Stern Advice: How not to buy an annuity

WASHINGTON, April 20 Wed Apr 20, 2011 3:39pm EDT

WASHINGTON, April 20 (Reuters) - Suddenly, everyone is talking about immediate annuities as if they were the answer to every retirement question.

Unions and other fans of traditional pensions like the guaranteed income stream these products promise to retiring workers. Employers, with the Obama Administration's encouragement, are trying to figure out how they can offer annuities to workers who are ready to withdraw money from their 401(k) accounts. Academicians are churning out studies about how immediate annuities can boost the lifestyles of retirees. And annuity companies, of course, would be happy with even a slice of the $17.5 trillion (yes, trillion with a "t") sitting in retirement accounts, according to the Investment Company Institute.

An immediate annuity is an insurance product that allows you to trade a lump sum of money for the promise of regular income for life. For example, a 65-year-old woman putting $100,000 into an immediate annuity today could draw $690 a month for life, according to AnnuityRateShopper.com. If, instead, she were using a reputable "safe withdrawal rate" to pull money out of her own $100,000 account, she'd be limited to about $333 a month in her first year.

People who buy immediate annuities are effectively pooling their risks with everyone else buying the same annuity; that enables them to get a bigger annuity payment every month than they could take from their own savings, if they wanted to make sure those savings would last a lifetime.

Furthermore, having some money tucked away in a guaranteed fixed annuity allows retirees to be a little bit more aggressive with the rest of their money, putting more money into stocks that should, if history continues to repeat itself, promise greater returns over the long term.

Sounds good, right? But before you hop on that bandwagon, think about this: Annuities can be expensive. They are particularly unrewarding now, because they are priced on the basis of interest rates, which are near historically low levels.

Spending too much on annuities could hurt your ability to pay healthcare costs or field other emergencies in your retirement. And you could lose money buying the wrong annuity. Here is how to balance the good and the bad, and avoid self-destructive annuity choices.

-- Don't annuitize all of your money. Even the folks who sell insurance would tell you that you have to keep some money under your own control for big emergencies or special expenses. Some advisers tell their clients to annuitize as much as they would need to cover their regular monthly expenses, like rent and utility bills. Others have suggested limiting annuities to 15 percent or so of your total savings. Fidelity Investments (here) and MetLife (here), both of whom sell annuities, have calculators on their sites to help clients figure out their proper level of annuitization.

-- Don't annuitize all at once. To figure out how much your annuity will pay you every month, the insurance company considers several factors, including your age, how much money you are putting into the annuity, and what the current interest rate is. By waiting before you annuitize, you will get a bigger monthly payout because you'll be older and have fewer years of life expectancy left. But you may also get a bigger payout because interest rates in general are low by historical measures now. The solution? Ladder into an annuity just as you would a bond or certificate of deposit portfolio. Break up that portion of your nest egg you intend to annuitize and lock some up now, and some later.

-- Don't forget about inflation, or your spouse. The example above shows that annuities pay out far more than the safe withdrawals from a single portfolio. But those self-directed withdrawals should be able to grow annually with inflation and the portfolio; most fixed annuities don't. You can shop for an annuity that offers inflation protection, or make sure that you have a backup plan (extra assets that you could sell down the road, for example), to make sure your income will keep with rising prices throughout your retirement. If you have a spouse who might depend on that same income, consider paying more for a joint life annuity, or one that guarantees income for 10 or 20 years after you purchase it.

-- Don't buy the first annuity you are pitched. It's conventional wisdom in financial planning circles that annuities are "sold, not bought." That means that charming salespeople account for far more annuity sales than careful retirement planners. And that could signal annuities replete with hidden fees and commissions. Several companies like Vanguard Investments, Charles Schwab, and Fidelity are seeking to sell lower-cost annuities. You can try those companies, and also compare quotes on websites like AnnuityAdvantage, ImmediateAnnuities.com, and AnnuityFYI.com.

(The Personal Finance column appears weekly. Linda Stern can be reached at linda.stern(at)thomsonreuters.com) (Editing by Matthew Lewis )

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