By Mark Miller
CHICAGO, March 7 You've done a good job
building your 401(k), and retirement is not far off. The
question now: how to make sure that nest egg generates
sufficient income to sustain you through a retirement that might
last two or three decades.
For years, retirement income has been something of a holy
grail for retirement experts who worry about longevity - the
risk that you will outlive your money. One solution is the
An income annuity offers a simple proposition: turn over a
chunk of cash to an insurance company, which then sends you a
monthly check for as long as you live.
Income annuities don't play a big role on the stage of
retirement solutions - but they have been in the spotlight
lately. The U.S. Treasury Department has proposed policies that
would make it easier to use income annuities within 401(k)
retirement plans or Individual Retirement Accounts (IRAs).
And income annuity sales rose 6.6 percent in 2011 to a
record $8.1 billion, according to LIMRA, an insurance industry
research and consulting group. That's still a very small
fraction of the overall retirement market, which had $17
trillion invested at the end of the third quarter last year,
according to the Investment Company Institute. But it is
movement just the same.
Savers may be drawn to the higher immediate rates of return
that income annuities provide when compared with traditional
fixed-income investments, like bonds and bank certificates of
deposit. For example, a 65-year-old man who bought a $100,000
immediate annuity would receive $562 per month for life,
according to Vanguard. That is an initial annual payout of 6.7
percent; far higher than any safe bond yields right now.
That's made possible by the "mortality credit" baked into
annuities - a term that refers to the money paid in by customers
who die earlier than their life expectancy; that money goes into
the overall pool and can be paid out to other annuitants.
"With expectations of low market returns for the next decade
and longer, immediate annuities may be one of the few investment
silver linings for investors looking to make their nest egg last
their life time," said Harold Evensky, president of Evensky &
Katz Wealth Management.
But income annuities have not taken off. Many retirement
investors do not like the idea of handing over their money to
insurance companies. And most immediate fixed annuities keep the
same monthly payouts forever; they do not rise with inflation.
So if the man in the above example lived to be 84, he would
still be getting $562 a month, and his rate of return would have
dropped to 2.74 percent, according to Vanguard. His rate would
fall over the long term because the monthly amount would never
increase with inflation or growth of principal.
Furthermore, some savers worry about the risk of taking on a
lifetime insurance partner that could go out of business.
However, like any insurance product, income annuities are
regulated by state insurance boards and backed by insurer-funded
state guarantee associations. (The conditions for these
guarantees vary by state, so it is important to understand how
much protection is available in the state where you live.)
Another way to feel more comfortable with the risk is to
spread an annuity investment among multiple carriers. And even
the staunchest advocates of income annuities do not recommend
annuitizing all retirement assets. "Most research suggests
anywhere from 20 percent to 50 percent," Evensky said.
OBAMA ADMINISTRATION SUPPORT
The Treasury recently unveiled a series of proposed
regulations and rules aimed at promoting the use of
annuitization. Some of the proposals involve enhanced features
in traditional defined benefit retirement plans.
But one focuses on a little-used form of annuity known as a
longevity policy - essentially a deferred annuity that can be
bought well ahead of retirement with payouts delayed to an
The deferral feature focuses specifically on that
frightening outlive-your-money longevity risk - and it makes the
policies much less expensive. For example, Metlife says that for
$43,000, a 65-year-old man could purchase a longevity policy
paying $2,000 monthly starting at age 85, compared with $398,000
for a policy generating the same payout immediately.
The Treasury plan aims to encourage people to buy longevity
plans with their 401(k) and IRA assets by relaxing the so-called
required minimum distribution rules that kick in when they turn
70-1/2. The proposal would allow savers to exempt the value of
their longevity policy from assets used to calculate those
"We hope this guidance will open up both the employer
retirement plan market and the IRA market to the option of
longevity annuities," said Mark Iwry, senior adviser to the
Secretary of the Treasury. "Because of the way the RMD rules
interact with the longevity annuity, both of those spaces have
been - as a practical matter - largely closed to longevity
But annuities in workplace plans face several hurdles. Here
are a few:
-- No comparison shopping. Retirees who buy an annuity
through a workplace plan would be relying on the employer to
have negotiated the best possible deal on rate of return and
fees. "You are relying on your plan sponsor to have negotiated
in good faith with the insurance company," says Jody Strakosch,
national director of strategic alliances for annuities at
In the retail market, it is easy to comparison shop
immediate annuities online by plugging in information on how
much income you want to generate, whether you want inflation
protection, a joint and survivor feature, and whether the
annuity payouts would be immediate or deferred. Vanguard has
created an online marketplace for annuity shopping ();
other examples include ImmediateAnnuities.com ()
and Annuity.com ().
-- Complexity. "It's hard enough getting employees to
understand the investing side of 401(k) plans," said
Metlife's Strakosch. "We definitely have challenges getting
people to understand annuities."
-- Lack of flexibility. A particular strength of 401(k)
plans is their portability. It is easy to roll over an account
to a new employer plan if you change jobs, or to a standalone
individual retirement account. But annuities - which are
lifetime insurance contracts - present special portability
challenges, said John Ameriks, who heads up Vanguard's
Investment Counseling & Research group. "It's a much less
flexible product than the other investment options in a
workplace plan," he said.
"Can I roll it over?" he said. "Do I have to leave it with
my former employer when I leave, or does the insurer offer a
rollover IRA product? If they do, how is that priced? Do the
features or price change?"
Ameriks thinks the use of annuities will continue to grow
over the next decade. "But it won't be an avalanche. It will be
a marginal, slow-burn change."