retirement

Rescue retirement with an annuity. The nerdy insurance product offers peace of mind

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Annuities: The next big retirement option?
By Jean Chatzky

Annuities make a very appealing pitch: monthly income for life. Their complexity and the range of choices have often left consumers feeling skittish about them, but in a volatile investment climate annuities might represent a safe haven.

Why might you think annuities are outside your comfort zone? They're a financial product issued by insurance companies, but "the insurance industry has not done a very good job recommending products that specifically fit their clients' needs," explains Tom Warschauer, professor of finance at San Diego State University. "They look at what they want to sell and find a place for them in everyone's portfolio."

One big issue has been the lack of transparency about charges embedded in annuity products; it has sometimes been difficult to decipher those costs. "There's a lot of room for abuse," says Warschauer, who's also the director of the Center for the Study of Personal Financial Planning at San Diego State.

He's not the only one with concerns. "The costs associated with the purchase of individual annuities eat away at the overall retirement nest egg," says Beth Almeida, former executive director of the National Institute on Retirement Security. "So a retiree may get a regular check, but their overall retirement income is diminished."

Still, she notes that, "Retirees and near-retirees are likely seeking safe haven." Warschauer agrees, adding that annuities "have some very valuable uses in retirement planning" in this economic climate.

During your working years, return on investment is generally a primary financial focus. But in retirement, "the new ROI is 'reliability of income,'" says Robert E. Sollmann Jr., executive vice president of retirement products for MetLife.

"The painful lesson we are learning from today's market is that the conventional wisdom -- 'diversify' -- isn't cutting it. … The guarantees provided by annuities that can deliver regardless of market performance" are needed to balance a retirement plan, Sollmann says.

Think annuities may be worth a look? With so many annuity types, it's easy to get overwhelmed by the possibilities.

Let's start with some basics definitions: Annuities are life insurance contracts sold by insurance companies, brokers and other financial institutions, and they provide a regular periodic payment to a policyholder for a specified period of time. They are paid for before retirement in exchange for lifetime payments after retirement and are intended to provide a regular level of retirement income to meet day-to-day living expenses.

Annuities come in two general categories:

Fixed annuity. The insurance company guarantees that the principal pays a minimum rate of interest. As long as the company is financially sound, money in a fixed annuity will grow -- not drop -- in value. The growth in value or the benefits paid may be fixed at a dollar amount, at an interest rate or by a specified formula. The interest rate usually starts out as a fixed percentage and is adjusted annually.

Variable annuity. Your money is invested in a fund similar to a mutual fund -- but one open only to the insurance company's investors. The amount paid out depends on the performance of the fund.

"I'm a real advocate of fixed annuities," says Warschauer, who draws the comparison to a fixed versus variable mortgage rate. "It's obvious with a fixed mortgage you're more secure. When you're in your retirement years, you really want to be able to count on the cash in-flow, and the fixed annuity does that." Of course, the fact that it's fixed means it doesn't go up with inflation. His recommendation: Package a growth element within your IRA or 401(k), and then shift money out into immediate fixed annuities for daily living expenses.

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