Retirement annuities: Cash for life

A new breed of annuity can help smooth out the uncertainties of retirement.

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Joel Flather's income has held steady since the sale of his canoe-making firm.
Income for Life?
Before investing a chunk of your savings in an annuity, consider these issues.
HOW BIG WILL MY PAYMENTS BE?
That depends on how much you put into the annuity and the type you buy. For example, a 60-year-old man who deposits $1 million into a fixed annuity today could get about $6,000 a month. Payments can last for life, but the amount may be reset periodically to reflect changes in interest rates.
WHERE DO I BUY ONE?
Annuities are sold through insurance agents and financial advisors at brokerage houses. You can also buy one more cheaply at vanguard.com.
WHAT RISKS DO ANNUITIES HOLD?
Some newer annuities let you access your lump sum early on, but in general, look out for the so-called surrender charge - a fee that may be levied if you cash in the annuity in the early years.
MUST I TAKE A PHYSICAL BEFORE BUYING ONE?
No. Life insurance is effectively an insurance company's bet that you'll live to a ripe old age. Generally, a lifetime annuity reflects the opposite

(Fortune Small Business) -- Making lightweight canoes had long been a labor of love for Joel Flather, founder of Compass Canoes in Taunton, Mass. But last year, at age 66, Flather decided to sell his ten-year-old business to a larger boating company. The transition confronted Flather with one great unknown. "We never had a pension plan at my company," he says, "so funding the future became an important issue."

Like many entrepreneurs, Flather was accustomed to the ups and downs of his business - the price of his raw materials, Kevlar and carbon fiber, had ratcheted higher in recent years because of heavy demand from the military - but the drumbeat of retirement anxiety never faded: Will there be enough? Will I - or my spouse - outlive the wealth we've created?

While any number of financial planners will help you figure out your future, none can guarantee that all will be fine. Here's the good news: A number of financial products now offer significant security for retirees.

Consider annuity policies, which allow you to invest a chunk of your savings in return for regular payouts. Annuities got a famously bad rap in the 1990s because of their unfamiliar - and surprisingly steep - fees. Since then, the variety of products has grown and some of the fees are down, especially if you shop around. Moreover, today there is an annuity to suit every stripe, and many are "unbundled," allowing consumers to customize their annuity just as they might tweak a new car purchase to add side-curtain airbags.

At the suggestion of his financial advisor, Joel Flather invested $500,000, about a quarter of his savings, in a Vision variable annuity from Allianz Life. (A number of insurance companies offer annuity products - see the box at the side.) "It will provide me and my wife with income for life," he says. But it also offers access to his invested dollars should he and his wife need it, plus - in exchange for a hefty annual fee - full protection from negative investment performance. "It's terrific," says Flather.

Even with all the bells and whistles, annuities still roll out of the factory on one of two basic chassis. Fixed annuities yield a steady stream of income for a set number of years or the rest of your life. Variable annuities can also provide regular checks, but they tie the amount of your payouts to the performance of an investment portfolio. Both types allow you to choose whether to begin receiving payouts immediately (in monthly, quarterly, or annual installments) or at a later date. And both varieties pay out partly taxable money - you are taxed only on your gains, not your original investment - at regular income-tax rates, an important fact to weigh when considering annuities for your financial plan.

Just like a new-car purchase, you then start adding options. You can buy fixed annuities and tack on inflation protection for your payouts; you can choose to add a death benefit - or not. Some policies offer an option for long-term-care insurance, which raises your payouts if you become disabled. On certain variable annuities, you can opt to have your portfolio value (and thus your payouts) reflect your performance only in neutral or good years, just as Joel Flather's annuity will do.

All these cool features come at a price, however, so do some soul searching to figure out what's most important to you, and follow that with energetic comparison shopping. On fixed annuities, the price comparison among different firms' offerings is relatively simple: "It all comes down to how much money you put in and what initial payment that produces," says Christine Fahlund, a T. Rowe Price senior financial advisor.

On variable annuities, try to determine the cost of a specific feature (it's usually expressed as percentage points deducted from your returns), then ask yourself how badly you want it. Features that limit downside investment risk tend to cost anywhere from 1 to 1 percentage points deducted from your annual portfolio returns. That's on top of annual investment-management fees, which can vary widely.

For fixed-annuity holders, the most important extra to consider is inflation protection. That's because even modest price increases can ravage your purchasing power over decades. For example, somebody living on $100,000 a year in 1980 would need $253,000 a year today to maintain the same lifestyle. Inflation protection in the form of annual adjustments to your income from the annuity is not cheap - it will slice about 30% off the first payout you receive - but that's not bad considering that the insurance company takes on a big unknown (after all, you could live to be 100).

Still, if all-out inflation protection seems too pricey, think about buying a policy with an escalation clause, which stipulates that your annual payout will rise, say, 3% each year through thick and thin. This typically shaves your initial payout by 25%. Notes T. Rowe Price advisor Fahlund: "I like this feature because it's more affordable, and it keeps you apace with inflation in all but the really bad years."

Annuity shopping can be tricky. But with the right product, you could glide through retirement like a canoe on Mirror Lake.  To top of page

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