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Your Financial Future

A Little More Respect for Annuities

With interest rates so low, it may not be the time to buy. But do your research

There was a time when I second-guessed my decision on what to do with a two-year lump sum I received on taking a buyout from the Washington Post. I put most of it into an income annuity. It was a conservative decision for someone who is fortunate to also have a monthly pension and can look forward to a decent Social Security income as well.

But the massive downturn in the stock market in 2008 and the first three months of 2009 wiped away any concern I had. It’s mighty nice to count on decent month-in, month-out income. When I got an unexpected bill from the IRS, I was able to just pay it, rather than having to sell soured investments at a loss.

Long a stepchild in the retirement income world, income annuities are getting increased respect in high places these days. President Obama’s Middle Class Task Force called earlier this year for wider availability of annuities and other forms of guaranteed lifetime income. Annuities reduce the risk “that retirees will outlive their savings or that their retirees’ living standards will be eroded by investment losses or inflation,” the task force observed.

The U.S. Treasury and Labor departments have since received close to 800 musings from the public as well as financial institutions, workplace consultants and other experts on whether employers should be required to offer income annuities as an option in their 401(k) retirement savings plans.

Interest rates and annuities

It looks like there’s more market volatility ahead, and safe investments such as savings accounts and money market funds are paying next to nothing. So would now be a good time for you to buy an income annuity?

The short answer is: No, this is probably not the time.

The reason is that the payouts of income annuities go up and down based on where interest rates stand at the time you buy yours. Interest rates are at rock bottom now, so an income annuity will pay better if you put off buying one until rates are higher, as they probably will be in the not-so-distant future.

Even though you might want to wait, you should at least start thinking about this kind of instrument. An income annuity can be an important part of a retirement portfolio, a guarantee of a lifetime of payments to protect against outliving your assets or having to sell assets at a loss in a depressed market.

In the retirement biz, an annuity is spoken of as a way to hedge against “longevity risk”—or what I like to call having more life at the end of your money than money at the end of your life.

At its simplest, an income annuity is similar to a traditional pension—except you’re the one who puts the money in, not your boss. But there’s an important difference in how the benefit is calculated.

When employers fund pensions, they can count on a portion of would-be beneficiaries dying young. As a result, money contributed on their behalf would be available to fund benefits for others. That variety in the random risk pool helped lower the cost of providing benefits.

Joining the risk pool

Alas, the risk pool for commercial annuities is less random. Would-be buyers are typically people like me, who are aware they have a family history of longevity and want to lock in an income stream for many years to come. As a result, there’s less benefit for the buck.

Still, being part of a risk pool is better than trying to manage the risk yourself, said Frank Todisco, the American Academy of Actuaries’ senior pension fellow, when he responded to the request for comment from Treasury and Labor.

“An individual on his or her own typically would require about 50 percent or more additional funds to achieve the same level of financial security during retirement” that a traditional pension would provide, he said.

The actuaries expressed support for requiring employers to add income annuities to the choices offered in 401(k) and other savings plans.

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