A long-life safety net
The good news: You will probably live longer than you think.
Now the bad news: Because people are living longer, there is a better chance they will run out of money before they die.
This good-news, bad-news conundrum is surfacing at a time when traditional fixed-benefit pensions are withering away and people are being urged to save for their own retirements through 401(k), IRA and other plans.
Meanwhile, annuities, a source of retirement income that have been promoted by many economists as protection if you live a long time, continue to languish in the financial planning backwaters.
According to their critics, there are several reasons for this:
• Annuities offered by insurance companies are complex and difficult to understand;
• High fees and charges reduce the return for beneficiaries;
• It is difficult to pass the principal to heirs;
• If you don’t live a long time, annuities are a bad investment.
But a properly structured annuity can be a good investment for people who are risk-adverse, are gun shy after the 2001-02 stock market plunge, expect to live a long time, or want to shelter investment gains from taxes, according to their proponents.
Ed Gessert of Grass Valley is “well-satisfied” with the annuity he purchased four years ago after he and his wife sold their house and move into an assisted living facility.
“This left the question of what to do with money from the sale,” he said. “After looking into possibilities, we decided on an annuity, which seemed to give us the best return.
“I made the decision at age 81. We are well-satisfied with the annuity as the return is great. It now provides about one-half of our retirement income.”
An annuity is an investment vehicle sold primarily by insurance companies that comes in two basic forms:
• Fixed: A sum of money that is invested by the insurance company in fixed investments, such as government securities and other conservative vehicles, and provides an immediate stream of income to beneficiaries;
• Variable: Money invested in stocks and other variable investments to provide a stream of income at some future date. They typically include some form of insurance.
But there are numerous variations to annuities, and that’s where the problems start. Considerable homework is required to understand their nuances.
“Annuities have a lot of moving parts, and all of these parts may not be suitable for everyone,” said Rick Fisher, manager of new business and a financial consultant at Ostrofe Financial Consultants of Grass Valley.
“If you are less than 591Ú2 years old and need liquidity, an annuity doesn’t make any sense,” he said. “Annuities work best for people with a healthy net worth who have maxed out their 401(k)s, IRAs or Roth IRAs. It’s another investment vehicle.”
Annuities have suffered from the belief that money invested in them can’t be passed down to heirs.
That is true if you’re talking about single-payment or immediate annuities, products designed to provide the maximum payout to the annuitant, according to Tom Cox, an agent for New York Life Insurance Co. in Grass Valley.
“But 99 percent of the annuities written in this country go to the heirs,” he added. “That misconception is something that won’t go away.”
Cox said annuities are flexible enough to be wrapped into IRAs, pension plans and other vehicles, and that variables are shielded from taxes – “the silent creeper” – while money is accumulating.
“In every session of Congress, somebody tries to end their tax-deferred status,” he said. “They must be good.”
Annuities are also criticized for the costs associated with them. Because they are sold by middle men, a sales commission is involved. Fees charged to administer annuities can run as high as 2.5 percent a year.
Then there are surrender fees if the annuitant decides to cancel the plan before a specified period of time – typically seven years – and the assumed interest rate (AIR) applied to the gains of some variable annuities.
Cox said insurers that guarantee a rate of return calculate the return after deducting expenses, and “the rate of return is greater than CD rates. That’s why banks are selling annuities now.”
Many annuities permit the withdrawal of up to 10 percent of their value annually without penalty, Cox said, and a variety of surrender periods are available. Fisher said he generally recommends a surrender period of four years or less.
One of the major arguments for annuities is they can provide a steady stream of income for life, an important consideration as people live longer.
And the older you are, the longer you can expect to live. “At 70 years old, we’re doing 20-year planning,” Cox said.
Fisher said anybody considering an annuity should ask the following questions:
• How strong is the insurance company? Fisher said it should be rated A or higher.
• What are the contract costs?
• What are the commissions or costs associated with the purchase of the annuity? “You have a right to know,” he said.
Cox said customers should study any annuity they are considering carefully, and demand a full explanation of any points they don’t understand.
“Much of the time, beneficiaries don’t understand what they’re buying,” he said. “You should work with an agent who has the ability to explain the pros and cons of these products.”
But like every other investment, annuities aren’t right for everyone. “Sometimes, the annuity is the only answer,” Cox said. “Sometimes, you would never recommend it.”
What is annuity, anyway?
An annuity is a contract where an individual pays an insurance company a sum of money that is invested, and in return, the company makes periodic payments to the individual specified in the contract.
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