There are many points to argue about what is right and wrong when it comes to Social Security and other age based entitled programs. But one point I think we can all agree on without beating the point to death is that Social Security is in serious trouble as we currently use it.

I am not interested in placing blame or running through all the statistical data why it won’t last. Simply put, we borrow from the future to pay for the present but sooner or later the future shows up. Anyone that borrowed against their homes in the last few years knows all to well how that statement rings true.

But what will Obama, McCain or other politicians going to do about it?  How about get real!

According to the American Academy of Actuaries, raising the retirement age to 70 will cut the projected Social Security deficit in half. The statistics back up this age as a base age to use to start benefits with incremental increases built in. The current system increases the social security age one month at a time to age 67 but that is not enough.

The fact of the matter is that people are living longer. In 1935 the retirement age was 65 and you could expect to collect for 12 years. Now that number is closer to 19 years. That’s the type of inflation we can live with, “age inflation”. But that puts pressure on the social programs geared to help seniors with their expenses including Medicare.

According to the National Bureau of Economics the retirement age that is more realistic is closer to 73-74. That might be pushing it a bit and probably impossible to get through politically. The American Academy of Actuaries concludes that long after all the baby boomers are gone the demographics tell us that social security will only cover 75% of its costs. Women will be affected even more since they live longer than men.

But will this be a blow to current generations regarding their expectations for retirement? The answer is no, at least not for those that have given it any thought. Many baby boomers have simply not saved enough for retirement and a large percentage of them do expect to earn some type of income through work during their retirement years.

Financial advisors are also not optimistic about their client’s chances of retiring at the current young age of 65 and having their money last. Inflation and modest investment returns over the last decade have pushed an even greater number of workers into that work longer, save more demographic that will come to dominate those tapping age based social programs.

Raise the retirement age and acknowledge the simple fact that were living longer and we need to make some adjustments to age based entitlement programs.

By Jaime Levy Pessin
A DOW JONES NEWSWIRES COLUMN

NEW YORK — State regulators are trying to give seniors more options to get out of long-term annuities that may have been improperly sold to them.

The state of Florida has legislation pending that would give older investors four extra days to reconsider any annuity purchases. In Minnesota, regulators have incorporated refunds into settlements with deferred annuity providers, allowing investors over age 65 who bought annuities from those firms after 2001 to rescind their purchases without penalty. A recent California settlement requires a long-term annuity provider to, in the future, call some seniors who buy the products and make sure they understand exactly what they’ve purchased.

“It’s important that seniors have the opportunity to really understand these products before they buy them,” said Karen Tyler, president of the North American Securities Administrators Associationand North Dakota’s securities commissioner. “Provisions that are geared toward a period of time after the sale offers the investor another level of protection.”

State regulators have long been concerned about the sale of long-term annuities to seniors, because the investments can lock up their money for years and seniors may need access to their money immediately. The latest moves come at a time when, at the federal level, proposals to simplify regulation might reduce the role of state regulators in investor protection. The states’ lawsuits were filed before the recent federal proposal was unveiled.

Michael DeGeorge, general counsel at NAVA, an annuity industry trade group, said the organization doesn’t condone misleading sales practices, but worries that regulators might paint annuities with too broad a brush.

“We think it’s unfair to blame the product,” he said. “Annuity products can be beneficial for a number of older people.”

The state-level push to give investors a way out of long-term annuity purchases comes amidst a keen regulatory concern that financial-services professionals are taking advantage of senior citizens. Especially as Baby Boomers start to retire in droves, the amount of money people have available to invest is staggering: A fund-industry trade group estimates that retirement assets amounted to $17.4 trillion by the end of 2007’s second quarter.

Worries About Fraud

Regulators worry that the huge assets are spawning a wave of fraud against people who might not have the financial know-how to protect themselves.

They have grown increasingly concerned about long-term annuities because people must hold onto them for years in order to avoid paying surrender charges. That doesn’t make sense for people who have shorter life expectancies or who may have an immediate need for cash with no way to earn it.

Also, long-term annuities tend to pay high commissions to the financial advisors who sell them, giving financial advisors a big incentive to push the products.

In Florida, a bill pending in the state House of Representatives would extend the state’s “free-look” period from 10 to 14 days for people over age 65 who buy any kind of annuity, giving seniors extra time to rethink their purchases, according to Florida Rep. Clay Ford, who introduced the bill. Originally the bill would have extended the free-look period to a year, but Ford said the industry protested and the two sides compromised at the 14-day mark.

“Part of the hazard is if they have their savings tied up there, they don’t have it in cash,” Ford said. “It’s a dangerous thing if they don’t understand what they’re doing.”

Minnesota’s attorney general has been aggressively pursuing lawsuits against deferred-annuity providers, alleging unsuitable sales practices. As part of settlements with Allianz Life Insurance Co., a unit of Allianz SE (AZ), and American Equity Investment Life Insurance Co., people ages 65 and older who bought annuities from those companies after Jan. 1, 2001 can submit claims for full refunds without penalties.

Regulators will consider whether the products were unsuitable or sold improperly, and the attorney general’s office has said refund requests will be “‘liberally construed” in favor of the consumer.”

An Allianz spokeswoman said the company has been proactive in establishing a nationwide suitability program that “exceeds market standards.”

“We want to ensure that consumers purchase only those products that meet their needs and support their financial objectives,” the spokeswoman said.

Wendy Carlson, general counsel and chief financial officer at American Equity, said her firm was committed to ensuring that customers understand the products they’re buying.

“If people aren’t interested in a long-term savings product.. it’s not the right product,” she said.

Two Other Pending Suits

Two other similar lawsuits are pending, said Minnesota Solicitor General Al Gilbert.

Gilbert said that seniors are “putting substantial amounts or all of their money into these,” but that they “don’t have the same flexibility in terms of source of income.” This can be especially problematic for a population that may need access to their money to pay for things like medical expenses or long-term care.

In California, the state’s insurance commissioner recently came to a similar settlement with Allianz. As part of that settlement, Allianz will in the future have to contact people who are either 75 and older or who reside in assisted-living facilities, after they’ve bought a long-term annuity. In phone conversations, the firm must confirm those buyers’ “thorough understanding” of what they purchased.

The Allianz spokeswoman said it had started a similar pilot program in December 2006 with one pool of agents. The program’s official launch, which opened the program to all sales involving customers over age 75, began last month.

It’s not just state regulators getting in on the refund act. Earlier this year, the Financial Industry Regulatory Authority fined a Chicago company in part for making unsuitable sales of variable annuities. As part of the penalty, the 23 affected customers were allowed to sell their annuities back to the company without penalty. The company had to pay any surrender charges.

Finra also recently enacted a rule that will require broker-dealers to ensure the purchase or exchange of a deferred variable annuity is suitable for a specific customer.

The AARP is supportive of efforts to protect seniors from unsuitable annuity sales; the advocacy group for people over 50 years old is supporting the Florida legislation, which includes other protections aside from the refunds, said Lori Parham, the state’s AARP director.

“There’s a real sense that folks are being taken advantage of, and it’s time something be done,” she said.

(Jaime Levy Pessin covers compliance and regulatory issues affecting financial advisors.)

Portfolio volatility and the sequence in which returns are realized play a unique role in portfolios subject to regular retirement withdrawals. Specifically, volatility affects a portfolio with systematic withdrawals much more negatively than portfolios with systematic contributions. Moreover, negative re-turns early in a withdrawal program can create disastrous initial conditions from which recovery is nearly impossible.

Financial advisers can use annuities and other techniques to manage this risk. Consider a client who in December 1999 was looking forward to working on his golf game and traveling during his retirement. Following conservative advice from his adviser, the client figured he could safely draw $40,000 a year from his $1 million nest egg to supplement his Social Security income and allow for inflation-adjusted increases for the next 30 years or so. Being entirely invested in broadly diversified equities, the client was more than a little disappointed that after only three years, his inflation-adjusted withdrawals and the market’s ensuing poor performance had eroded his portfolio to less than $538,000. By that time, his withdrawals represented almost 8% of his dwindling portfolio value — a rate that is hardly sustainable. Strong positive returns over the next five years improved matters modestly. But by the end of last year, the client’s portfolio had grown only to about $670,000, by which time withdrawals were still 7.3% of the portfolio.  Although the client in this scenario is fictitious, his predicament is real. ALLOCATION SHIFTAvoiding severe initial negative returns is critical to sustaining withdrawals over long periods. A simple approach to managing this risk is to shift to a more conservative asset allocation as retirement approaches and during those early retirement years. Advisers can return to a more aggressive posture afterward. Contrary to conventional wisdom, retirees can often accept more risk as they age, because the horizon over which withdrawals must be sustained shortens. A related strategy is constructing a laddered portfolio that earmarks specific assets for particular withdrawal years. For example, cash can be used to fund the first three to five years of withdrawals, and intermediate bonds for the next three to five years. The equity portion of the portfolio can be reserved for withdrawals that begin at a later date. The equity portion then has a chance to recover from an early bear market, if it occurs, without being crippled by withdrawals. Like the asset allocation strategy, equity will tend to grow proportionately as the cash and bonds are liquidated early on.  However, these strategies don’t effectively address longevity risk as do fixed annuities. Including a deferred annuity in the ladder strategy provides a fixed stream of income after a certain point in time — say, 20 years — significantly reducing the amount of precautionary savings necessary to sustain withdrawals over a conservatively long-term horizon. An article in the January/February issue of Financial Analysts Journal shows that deferred annuities are much less expensive than immediate annuities and efficiently transfer longevity risk to insurance companies that can better diversify it. Variable annuities can also manage the problem effectively. Guaranteed-minimum-income benefit riders, for example, give the annuitant the ability to annuitize a guaranteed amount of principal at a specified rate at some future date. If the underlying portfolio suffers from negative returns in early retirement years, the annuitant can still choose to receive a stream of fixed income. This kind of VA protection is like a put option on an equity portfolio and typically costs 0.5 to 0.8 percentage points in extra management fees each year. Unlike a standard put option, its cost is uncertain and spread out over a number of years rather than set at a fixed price today — an arrangement that obscures the price. Equity-linked annuities provide similar protection. Most of the annuity premium is invested in a fixed annuity. The remainder is invested in a series of equity index call options. Like a variable annuity with a guaranteed-minimum-income rider, they are designed to provide potential upside return in exchange for a slightly reduced fixed income. Investors can construct similar results themselves by combining a diversified equity portfolio with an index long-term equity anticipation security put option or by combining a fixed annuity with a Leaps call option. With expirations up to three years, Leaps can protect investors during the critical early years of retirement. This do-it-yourself strategy is often far less costly. Cost is vital. The protections offered by a variable annuity can be eliminated if the cost of acquiring them is too high. As part of their due diligence, advisers need to understand and communicate the material nature of the products they sell and know whether similar products with lower costs, risk or complexity are available in the marketplace. 

Most retirees or those about to enter retirement have at least one (if not all) of the following concerns:

1. Protecting their savings
2. Creating and protecting their retirement income stream, and
3. Protecting their heirs.

 Roll these concerns all up together and we see that the underlying issue is risk management. Invested properly, annuities can be a significant anecdote to these problems, especially for retirees.  An annuity is an investment designed for retirement. It is a written contract between you and an insurance company. The contract allows you to potentially accumulate funds and then provide lifetime income payments.

 Fixed, Immediate, or Variable: Which Annuity is right for you?

 There are two main categories of annuities immediate and deferred. Within each of these there are two sub-categories, fixed and variable.  

Fixed Annuity:

 With a fixed annuity, you invest your capital with an insurance company which promises to pay you interest and return your capital at an agreed upon future date.  Just like a bond or C.D.  

The safety has to do with the rating of the insurance company, once again, much like a bond, make sure the insurance company you are using is rated ”AA” or higher. Rule of thumb: Invest in the best. After all, we are choosing this investment option for the safety. Do not compromise of this issue.

Fixed annuities, like all annuities offer the advantage of tax-deferral. You will be required to pay taxes on profits when you withdrawal the money at ordinary income tax rates. If you choose to reinvest, current tax will not be owed. This must be considered when comparing the rates on fixed annuities as compared to other fixed income investments. And that’s exactly how you should approach this investment choice. Shop and compare before you buy!

Know also that the choices of rates and maturities vary from company to company. Consulting a financial advisor before making your final decision is, as always, prudent since they should have access to many insurance providers and that will make it easy to quickly compare current rates.

Immediate Annuities

This type of annuity is a fairly straight forward investment choice. You turn over a certain amount of your money to an insurance company which in return agrees to pay you a certain amount of money for a specified period of time or the rest of your life.

Once you invest in an immediate annuity, the insurance company keeps your principal. It is not returned to you at any time. You give up the rights to your money in turn for an income stream. It is not given to your heirs either.

So when investing in an immediate annuity, be sure to live a very long time. It will drive the insurance company crazy! Knowing when you will die is the only true way to know if this choice is right for you.

The immediate annuity rate an insurance company quotes you fluctuates from week to week, just like the rates on a C.D. One week an investment in an immediate annuity may net you $1000 per month, and the next week $950. So the direction of interest rates will affect the timing of when you should purchase an immediate annuity. Once you buy it the rate is set for life so you may not want to invest your capital all at once. Spread your purchases out a bit especially when rates on moving higher. 

Immediate annuities are becoming more popular as retirees look to supplement other sources of income like social security and pensions. They want to know that check is coming in month after month, year after year no matter what.

Variable Annuities:

In the first two examples, the investor knew ahead of time, at a minimum, what the return and income stream would be. When investing in a variable annuity, the return is variable and unknown.

When you purchase a variable annuity contract, your money is invested into sub-accounts. These sub-accounts are like mutual funds. They are professionally managed and invest in stocks, bonds and a wide variety of other market sectors. .

You may choose the sub account(s) you prefer just as you may choose a mutual fund. If they do well you will have more money in the pot, if they don’t you will have less.

The variable annuity does offer a guaranteed income payment based on your initial investment but the goal with a variable annuity is to grow you capital to a higher level which, at some point you can turn into a larger income stream.

The primary difference between a variable annuity and a mutual fund, aside form the tax deferral advantage of the annuity, is that you can also purchase guarantees, called riders, to protect yourself against potential declines in you annuities value. There are, however, many different types of riders. Consider them carefully before making a purchase as each adds an additional cost along with the benefit. For more information on riders, visit www.livelongliverich.com.