Cutting Through Confusion Over Annuities


My wife is 79 and I am 81. We are interested in investing $300,000, which is nearly all of our savings, in products that would produce a steady stream of income, leaving the principal intact and not having to worry about the stock market. We have attended a dozen investment seminars for senior citizens and have learned that something called an equity-indexed annuity would appear to meet our needs better than any other investment I am aware of.

My wife, however, has been very cautious about annuities, partially because the press has reported numerous instances in which annuities have been sold to seniors when the product does not suit their needs. In view of the above, we have decided to obtain your independent opinion.

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Are you sure you heard right in the seminars you attended?

An equity-indexed annuity is not designed to throw off income, but rather to offer the potential to grow your principal over time without risk of principal loss. With an equity-indexed annuity, your return is based on that of a stock market index, such as the Standard & Poor's 500, for example.

Under a typical scenario, the value of your annuity would go up on years the S&P 500 Index goes up and would stay the same on years the S&P 500 Index goes down, preserving any previous gains. The catch? The gains, while "linked" to those of the index, are usually subject to "participation rates" and "caps." For example, you may be credited with 70 percent rather than all of the gain of the index on years that it goes up, and your maximum gain may be capped at 8 percent a year, no matter how high the index soars.

In addition, you often must agree to keep your money in the annuity for many years (I've seen as many as 15), or pay a hefty surrender charge (I've seen as high as 15 percent) to get out. True, many equity-indexed annuities do allow partial penalty-free withdrawals, such as up to 10 percent of the account value a year up to a maximum 25 percent for the life of the annuity. But these withdrawals would be partly (if not mostly or all) a return of your own principal rather than interest, depending on how the annuity performs.

For somebody your age who wants steady income while leaving your principal intact, an equity-indexed annuity strikes me as a particularly unsuitable investment. Even if it were suitable, I'd be leery about putting nearly all my money in it.

For steady income while retaining access to principal, a "ladder" of certificates of deposit, Treasury notes and investment-grade corporate bonds, each maturing at different times, would be a far better option. While bond prices would fluctuate, you would get your principal back at maturity.


We are deluged daily in the press with information about how annuities are bad investments. So please elaborate soon on when annuities are a good investment and the terms to be looked for.


You and more than a dozen other readers who wrote with the same question are confusing two kinds of annuities, immediate and deferred.

What I've said a number of times is that retirees, particularly those who are 70 and older and in good health, should consider annuitizing some of their money -- that is, using it to buy an immediate annuity to cover basic living expenses. With an immediate annuity, you pay a lump sum premium to an insurance company and in return the company guarantees you a monthly income for life. An immediate annuity is insurance against "longevity risk," or the risk of living "too long" and running out of money.

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With a "deferred" annuity, on the other hand, the money you give to the insurance company (minus insurance charges, commissions and other costs) is invested and grows tax-deferred until you take it out. The bad press you talk about, mostly quite deserved, is against high-cost deferred variable annuities in which your money is invested in mutual fund-like "subaccounts."

Because of the high costs, including surrender charges the first few years, it would take 15 years or more in many cases for the tax-deferral benefits to overcome the impact of expenses. For this reason, high-cost deferred variable annuities are unsuitable for the same seniors who'd do well to consider an immediate annuity.

Source: 04-04-2005

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