A Bird in the Hand

Even the best prepared seniors enter retirement facing a dilemma: Is it possible to live on savings and investments, and have enough left over to pass on to the next generation?

That’s the question Barbara B. Pendleton confronted four years ago, when she retired at age 57 from her career as a public health microbiologist at Tulare Labs in Tulare, California. Pendleton opted for early retirement to relocate with her terminally ill husband, James, from the West Coast to suburban Atlanta. Shortly after the move, James died in hospice care. Pendleton then began working with a financial adviser, in part, to make certain she could live her retirement dreams while still saving enough to pass on to her grandchildren. Her adviser’s answer: annuities, insurance products that, for a lump sum, offer a guaranteed stream of payments during retirement.

One of the annuities Pendleton holds with MetLife pays out $600 each month for the rest of her life. According to her contract, if she dies prematurely, those payments will go to her heirs for 20 years after the contract’s initiation. For now, the annuity payments are a nice supplement to Pendleton’s Social Security and pension income. All the while, the nest egg she saved while working remains invested and untouched. “I was looking for security,” says Pendleton. “I’m using the annuity to get fluid income for everyday living. It allows me to live comfortably.”

There are two types of annuities–fixed and variable. With a fixed annuity, the insurance company promises under contract that you will earn a minimum amount of interest (at a “fixed” r

ate) on your lump-sum payment or series of payments. Pendleton, for example, gave her insurer, MetLife, $100,000 in exchange for her $600 per month checks. Insurance firms typically guarantee these periodic payments for a defined length of time such as 20 years, your entire life, or the lifetime of you and your spouse. Pendleton’s fixed annuity will pay for the rest of her life–and to her family members.

A variable annuity is a bit more complicated. With these vehicles you can invest in a basket of mutual funds or other investments. The rate of return on your initial payment depends on the performance of your holdings. The variable annuity also lets you receive periodic payments. The value of the annuity while it’s invested and growing is not subject to income tax. Investors pay fees and expenses, of course, imposed by the underlying mutual funds, and there are other administrative fees as well. As it happens, Pendleton holds both variable and fixed annuities. They come with a 5% “guaranteed minimum income benefit” that pays her regardless of market performance.

Annuities–both variable and fixed–are growing in popularity as a retirement tool to augment investment portfolios. In past decades, companies offered workers a defined-benefit pension plan, issuing retired employees a monthly check during their post-employment years. Those plans are all but extinct today. For some, annuities have taken their place. Between 1999 and 2008, U.S. annuity sales have grown more than 60%. Recent stock market volatility–and interest rates that make annuities preferable to, say, CDs–are also driving some investors

into annuities. In the final three months of last year, for instance, fixed annuity sales soared 79%. “When the markets are trending down, people are moving out of equities and looking to earn interest in fixed vehicles–into something that’s making money,” says Dan Beatrice, an analyst at LIMRA, a financial services research firm.

Under the right circumstances, annuities can be very beneficial. “They serve as a place for people over 60 who’ve completed putting the maximum in their 401(k) plan,” says Kathy Williams, president and CEO of financial advisory firm Williams Financial Services Group. “For those who have extra money that’s taxable, it’s a nice alternative to a CD.”
These days, investors need to conduct careful research into annuity providers. In early April, the U.S. Treasury Department extended bailout relief to a handful of struggling large insurers. Hartford Financial Services Group, Lincoln National, and Prudential Financial have all applied for the government’s Troubled Asset Relief Program (TARP) funds. Falling financial markets have put many insurers under pressure because they guaranteed minimum returns on variable annuities and are now obligated to make large future payouts–even though they’ve lost substantial amounts on investments in equities, bonds, and real estate.

In a recent survey, more than 70% of financial advisers expressed concern about the risks insurers have taken with guaranteed-minimum variable annuities. Where’s the best place to start your research? Check the insurer’s current “claims paying rating,”(the best indication of its ability to pay back debts) with a credit rating agency such as Moody’s, Standard & Poors, or Fitch.

For Pendleton, annuities still offer her peace of mind. She recently purchased a condominium in Stone Mountain, Georgia, not far from her daughter’s family. She has plans to travel in the coming years, and most important, anticipates a chunk of her savings going toward the college education of her four grandchildren. “It’s nice to know the majority of my savings are sitting there, growing, to be passed on to my family,” she says. “That’s a real security blanket.”

This story originally appeared in the June 2009 issue of Black Enterprise magazine.