Tools to safeguard your retirement income

washington post

By Kimberly Lankford April 18, 2010

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The need for lifetime income is huge and growing as life expectancies continue to increase and traditional sources of guaranteed income disappear. For a couple of 65-year-olds, there's a 25 percent chance that one spouse will live until 97, yet fewer people are retiring with pensions and Social Security covers only a small portion of most people's expenses. Many retirees who had planned to fill the income gap with their savings are wondering where to turn after suffering through two severe market downturns in a decade. An annuity may be the answer, but not all annuities are alike, and some may not be appropriate for you.

Plain and simple

An immediate annuity is based on a simple concept: You give an insurance company a lump sum and it promises to send you a monthly check for the rest of your life -- no matter how long. For example, a 65-year-old man who invests $100,000 in an immediate annuity today could collect $8,112 a year. That's about twice as much as he could safely withdraw from his savings each year if he followed a widely accepted recommendation: Limit initial withdrawals to 4 percent of your portfolio to avoid outliving your savings.

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Part of the reason for the bigger annuity payout is that each distribution consists of interest as well as a return of principal. But the real secret behind the beefed-up annuity checks is that you pool your risk with other policyholders. Those who die at earlier ages end up subsidizing the payments of people who live longer. You get the biggest bang for your buck if you buy a "straight life" annuity, which pays out only for your lifetime, with no survivor benefits. Most married couples, however, prefer to buy annuities that pay out as long as either spouse lives, even though it means smaller benefits. For example, a 65-year-old couple who invests $100,000 in an immediate annuity and chooses dual coverage would receive an annual payout of $6,634.

How to shop

When deciding how much to invest in an immediate annuity, add up your monthly expenses, subtract any guaranteed sources of income (such as Social Security and pension benefits) and buy an annuity to fill the gap. But watch out: Payouts can vary enormously by insurance company, so it's a good idea to shop around. "There's easily a 10 to 15 percent spread from the top to the bottom of the list," says Hersh Stern, publisher of

One risk of immediate annuities, however, is that your fixed monthly check will lose buying power over time, so it's important not to tie up all your cash at once. Interest rates and your age also affect the payments. Because current interest rates are so low, you may want to ladder annuities, meaning you invest some money in an immediate annuity now and buy another later when interest rates may be higher. Plus, you'll get a bigger payout because you'll be older and have a shorter life expectancy.

Hedge your bets

Another way to deal with rising expenses is through a deferred variable annuity. (Despite the shared "annuity" label, the similarities end there.) Deferred variable annuities are complex products that try to do a lot at once. You invest in mutual-fund-like accounts that can grow through time, and they give you a minimum guarantee in case the investments lose money. They're most attractive to pre-retirees in their fifties or sixties who want to capture stock-market gains during their final decade of work without exposing their nest egg to investment losses.

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James Rogers, a financial planner in Exton, Pa., had avoided recommending deferred annuities for years, mainly because the distributions are taxed at ordinary income-tax rates rather than lower capital-gains rates reserved for most other investments. Rogers took a second look when insurers started offering generous guarantees.

Unfortunately, annuities with guaranteed minimum-withdrawal benefits aren't as good a deal as they were even a few years ago. After ratings agencies expressed concerns over insurers' ability to make good on their promises, many companies scaled back their guarantees and increased fees for new policyholders.

An alternative strategy

Mark Cortazzo, a financial adviser in Parsippany, N.J., has devised an alternative strategy to replicate the growth and income benefits of an annuity at a much lower cost. His clients invest some money in longevity insurance and the rest in a portfolio of low-cost exchange-traded funds that he manages.

In its purest form, longevity insurance allows you to buy an annuity now and begin receiving a generous payout for life 15 to 20 years afterward. For example, invest just under $200,000 at 65 and you could receive $50,000 every year for life starting at 80. MetLife recently introduced a version of longevity insurance that provides extra benefits if you die early, for a relatively low cost. Cortazzo took notice and used it as a cornerstone to build a new model for retirement income.

"You just need enough money make it to the finish line at age 80," he says. And if the investments perform well, you'll have extra cash to supplement your longevity insurance or leave to heirs.

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