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How safe are annuities?
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October 26, 2001: 11:29 a.m. ET
I'm worried about my retirement savings. How safe are annuities?
MONEY columnist Walter Updegrave
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NEW YORK (CNNmoney) - I'm worried about my retirement savings. How safe are annuities?
That depends on the kind of annuity you're talking about. Basically, there are three types -- fixed annuities, variable annuities and immediate annuities. All three are issued by insurers, although they're often sold not just by insurance agents but by brokers and financial planners. Each type differs somewhat in the risks it poses and the safety it provides. Let's take them in order.
Fixed annuities
Fixed annuities pay a fixed rate of interest for a certain period -- usually one to five years -- much like bank CDs. Unlike CDs, however, the interest fixed annuities pay is tax-deferred until you withdraw your money from the annuity. At that time, your earnings are taxed, plus you'll be hit with a 10 percent penalty if you're under age 59 1/2.
You'll often see the word "guaranteed" plastered all over ads and marketing brochures for fixed annuities, suggesting that the value of the annuity is somehow guaranteed like a bank deposit. Not true. There's no federal insurance covering annuities as Federal Deposit Insurance Corp. covers bank deposits. Rather, individual insurers guarantee the value of their annuities -- but that guarantee is only as secure as the financial stability of the insurer. In the 1980s, several well-known insurers ran into problems and were unable to meet their guarantees.
So if you're buying a fixed annuity, I recommend that you stick to insurers that have received high ratings (AA or higher) from rating companies like Standard & Poor's and Moody's and that you spread your money among a few insurers rather than keeping it with just one.
Variable annuities
Like fixed annuities, variable annuities also pay a tax-deferred return and are subject to the rules concerning taxes and penalties. But there's a major difference between the two. When you buy a variable annuity, you're essentially investing in a mutual fund-like portfolio known as a "subaccount" in variable annuity lingo. That subaccount may own stocks, bonds, or a combination of the two, just like a regular mutual fund. Which means that rather than getting a fixed rate of interest for a given period, you're getting a return that varies with the market (although some variable annuities promise that when you die, your heirs will receive at least the amount you invested). The assets within a variable annuity are not mingled with the insurer's own assets, as is the case with a fixed annuity. So you don't have to be quite as concerned with an insurer's rating when buying a variable.
Immediate annuities
Finally, when you buy an immediate annuity, you're essentially giving an insurer a lump sum (either from cash or from a fixed or variable annuity you already own) in return for the insurer's promise to pay you a monthly income, typically for as long as you live (or your spouse lives). The size of the monthly payment you get depends, among other things, on the amount of money you fork over and your life expectancy.
That income stream can be fixed, say $1,000 each and every month (in which case you've chosen a "fixed immediate annuity") or it can vary according to the performance of the subaccounts you've invested in (in which case you've chosen a variable immediate annuity). In both cases, however, you're depending on the financial stability of the insurance company to assure that you get your payments each month. Thus, again, I recommend doing business with insurers that have earned high ratings from the ratings companies.
One final caution: once you've converted your lump sum into an income stream via an immediate annuity, there's usually no going back -- that is, you can't get your money back. So to retain flexibility to handle emergencies and changes in my financial circumstances, I'd consider an immediate annuity with only a portion of my investments, and a small portion at that. 
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