Making Money Last: How to Retire Comfortably

Carmela Hache thought long and hard before deciding to purchase an annuity.

"These are very complex products," said Hache, the director of development at NYU's School of Continuing and Professional Studies, who lives on the Upper East Side.

Five years ago, after receiving a divorce settlement, she started looking for ways to help secure her financial future, but needed to learn more about annuities before taking the plunge.

After six months of consulting with her financial adviser, Joe Yagar, an insurance broker in midtown, Hache bought a variable annuity that offered her a variety of investment options and provided a guaranteed minimum income for life.

"I can go to sleep at night," Hache said.

It's a fear that grips many especially in these tough times: Even if they have saved up all of their lives, a sudden change in fortune or a sharp decline in the value of their investments could mean they’ll outlive their retirement savings.

This is where annuities can come into play.

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Issued by insurance companies, annuities are retirement accounts that can provide built-in safety nets.

You invest a sum of money in an annuity either all in one shot or over time. The insurer, in most cases, provides you with some form of guaranteed payments which can come immediately or at a later date. These payments usually last the rest of your life.

"It's a way to guarantee that your income will never run out, which is the No. 1 fear of retirees," Yagar said.

Because of their high fees and complexity, the most popular annuity flavor — variable annuities — have gotten a bad rap.

Aggressive insurance salesmen, stoked by big commissions paid by insurance companies, have been faulted for pushing customers into products they may not have needed and did not understand.

But depending on your goals, annuities can play a role in your retirement planning — if you proceed carefully.

Before you make any decision, make sure you understand what you are buying. Be sure to weigh the cost of the annuity against its benefits and compare it to other investments.

There are two broad types of annuities, fixed and variable, with numerous variations of each.

A fixed annuity guarantees you a set return. It can be immediate, meaning you get paid right away, or it can be deferred.

Many financial planners recommend immediate annuities because they are low risk and easy to understand. Web sites such as will give you quotes on your potential payments.

"People should think about immediate annuities if they are approaching retirement and they don't have enough money to provide them with the lifetime income they need," said Glenn Daily, a fee-only insurance consultant on the Upper East Side.

But keep in mind that immediate annuities aren't great vehicles for passing on wealth to loved ones, as the income stream typically dies when you do.

However, your beneficiaries would typically receive an amount equal to or greater than the amount you have contributed to the account less any withdrawals you've received.

Since most immediate annuities offer fixed monthly payments, your buying power may dwindle if inflation kicks in unless you select a feature that mitigates inflation risk.

By contrast, variable annuities allow you to invest in mutual fund-like products to provide future benefits that could keep pace with or surpass inflation. But just as an investment may rise in value, it could also diminish depending on its performance.

Another advantage: Your account grows tax-deferred until you start taking payments. But when you do take money out, you will be taxed on the earnings at ordinary income tax rates rather than lower capital gains rates.

Many variable annuities offer a variety of guarantees, such as guaranteed minimum income benefits. These provide a certain annual income — currently about 5% of your contribution — regardless of your portfolio’s performance.

Of course, the more guarantees you layer on, the higher the cost of the annuity.

"If you want marble tile in your kitchen, it’s going to cost more than linoleum," Yagar said.

Variable annuities make the most sense for wealthier people who have maxed out their 401(k)s and IRAs and are looking for an additional tax deferred account, said Chris Fichera, an associate editor at Consumer Reports.

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They might also appeal to someone who is extremely risk averse and is willing to pay more in exchange for certain guarantees, said certified financial planner Bill Losey, the author of "Retire in a Weekend! The Baby Boomer’s Guide to Making Work Optional."

But even if you fit that description you should limit your investment, he added.

“I like to suggest that a person invest no more than 25% of their total portfolio,” Losey said.

Annual fees for the most expensive variable annuity could be as high as 3% to 4%, compared with actively managed mutual funds which might charge 1% to 2% annually.

Shop around. Mutual fund companies such as Fidelity, Charles Schwab and Vanguard, offer low-cost options, Fichera said.

Be aware of hefty surrender charges. If for some reason you need to take money out of your account within the first few years of your contract, you could be zapped with a 6% to 8% charge, depending on which year you withdraw. That’s on top of the 10% penalty you’d have to pay if you withdrew before age 59 1/2.

“Ask your agent, how many years is the surrender period,” Losey said. “Have him quantify, in dollars and cents, what the cost will be.”

One of the most important things to understand about annuities is that they are issued by insurance companies, meaning you are depending on the stability of the insurer. Check out insurers with credit rating companies such as Moody’s, Standard and Poor’s and A.M. Best.

“You’ll want to make sure you’re dealing with one that is financially solid,” Losey said. “Diversify among various carriers.”

Before making any decisions, keep asking questions until you feel comfortable. “If you don’t understand, ask until you do,” Yagar said.

Source: 08-16-2010

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