As baby boomers retire, fixed immediate annuities have emerged as one of the most attractive ways to reduce a client's longevity and investment risk.

Although sales were down a tad in the first quarter of 2010 compared with the prior year, fixed immediate annuity sales for 2009 more than doubled over 2008. Sixteen billion dollars worth was sold in 2009, according to LIMRA, Windsor, Conn.
A fixed immediate annuity is a contract with an insurance company. Policyholders invest a lump sum in return for insurance company-guaranteed income, generally monthly, for as long as they live.

If the policyholder dies, the insurance company keeps the balance of the proceeds-unless arrangements are made to pass proceeds to loved ones, typically in exchange for lower monthly payouts. With one of the most common contracts, called "10 year certain and life," periodic checks come to a client for life. If the annuitant dies within 10 years, checks continue to a designated beneficiary for the remaining term. Or, the beneficiary may receive a lump sum in cash. Another payout option enables the surviving spouse to continue receiving income for as long as he or she lives.

A 2009 report by Conning Research, Hartford, Conn., says increased sales of all types of fixed annuities are a harbinger of things to come.

"The severity of the current recession, which began in 2008, reignited customer concerns about their principal's safety, renewing interest in fixed and indexed annuities," the report says. Meanwhile, the baby boomer generation is shifting its focus from accumulating assets to spending them.

Demand has been so strong for fixed immediate annuities that New York Life plans to make its product available to fee-only advisors, says Chris Blunt, that company's executive vice president. New York Life sells a product with a trailing commission through its agent force, banks, wirehouses and independent broker-dealers.

Some $2 billion flowed into New York Life's fixed immediate annuity in 2009, making it the number one product on the market, according to LIMRA. By contrast, in 2005, only $11.5 million was invested in the product.

Blunt says insurance-guarantee payout rates that are as high as 8%, depending on a person's age, are attracting retirement investors. Lifetime income payments are higher than bonds, CDs and dividend-paying stocks for a couple of reasons. The monthly payments are comprised of a return of premium, and interest earned from insurance-company investments of premiums and mortality credits, also known as mortality yields, which factor in the policyholder's life expectancy. The older the policyholder, the higher the payout will be due to a shorter life expectancy.

With fixed immediate annuities, premiums paid by those who die early are expected to contribute to gains on the overall pool and provide a higher credit to survivors.

"Baby boomers are getting older and haven't saved enough,"  Blunt says. "The payout rates of 7% to 8% on immediate annuities are higher than CDs and mutual funds."

MetLife also reports stronger demand for fixed immediate annuities. Retirees put $560 million into MetLife's fixed immediate annuity in 2009, representing a 109% gain over 2008.

"We are seeing an inkling of more demand and interest in single-premium immediate annuities," says Dan Weinberger, a MetLife vice president. "Financial planners are interested in understanding how it fits into the big picture."

Weinberger says that depending on a client's financial situation, advisors should use a range of investments that may include a fixed immediate annuity, a variable annuity with a guaranteed lifetime withdrawal benefit or a deferred immediate fixed annuity that begins payout at a specified time in a policyholder's old age.

Older individuals often select the fixed immediate annuity with a 10- to 20-year period certain option because of the high payouts compared with selecting the payout option that continues the income payment for the surviving spouse's lifetime.
Independent research shows that adding the fixed immediate annuity to a portfolio of stocks, bonds and mutual funds decreases the probability that the retiree will run out of money. Separate studies, including a 2005 research report by Conning Research, as well as a 2006 study by Moshe Milevsky, finance professor at York University, Toronto, indicate that cash-flow planning should include immediate annuities. Plus, with a fixed immediate annuity, the overall portfolio's risk-adjusted rate of return is higher than that of a portfolio without an immediate annuity, both reported.

John Diehl, financial planner with Hartford Life, Wayne, Pa., recommends anchoring a client's retirement portfolio with guaranteed sources of income. He suggests an immediate annuity or a deferred variable annuity with a lifetime guaranteed withdrawal benefit. Then policyholders can tap other investments to help maintain current lifestyles and grow wealth to keep pace with inflation.

"Most people invest in stocks and bonds or mutual funds when they are saving for retirement," he said. "But they need to invest to have income for as long as they live."

Diehl says, for example, that someone who rolls over a 401(k) into an IRA needs to segment those assets as well as their other investments.

There should be a guaranteed source of income to cover basic expenses such as food, clothing, housing and medical needs.
"If you have $5,000 a month in basic expenses and get $4,000 from a pension or rollover IRA and Social Security, you have a $1,000 a month gap," he says.

To cover that gap, he suggests, for example, putting about $148,000 in an immediate annuity that will pay $1,000 monthly for a 65-year-old male. Or the client could put $192,000 in the annuity, so the surviving spouse could receive the $1,000 in monthly income for as long as he or she lives. 

Lifestyle expenses, such as travel, entertainment and maintaining a comfortable living situation, can be funded in taxable accounts by tax-free municipal bonds and dividend-paying stocks or stock funds. In the tax-advantaged rollover IRAs, retirees might invest in bonds or bond funds and stock funds that generate a lot of short-term capital gains, which otherwise would be taxed as ordinary income.

Kevin Seibert, a Lubbock, Texas-based financial planner and managing director of the International Foundation for Retirement Education, stresses that advisors need to assess when clients should take Social Security. Some retirees buy a fixed immediate annuity so they can defer taking their Social Security at age 62 and 65. Reason: Their Social Security payments are higher when taken at an older age.

Seibert recommends using Social Security and pensions for essential expenses, such as food, clothing and shelter. The immediate annuity and other lifetime income investments should be used to fill any expense gap. Discretionary expenses should be funded by income from taxable accounts, personal retirement accounts, employment income and other managed sources.
Seibert recommends combining a systematic investment withdrawal plan with an immediate income annuity in retirement. With a systematic withdrawal plan, the client withdraws a specific percentage or dollar amount from an account, say monthly.

By combining a systematic withdrawal plan with an immediate annuity, he says, a client can increase the allocation to stocks for growth because less money must be withdrawn from other accounts. A 3.5% systematic withdraw rate, for example, combined with an immediate income annuity would help a retiree's money last longer. Among the benefits of immediate annuities:
The policyholder only pays taxes on about 40% to 60% of the immediate annuity income, based on his or her age. The rest is considered a return of principal.
Newer contracts offer cost-of-living adjustments so that the income will rise with inflation. Beware that if a client selects any of these options, monthly payouts will be slightly lower than without the options. For example, Blunt, of New York Life, says his company offers three types of expanded inflation protection. With the "Annual Increase Option," the policyholder gets less income up front. But payments should increase annually by 1% to 5%, depending on the percentage chosen. The "Changing Needs" option offers policyholders a one-time opportunity to increase monthly payments or reduce them-perhaps to defer more income. Meanwhile, the "Enhanced Income Option" includes a one-time increase in payouts if an interest-rate benchmark is at least two percentage points higher on the policy's fifth anniversary. 

Some insurers allow persons with serious health problems to get special medically underwritten immediate annuities. Because the policyholder's life expectancy is shorter, he or she may qualify for higher payouts.
But there is no free lunch with fixed immediate annuities.

Once the insurance contract is signed, the policy can't be surrendered. However, most of today's fixed immediate annuities will let policyholders withdraw some of the cash. The tradeoff: lower monthly income.

Meanwhile, states nationwide have been making both annuities and sales of investment products to seniors the focus of increased regulation. Florida, for example, last year adopted a law that more than doubled penalties for specified willful unfair or deceptive life insurance and annuity sales practices. The law also requires an insurer or insurance agent to have an objectively reasonable basis for believing that an annuity recommendation to a senior consumer is suitable. Plus, it stiffens penalties for making misleading representations to induce a consumer to cash in funds from a current investment or insurance product to purchase another product.

Not all immediate annuities are alike. So advisors need to shop for the best payouts from the financially strongest issuers. The strongest companies are rated A+ and A++ by A.M. Best.

Randy Spiegelman, financial planner with Charles Schwab, San Francisco, stresses the importance of scrutinizing the annuity payout rate, which may be artificially high.  Financial advisors should seek the rate based on the individual's actuarial life expectancy-not the payout rate based on a client outliving his or her life expectancy.

For example, a male age 65, who invested $300,000 in a single-life immediate annuity would get $24,000 a year or $2,000 per month for as long as he lives. That could translate into an 8% payout rate for life-even if the policyholder lives to be 300 years old. However based on the true 18-year life expectancy of that 65-year-old man, the payout rate is only 4.16%.

Another drawback: Depending on where the client lives, he or she may pay a state premium tax on an annuity.

Financial advisors also need to consider Medicaid rules when dealing with older clients, who may some day go into a nursing home. A policyholder who has exhausted his or her funds due to a nursing home stay may have no choice but to apply for Medicaid-the public assistance program funded by states and the federal government.

A good-quality nursing home can cost $80,000 a year-not including drug and medical expenses. So it's possible that even an affluent individual could exhaust his or her resources.

To qualify for Medicaid, persons needing long-term care typically must "spend down" assets to $2,000. The "community spouse," who remains at home, generally is permitted to keep some $100,000 in resources.

State Medicaid laws are complex and always change. Bennett Kleinberg, senior actuary at MetLife, recommends that advisors consult with an elder-law attorney before placing clients' money into the annuity. Medicaid rules may require that the immediate annuity name the state as the "remainder beneficiary," so the state gets reimbursed for medical assistance, long-term care and community services. The primary beneficiary is typically the policyholder's spouse. Otherwise, an annuity would be a "countable asset," hindering a policyholder's ability to reach the asset thresholds needed to qualify for Medicaid.

The remainder beneficiary is the beneficiary who will become a current beneficiary after a specific event, such as the death of another beneficiary.

Some actuaries say that younger retirees may be better off in a variable immediate annuity, which invests in different types of mutual funds.

Jeffrey Dellinger, actuary and author of "Variable Income Annuities," says fixed immediate annuity income payments don't keep pace with inflation.

A better option, he says, is to invest in a variable immediate annuity. Over a lifetime, with the proper asset-allocation mix of stocks, bonds and other asset classes,  income payments should more than keep pace with inflation. In addition, most variable immediate annuities have a guaranteed payout floor to protect against poor financial performance.

There is more potential for return with a variable immediate annuity," he says. "The payouts are better in the long run."