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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Why look into annuities? If you're a Baby Boomer with little or no pension and most of your money in low-interest savings accounts, an annuity may be the key to a secure and comfortable retirement. How can you find out whether an annuity is right for you? Read Annuities For Dummies, 3rd Edition. This completely revised and updated, plain-English guide is packed with the latest information on choosing the best annuity for your retirement needs. You'll find out exactly what annuities are, whether they're the right financial vehicle for you, and which of the many annuity options might have your name on it. You'll learn the ins and outs of using annuities to fund your retirement years, figure out whether to stress investments with insurance or insurance with investments, and find out how the right combination of annuities can help you squeeze more income out of your savings that any other financial tool. Discover how to: * Identify the main types of annuities * Weigh the pros and cons of annuities for yourself * Minimize the complexity and cost of your annuity investment * Figure out how much money to commit * Avoid common annuity pitfalls * Create an income you can't outlive The time to start securing your financial future is now. Annuities For Dummies, 3rd Edition, gives you knowledge, insider tips, and expert advice you need to make your money do its best for you.
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Annuities For Dummies
by Kerry Pechter
Annuities For Dummies®
Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com
Copyright © 2008 by Wiley Publishing, Inc., Indianapolis, Indiana
Published by Wiley Publishing, Inc., Indianapolis, Indiana
Published simultaneously in Canada
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Manufactured in the United States of America
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About the Author
Kerry Pechter is the senior editor of Annuity Market News. As a reporter who writes about annuities and the annuity industry full-time and as a former marketing writer who specialized in annuities at The Vanguard Group, he brings both an outsider’s and an insider’s perspective to the writing of this book.
A financial journalist for many years, Kerry has written for the New York Times, the Wall Street Journal, the Los Angeles Times, and many other national and regional publications. His previous books include two career guides, A Big Splash in a Small Pond: How to Get a Job in a Small Company (Fireside) and An Engineer’s Guide to Lifelong Employability (IEEE). He is a graduate of Kenyon College.
Dedication
To my family — my supportive and resourceful wife, Lisa Higgins; my three wonderful daughters, Hannah, Ariel, and Mattea; my brother, David, and his wife, Jean; my sister, Carol, and her husband, Andy; and my parents, Allen and Dorothy.
Author’s Acknowledgments
The community of people who think about, write about, create, and sell annuities is a relatively small one. Many of its members patiently guided me through the intricacies of these odd but necessary insurance products when I was figuratively climbing stairs in the dark.
A special thanks goes to Noel Abkemeier, Jeremy Alexander, Lisa Bennett, Garth Bernard, Scott DeMonte, Howard Drescher, Jerry Golden, Pem Guerry, Kelli Hueler, David Macchia, Moshe Milevsky, Lisa Tibbitts, Tamiko Toland, John Ziambras, the folks at NAVA (Mark Mackey, Deborah Tucker, and Kathleen McKee), and to the media relations professionals at dozens of insurance companies who cheerfully responded to my last-minute requests for information.
I’m grateful to Adam Reinebach and Lee Barney, the publisher and editor of Annuity Market News, respectively, for supporting this project and for sharing my editorial values. I am also indebted to my former colleagues at The Vanguard Group, who taught me the true fundamentals of investing.
Thanks to my agent, Marilyn Allen, my acquisitions editor, Stacy Kennedy, and my project editor, Natalie Harris, for recognizing the value of publishing this book and welcoming me into the fold. I’d also like to thank my friend and fellow Dummies author, Russ Wild, for his indispensable help. Finally, I owe a huge debt to Jesus Salas for his wise counsel.
Publisher’s Acknowledgments
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Contents
Title
Introduction
About This Book
Conventions Used in This Book
What You’re Not to Read
Foolish Assumptions
How This Book Is Organized
Icons Used in This Book
Where to Go from Here
Part I : Annuities: A Blend of Insurance and Investment
Chapter 1: Making Sense of Annuities
Annuities: Older Than You (Probably) Think They Are
Should You Get an Annuity?
Raising Your Awareness
Seeing How Annuities Work
Chapter 2: Using Annuities to Meet Retirement Challenges
Calculating Retirement Risks and Solutions
Countering the Main Risks of Retirement
Chapter 3: Dissecting an Annuity
Examining the Elements of Annuities
Telling One Annuity from Another
The Life Cycle of All Annuities
Chapter 4: Weighing the Pros and Cons of Annuities
Evaluating Annuity Pluses
Confronting the Annuity Negatives
Comparing Annuities with Their Competition
Chapter 5: Deciding Whether an Annuity Is Right for You
Who Should Own an Annuity?
Preparing for the “Suitability” Test
Part II : Identifying the Main Types of Annuities
Chapter 6: Saving with Fixed Annuities
How Fixed Annuities Work
Examining the Main Types of Fixed Annuities
Pros and Cons of Fixed Annuities
Buying a Fixed Annuity
Managing Your Fixed Annuity
Chapter 7: Experimenting with Index Annuities
Defining Index Annuities
Seeing How Index Annuities Work
Comparing Types of Index Annuities
Looking at the Pros of Index Annuities — and Avoiding the Cons
Tracking Index Annuity Performance
Why You Should Consider Waiting
Chapter 8: Meeting the New Generation of Variable Annuities (VAs)
Defining VAs
Pros and Cons of VAs
Getting to Know GLBs
Chapter 9: Financing Your Retirement with an Income Annuity
Generating Income with an Annuity
Buying and Paying for an Income Annuity
Getting Your Money’s Worth
Customizing Your Income Annuity
Chapter 10: Aging Gracefully with an ALDA
Insuring Your Old Age: What ALDAs Do
How ALDAs Work
Pros and Cons of ALDAs
Longevity Risk: The Reason for ALDAs
Paying for an ALDA
Shopping for an ALDA
Part III : Making the Most of Your Annuity
Chapter 11: Structuring Your Annuity Correctly
Building a Proper Structure
Understanding Death Benefits
Chapter 12: Optimizing Your Variable Annuity (VA) Investments
Choosing Investments for Your VA
Managing Your Accounts for Optimum Results
Chapter 13: Accessing, Escaping from, or Converting Your Annuity
Knowing Where the Exits Are
Swapping One Annuity for Another (1035 Exchange)
Selling an Annuity
Converting an Annuity to Life Insurance
Chapter 14: The Taxing Side of Annuities
Understanding Annuity Taxation: The Basics
Taxing Additions to Deferred Nonqualified Annuities
Taxing Withdrawals from Deferred Nonqualified Annuities
Pros and Cons of Annuity Taxation: A General Overview
Other Annuity Tax Issues
On the Horizon: Exemptions for Annuity Income?
Part IV : Navigating the Annuity Superstore
Chapter 15: Getting Creative with Annuities
Combining Stocks, Cash, and Income Annuities
Buying Guaranteed Income in Stages
Creating Inflation-Proof Income
Building a Ladder of Fixed Annuities
Using an Old-Fashioned Split Annuity
Being Bullish with a Variable Income Annuity
Buying Future Income at a Discount
Turning Home Equity into an Annuity
Bridging Your Way to Higher Social Security Benefits
Blending an Annuity with LTC Insurance
Earning a Discount for Poor Health
Chapter 16: Going to Meet the (Sales) Representative
Getting to Know the Annuity Sales Force
Buying Annuities on the Job
Buying Your Annuity Direct or Online
Chapter 17: Avoiding Annuity Pitfalls
Watching Out for Common Annuity Missteps
Heading Off Income Annuity Errors
Deflecting Deferred Variable Annuity Problems
Preventing Silly Mistakes
Part V : The Part of Tens
Chapter 18: Ten Essential Annuity Expressions
Annuities and Annuitization
Contract Owners and Annuitants
Contract or Policy versus Investment
Death Benefits versus Living Benefits
Understanding the Exclusion Ratio
Fixed versus Variable
Reaping the Survivorship Credits
Qualified versus Nonqualified
General Accounts and Separate Accounts
Surrender Period and Surrender Charge
Chapter 19: Ten Questions to Ask Before You Sign a Contract
“How Will This Annuity Reduce My Risks?”
“What Is My Risk Tolerance?”
“How Much of My Assets Should I Put into an Annuity?”
“What Is the Strength and Integrity of the Issuer?”
“What Are the Fees?”
“What’s My Upside Potential?”
“How Do I Get My Money Out?”
“Where Can I Get More Information about This Annuity?”
“Am I Better Off Exchanging My Annuity for Another One?”
“What Are the Tax Implications?”
Chapter 20: Ten Factors that Determine Longevity
Earning (Somewhat) Big Bucks
Having the Right Demographics
Watching Your Weight
Getting Hitched
Going Easy on the Vices
Being Female
Exercising Regularly
Wearing Good Genes
Avoiding Tobacco
Staying in School
Chapter 21: Ten Web Sources for More Annuity Information
Advantage Compendium
Annuity Advantage
Annuity FYI
ELM Income Group
Errold F. Moody
Immediate Annuities
Internal- and Federal-Governing Sites
Mutual Fund Sites
Trade Association Sites
Variable Annuities Knowledge Center (VAKC)
Appendix A: Key Research Sources
Factors to Keep in Mind While Researching
Variable Annuity Leaders
Fixed Annuity Leaders
Direct Sellers
Distribution Channel Champs
Dalbar Ratings
Income Annuity Leaders
Appendix B: Protection from Insurer Default
Appendix C: General Rule for Pensions and Annuities
Glossary
: Further Reading
Introduction
The oldest members of the baby-boomer generation reached age 60 in 2006. Every year for the next 18 years, millions of these former rock-and-rollers, flower children, peaceniks, backpackers, Yuppies, do-it-yourselfers, suburbanites, and Mr. Moms will reach this milestone and begin riding off into their sunset years. I’m a boomer. Perhaps you are, too.
Boomers and later generations have good reason to be curious about annuities. Millions of these folks will have no other guaranteed income in retirement than the soon-to-be-underfunded Social Security program. They may have savings — trillions overall — but they need a financial tool that can help turn decades of savings into lifetime income streams. Annuities, when used wisely, can fill the bill.
Think of annuities as investments with insurance features or insurance with investment features, depending on the particular contract. For people in their prime earning years, these insurance features can make as much sense as training wheels at the Tour de France. But for people in their 50s — whose financial priority is no longer speed but safety and whose savings’ interest isn’t great enough to live off of — those training wheels can be appealing.
You may have heard about annuities with costs and complexities that are downright prohibitive. But, as I show you in this book, the right annuity (or combination of annuities) can help you squeeze more retirement income out of your savings than any other financial tool. The right annuity can assure you a decent income, no matter how long you live.
About This Book
If ever a candid, consumer-driven book about annuities has been needed, the time is now.
Thousands of companies have replaced their traditional pension plans with defined contribution plans like 401(k)s. As a result, their millions of employees will be cobbling together their own pensions rather than relying on their employer’s pension-fund managers. Yet these employees have no equivalent of Home Depot, or This Old House, or even a user’s guide to help them.
Several books have been published on annuities, but they aren’t aimed at do-it-yourselfers; they’re written for professionals (financial advisers, tax experts, and public-policy mavens) who specialize in pensions and retirement issues. In addition, most of these books give fairly short shrift to the annuity’s unique ability to generate guaranteed lifetime income.
Annuities For Dummies, in contrast, is written and designed for the average person, and it focuses a lot of attention on the income-generating aspect of annuities. Like all the For Dummies books, this one has an open architecture that lets you read the contents in any order. Its bold headings and eye-catching icons tell you exactly what you’re reading and how the details relate to the big picture. You don’t have to dig very far to find the information you need.
Annuities are pretty simple when you can clear away all the technicalities and legalities. Basically,
1.You put money into them — a little at a time or all at once. This is the accumulation phase.
2.The money appreciates — you hope — by earning interest or through capital gains.
3.You take money out — all at once, at your own pace, or in the form of a regular income. This is the income phase.
Note: The tax breaks and insurance guarantees associated with annuities tend to complicate matters because they have all sorts of conditions and restrictions. But in this book, I try to keep the larger picture firmly in view.
I suggest you don’t ask whether annuities are good or bad. The right questions are
Would I feel safer in retirement if I had insurance against certain financial risks like running out of money?
How can I make sure I buy the right annuity for my particular needs?
How can I make sure I buy an annuity that doesn’t cost too much?
This book answers these questions in language that most people with a bit of investment experience — the typical baby boomer with a 401(k) plan, for instance — can understand. For casual reading or future reference, Annuities For Dummies is your DIY guide to the strange but potentially rewarding world of annuities.
Conventions Used in This Book
When this book was printed, some Web addresses may have broken across two lines of text. If that happened, rest assured that I haven’t put in any extra characters (such as hyphens) to indicate the break. When you want to use one of these addresses, just type exactly what you see, pretending that the line break doesn’t exist.
What You’re Not to Read
If you’re in a hurry to read through a chapter (although I hope you’ll read every bit of information in the book — the more you know, the better!), you can take some shortcuts. For example, you don’t have to read the text preceded by the Technical Stuff icons in order to understand the subject at hand. You’ll also see sidebars, text in gray boxes. Sidebars are merely asides; the information is interesting but not critical to the text. You can safely skip it.
Foolish Assumptions
When an author sits down to write a book, he tries to envision the people — or sometimes a single person — to whom he’s speaking. In the process, he makes certain assumptions about that audience. In writing this book, I’ve made a few assumptions that may apply to you:
You’re looking ahead toward your retirement years, and you’d like to make them more financially secure.
You know a fair amount about saving and investing for retirement (perhaps through your employer-sponsored retirement plan), but you know little or nothing about annuities.
You want to participate in the financial decisions that affect you. Even if you leave the details to a financial adviser, broker, or insurance agent, you still want to understand what’s going on and whether your adviser is taking you in the right direction.
You’re a bit skeptical. You’ve heard or read some negative media about annuities, including lawsuits against salesmen or companies that allegedly prey on retirees.
You tend to be a risk-averse investor. You understand that the stock market isn’t just a roller-coaster ride for thrill seekers but also a place where prudent people can take steps to protect themselves against its volatility.
How This Book Is Organized
Here is a general overview of how the book’s contents are separated into parts.
Part I: Annuities: A Blend of Insurance and Investment
Part I defines annuities and lays an informational foundation for what’s to come. The text includes a high-altitude view of annuities and their place within the larger context of retirement security. It also descends to the microscopic level for a close-up view of an annuity’s internal parts. After reading Part I, you should know whether an annuity is right for you.
Part II: Identifying the Main Types of Annuities
In Part II, I devote an entire chapter to each of the major types of annuities. Chapters 6, 7, and 8 focus on the most common annuities for accumulating wealth. Chapters 9 and 10 concentrate on annuities that are typical for spending wealth in retirement. In some ways, all annuities are alike. But in other ways, the five types of annuities are so dissimilar that having a common name can seem downright misleading.
Part III: Making the Most of Your Annuity
When you purchase and own an annuity contract, you make a lot of intermediate decisions — or at least help your financial adviser make them. This section shows you where those decisions arise and how to make them. Ultimately, no two annuities are alike because annuity owners customize their contracts to match their particular needs and preferences. Your satisfaction with your annuity will depend on how carefully you customize it.
Part IV: Navigating the Annuity Superstore
With dozens of insurance companies offering annuities and dozens of ways for buying them, finding the right annuity at the right price isn’t necessarily easy. In Part IV, you meet the insurance carriers who manufacture annuities, the channels through which annuities are sold, and the agents and brokers who sell them. I also provide resources for reliable annuity information on the World Wide Web. To spare you from finding out the hard way, I point out some annuity pitfalls you’d be wise to avoid.
Part V: The Part of Tens
Whenever you need instant information about annuities, you can turn to these lists. Suppose you have an appointment with a broker to talk about annuities; use Chapters 18, 19, and 20 for quick prep work. If you find time for Internet research, Chapter 21 can show you where to start surfing.
Also, check out the three appendixes:
Appendix A provides research tips and background information on several of the largest insurance companies.
Appendix B explains the reimbursements that state guaranty associations make to annuity owners whose insurance companies go bankrupt.
Appendix C contains a good chunk of IRS Publication 939, General Rule for Pensions and Annuities, to further help you with your research.
Icons Used in This Book
Throughout this book, you find icons that alert you to especially useful tidbits of information. If they were in a more formal book, they’d sound like editorializing, but I use them to tell it like it is.
When you see this icon, look for useful advice that can probably save you time or money or both!
I try to make each chapter as independent as possible. But occasionally I need to remind you of a fact from another part of the book. You’ll see this icon whenever something bears repeating.
The world of annuities can be like an evil golf course — full of rough patches, water hazards, and sand traps just waiting to add strokes to your score. This icon points them out.
Number crunching may not be your favorite pastime, but make note of the numbers that come up with this icon, because you can use them to your advantage.
You can skip this stuff if you want to, but if you really want to get down and dirty with annuities details, dive in.
Where to Go from Here
Feel free to dive into this book wherever the headings catch your interest or wherever the table of contents directs you. The For Dummies books are designed for use as references as well as narratives. (They’re not just for beach reading!)
If you don’t know anything about annuities, definitely read Part I. If you’re already conversant with annuities, however, try skipping straight to Chapter 15. If you’re in the throes of deciding whether to buy an annuity, definitely read Chapters 4 and 5. And if you’re ready to shop for an annuity or call a broker, cut right to Part IV.
Part I
Annuities: A Blend of Insurance and Investment
In this part . . .
Here you learn that annuities are investments with money-back guarantees of one kind or another. They include elements of both insurance and investment products. I define annuities, identify their internal parts, and explain how they work. You discover that income annuities are the most efficient way to convert a limited sum of money into a retirement income stream that you (or you and your spouse) can’t outlive. I reveal their unique contribution to retirement security: survivorship credits.
Chapter 1
Making Sense of Annuities
In This Chapter
Introducing annuities: The big picture
Deciding whether an annuity is right for you
Checking out the nitty-gritty of annuities
Many people confidently walk the financial high wire of life without a safety net. Others, especially those who are approaching retirement, feel more secure when a net is there to catch them — just in case the tightrope snaps.
If you prefer a financial safety net and you’re willing to pay for one, then consider an annuity. Put simply, annuities are investments with money-back guarantees. Imagine a typical investment in stocks or bonds; then imagine that same investment with a guarantee that you’ll get your money back with interest after (or over) a certain time period. That’s an annuity.
Of course, annuities aren’t quite that simple. Most annuity brochures and prospectuses contain enough disclaimers, footnotes, and contingencies to keep a dozen lawyers busy. But it’s useful, at least at first, to ignore the complexities of annuities and take a high-level snapshot of what they are and how they work.
To resume the circus metaphor, an annuity is both a tightrope and safety net; it’s an investment and insurance against the loss of that investment. Annuities aren’t always as exciting as the investment alone (like a tightrope walker without a net), but they’re not as risky. If you’re in or near retirement, you might find such a trade-off appealing.
In this chapter, I give you the basics by explaining what annuities are, what they do, how they work, who should buy them, and so on. In the interest of full disclosure, I also share my own opinions about annuities, because my opinions inevitably shape this book.
Annuities: Older Than You (Probably) Think They Are
Because people don’t know how long they’ll live, they don’t know how much money they’ll need to support themselves for the rest of their lives. The history of annuities is the search for a solution to that problem.
Annuities have existed for at least 1,800 years. In ancient Rome, contracts called annua promised a stream of payments for a fixed number of years or for life in return for an up-front payment. Speculators who sold insurance for Mediterranean shipping ventures sometimes offered these insurance contracts to the public.
Wealthy Romans often willed their heirs or friends an income for life. Because tax collectors needed to know how much that income would cost the benefactor’s estate, they also needed to know how long those heirs or friends were likely to live. In AD 225, a Roman judge named Ulpanius produced the first known mortality tables. By his reckoning, a 30-year-old Roman man would live until age 60, on average. Any man over age 30, he concluded, had an average life expectancy of 60 years minus his current age.
William Shakespeare is said to have invested a large part of his wealth near the end of his career in an “annuity-like arrangement.” In pre-Renaissance Europe, both the Church and assorted annuity dealers sold life annuities to raise funds. As early as 1540, the Dutch government sold annuities to finance wars and public works, just as modern governments sell bonds.
In the 1600s, special annuity pools called tontines operated in France. In return for an up-front payment, purchasers of tontines received a lifetime income. As purchasers died over time, their income was divided among the survivors. The last purchaser to die collected the remaining money. Tontines were eventually banned — partly because they gave the last two or three survivors a motive to kill each other!
Edmund Halley, the famous astronomer, used the birth and death records of an isolated German town to create the first modern set of mortality tables. He surmised that if the town had 600 30-year-olds but only 300 57-year-olds, a 30-year-old’s average life expectancy must be 27 years. He published his tables in 1693, but they weren’t widely used for another century.
The first record of annuities in the United States is from 1759, when the Corporation for the Relief of Poor and Distressed Presbyterian Ministers and Distressed Widows and Children of Ministers was chartered in Pennsylvania. In 1812, the Pennsylvania Company for Insurance on Lives and Granting Annuities was founded.
After the stock market crash of 1929, many people turned to guaranteed annuities as a safer place to put their retirement savings. The modern era of annuities began in 1952, when TIAA-CREF (the educators’ retirement fund) offered the first group variable deferred annuity — a precursor of other employer-sponsored retirement savings plans.
Individual annuities (which are purchased by individuals from insurance companies) flourished after the tax reforms of 1986, when deferred annuities became the only remaining financial product that allowed people to save and invest unlimited amounts on a tax-deferred basis. As of 2007, Americans have saved more than $1 trillion in annuities, along with the trillions they hold in employer-sponsored retirement plans and other accounts.
Today, many economists and finance professors (not to mention life insurance companies) hope that the baby boomer generation, whose oldest members are just beginning to retire, will rediscover the original purpose of annuities and use them to turn their 401(k) accounts and IRAs into guaranteed lifetime income.
Should You Get an Annuity?
So, should you get an annuity? This is a not a simple question. The only sensible answer is that certain annuities are right for certain people. If you recognize yourself in any of the following categories, then you should definitely explore annuities further:
People in high tax brackets often like deferred annuities because they can contribute virtually any amount of money to the plan and still defer taxes on the gains for as long as they like.
Middle-class couples in their 50s who are earning $100,000 or less and have a savings of $250,000 or more but no pension should like income annuities. They have a 50-percent chance that one of them will live to age 90.
Financial advisers sometimes put their wealthy clients’ money in variable annuity subaccounts (mutual funds) instead of conventional (taxable) mutual fund accounts so that they can defer taxes on any gains they realize when buying and selling fund shares.
Pessimists — otherwise known as Cassandras, doomsayers, and bears — who believe that the gigantic, highly leveraged house of cards (the United States’ financial system) may collapse at any time, should like the guarantees that annuities provide.
Women are much more likely to need annuities than men. It’s true. Women live significantly longer and are therefore at greater risk of running out of savings.
Single or widowed women are more likely to be poor in old age than single or widowed men. Many people expect that, in the future, as birth rates in developed countries (the United States, Japan, and much of Europe) fall, and the number of elderly citizens rises, a retirement financing crisis will occur. Women will probably bear the brunt of that crisis.
For more on this topic, see Chapter 5.
Raising Your Awareness
As I mention earlier in this chapter, I hope this book raises your awareness of annuities and makes you a reasonably savvy consumer of these complicated but useful financial tools. And although I try not to prejudice you for or against them, I do share my point of view, make judgments, and draw conclusions.
So, as you read, don’t be surprised when you hear elements of my credo more than once:
Costs matter. John C. Bogle, the founder of The Vanguard Group and the best friend an individual investor can have, has said it loudest, “Costs matter.” Don’t expect annuities to be cheap; guarantees are expensive. But be vigilant about the annual costs, fees, and expense ratios you’ll pay, particularly if you buy a deferred variable annuity. See Chapter 8 for more information.
Don’t invest in a contract you can’t understand. Many annuities are highly (and sometimes necessarily) complex. They may have moving parts that can change your costs from year to year, and they often function in counterintuitive ways. Many annuity prospectuses defy comprehension entirely. If one contract makes no sense to you, investigate another.
Thesurvivorship creditis the core strength of annuities. Income or immediate annuities distribute the assets of deceased contract owners to the remaining owners, thus enhancing the income of all surviving contract owners. This often-neglected feature makes an annuity an annuity, and some experts think it should get more attention.
Creative combinations of annuities should be explored. The question is not, “Should I buy an annuity?” The question is, “Is there an annuity or a combination of two or three annuities that can give me the financial security I need in retirement?” A creative mixture of deferred and immediate annuities can often do the trick. For tips on how to work this magic, see Chapter 15.
The best annuities are yet to come. Many of today’s annuities are prototypes of better annuities to come. As more baby boomers retire and recognize that they need guaranteed lifetime income, they’ll demand cheaper, more attractive annuities. For more information on new types of annuities that are just around the bend, see Chapter 15.
Mortality pooling (see the sidebar “Survivorship credits — the unique aspect of annuities” later in this chapter) allows all annuity owners not only to receive lifelong income but also to maximize the amount of income they receive from a fixed amount of money while living. For instance:
• If a 65-year-old man retires with $300,000 and wants it to last at least as long as he lives, research shows that he can safely withdraw about 5 percent a year ($15,000) from age 65 until around age 90.
• If the same man buys a single life annuity with $300,000 at age 65, he can receive more than $25,000 a year for life, no matter how long he lives. To protect his beneficiaries, he can buy an option that guarantees payments for a certain number of years or until he dies, whichever is longer.
Annuities guarantee a pension-like income for life better than any other financial product. There is no more efficient tool for converting a specific sum of money into a monthly income that lasts as long you live — even if you’re still kicking at 105.
So why don’t more people buy annuities when they retire? There are lots of reasons, which I describe at length in Chapter 4. But it’s likely that more people will buy annuities in the future. People are living longer and saving less. Fewer employers provide pensions. Social Security benefits may be trimmed back. Millions of people will replace their lost pensions and benefits with annuities.
Seeing How Annuities Work
Annuities are intended to help you save for retirement and supplement your retirement income. To encourage this practice, Uncle Sam lets you defer taxes on the growth of your annuity. And to discourage you from spending your annuity assets before retirement, the IRS penalizes you for any withdrawals from annuities and other tax-deferred investments before you reach age 591/2.
Various types of annuities can make your retirement more secure by helping you:
Save for retirement. Before you retire, fixed deferred annuities (including CD-type annuities, market value-adjusted fixed annuities, and indexed annuities) allow you to earn a specific or adjustable rate of interest on your money for a specific number of years, tax-deferred. They’re also a safe place to park money during retirement. See Chapter 6.
Invest for retirement. Before you retire, variable deferred annuities (a basket of mutual funds, essentially) allow you to invest your savings in stocks or bonds and still defer taxes on all the capital gains, dividends, and interest that mutual funds usually throw off every year. See Chapter 7.
Distribute your savings. Most baby boomers who retire with six-figure balances in their employer-sponsored retirement plans aren’t sure how fast or slow to spend their savings. An immediate annuity or a variable deferred annuity with guaranteed lifetime benefits can provide structure to the process. See Chapter 8.
Insure against longevity risk. Just as life insurance insures you and your family from the risk of dying early, an income annuity or an advanced life deferred annuity (ALDA) can insure you against the risk of living so long that you run out of money. See Chapter 10.
Manage your taxes. Everybody with a big 401(k) or 403(b) plan will retire with a massive income-tax debt to the government. A life income annuity allows you to spread that tax liability evenly across your entire retirement. See Chapter 15.
The strength of an annuity’s guarantee depends on the issuer’s ability to pay you back. Every insurance company receives ratings for financial strength from the major rating agencies (A.M. Best, Fitch, Standard & Poor’s, and Moody’s Investors Services). Note: Do business only with carriers who have an all-A rating. (See Appendix A for more on these ratings.)
Note: To understand the functions of annuities better, you need to look at the types of annuities — and there are several. Please review the chapters in Part II to understand the types of annuities and what they can do for you.
The annuity purchase process
Like some other vital commodities (think air, gasoline, or even money itself), annuities are both ubiquitous and invisible. You don’t smell, hear, or taste annuities, yet they’re all around you. For example:
Social Security benefits, pensions, and structured settlements of personal injury lawsuits are all annuities.
Many state lottery jackpots are paid out as annuities.
Thousands of university employees contribute part of their paychecks to group retirement annuities.
But the annuities in this list aren’t the focus of this book. Instead, I focus on the individual annuities that people purchase from insurance companies or their designated representatives. Here’s a rough description of the sales process:
You probably buy your annuity from a licensed insurance agent, broker, or financial adviser. Standing directly behind these intermediaries are brokerage firms (for brokers and financial advisers), marketing organizations (for independent insurance agents), or the insurance companies themselves (in the case of career insurance agents). Note: Insurance agents aren’t licensed to sell variable annuities. (See Chapter 16 for more about this licensing.)
The transaction includes these steps:
1. You meet with the agent or broker to discuss your finances and choose a suitable product.
2. You complete an application and the agent or broker submits it to the contract issuer for approval.
3. After your application is approved, you send the contract issuer a check for the minimum amount (every carrier sets its own minimum initial premiums) or more.
4. The carrier sends you your contract.
You have 10 to 30 days to reconsider your decision and send the contract back for a refund.
5. If you decide to keep the annuity, put the contract in a safe place. Shoeboxes, filing cabinets, desk drawers, and safe-deposit boxes are among the preferred destinations (but not necessarily in that order!).
Be sure to check out Chapter 16 for more on the sales process.
Important participants in the annuity food chain include:
Annuity issuers: Only insurance companies issue annuities. Hundreds of issuers are out there, but the 25 largest firms — household names like The Hartford, MetLife, and Prudential — account for about 90 percent of all annuities sold each year.
Some insurers are publicly owned and some are mutually owned. The two types may have different cultures, attitudes, and slightly different products:
• Publicly owned firms are owned by their stockholders.
• Mutually owned firms are owned by their customers.
Look for a company whose view of risk and reward matches your own.
Annuity distributors:Distributors serve as middlemen between the carriers and the producers (see the next bullet). In many cases, they employ or supervise the producer, making sure the producer complies with insurance and investment laws. Distributors include
• Wirehouses (Large, established full-service brokerages like Merrill Lynch and Morgan Stanley; so called because their ancestors were among the first to use the telegraph or “wire”)
• Independent broker-dealers like Raymond James and LPL (Linsco/Private Ledger) Financial Services
• Banks like Bank of America and Wachovia that sell annuities through their branches
Annuity producers:Years ago, most insurance companies employed an army of career agents to represent their products. Although carriers like AXA Equitable, New York Life, and others still employ these “captive” agents, many insurers now rely entirely on independent agents, brokers, and bank officers to sell their annuities.
These independents can recommend any annuity they want. In practice, they may steer you toward their list of preferred products or carriers. Be aware that a producer may earn a higher commission or a free trip to Cancun for selling certain products. Feel free to ask the producers about their rewards. See Chapter 19 for more questions you should ask.
Direct marketers: Some (but not all) insurance companies sell no-load (that is, no sales commission) contracts directly to the public. If you’re the self-reliant type and don’t need an agent or broker to explain annuities to you, you can buy your annuity direct and save that added commission cost.
No-load mutual fund companies like Vanguard, Fidelity, and T. Rowe Price also sell no-load annuity contracts over the phone or Internet or by mail. Their contracts are issued by third-party insurance companies.
Relatively few people buy annuities direct. Most people need intermediaries to explain annuities and help them choose the right one. There’s nothing wrong with that. But you can save big by cutting out the salesman.
Chapter 16 contains even more information on how to acquire annuities, so please flip to that chapter when you’re ready to know more.
Getting your money out of an annuity
Putting money into an annuity is relatively easy. Getting money out is “sticky” — that is, more complicated.
Annuities are “sticky” for a reason. The benefits of fixed deferred annuities, variable annuities with guaranteed living benefits, and income annuities all depend on your agreement not to touch your money for a while. To discourage you from taking out your money until the “cake is baked,” in a sense, insurance carriers and the government both charge fees or levy penalties on early withdrawals.
But insurance companies and the IRS aren’t totally inflexible about withdrawals. For instance, you can withdraw 10 percent of most fixed annuities every year without a penalty. The newer income annuities allow emergency lump-sum withdrawals and provide for almost unlimited withdrawals to pay for nursing home care. You can tailor an income annuity so that, if you die before receiving at least as much as you paid for your annuity, your beneficiaries will recover the difference. For more details, see Chapter 13.
Understanding the dual nature of annuities
Think of annuities as the financial world’s version of the platypus, the egg-laying mammal that’s part duck, part beaver. They’re neither pure investments nor pure insurance; instead, they have one foot in the investment world and one foot in the insurance world. I’ve also heard them compared to the Osprey — an aircraft that can hover like a helicopter and fly like a plane.
Ospreys don’t hover as well as helicopters and don’t fly as well as planes, but no other vehicle in the world does both. Similarly, annuities aren’t the most lucrative investments and they don’t insure you against every financial disaster. But, for the right candidate, they can offer an attractive blend of earnings and safety that few other readily available financial products can match.
Part investment, part insurance
An annuity is an investment because you give a sum of money to a financial institution with the hope that you’ll get back more than you put in. Your investment — in this case, a premium — can range in size from $2,000 to over $2 million. The financial institution, usually an insurance company, puts your money in its general account (if you buy a fixed annuity) or in a separate account (if you buy a variable annuity).
An annuity is also insurance because a small portion of your premium buys a guarantee (the exact nature of the guarantee varies with the type of annuity). For example:
In fixed annuity contracts, your guarantee is the rate of return for a certain number of years.
In the latest variable annuity contracts, your guarantee is the locked rate of return.
With an immediate annuity, the guarantee is your income.
Survivorship credits — the unique aspect of annuities
When you buy an annuity for lifetime income, you throw your money into a pool with money from thousands of other annuity owners your age. This is mortality pooling; Social Security and corporate pensions are based on the same principle.
With annuities, an insurance company puts the money into its own interest-bearing account or into a separate account where your money goes into subaccounts (mutual funds) that a professional fund manager oversees. All owners then take an annual income from that pool.
Each month (or quarter, if you prefer) you receive a payment consisting of three elements:
A little bit of your principal
A bit of the pool’s investment growth
A bit of the money left behind by fellow annuity owners who have died
This amount is your survivorship credit or mortality credit.
Of course, this income depends on (is “contingent upon,” the lawyers might say) certain circumstances:
If you die early, you may not receive as much as you put in.
If you live exactly to your life expectancy, you get back exactly what you put in, with interest.
If you live past your life expectancy, you get back much more than you put in.
True annuities serve two purposes: They guarantee you an income for life (or a specific number of years), and they maximize your income rate while you’re alive.
Risk reduction versus risk taking
Annuities are all about trade-offs between risk and return. The guarantees reduce your risk of losing money, but the fee for the guarantee generally reduces the potential growth of your investment. Note: That’s not always the case, but the principle holds true — lower risk brings lower returns.
If anybody tries to convince you that an annuity lowers your risk without curtailing your potential return, put your hand on your wallet and slowly back away. There are no free lunches.
Chapter 2
Using Annuities to Meet Retirement Challenges
In This Chapter
Identifying the financial risks of retirement
Coping with longevity, investment, and planning risk
Understanding your role in retirement planning
For most baby boomers, retirement will be different from the way it was for previous generations. The disappearance of company pensions and the replacement of defined benefit plans by defined contribution plans will have a profound effect on the way the boomer generation copes with retirement. Sure, many people will still have pensions, but not nearly as many as before.
As a result, ordinary people in their 50s and 60s who know nothing about finance will need to deal pragmatically with sophisticated questions of longevity risk, investment risk, and planning risk that used to be the province of professional pension managers. It’s a precarious situation.
To insure against those risks and convert their savings into do-it-yourself pensions, many boomers will turn to annuities. The annuities won’t necessarily be cheap, and some people will need help understanding them. But the alternative — an epidemic of poverty among the very old — is unthinkable.
This chapter describes the most common financial risks that tend to vex people over age 55, and shows you which annuities can help you hedge against those risks. Sure, there are risks involved in purchasing an annuity. You could pick the wrong one, or you might overpay for it. But you’re a boomer. You can wade through the risks, if you’re well prepared.
Calculating Retirement Risks and Solutions
In 2006, the Society of Actuaries (the mathematicians who calculate insurance premiums) took a close look at the risks baby boomers would face in retirement. After identifying the risks, the actuaries estimated the extent of those risks and suggested financial products that offered protection against them. Table 2-1 shows the findings of their study.
Chances are you’ll be vulnerable to at least three of the financial risks in this chart. (Health risks are financial risks, indirectly.) You can ignore those risks, self-insure against them by increasing your savings, or consider insuring yourself against them with one of the products described in the third column.
*Excerpted from The Society of Actuaries’ “Key Findings and Issues: How Americans Understand and Manage their Retirement Risks” in its 2005 Risks and Process of Retirement Survey Report.
How can you minimize your risk of running out of money in retirement? Research shows that if you put one-fourth of your money in a fixed income annuity and keep the rest mainly in stocks, your risk will be much lower than if you buy no annuity and keep your money mainly in bonds.
Back in December 2001, two leaders in the field of retirement research, John Ameriks and Mark Warshawsky, along with Robert Veres, a journalist, published an article in the Financial Planning Association Journal that examined the risk of running out of money during retirement.
The researchers offered the hypothetical portfolios of two investors (I’ll call them “Smith” and “Jones”):
Smith put 20 percent of his money in stocks, 50 percent in bonds, and 30 percent in short-term liquid assets such as money market funds.
Jones used 25 percent of his money to buy a fixed income annuity, and then put 64 percent in stocks and 11 percent in bonds.
In retirement, Smith and Jones started drawing their money at an inflation-adjusted rate of 4.5 percent a year. Then, in what’s called a Monte Carlo simulation, the researchers ran the two portfolios through software that showed how they’d perform over 40 years and in thousands of hypothetical stock market scenarios.
The result? Jones was much better off. Both strategies kept a 65-year-old retiree safely afloat until age 85. But by age 90, Smith ran out of money in 25 percent of all possible outcomes. Jones ran out in only 2.2 percent of the outcomes.
By age 95, Smith ran out of money in 67 percent of the cases, but Jones ran out in only 5.4 percent. The apparent lesson: A portfolio that focuses on stocks and annuities is safer in retirement than a portfolio that focuses on bonds and cash.
Let me repeat: stocks and annuities are safer than bonds and cash. This assertion runs counter to conventional wisdom, which says that bonds are safer than stocks. But, in retirement, the returns from bonds may be too low to sustain you over the long term.
Annuities, by covering your basic expenses, allow you to invest the rest of your savings more aggressively. The result: more money for you to spend or bequeath. Suppose, for instance, that you and your spouse have $300,000 in savings, $34,000 in Social Security income, and household expenses in retirement of $50,000 a year.
If you spent $200,000 on a fixed-payout income annuity that paid $16,000 a year for life and then invested the rest of your savings in stocks, you’d have a secure income of $50,000 and $100,000 in stocks. On the other hand, if you put your $300,000 in bonds earning $15,000 a year in interest, you’d have an income of $49,000, no liquid assets and no significant chance for growth. You might feel richer for still having $300,000 in bonds, but you couldn’t spend it without reducing your source of annual income.
In the rest of this chapter, I discuss the three main types of risks in retirement, along with suggestions for the types of annuities that might help control those risks.
Countering the Main Risks of Retirement
A number of surveys have tried to measure how well Americans are prepared for retirement, how well they understand the risks they face, and how anxious they are about the future.
Generally, the surveys have shown these results: Most people are not well prepared for retirement; they underestimate some risks and overestimate others; and they’re unaware of a few of the most important risks.
The most common retirement risks tend to fall into three main areas:
Longevity risks: The hazards of aging
Investment risks: The uncertainty of the financial markets
Planning risks: The chance that people will make mistakes with their money
In the following sections, I first talk about each type of risk. Then I explain how specific annuities can reduce those risks and provide greater peace of mind in retirement.
Longevity risks
“You can be young and poor but you can’t be old and poor, and that’s the truth,” wrote Tennessee Williams in A Glass Menagerie. Everyone faces the risk of living long enough to run out of savings. Public annuities (Social Security), group annuities (traditional pensions), and individual annuities are the only investment products that can relieve you of that risk.
Outliving your savings
When you’re young, you worry about dying young — if you think about mortality at all. But when you’re older, you face the risk of living too long and running out of your savings; technically, this is longevity risk. Most Americans aren’t aware of these statistics:
At age 65, men have a 50-percent chance of living past age 81.
At age 65, women have a 50-percent chance of living past age 84.
The World-War-II generation relied on a combination of Social Security and company or government pensions to provide a guaranteed lifelong income. In contrast, most baby boomers have only one source of guaranteed lifelong income (Social Security), and they’re generally living longer than their parents. End result? Boomers are more likely to run out of money before they die.
Losing a spouse
As married couples get older, they inevitably worry about the spouse who outlives the other. The surviving spouse loses a guide and a caregiver. In addition, for two-income couples, the death of one spouse can mean a decline in Social Security benefits. Similarly, if the recipient of a corporate or government pension dies, the surviving spouse may stop receiving benefits.
Most surviving spouses are women. Women live an average of two years longer than men, and 46 percent of women over age 65 are widows. In contrast, only 14 percent of men over 65 are widowers, according to LIMRA International, the life insurance research organization. As the last to die, women are much more likely to run out of money in old age than men.
Requiring long-term care
Today’s retirees know that if they live long enough, they’ll probably need nursing-home care. According to the Society of Actuaries, about 60 percent of pre-retirees and 50 percent of retirees worry that they won’t be able to afford the care they need. Even if they do have substantial savings, they face the risk that nursing-home costs will eat up the resources they’d prefer to leave to their children.
Good nursing-home care costs as much as $150 to $200 a day today, and it may cost much more in the future. One solution is to buy long-term care (LTC) insurance, but it can be prohibitively expensive. So far, the insurance industry has not come up with a truly affordable solution. Regardless of whether people buy LTC or reserve part of their savings for future care, the mere possibility of nursing-home expenses will affect their finances throughout retirement.
Using annuities to insure against longevity risk
Annuities are the only financial product that can provide you with guaranteed lifetime income and insure against the risk of outliving your money. In fact, several types of annuities can help you turn a limited amount of savings into an income that never stops. Check out these four examples:
Variable deferred annuities with living benefits:This annuity is a vehicle for tax-deferred investing that has been around for about half a century (see Chapter 8). But in the past few years, insurance companies have reinvented it as a way to provide one person or a married couple with living benefits that include guaranteed lifelong income for one or both of them.
Some products allow you to invest, say, $200,000 at age 55; they guarantee that, if you don’t touch the money for ten years, you’ll receive at least $20,000 a year for life — with the option to dip into your savings for large purchases or nursing-home expenses. You can arrange for the income to last until you die or, for a higher fee, until both you and your spouse have died.
Fixed and variable immediate annuities: Immediate annuities provide guaranteed income for life — either for a specific period or for as long as both spouses are alive (see Chapter 8).
Note: Immediate annuities provide more income than deferred variable annuities with living benefits because you receive income from three sources: your investment in the annuity, the earnings on your investment, and the survivorship credits you receive by outliving other annuity owners.
A fixed immediate annuity pays a preset monthly income every month for life, or for two lives, or for a specific period.
A variable immediate annuity also pays a monthly income, but the payments fluctuate with the market value of the underlying investments (think of these as clones of mutual funds).
Annuity and long-term care insurance combinations: A number of companies now guarantee you an income for life or nursing-home coverage for a specific number of years in return for your lump sum investment. Essentially, they’re high-deductible LTC insurance; the deductible is paid by the money in the annuity. (Chapter 15 has more info on this combo.)
For years, the different tax treatments of annuity income and nursing-home benefits delayed the development of these products. (The income is taxable; the benefits aren’t.) But the Pension Protection Act of 2006 cleared that obstacle away. Genworth Financial, Lincoln Financial, and several other insurance companies now offer LTC/annuity hybrids.
Advanced-life deferred annuities: Also called longevity insurance, this annuity pays you an income only if you live beyond a specific advanced age such as age 80 or 85. It’s the cheapest way to ensure that you’ll always have an income. (See Chapter 10 for more on these annuities.)
Investment risks
Every investor experiences investment risk, the volatility of the financial markets. When you’re young, you can laugh off the ups and downs of the market because, over the long run, the market has always risen. When you’re older, however, time is no longer on your side. You’re more vulnerable.
The risk of a market crash
Americans became reacquainted with the risks of investing in equities in early 2000, when the Internet bubble of the late 1990s collapsed and stocks averaged a one-third loss of value. Before 2000, people thought the market would gain 25 percent a year forever.
Retirees used to play it safe by putting their money in bonds or bond funds. But today’s soon-to-be retirees are often advised that they’ll run out of money if they don’t invest in stocks. The downside? When you rely on stock investments for retirement income, you experience market risk. That’s not a bad thing — risk is the source of returns. But it’s a factor that must be considered and controlled.
Sequence of returns risk
Here’s a risk you may not be aware of and may not want to know about: timing risk or sequence-of-returns risk. To a great extent, the ability of your savings to last until you die depends on when you decide to retire. For example:
A person who retired in 1970 (a prosperous year in itself) was headed for trouble. His stock investments were reduced to pocket change by the 1974 to 1975 recession.
An investor who retired in 1980 (a dismal year economically) rode the 1982 to 1999 bull market to financial glory.
The five years immediately before and after you retire are the most vulnerable years for your savings. A serious bear market during that time can put you in a financial hole that you don’t have time to earn your way out of. One insurance company calls this period the retirement red zone.
Consider, for instance, someone who retired in August 2000 with $200,000 in shares of Vanguard 500 Index Fund, whose price follows the performance of the stocks of the 500 largest U.S. companies. From September 2000 to September 2002, the share price of that fund fell from $140 to $75, reducing a $200,000 investment to a $107,000 investment.
