Variable annuities: Beware of shrinking payouts (pg. 3)

  @Money August 6, 2013: 5:35 PM ET

What to do if you're shopping for income

Take stock of your stock anxiety. Even before the changes in rider terms, "there were cheaper ways of guaranteeing income," says insurance adviser Witt.

Still, the product can make sense for certain people -- in particular, those so fearful of another 2008 that they're taking much less risk than they should. For such individuals, a VA-rider combo presents a shot at growth, notes Miami financial planner Bruce Cacho-Negrete.

To overcome the fees, though, you need to be mostly in stocks, he adds: "If you can't get at least 80% exposure, it's harder to make the case for these." (Right now only one insurer, Jackson National, lets you go in that deep.)

Invest conservatively now, annuitize later ... Got a stronger stomach? You'll have potential for more income if you stash your money in a conservative, low-fee mutual fund portfolio until you need income, then purchase an immediate annuity at that time.

With this type of annuity, you hand over a lump sum to the insurer and start getting paid immediately. Unlike the VA, the amount you invest is the insurer's to keep even if you die the next day. But payouts are higher, since insurers can transfer premiums of those who die early to those who live longer.

Currently, a 65-year-old man investing $100,000 could get $6,800 a year. The size of the check depends on your age and interest rates at the time of purchase, though -- good reasons to wait to buy. (Find quotes at ImmediateAnnuities.com.)

Related: What are the different types of annuities?

Last September, Wade Pfau, a researcher at the American College of Financial Services, analyzed various income strategies for a 65-year-old couple, including immediate annuities, a VA-rider combo, stocks, and bonds.

His conclusion: A mix of stocks and immediate annuities provided the best balance of guaranteed income and flexibility to draw from savings for lifestyle needs or to cover emergencies. The exact percentages of each, he says, depend on your preference for meeting a spending goal, vs. having leftover wealth. But, Pfau adds, "50% stocks/50% annuity could be a pretty good mix."

...Or nail down later income now. An alternative strategy would be to buy a deferred-income annuity, similar to an immediate annuity except that it allows you to lock in future income. You buy now and delay paychecks anywhere from 13 months to 45 years. A 65-year-old man with $100,000 can buy $16,520 a year starting at age 75; if he waits until 85 to start collecting, he'll get $62,950.

The reason for the gaping difference: the increased likelihood he will die between 75 and 85 and the insurer will pocket the money. (Shop for these, too, at ImmediateAnnuities.com, but be aware that a deferred annuity is different from a deferred-income annuity.)

Related: Want $1 million? Protect your portfolio

On the upside, this method cuts out investment risk in the period before you need income. Downside: You lose the potential for market rallies that would boost your portfolio and interest rate hikes that would make the contract more productive.

The most effective way to use a deferred-income annuity is to buy one with a slim slice of your portfolio and push the income way into the future, says Pfau. The goal: to ensure you'll have some income in your later years if your portfolio runs dry. You'll pay much less for that security than you would for a variable annuity. To top of page

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Comparing retirement income strategies
A 55-year-old man with $100,000 to invest hopes to start taking income at age 65. He could buy one of the annuities below.
Annuity Annual income, good market Annual income, bad market
Variable annuity plus rider $14,090 $8,144
10-year deferred-income annuity $11,300 $11,300
Invest for 10 years, then buy an immediate annuity $21,012 $9,708
Notes: VA example assumes investing in a 60% stock/40% bond portfolio with a rider providing 5% minimum return on benefit base and 5% withdrawal rate; expenses of 3.67%. Immediate annuity assumes investing in a mutual fund portfolio with 0.75% expenses of 50% stocks/50% bonds for 10 years before buying annuity. Good market returns based on 1991 to 2000; bad market on 2001 to 2010. Sources: Morningstar, MONEY research, New York Life
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