Retirement Planning: Understanding Lifetime Annuities And Reverse Mortgages

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Karen and Dennis Defnet at their home in Winneconne, Wis. The Defnet's, who are in their 60s, have three annuities that pay them several thousand dollars a month combined. (AP)
Karen and Dennis Defnet at their home in Winneconne, Wis. The Defnet's, who are in their 60s, have three annuities that pay them several thousand dollars a month combined. (AP)

Our recent conversation about baby boomer retirement with Alicia Munnell, director of Boston College’s Center for Retirement Research, prompted a lot of questions.

She recommended lifetime annuities and reverse mortgages as two ways to help plan for retirement. But some listeners correctly pointed out that there are risks involved with both.

Mary Beth Franklin, senior editor at Kiplinger‘s Personal Finance, joined us to sort out the risks and benefits.

The Pros And Cons Of Annuities and Reverse Mortgages

Franklin recommended an immediate fixed annuity for those who are currently retired -– to guarantee some additional income.

The investor gives a chunk of his money to an insurance company. In turn, that company promises to send him a check every month for the rest of his life or for a specific length of time.

“But of course there are trade offs,” Franklin said. “If you get hit by a bus tomorrow, they get to keep the money. A very conservative rule of thumb of how to make your money last over retirement that could last 30 years is that you try to restrict your withdrawals from your savings to 4 percent a year.”

Here & Now Listener David Rosin wrote to ask “what about not buying an annuity at all?”

"Now may not be the best time to lock up a chunk of your money because interest rates are so low. But if you were in work that's not covered by Social Security, if you don't have a traditional pension, if you rely strictly on your savings, it might be appropriate to buy an immediate annuity," Franklin said. "But I would never use all your money at once. I would only restrict it to a third or half of your nest egg."

A term-specific annuity that spells out how long you'll receive your payouts is similar to an immediate fixed annuity, but you end up paying for the privilege.


“Each time you add one of those caveats, you get a lesser amount of money,” Franklin said.

A deferred variable annuity is less risky, according to Franklin.

“Your balance will be worth what the underlying investments are worth, or you could be guaranteed a 5 percent increase per year,” she said.

No matter what happens to the stock market, the investor is guaranteed an increase in income.

The downside: “The fees are much higher than a straight payout annuity and they can be very complicated products,” Franklin said.

In a deferred variable annuity, there is usually a period in which you can't withdraw your money. The "surrender period" is generally two to seven years, and you may face fees or penalties if you take your money out of the annuity during that time.

Franklin recommends asking the question: “Do you have a product that has a shorter surrender period or one that has no surrender period at all?”

Longevity Insurance

Franklin calls longevity insurance the roulette wheel of the insurance industry. If the investor buys a policy for $200,000 at age 65, he could receive a payoff of $50,000 a year at age 80. But if he dies before then, he gets nothing.

“While that may sound like quite a gamble, it’s a huge payoff,” she said.

Reverse Mortgage

Franklin said she thinks most adult children would rather see their parents or their grandparents comfortably retired in their home than inherit the family home.

That’s the intent of a reverse mortgage.

“Rather than you paying the bank each month, the bank pays you each month. It’s a way of creating retirement income,” she said.

The investor can borrow up to the national value limit of $625,000 against their home, according to Franklin. The loan can be withdrawn as a monthly stream of income, a lump sum, or as a line of credit that’s tapped as needed.

“When you move or die, the loan has to be paid off,” she said.

Usually the home is sold. “The one great consumer protection is that you can never owe more than the house is worth,” said Franklin.

Franklin also mentioned the Department of Housing and Urban Development recently introduced a new reverse mortgage that allows people to borrow a smaller amount.

“Like any other financial instrument, it’s complicated,” Franklin said. “Never agree to anything you don’t understand. Nothing is free.”

Story written by Meena Ganesan

This segment aired on February 8, 2011.


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