Financial Literacy - Retirement Income Planning
retirement
Guaranteed income for life -- at a price

In recent years, insurance companies have thrown many sweeteners into the pot, in the form of guarantees called living benefits, to make annuities more appealing to consumers.

"You could buy a mutual fund instead and if it goes up, great. If it goes down, uh-oh," says Hemke.

If you buy a variable annuity with a guarantee, your investments still have the potential for growth, but if they lose money, your payout level will never dip below a certain point, Hemke says.

In the recent market downturn, variable annuity investors enjoyed protection from losses and some even made money in 2008, when the S&P 500 lost nearly 39 percent, according to The Wall Street Journal. In response, insurers had to build up their reserves, and some have scaled back their guaranteed offerings.

Bells and whistles

While guarantees hedge the downsides of variable annuities -- such as losing money and forgoing a legacy for heirs -- they add to the ongoing expense of the product. Warning: They are also incredibly complex and restrictive. Below are simplified explanations of some available guarantees. Be sure to dig up all the details (read the prospectus) before parting with your money.

Guaranteed minimum income benefit

As described above, this guarantees a certain level of payments after annuitizing, even if your account experiences investment losses. To get this guarantee, you generally cannot access your money during the accumulation period without possibly jeopardizing the guarantee. Income payments are based on the greater of either the actual realized value or your principal plus an interest rate.

Guaranteed lifetime withdrawal benefit

These riders allow investors some flexibility. For instance, you can withdraw a percentage of your funds (generally between 3 percent and 7 percent, depending on your age) without annuitizing, and you can increase the amounts withdrawn if the investments do well -- provided certain conditions are met.

Simply put, they "guarantee you an income without annuitizing," says Douglas Neal, CFP at Neal Financial Group in Houston.

"It can go by different names, but the gist is that the insurance company says if you don't take out more than 5 percent a year (of the account value on the date the withdrawals begin), then we guarantee you that amount of money every year that you live, even if you use up all your money in the annuity," he says.

Guaranteed minimum withdrawal benefit

This is a similar guarantee to lifetime withdrawal benefits, except that the payout lasts only as long as the original principal amount. It protects your investment even if the market erodes its value, and will allow you to withdraw a certain percentage every year until you've recovered the initial investment.

Death benefit

One of the risks of buying an annuity is that you will die before you begin taking payments or before your investing principal has been exhausted. A death benefit rider ensures that if your life ends before the annuity payments begin, your heirs can still cash in. On a variable annuity, where the value of the account can rise and fall with the market, a guaranteed death benefit enables beneficiaries to inherit the full investment amount even if the market diminished the value of the account.

Other guarantees

Though the most common way of buying an immediate annuity is called life only, where the buyer is basically making a bet against the insurance company that he or she will live longer than the company expects, you can get some guarantees and protections for your beneficiaries. Of course, these guarantees come with a price in the form of lower payouts.

For example, buyers can attach a period certain guarantee, where the insurance company guarantees you at least a minimum number of years of payments.

"If you were to buy life-only with 10-year period certain, that means they're at least going to guarantee 10 years' worth of income to somebody," says Hemke.

"So if you live for 40 years, the income will go for 40 years. But if you live for four years, the contract guaranteed a minimum of 10. So whoever you named as beneficiary is going to get the other six," says Hemke.

Cash refund is another option that is becoming even more popular.

"That is a refund or return of your principal. Say you put $100,000 into an immediate annuity, and that is going to pay you $10,000 a year for life," says Hemke.

"So a bus comes along and flattens you after you have gotten out $20,000 -- there is an $80,000 difference between what you put in and what you got out. Whoever you named as beneficiary is going to get the $80,000 back," he says.

Financial planners are split on annuities. Though most concede that there is a time and place for all types, the most commonly recommended is an annuity with a fixed payout.

They can provide a little bit of insurance against landing in the poorhouse in your old age.

But before purchasing an annuity, read about some of their pros and cons.

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