Annuities confusion a long-running sage

Orlando Sentinel

Humberto Cruz

Will these e-mails ever stop?

"I just lost a friend of 20 years when I tried to tell her the truth about her variable annuity," a reader wrote. "She believes her $400,000 investment is guaranteed to be worth $800,000 in 10 years.

"I said she didn't understand how it works, and she said I insulted her lawyer, her ex-husband, who somehow approved of the annuity, and the financial planner who sold it to her. Friendship ... gone!"

Or:

"I had $100,000 in my account three years ago and wanted to preserve that money. My broker said he had the `perfect product' and told me about a variable annuity that invests in mutual funds and would `lock in' my principal and still give me a chance for growth if the market rose. On his advice, I transferred everything into this annuity. Subsequently, my broker quit his firm.

"This year, I commented to my new broker that I was glad I'd chosen this annuity because it locked in my $100,000. He looked at me funny, got the annuity company on the phone and they explained my account was now worth $55,000, not $100,000. I was told I was `lucky' I had this annuity because I could withdraw $5,000 to $6,000 a year for the rest of my life."

Sadly, dozens of e-mails and letters have similar tales. They show that many violate a cardinal rule by investing in things they don't understand -- and sound too good to be true. Their advisers may not understand the products either, particularly variable annuities with guaranteed minimum withdrawal or income benefits.

These annuities come in many flavors. Some, in exchange for an annual fee, do guarantee a return of the original principal, but only after 10 years or so.

But the basic idea is that, for an annual fee, insurance companies issuing these annuities guarantee purchasers a minimum lifetime income regardless of the value of their account.

That's where the confusion comes in. Insurers base the minimum guaranteed payouts on the "protected withdrawal value" or some other similar name.

Typically, this "protected" amount equals at least the original principal and may increase by a set percentage each year. Some annuities guarantee that, if there are no withdrawals, the protected withdrawal value will be at least double the original after 10 years, even if the account value has tanked. But this "protected" value is not cash: It is a number used to calculate withdrawals. To keep the minimum income guarantee, you may withdraw only a small percentage of the protected value each year, say 5 percent.

Ultimately, you must decide whether the fees annuities charge for these guarantees are worth it. If all you want is the minimum guaranteed income, however, you'd get a higher payout by investing in immediate annuities in which you surrender your principal, and thus give up the possibility of gains, in exchange for lifetime income.

Humberto Cruz is a columnist for Tribune Media Services. E-mail him at yourmoney@tribune.com.