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AARP Article

FIA: Dream Investment or Potential Nightmare?

Fixed-index annuities are popular — but carry risks

I’m getting mail about an apparent dream investment. It promises gains if stocks go up, zero loss if they fall and guaranteed lifetime income, too. What’s not to like? Plenty, as it turns out.

The investment is called a fixed-index annuity, or FIA, and it’s issued by an insurance company. Sales are booming — $60.9 billion in 2016. FIA contracts vary, but this is how they work.

You buy the annuity with a lump sum, which goes into the insurer’s general fund. You are credited with a tax-deferred return that’s linked to the market — for example, to Standard & Poor’s index of 500 stocks. If the S&P rises over 12 months, you receive some of the gain. For example, your credits might be capped at an increase of 5 percent, even if the market soars. If stocks go down, you take no loss — instead, your FIA receives zero credit for the year.

Each year’s gains or zeros yield your total investment return. But I see problems:

Low returns. Salespeople might claim that FIAs could earn 6 or 7 percent a year. But with fees, they’ll struggle to match the low returns from bonds, says Michael Kitces of the wealth management firm Pinnacle Advisory Group in Columbia, Md.

High fees. You can’t find out what you’re paying for investment management. Costs are buried in the black-box system used to adjust the credits to your account. Sales commissions run 5 to 7 percent and may be hidden, too. Under the new fiduciary rule, which requires advisers to put your interests ahead of theirs, commissions have to be disclosed if you’re buying the annuity for a retirement account, but not for other accounts. Salespeople sometimes claim, falsely, that their services are free.

Profit limits. Every year, the insurer can raise or lower the amount of future gain credited to your account. You face high risk that returns will be adjusted down.

Poor liquidity. You can usually withdraw 10 percent in cash, each year, without breaking your guarantee. But you’ll owe surrender charges if you need your money back before five or 10 years are up. You might also forfeit some gains.

Lifetime benefits. For about 1.5 percent a year, you can add a “guaranteed lifetime withdrawal benefit” to your FIA. Promised yearly payments run about 5 percent. But, Kitces asks, why do it? Your basic FIA already provides a lifetime income. What’s more, 5 percent is not a return on your investment. The insurer is merely paying you your own money back, in 5 percent increments — and charging you 1.5 percent for the “service.” If you live long enough, you’ll exhaust your money and the insurer will pay, but that doesn’t happen often.

For a guaranteed income, try a plain-vanilla immediate or deferred annuity. It’s cheaper, and you’re not apt to be led astray.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

How to Financially Protect Your Spouse

When faced with decisions about pension benefits, shortsighted choices now can cause harm in the future

I had lunch recently with a friend whose husband, a teacher, retired five years ago. “We made a big mistake with his company pension,” she told me. “We took the wrong one.”

Pensions come in two versions — a larger check that covers only the lifetime of the person who earned it, and a smaller check that also covers the lifetime of his or her spouse. They chose the larger check to give themselves more money to spend. Now, they both wish they’d taken the version that covered her, too. The prospect of losing his pension income if he dies first has left her a little scared.

Unfortunately, that’s a common story — and not only for pension decisions. Caring partners each want the other to be financially protected, if left alone. But sometimes they make shortsighted choices or accidentally cut a spouse out of money that he or she needs by failing to submit the right paperwork. Here are four things couples should think about that can save a spouse from financial harm:

Leave a larger income

When will you start taking Social Security? A relative of mine, who retired (with pension) at 60 and now has a different and well-paying job, intended to take his Social Security at 62. When I heard that, I yelped. His wife has savings and a pension of her own, and they don’t need extra money now. If he waits until 66 to collect, his Social Security check will be 33 percent larger (plus inflation adjustments) than if he starts at 62. It will be a fat 76 percent higher if he waits until 70.

Money Matters

It’s common to say, “I’ll take Social Security at 62 so that, if I die early, I won’t have lost income that I should have had.” That could be a two-way mistake. First, if you’re healthy, you’ll probably live longer than you expect. By waiting to file for Social Security, you’re storing up extra income for your retirement’s later years. Second, married people shouldn’t think only of their incomes today. If the husband, say, was the main breadwinner, the longer he waits before collecting, the larger the income he’ll leave to his surviving spouse, if he dies first.

Check your individual retirement account beneficiary

Whoever you name on your IRA’s beneficiary form will get the money, whether it’s fair or not. Say that you divorced and remarried, named your new spouse as your heir in your will, but forgot to take your ex’s name off the IRA form. Your ex will get the money, even if the divorce decree said otherwise. You should clean up all your beneficiary forms when you divorce or marry, to avoid accidentally disinheriting a spouse.

Have the power of “I do”

Who will inherit the savings in your 401(k) or similar plans? Here, spouses have super-protection. When you marry, your spouse is entitled to every penny in your 401(k), from the moment you both say “I do.” That’s federal law. The beneficiary form is irrelevant, and so is your will. If you want a different outcome — for example, to leave part or all of your 401(k) to children of a previous marriage — you can ask your spouse to waive his or her rights. The waiver has to be in writing, notarized or witnessed by a plan representative, and filed with your plan.

This can’t be done in advance of the wedding — only a spouse can waive these rights. If you have a prenuptial agreement, it should include a promise to sign. And get thee to a notary right after the honeymoon or even before. In my personal case, there was a notary at the ceremony. My lovely husband signed even before the music struck up.

Guarantee lifetime benefits from a variable annuity

These annuities combine an investment with a guaranteed lifetime income. But the income normally lasts only for the buyer’s lifetime and ends if he or she dies. Any spousal benefits might cover only the annuity’s current investment value or a death payout, says annuity expert Kevin Loffredi, a vice president of investment research firm Morningstar. If you want the annuity to cover both lives, you generally have to pay more or accept a lower income guarantee. Couples often don’t realize that their annuity cuts out the survivor, says Mark Cortazzo of annuityreview.com, which evaluates variable annuities. Some salespeople also have no idea. If you venture into one of these complex contracts, think “spouse first.”

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Is an Annuity Right for You?

The challenge: Making your money last for life

Here’s the single most important question for people who are planning for — or already into — their retirement years: How are you going to make your money last for life? With good health and good cheer, you’re likely to be among the half of your age group that dances past your official life-expectancy age.

Social Security lasts for life, and so does an employer pension. If you don’t have a pension, annuities can serve as a pension substitute. Increasingly, financial planners are paying attention to this option as a way of ensuring that their clients don’t run out of money.

Annuities are sold by insurance companies. Some come with bells and whistles that aren’t worth their price. The safest policies are “immediate pay” annuities, in which you put up a sum of money and your insurer starts paying you a certain percentage of that for life. The payments can also cover the lifetimes of you and a beneficiary, such as your partner or spouse.

Choosing the right type of annuity

These pension substitutes come in three main varieties. An “immediate fixed” annuity provides a fixed number of dollars per month. An “immediate variable” annuity, invested in a mix of stock and bond mutual funds, pays you a fixed percentage of the portfolio’s value, which will rise and fall. An “inflation-linked” annuity adjusts your payments for inflation every year (you can also pick a fixed annual adjustment, such as 2 or 3 percent).

You generally get the largest initial payout from the immediate fixed annuity. The others might start smaller but can increase your payouts over time.

What has always bothered people about annuities is what I call the sucker factor. If you put $100,000 into the plan today and die next year, you’ll think (from the grave) that you were a sucker because the insurance company retained the money you didn’t receive.

Escaping the sucker factor

But it’s this very sucker factor that makes annuities so attractive. Because some people will die early, the insurer can afford to pay you more per month than you could prudently draw out of personal investments.

For example, take a 65-year-old woman who has $100,000 in savings. If she puts half of it into stock mutual funds and half into bond funds, and withdraws the traditional 4 percent in the first year, she’ll get $333 a month. If she raises that amount by inflation each year, the money could last for 30 years (but with no guarantee).

If she puts $100,000 into a Principal Life Insurance Co. inflation-adjusted annuity, she’ll start higher — with $379 a month (at this writing), plus guaranteed lifetime inflation protection. The fixed-payment annuity gives her $531. If she dies after just a few years, “So what?” says Miami financial planner Harold Evensky. “The annuity served its purpose. It paid her more than she could take from systematic withdrawals from savings and insured her in case she lived too long.”

Weighing benefits and risks

If you can manage payments that change, consider an immediate variable annuity, says annuities expert Moshe Milevsky of York University in Toronto. You choose the percentage of the total portfolio that you’ll want paid out, in monthly amounts. Starting with a lower percentage sets you up for higher payments in the future, as long-term stock values grow. “The potential upside seems to compensate for the downside risk,” he says.

Milwaukee financial planner Paula Hogan encourages clients to consider inflation-protected annuities, to preserve their lifetime purchasing power. But don’t annuitize all your money, she warns. You need ready cash for unexpected expenses, such as health costs. If you’re living on Social Security plus modest savings, annuities may not be for you. They’re best suited to people who use them as the safe part of their investment mix, with the rest of their money invested for long-term growth.

Financial planner Michael Kitces of Columbia, Md., has a smart idea for people who’d rather keep their cash and take systematic 4 percent withdrawals adjusted for inflation. Split your savings evenly between stock funds and bond funds, and take the withdrawals mostly from bonds for the first 10 years. The value of your equities should more than beat your gains from inflation-adjusted annuities, his research shows. Of course, there’s no guarantee. If you live well into your 90s, Kitces says, the annuities will win.

(Originally published in The AARP Monthly Bulletin.)