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.

retired couple paperwork
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retired couple paperwork

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 percent to 3 percent 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.

Next: What to do after you've bought one...