From the January 2007 issue of Boomer Market Advisor • Subscribe!

January 1, 2007

Variable annuities: Retirement account insurance

Most Americans can no longer rely on pension plans or Social Security to provide guaranteed income for life. Instead, more baby boomers must rely on IRAs, 401(k) plans and other retirement assets to last a lifetime. They will need to develop a plan not only to protect their retirement assets against market inflation and longevity risks but also provide a potential legacy for heirs. This is where annuities have advantages over other product types.

Comprehensive investment choices -- The variable annuity offers an easy way to invest with different asset management firms and to diversify among a wide range of portfolios without the need to set up separate IRAs. But the main appeal is the insurance company's guarantees, which allow investors to invest confidently in equities because the guarantee provides an important safety net in volatile markets.

Guaranteed withdrawal benefits -- Some insurers offer guaranteed minimum withdrawal benefits that provide protection against downside market risks. A typical GMWB guarantees at least 100 percent of the IRA assets in the form of regular withdrawals paid over a specified period, regardless of market performance. More recently, many GMWBs offer a "For Life" component to the rider. A typical GMWB "For Life" rider, for instance, will guarantee a 5 percent withdrawal rate for life beginning at age 65. The withdrawal rate is guaranteed regardless of market performance and regardless of how long the investor lives. Best of all, the annuity does not have to be annuitized to trigger this type of guarantee.

Additionally, some annuities offer a bonus up to an additional 50 percent if no withdrawals are taken during the initial years. Another benefit is an optional step-up feature, allowing the guarantee to be reset at the new higher account value should the IRA perform well. This helps the investor protect against market risks and the longevity risks of outliving his retirement assets.

Guaranteed death benefits -- A common annuity guarantee provides a death benefit to the IRA beneficiaries in an amount at least equal to the amount originally contributed to the IRA, even if the market value of the IRA was considerably less at the time of the IRA owner's death. An optional step-up feature generally locks in potential market gains on each contract anniversary and passes the highest of these gains to beneficiaries prior to annuitization. These guaranteed minimum death benefits particularly are attractive to IRA investors who intend to leave substantial assets to heirs.

Sophisticated distribution and estate planning strategies -- Annuities used to fund IRAs also can offer wealth transfer strategies that maximize the amount transferred to IRA beneficiaries. A "stretch" strategy leverages certain Internal Revenue Code provisions whereby the beneficiary can take a distribution in installments, paid over his life expectancy, with the undistributed amount growing in a tax-deferred manner. Combined with guaranteed withdrawal and death benefits, this strategy could result in the beneficiary receiving significantly more assets.

Annuities are not appropriate for everyone or for all IRAs. They should not be used in IRAs solely for their tax-deferral benefits, as such benefits are already available in IRAs. Annuities should be considered in IRAs only for those investors who find the guarantees and annuity benefits, other than tax-deferral, important to them. Furthermore, annuities are long-term investments. So for those IRA investors intending to liquidate their IRAs in a relatively short period of time, the annuity will probably not be appropriate. Lastly, the cost of the guarantees and applicable surrender charges always must be considered.

The benefits of IRA annuities will become more attractive as baby boomers begin to retire in the coming years. Americans who insure their houses, cars and lives are now realizing that it makes sense to insure one of their most valuable assets -- their retirement accounts.

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