AKAMAI MONEY

By Deborah Adamson
Advertiser Staff Writer

Q: I'm 84 and I recently bought a fixed annuity from my bank because I didn't want to continue making 0.15 percent on my money market. Could you tell me more about them? — Florence Mikaido, Pearl City.

A: An annuity is an investment contract set up by an insurance company and sold through banks, brokers, financial planners, insurance agents or directly through insurers. It's a retirement vehicle in which you usually get regular payouts for the rest of your life.

But annuities are complex investments that can be fraught with penalties and restrictions, so understand what you're buying, said J.P. Schmidt, the state Insurance Commissioner. If not, you could be locked out of your money for many years — unless you're willing to pay substantial penalties.

Complaints about annuities have gone up in Hawai'i, he said. Several cases involve seniors in their mid-80's who have been told to get out of investments that gave them more flexibility and sign up with an annuity that locks up their money for 10 years. Schmidt said his agency is investigating the complaints.

For complaints or help with annuities, call the Insurance Division at 586-2790 or the state Securities Enforcement branch at 586-2740.

Still, there is a place for annuities in some people's portfolios. If you're well-off and you've already maxed out on all other tax-deferred, tax-deductible or tax-free investments such as 401(k)s, SEP-IRAs or 403(b)s, then consider annuities if you can afford to leave the money untouched for at least 10 years, said Michael Iraha, a certified financial planner in Honolulu. You'll pay steep penalties if your cash out in the first several years.

Another reason to buy an annuity: If you don't have the discipline to manage a lump sum to make it last your entire life, said Lesley Brey, a fee-only certified financial planner in Niu Valley.

How an annuity works: You give the insurer your money — in a lump sum or through monthly premiums — and the company invests it or gives you a choice on where you want to invest. In return, you either get a regular payout immediately or after retirement, usually for the rest of your life.

How much you get depends on your age and gender, as well as features you want included in your annuity. The insurer makes more money from the contract if you die in the time frame they expect or earlier. You win financially if you outlive their expectations.

In general, the older you are the higher your payout, Iraha said.

Annuities are not insured by the Federal Deposit Insurance Corp., or FDIC. So make sure your insurer is financially strong so they can pay out your benefits. Five agencies rate them: A.M. Best (www.ambest.com), Fitch Ratings (www.fitchratings.com), Moody's (www.moodys.com), Standard & Poor's (www.standardandpoors.com) and Weiss Ratings (www.weissratings.com). Look for the top ratings.

Two types of annuities

There are two basic types of annuities — immediate and deferred. With immediate, you give the insurer a lump sum and you immediately get a set monthly, quarterly or annual payout for the rest of your life. Once you die — even if it's two days after you buy the annuity — the insurer keeps what's left.

If you want to bequeath your annuity to a beneficiary, you can buy that option but you'll end up with a lower payout.

A deferred annuity defers your payout until a later time — whether it's one year, five years, 10 years or longer. You may put in a lump sum or make monthly payments to the annuity. The longer you defer the payout, the higher it could be.

Under deferred, there's fixed and variable annuities.

With fixed, the insurer invests your money as it sees fit. But you are promised a set payout.

With variable, the insurer gives you a choice of where to invest your money. Your payout depends on how well your investments perform.

Within these basic types of annuities are many variations and additional features. But additional features would come at a cost, in the form of decreased payouts or higher fees.

Let's say you buy a $100,000 annuity with a $500 a month fixed payout at the age of 60. If you had put the money in a checking account and withdrew $500 a month, it would take you 16.7 years to use up your $100,000.

Deciding which is best

So which one is the better option? If you expect to live until 90, the annuity is better for you. If not, you might be better off exploring other options.

Let's say instead of putting your $100,000 in a checking account, you invest half of it in stocks and half in bonds. Brey said you would get a 6 percent return a year and your money would last 30 years. If you die 10 years later, your heirs would get the money.

One of the major drawbacks of annuities are steep charges and fees. There could be a sales commission to pay to buy an annuity. If you withdraw within the penalty period, typically seven years, you have to pay surrender charges.

For example, you may have to pay a 7 percent surrender charge if you withdraw from your annuity within the first year. If you withdraw the second year, the charge might fall to 6 percent and so on until the surrender charge completely disappears.

On a $100,000 annuity, the first year surrender charge could be $7,000 if you withdraw the entire amount.

On top of surrender charges are other annual costs, such as the mortality and expense risk charge, usually 1.25 percent of your assets a year, according to the Securities and Exchange Commission. There also are administrative fees. If your annuity invests in mutual funds, you would have to pay the fees assessed by the fund companies on top of annuity charges.

The taxman gets his cut, too: The earnings portion of your payout is taxed as ordinary income, as if it came from a job, instead of the lower capital gains tax rate of 10 or 15 percent. If you withdraw part of your capital before you reach 59 1/2, in most cases you have to pay an IRS penalty of 10 percent of assets. To minimize fees and charges, look for companies that offer lower cost annuities, such as Vanguard (800) 522-5555, TIAA-CREF (800) 842-2776 and USAA (800) 365-USAA or 8722.

Dennis De Stefano, a fee-only financial planner on Maui, says he steers clear of annuities. "They're expensive products and you can't (easily) access your money," he said.

Reach Deborah Adamson at dadamson@honoluluadvertiser.com or 525-8088.