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Retirement

If you understand the cons, annuities can have a lot of pros

Robert Powell
Special for USA TODAY

Q:What are the pros and cons of annuities for a couple in their 60s? Robert Crowell, Winter Park, Fla.

A: Annuities come in many flavors. There are single- and flexible-premium; immediate and deferred; qualified and non-qualified; and fixed-interest, indexed and variable.

So, it might be a bit hard to outline all the pros and cons of each type of annuity here. Suffice it to say that each type of annuity comes with advantages and disadvantages and that some, all or none of these different types might have a place in your portfolio depending on your personal circumstances. What's more, you shouldn't rule in or rule out the use of any of these annuities in your plan if that is what is in your — not the insurance salesman's — best interest.

"It's important not just to consider annuity purchases in isolation, but to fit them into an overall financial plan," says Joe Tomlinson, a certified financial planner in Greenville, Maine.

Enough soapboxing.

Let's take a look at the annuity that Tomlinson says might make the most sense for a couple in their 60s — the single premium immediate annuity or SPIA, and the pros and cons of that product.

But first a definition. The SPIA is a contract with an insurer whereby the purchaser, after giving the insurer money, will receive a certain amount of income, depending on the type, for a certain period of time or for life.

The biggest advantage: "The income annuity provides an excellent way to cover basic living expenses above those covered by Social Security and pensions," says Tomlinson. "Couples can gain a lot of peace of mind knowing they have income that will pay for basic expenses no matter how long they live. Plus, it beats withdrawing funds from savings and panicking every time the stock market hiccups."

The big downside to SPIAs is that your lose control of your money. You can't access your funds. And while that's true, Tomlinson recommends that you avoid this negative by using only a portion of your savings to buy an annuity and keep other funds for liquidity and flexibility.

Other disadvantages:

• Your heirs lose out. Yes, it's true that if you and your wife die early, your heirs won't receive any money. But you likely purchased a SPIA for other reasons. "It's important to remember that the basic living expenses the annuity is paying for will also end at death," says Tomlinson. "And owning an annuity protects against the risk of living longer than expected, depleting savings and being a burden on heirs."

And if you want your cake and eat it too, consider that there are annuities that, for a lower payout rate, provide payments to heirs in the event of early death, says Tomlinson.

• Now's not a good time to purchase an SPIA. Many naysayers say that interest rates are low and higher payout rates will be available when interest rates go up. True enough, but to accommodate this risk, Tomlinson says, it may make sense to make three or four separate purchases of SPIAs over the next 10 years or so.

• The insurance company may go bankrupt. That's a legitimate concern, but there are state guaranty associations that help keep the promises of the insurance industry, though there are limits. "The history has been that losses to purchasers of annuities have been practically nonexistent," says Tomlinson. "Owners of annuities came through the financial crisis just fine, without losses or delays in payments."

• You lose the chance, with an annuity, to earn higher returns in the stock market. Again, this might seem true at first blush. But the research shows, according to Tomlinson, that having basic living expenses paid for with annuity income provides the opportunity to invest remaining funds more aggressively.

• The insurance companies make huge profits, and that means you get a bad deal. Not so, says Tomlinson. "If you compare the income annuities generate to what one can generate with other low-volatility investments such as bonds, annuities do very well in such comparisons — plus they generate an income that can't be outlived," he says.

So, how might SPIAs work in reality for you now?

Based on a $100,000 up-front premium and rates from Vanguard, a 65-year-old couple could receive $321.09 per month that would increase with inflation each year (similar to Social Security) and last until the last member of the couple dies, says Tomlinson. That's an annualized payout rate of 3.85%.

To be sure, Tomlinson says the 3.85% may seem unattractive to folks who are familiar with the 4% rule. "However based on current low interest rates and prospects for lower-than-historical returns on stocks, the 'safe' 4% is more like a safe 2.5% to 3% these days," says Tomlinson.

Some good resources: Annuities for Dummies by Kerry Pechter and Variable Annuities—An Introduction, published by the Securities and Exchange Commission.

Robert Powell is editor of Retirement Weekly, contributes regularly to MarketWatch, The Wall Street Journal, USA TODAY, and teaches at Boston University. Got questions about money? Email rpowell@allthingsretirement.com.

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