Making Annuities Work For You – And Your Heirs

One of the main topics around many kitchen tables right now is how to retire on what money you have left. Along with that goes the question of what, if anything, to leave your heirs.

Last week I wrote about the idea of "filing Chapter Heaven" – basically, converting your savings into annuities that pay out a regular income and leave nothing behind.

After the column appeared, many financial advisers weighed in. Most are helping clients grapple with these issues in their offices every week. Many wrote in with helpful observations, strategies and tips.

The advisers pointed out the weaknesses of many immediate annuities, and offered suggestions for getting around them. They also touched on the considerable emotional issues of cutting back on a planned inheritance.

One risk of a single premium immediate annuity is that you must place a lot of trust in the strength of an insurance company. Many people are understandably reluctant to do so, especially after the events of the last year. But advisors note that each state's Guaranty Fund backs up many policies up to a certain limit. These funds operate a little like federal bank deposit insurance. (You should check with your state's fund to see which policies are covered and up to what limits. You can find the state funds through the National Organization of Life & Health Insurance Guaranty Associations' Web site, linked here)To minimize risks, some advisers suggest buying multiple policies, each within the limit, from different insurers. That strategy is more complex than buying from a single firm. But it may give you added security.

Several advisers warned of the high fees often associated with annuities. Fees can take a big chunk out of your retirement savings. In the case of single premium immediate annuities, the costs are reflected in the income you receive. And these costs vary widely. Hersh Stern, the founder of the annuity comparison site ImmediateAnnuities.com, says higher costs are the principal reason some annuities pay 10% less than others. "It's very important to shop around," he says. "The monthly income range for the same age person can be as great as 8-10%."

Plus, annuity income is taxable. Bob Frey of Professional Financial Management, Inc., in Bozeman, Mont., says a smart strategy is to use annuities "only to fund recurrent and predictable basic living expenses," such as grocery bills, car payments and utilities, among others. Otherwise you could end up paying taxes each year on income you didn't need.

David Hultstrom of Financial Architects LLC in Woodstock, Ga., says delaying Social Security is probably a better deal than an annuity. The income stream is backed by the government, he notes, is inflation adjusted "and more attractively priced than commercial annuities," he says.

In last week's column, I noted another weakness of most annuities: If the income is fixed, you lose purchasing power over time. One solution is to purchase an inflation-protected annuity, whose annual payments rise in line with prices.

A number of advisers suggested longevity insurance as an alternative, an intriguing option. Longevity insurance, a relatively new product, is effectively an annuity that begins paying out only if you live past age 85. (According to MetLife, which offers the product, a 65-year-old man could pay about $115,000 and receive an annual income of $100,000 when the policy kicks in 20 years later.) Longevity insurance could let you retain control of your investments, finance your retirement for a set number of years and live without worrying about outliving your capital.

As for the emotional issues surrounding inheritance, financial planners say they have a tough time persuading some clients to put their own needs first. Lauren Lindsay, at Personal Financial Advisors LLC in Covington, La., says: " I have many clients who have paid for college, graduate school, weddings, homes -- in short, given their children a great financial start in life and yet still feel obligated to leave them something when they die." It's a common theme.

Julie Schatz adds: "All too often I have to remind my clients (even before the devastation of 2008) that we raise our kids to be independent and self-supporting. If we can leave them something, then great -- but it's not a necessity."

Several advisers noted that in some cases the retired parents are keeping a lower standard of living than their middle aged children. And they're still giving those children money.

Edward Gjertsen says his clients fall into one of two camps: Those who are obsessed with leaving an inheritance, and those who look after their own needs, and figure the children can have anything that's left over. One big difference, he notes wryly: "The clients who focus more on their own retirement needs are generally a lot less stressed." You can see why.

Source: online.wsj.com - 07-17-2009