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Rolling into annuities?
The advisor for my 401(k) plan suggests I roll over my 401(k) into annuities. Should I listen?
June 9, 2003: 11:40 AM EDT
By Walter Updegrave, MONEY Magazine

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NEW YORK (CNN/Money) - I'm 55 years old and have just been terminated from my job. The financial consultant for my 401(k) plan is suggesting I roll over the $30,000 balance of my 401(k) into annuities that guarantee a minimum 5 percent rate of return with a focus on safe investments. I plan on finding new employment and will continue to invest for the future, either through a 401(k) or on my own. Do you think I should take the consultant's advice?

-- Richard Bostwick, Rochester, New Hampshire

I would be reluctant -- no, let me make that stronger -- I would be extremely reluctant to take my 401(k) money and roll it into an annuity if I were in your situation. Why? Several reasons.

First of all, one of the main attractions of annuities is that the gains you earn are sheltered from taxes while they remain within an annuity. But since your money is in a 401(k), it's already being sheltered from taxes.

And you don't need an annuity to maintain that shelter. All you've got to do is roll over your 401(k) assets into a Rollover IRA and your money will continue to grow without the drag of taxes. So, as I see it, there's certainly no need from a tax standpoint to consider an annuity.

About that "guaranteed return"...

Ah, but what about that 5 percent minimum guaranteed return -- that's worthwhile in and of itself, isn't it? I'm not so sure. You see, the words "guaranteed" and "returns" are thrown around by annuity sales people in so many ways that it's easy to get the wrong impression of what's being offered.

For example, some annuities will guarantee a certain rate of return as long as you promise to later "annuitize" your account balance with that company -- that is, you promise to convert your balance into a lifetime payment stream. But that might not be such a hot deal if the payments they're offering in the future are much lower than that what you could get from other annuity companies for the same account balance.

And some people confuse a guaranteed rate of return with a guaranteed rising "death benefit." Some annuities, for example, promise that if you die while you still own the annuity, your heirs will receive the greater of your account balance or the original amount you invested compounded by 5 percent per year.

But this isn't the same as a guaranteed 5 percent return because your heirs only collect if two things happen: you die and your account has earned less than 5 percent annually. If your account balance has fallen and you're still alive and kicking, well, the guarantee does zip for you.

Fixed annuities do have a guaranteed rate of return

Now, there are some annuities that tout guaranteed rates of return. These are what are known as "fixed" annuities. Essentially, they work a bit like certificates of deposit. You invest your money with an insurance company in its fixed annuity, and the insurer promises to pay you a specified rate of return.

But here's where you've got to be careful. Sometimes, annuities tout high "teaser" rates that last only one year. After that, the insurer has the option of changing it virtually at will, although many do offer a minimum guarantee of about 3 percent.

What's more, if you don't like the new rate and decide to pull your money out of the annuity, you may face surrender charges as high as 10 percent of your investment. One type of annuity, a "CD annuity," does promise a specific rate for a specified period that can be as long as five or even 10 years. But given how low interest rates have sunk today I think you'll have a tough time finding a CD annuity that pays a guaranteed 5 percent for a five-year term.

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I could go on and on about the various things you've got to be aware of when considering annuities. (And in several stories in MONEY Magazine, I've done just that. Click on the stories to the left to check them out).

I could also go on at length about the gimmicks you have to look out for when buying annuities and how people sometimes get snookered when buying them. Indeed, the NASD, the organization that regulates investment firms and their sales people, is currently investigating shady annuity sales practices.

You don't need an annuity now

But the real point here is that I don't think a person in your situation should be looking to put his or her 401(k) money into an annuity. If you're going to continue working, saving and investing for another 10 years or so, you don't want to hunker down in what's essentially a fixed-income investment. You want to create a diversified portfolio that gives you a shot at long-term growth. Which means owning stocks (or stock funds) and bonds (or bond funds).

Annuities can be a useful tool for providing income once you're in retirement and you want to convert a portion of your assets into a lifetime income. But until you're ready to do that, I think there are many better places for your money.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged."  Top of page

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