of my much devalued investments and can wait for the markets to recover.

“If people have a retirement income plan and feel confident that they have a certain stream of income, they then feel they have more flexibility to invest in the equities market or to stay invested for the long term,” says Fidelity’s Bloom. “Hopefully, their ending assets will be higher.”

Hopefully.

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