As stock-market volatility continues to make retirement income a dubious proposition, don't annuity guarantees look sweet?
By promising specified payments over time, insurers are offering myriad ways to secure retirement income. Yet you have to wade through pages upon pages of fine print to find out that many of these guarantees are not as good as they seem.
Insurers are constantly adding new twists to the $127 billion-plus in variable annuity products they sell. These products, often festooned with "living benefit riders," are basically insurance policies linked to separate investment accounts. Unlike immediate annuities, which pay a fixed amount, the return and payments can fluctuate in variable annuities, which typically are tied to the stock or bond markets.
By combining retirement income with a "death benefit" that pays a beneficiary upon your demise, annuities are worth considering, but only after you gauge their costs carefully and consider a number of alternatives.
My main bugaboo with annuities is that most of the folks selling them are on commission and may operate with business models that put sales goals ahead of your best interest. There are also layers of expenses with variable annuities. Commissions are typically generous to agents and brokers. Then there's an insurance charge and yet another expense for the investment portfolio manager.
Variable-annuity guarantees come in a number of different flavors. They are largely designed to address a fear you may have as an investor, although they may not be the best approach to providing maximized retirement income.
- Guaranteed Minimum Withdrawal Rate. When you choose to take regular monthly payments, you "annuitize." This vehicle guarantees return of the money you paid into the contract at a certain annual percentage, regardless of how well the investment portion of your annuity fared. Reading the fine print reveals that you can only withdraw from 5% to 7% of premiums annually. So if you needed more, you'd be stuck, and you can't cancel this option once you elect it. If you're looking for flexibility, this is not the contract for you. A guaranteed minimum withdrawal rate rider will cost you an additional 0.40% to 0.75% annually. That's on top of the other expenses I mentioned earlier.
- Guaranteed Minimum Income Benefits. This rider assures that you can receive a minimum fixed amount when you annuitize. Say you put $50,000 into a contract. Under GMIB, you may be guaranteed a monthly payment of at least $420 per month, no matter how dismal the stock market is at the time. The catch is you may have to wait at least 10 years to able to take advantage of this benefit. The additional cost for this rider is from 0.50% to 0.75% annually.
- Guaranteed Death Benefit. This is only of value for your survivors, of course, and won't do much for your retirement income stream. Your beneficiary will be paid if you die before you start receiving payments, so this is one among many "peace of mind" riders (aren't they all?). You'll pay an additional 0.15% to 0.35% annually for this guarantee.
- Guaranteed Minimum Accumulation Benefit. You can protect your principal with this rider by either (pick one) locking in the growth of the investments in your annuity or choosing a guaranteed return. You get to make this decision at the end of a 10-year term and can choose which option yields the bigger balance. The cost is from 0.25% to 0.75% annually.
As you can see, each one of these products offers some kind of downside protection from market turmoil. Is it worth the price and inflexibility? Keep in mind that insurers are mainly in the business of investing money over time. They are charging you for these guarantees, so there's no free lunch.
Yet it's okay to seek a comfort zone when shopping for an annuity, just ensure that you've done your homework to compare variable annuities with immediate annuities that start paying you at the time of purchase. Not all variables are a bad deal, according to David Jacobs, a certified financial planner who does a presentation entitled "Living Benefit Riders Exposed." It depends on market conditions when you retire.
Say you were considering a product that guaranteed a lifetime withdrawal benefit. "In return for a guaranteed income that is 10% to 20% lower than what an immediate annuity (with cash refund) would provide, you get the potential of higher payments if the stock market does well at the beginning of your retirement," says Jacobs.
"For example, if you retired a year ago in March, you would be better off today if you used this rider rather than an immediate annuity with a cash refund," he says.
If you're considering an annuity, I'd always consult with a fee-only, certified financial planner first to vet the products you have in mind. See www.napfa.org
for a referral. You'll need to know the tax, retirement, and estate consequences from a third party who will only charge you for their advice and has no interest in the sale.