Use Annuities to Protect Your Retirement?

Searching for a way to protect their already-hammered retirement portfolios, conservative investors are inquiring about annuities in increasing numbers these days, says Kasey Gahler, CFP and owner of Gahler Financial in Austin, Texas. And with insurance companies and financial advisers offering annuities that can offer a guaranteed income for life, as well as various levels of protection from market fluctuations, it's easy to see why consumers are interested.But annuities are complex investment vehicles, and investors often are unaware of all the strings attached to various products. Below is a brief primer on the pros and cons of annuities.

Why invest in annuities?

Annuities have traditionally gotten a bad rap from the media and consumers, says Bradley Bofford, managing partner at Financial Principles in Fairfield, N.J. But over the years, the products have "evolved dramatically to become more competitive and provide truly valuable benefits," he says.

For instance, 20 years ago, annuities offered a guaranteed return of principal minus withdrawals,says Arthur Montgomery of Paramount Financial in St. Louis. Later, they began offering "high watermark resets," which would lock in a death benefit at the highest anniversary value of the contract. Later still, they offered annual step-ups of income and death benefits, along with a guaranteed income stream.

"Now most variable annuity companies offer some combination of all of these guarantees," Montgomery says. (A variable annuity enables the contract owner to invest premiums in a selection of investments, and their performance impacts the annuity's value.)

In addition to offering a variety of benefit options, today's annuities offer "consistency and peace of mind," Bofford says, by guaranteeing either no loss of principal or a set amount of income for life -- or both, for an additional fee.

Consumers who are invested in annuities may feel more committed to these products and, as a result, avoid making rash decisions about portfolio changes based on market fluctuations. "A client is more apt to stay invested when they know they have guaranteed living riders in place," Bofford says.

Living benefit riders generally guarantee a defined payout during the annuity owner's life.

Why not invest in annuities?

While annuities may offer guarantees unavailable with other investments, the guarantees come at a price. A living benefit rider, guaranteed income rider or other add-on guarantee always comes with a fee, and those fees can add up.

"The largest negative to annuities is the cost associated with the product compared to other investment alternatives," Gahler says. "Depending on the insurance company (selling the annuity), the fees can range from 1% to 3% more per year versus investing the assets in an IRA or brokerage account."

In addition, all the various riders and different rules that apply to each one can become confusing, not to mention the "avalanche of prospectuses and statements associated with annuities," Bofford says.

It's important to read the fine print, but the fine print is often difficult to understand. Andy Hempeck of California-based Creekside Partners says investors should be aware of the commissions being paid to the broker or agent when you purchase the annuity, the total annual expenses charged by the annuity, recurring commissions or "trailers" paid to the brokerage firm or agent, surrender charges that will be applied if you change your mind about the investment, and who will manage the investment mix after you purchase the annuity.

"All of this information is available in the prospectus if you know what you are looking for and really dig, but most investors are charmed by the salesperson and do not spend time with the footnotes," Hempeck says.

Because of the extra fees associated with annuities and various riders, the price of the product "can ride up over the course of 30 to 40 years," says Gotham Financial Services' Ori Pagovich. This means annuities may not be an efficient savings or investment vehicle for younger investors. "When comparing it to other investments over such a long period of time, the difference can be significant."

In addition, annuities are illiquid and less flexible than other investments. Ted Snow, CFP, owner of Snow Financial Group in Addison, Texas, says many companies now have contracts that allow the investor to get out of a variable annuity without any surrender charges. However, sometimes the inability to surrender is psychological. "I have seen annuities that were sold with a step up in death benefit, and due to the market drop and the fees, the death benefits are so much higher than the actual value (of the annuity) that people don't feel they can take money out of these accounts," Montgomery says. "They wind up as a life insurance policy that they can only collect on when they die."

Advice for purchasing annuities

When looking at annuities, "be sure you are working with a financial professional who can offer all the major categories of annuities, including immediate, fixed, indexed and variable," says Ryan Pinney, brokerage director at Pinney Insurance Center in Roseville, Calif. "Many advisers are limited in the type of annuities they can offer. Choice and full disclosure of your options and risks are key."

Also pay attention to fees as well as an insurance carrier's ratings. An insurance policy is only as good as the company that backs it.

"Especially in this tough economic environment, you want to entrust your money to a carrier that has a strong balance sheet," Pagovich says. "And make sure fees are kept low. Add on riders that you will actually use; just because it sounds like a good idea doesn't always mean it is."