Friday, October 12, 2007

No Good Thing Lasts Forever - Except, Perhaps, Immediate Annuities

Most people will agree that nothing lasts forever, but a careful look at various investment options might yield an exception or two. Rising health-care costs, inflation, and consumer prices are just a few of the variables that cause people to struggle to make ends meet these days. Unusually low interest rates only exacerbate the problem, forcing countless retirees to tighten their belts. If this outlook matches what youre currently facing, dont abandon hope; an immediate annuity might be the solution for you.

Recently, we were asked for advice by an 86-year-old former executive assistant who well call Jacqueline. She came to one of our seminars at a local library. Afterward, Jackie approached us and started to talk about her situation. She never married and has no children. Shes been retired for about 20 years, and recently sold her home so she could move into a comfortable assisted-living residence. Jackies primary concern was to have enough income to supplement her Social Security and pension benefits so as to maintain the standard of living to which she had become accustomed factoring in inflation, rising housing costs, personal health-care costs, and taxes. Her will would donate the remainder of her estate to a few charities of her choice.

To meet these goals, Jackie needed more income than her principal would allow under traditional conservative investments. Like many of her contemporaries, she did not have the physical stamina to re-enter the work force. This meant that she could not afford risks associated with the stock market. What she wanted, in her own words, was a guaranteed, preferably tax-favored income stream for the rest of her life, an income that would remain perfectly stable despite fluctuations in the stock market. After a thorough investigation of many options and detailed conversations with Jackies accountant and attorney, we narrowed the possibilities to one investment vehicle: the single-premium immediate annuity.

An annuity is a tax-deferred investment vehicle that gives you a fixed or variable annual income. The amount of that income is based on the initial value of the principal and the type of annuity the owner chooses to invest in. There are many different types of annuities, all of which are designed to meet various needs. Annuities can be fixed, variable, immediate, deferred, medically underwritten, etc. As with any purchase, investors must weigh the benefits that an annuity may offer against the costs, management fees, liquidity, and the price of added benefits. The key to remember is that annuities come in different shapes, colors, and sizes. There are literally hundreds of different ways they can be purchased, but one way needs to be found. When looking to buy, you should always evaluate how the benefits match up with your own needs. It is for this reason that we always recommend that investors have a meeting with their accountant and attorney, along with the person who is selling the annuity, so that nothing gets lost in the translation. At this time, a detailed discussion of all the pluses and drawbacks can take place and an informed decision can be made taking into account factors the investor originally may not have thought about.

Although New York State is a highly regulated market that maintains a close eye on the types of products sold to investors, you should always be fully aware of the ins and outs of the product youre dealing with. Often, certain types of annuities pay a high commission to the people selling them. Because of this, and the complexities discussed earlier, it is not uncommon for the seller to place his or her interests above those of the (typically less savvy) investor. Contrary to popular belief, annuities are not only sold by insurance agents, but by brokers, CPAs, CFPs, tax preparers, local banks, and many other people and institutions as well. As always, its important to know who youre dealing with and dont be afraid to ask questions! Whether you live in NYC, the east coast, west coast, or some place in between, it is best to be prudent and always do the required due diligence. The type of annuity Jackie did her due diligence on was an immediate annuity.

With immediate annuities, the investor or investors (ownership can be single-life or joint-life) puts up an initial principal in exchange for a stream of payments. An insurance company is typically the seller of the annuity and will be the one that sends you the monthly, quarterly, semi-annual, or annual checks. Why would an insurance company be willing to take on this tremendous responsibility of lifetime payouts? Well, it is all based on life-expectancy statistics, which are derived from actuarial tables.

Immediate annuities have various payout options. Some of the more common are lifetime income-only, lifetime period-certain, lifetime income-with-cash (lump sum) refund, lifetime income-with-installment refund, and period-certain. Simply said, you have several choices about how you receive your money. Keep in mind, however, that different types of annuities are sold through different insurance companies, with various credit ratings. Because so many factors play into a decision about which type of annuity to purchase, it is essential to consult a financial professional before making your final decision.

The payout amount of an immediate annuity is determined strictly by age and gender, unless it is a medically underwritten policy, in which case the health status of the annuity owner also plays an important role. (The insurance company will often pay more when your life expectancy is altered because of poor health.) What made this investment appropriate for Jackie was largely the fact that she had no heirs, because when you set up an immediate annuity you forfeit all rights to ownership of your initial investment principal. If you have heirs who are dependent on an inheritance they assume theyll receive, a conversation about the consequences of going through with this kind of an investment should definitely occur. Still, the benefits associated with an immediate annuity are impressive; the insurance company will guarantee your income payments for the remainder of your life, even if you live to be 120.

Jackies Social Security, pensions, and bond income did not generate enough cash to meet her high monthly expenses, which meant that she had no choice but to dip into her principal every year. Had she stayed on that path, Jackies entire principal would have been depleted in about six years. We were tempted to recommended tax-free municipal bonds because of their liquidity, income security, and tax-free status. But current interest rates and Jackies high income needs would again have forced her to invade and ultimately deplete her principal within those same six years. Knowing that the national life-expectancy average of a woman Jackies age is currently around six years, and taking into consideration her superb health and strong genetic background, investing in municipal bonds created a risk we did not feel at all comfortable with.

In Jackies case, we chose a lifetime income-only annuity because the alternatives were too risky, and also because not being able to afford to live where she wants, with the people she cares about, was unacceptable to her. If, like Jackie, you are looking for consistency, guarantees, or just peace of mind that you wont run out of money during the final stage of your life, an immediate annuity could be the solution for you.

Don Conrad is president of Conrad Capital Management, an independent registered investment advisor, in Melville, New York. Can be reached by phone: (631) 439-7878 or email:

Don started his career in the late 1970s at a nationally recognized mutual fund company and was recruited after three years by E.F. Hutton Company to work in the consumer retail division. During his thirteen-year tenure there, he spent two years specializing in and trading the 30-year treasury bond. For the last five years, he served as a senior vice president focusing his efforts in the Consulting Services division, maintaining offices in both Long Island and Manhattan.

In 1993, he was recruited by PaineWebber as a Senior Vice President in the consumer retail division. In addition to managing his clients assets, he was asked by senior management to conduct a nationwide tour to train financial consultants in the Consulting Services division. Don also made a video on the use of advanced technology in the financial services industry. This video was distributed to PaineWebber offices internationally.

After almost five years at PaineWebber, Don decided to pursue his dream by starting Conrad Capital Management in order to offer his clients more choices and flexibility.