Registered Investment Advisor specializing in Model Portfolios

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SSep 13, 2012

To a hammer, everything is a nail.

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Q. I am 61 years old and anticipate retiring in August of 2013. I have been abused by the stock market for the last 10 years, having lost all of my gains twice in that period. Two years ago I moved my retirement investments to fixed index annuities. I am comfortable with the security of the annuity but I am not certain that what I am purchasing through my adviser is the best I can do. My adviser recommends a 25-year plan with a separate annuity for each 5-year increment. I have funded the first 15 years and I am now waiting to see results before I commit to the last 10 years.

One of the things I did not understand about the annuity was the guaranteed interest. I thought this was an annual guarantee not a guarantee over the life of the plan. I know my adviser is making commission on these sales and I am concerned that his recommendations are not always in my best interest. I thought I would try to find an annuity myself on line but there are so many and it is difficult to tell the good guys from the bad guys. Even the terminology seems to vary. I know you are not a big fan of annuities but is there a place you would recommend to search for annuities?  —J.L., Akron, OH

A. You've probably heard the old saying, "To a hammer, everything is a nail." Well, if annuity products are the only tools in your adviser's toolbox, chances are he's going to solve every retirement question with— you guessed it! — An annuity product.

As a practical matter, you have been paying for a substantial life annuity since you started working— the inflation-adjusted life annuity of your future Social Security benefits. For the vast majority of people (the 90 plus percent of all workers who earn less than the Social Security wage base maximum, $110,100 for 2012) the next two steps for building retirement security are (1) the elimination of all debt, including home or condo mortgage debt and (2) building a nest egg of financial assets that is flexible, diversified and liquid.

Adding annuity products to the list is something you consider when your income is near $100,000 or more, when you don't have an employer pension, and when you have the other pillars of security well in hand. At that point you might start thinking about a ladder of life annuities. Conventional life annuities will bring you a relatively high cash income but like Social Security, they die when you do.

Fixed index annuity contracts avoid the immediate loss of estate value in life annuities by reducing the lifetime payout and making future value uncertain. Guaranteed withdrawal rates are now about 5 percent for people between 65 and 74. They appear to offer the possibility of having some value when you die.

If you visit the website immediate annuities.com you will find that a 65 year old male can expect a life income payout of 6.95 percent on a $100,000 life annuity or $579 a month. At age 74 the same $100,000 would bring a payout rate of 8.9 percent or $742 a month. The increase as you age is one of the reasons many advisors suggest buying life annuities over a period of years. Note that regardless of age, the simple life annuity pays out more than the complicated, full of strings and penalties, fixed index annuity.

Warren Buffett has repeatedly said that he won't invest in any business he doesn't understand. It's a simple rule. It has served him very well. That's why the annuity product that you'll read the most about in this column is a simple life annuity. It increases your spendable income in early retirement while guaranteeing that you'll have a monthly check for the rest of your life.

Fixed index annuities, on the other hand, are extremely complicated, difficult to compare, and contain a speculative element— uncertainty about future returns in the stock market. Equally important, while you can research mutual funds and exchange traded funds easily by visiting the Morningstar website and a variety of other sources, there is no comparable data source for fixed index annuities.

Filed Under: Retirement