Annuities Attract More Than $1 Trillion

The combination pension-and-insurance plan usually faces a hurdle of high expenses

LITTLE wonder the Fidelity Investment VIP Equity-Income Fund, an annuity product, continues to attract dollars. So far this year, the fund has held its own against the returns of Standard & Poor's 500 stock index. In 1992, 1993, and 1994, the fund actually outperformed the S&P 500.

Fidelity's VIP Equity-Income Fund is but one of hundreds of annuity products. Once touted as the answer to individuals' tax-sheltered retirement needs, annuities have been overshadowed in recent years by Individual Retirement Accounts (IRAs), and 401(k) and 403(c) retirement plans, in which employers match voluntary contributions from employees. But annuities are hardly passe: Dollars continue to pour into the products, particularly into variable annuities.

Since its inception in 1988, the Fidelity annuity has attracted more than $3 billion.

Performance mixed

The investment performance of annuities has been mixed. Of those invested in a diversified portfolio of United States corporate stock like the Fidelity fund, the average annuity did better than the S&P 500 over the past three years with an annual return of 13.99 percent, slightly better than the 13.23 percent return for the S&P index, according to Morningstar Inc., a Chicago-based investment-research firm. But over the last 10 years and so far this year, the average equity annuity has performed slightly worse than the stock index.

Annuities are retirement plans - with an insurance aspect to them - offered by banks, mutual funds, financial management companies, and insurance agents. But, in general, all annuities are backed by insurance companies. According to the American Council on Life Insurance (ACLI) in Washington, more than $1 trillion is now held in annuities. Some $482 billion is held in individual annuity accounts; another $612 billion is held in group-employer annuity plans. In 1980, individuals had annuity accounts worth only around $32 billion; group plans totaled $140 billion.

Moreover, the number of annuities has exploded in recent years. Jennifer Strickland, who tracks annuities for Morningstar, follows some 227 variable annuities, which are both the hot sellers and the better performers in the annuity world. These 227 annuities altogether offer a means for investing in some 2,200 specific funds, such as equity mutual funds.

There are two basic categories of annuities: fixed annuities, which provide a fixed rate of return and, in that regard, are similar to a bank certificate of deposit; and variable annuities, whose earnings reflect market changes in the underlying assets selected by the investor from a menu offered for the annuity product. These assets could be bonds, stocks, or some other financial instrument.

Within these two categories, there is a wide variation of annuities designed to meet different needs of individuals.

Like IRAs or 401(k) or 403(c) qualified retirement plans, the earnings of an established annuity are tax-deferred. Taxes are paid on earned income only when withdrawn. But unlike IRAs and 401/403 plans, the dollars going into an annuity are not immediately tax-sheltered. They are subject to taxation. The aim for most annuities is to provide a steady flow of income to a retiree over many years. Some annuities provide a death benefit to heirs. That benefit could be the principal paid into the annuity, minus withdrawals, even if the annuity underperforms financial markets.

Who should have an annuity? "Anyone who plans on someday retiring, which means almost everyone," says Lee Feldman, president of America's Best Annuities, an insurance agency based in Pittsburgh. "The amount of retirement income that the average person is going to need in the years ahead is staggering." One way to do that is to "buy an annuity," he says, starting as early as possible.

Indeed, time is both an asset - and a liability - for annuities. "Unless you have 10 to 15 years left until retirement, you probably shouldn't buy an annuity," says Mr. Feldman. "You definitely need at least 15 years to make a variable annuity work."

The reason is the combination of often-modest market gains achieved by annuities, and their high commission charges and management expenses. "I am not particularly sold on annuities, and I don't often recommend them to other people," says James Fraser, president of Fraser Management Company, an investment management-publishing company based in Burlington, Vt. The products are loaded with restrictions, Mr. Fraser notes. Putting together an annuity can require special expertise about death-benefit terms, withdrawal amounts, and survival rights for heirs, he says.

A high rating needed

You also need to make certain that the insurance company with which you have the annuity contract is reliable, experts note. It should have a high rating by A.M. Best or other rating agencies. "It's a matter of having a safe insurance company that will be there when you need it," says a spokesperson for Palm Beach, Fla.,-based Weiss Research, considered one of the toughest rating services.

Management fees on annuities can be considerable. Fees tend to average around 2 percent a year, according to Morningstar. Fees on stock mutual funds run about half that. Surrender fees, that is, penalties paid on early withdrawals, can amount to 7 percent the first year. The upshot: The annuity has to post sizable annual earnings to offset high management fees plus normal increases in inflation.

As the mixed investment performance of annuities indicate, many have trouble overcoming the high fees. And most annuity investors tend to go for the most conservative investments.

Many financial planners recommend that people first invest the maximum allowed in 401/403 plans, in which initial payroll deductions, as well as earnings, are tax sheltered. That done, individuals should consider investing maximums allowed in IRAs. Then individuals could put surplus savings into annuity products.

A number of companies now offer no-load annuities that substantially slash management fees.

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