Today, the boomer generation worries about amassing enough money for retirement. Tomorrow will bring another worry: how to make a limited pool of savings last for life.
That's where annuities come in--the type known as "immediate pay." These annuities guarantee you a permanent income, no matter how long you live.
They have some drawbacks. But insurers are starting to rethink immediate-pay annuities to make them more salable--especially annuities linked to the performance of stocks.
But first, some background:
You buy an immediate-pay annuity with a lump sum of money. The funds might come from regular savings, stock market gains, a retirement plan, even the cash in a life insurance policy.
The insurer will turn that money into a lifetime income. The income could also cover the joint lifetimes of you and your spouse. Neither of you would ever run out of cash, no matter how long you lived.
With immediate-pay annuities, you and other buyers pool your longevity risk. If you die early, the money you didn't use goes into the pool, to pay benefits to those who outlive their expected life span. You don't know in advance which group you'll be in.
Most people hate the thought that they might die soon after purchasing the annuity. So they make a trade-off. They take a lower monthly payment in return for a death benefit. Sometimes, the annuity comes with a death benefit built in.
This benefit guarantees that monthly payments will be made for at least 10 or 15 years--to you, while you live, or to a beneficiary if you die early. The beneficiary might also take the money in a lump sum.
You can annuitize your savings in one of two ways:
Take fixed payments. You get a guaranteed sum each month, but inflation will lower its purchasing power.
Take variable payments. Your annuity is invested in mutual funds, and your future income depends on how well they do.
Variable payments give you a shot at a rising income. But you run the risk that, in some years, your income might decline.
There are two things the public dislikes about buying immediate-pay annuities, besides the risk of dying too soon:
The decision to annuitize is usually irrevocable. You can't change your mind and get your remaining money back.
With variable payments, your income could drop a lot, if the stock market does.
To solve the first of these problems, a few insurers offer you a chance to retrieve any funds that haven't yet been used. One such: Golden Rule Insurance, in Lawrenceville, Ill., which has added a cash-out option to its fixed-payment annuities.
But there's no guarantee. You can cash out only if you're healthy at the time.
Minnesota Life in St. Paul and T. Rowe Price in Baltimore both sell variable immediate-pay annuities. Both offer cash-outs, for any reason, and both give you income guarantees.
At Minnesota Life, you can make withdrawals, for a period equal to your life expectancy. Your payments will never fall below 85 percent of the initial amount, no matter how poorly the stock market does. It's one of the few annuities with an upfront sales commission (4.5 percent). Insurance and money management costs 1.25 percent a year.
At Price, you can make withdrawals during the first five years, although there's a penalty attached. Your payments will never fall below 80 percent of your initial amount. Cost: 1.4 percent a year, plus management fees for whichever mutual funds you choose.
On average, the industry charges 1.2 percent for variable-pay annuities that generally lack cash-out provisions or income guarantees, according to the VARDS Report, an industry publication based in Marietta, Ga.
To show you how variable-pay can work when invested in stocks, I asked Price to examine two time periods.
First, 1968-1998--an era that started with a bad bear market. For most of the first 12 years, payments were smaller than the starting amount. Then they rose spectacularly.
Second, 1998-1968--the same period, run backward. Monthly payments jumped for most of the first 24 years, then slid. At the end, however, they were still almost four times as high as they were at the start.
Conclusion: If you want an income guaranteed for life, a variable-pay annuity makes sense, provided that you can manage during years when the annuity payout drops.
But buy it as soon as you retire, says Moshe Arye Milvesky, an assistant professor of finance at York University in Toronto. You need to allow enough time for a stock market strategy to work out.