TIAA-CREF Series Looks at Myths and Facts about Retirement Income

Personal Finance Writers/Business Editors/Financial Editors

NEW YORK--(BUSINESS WIRE)--July 30, 2008--As Baby Boomers approach retirement, a growing number of individuals will confront the challenge of converting their savings into income that may need to last for as long as 30 years. A new article by TIAA-CREF explores approaches to maximizing the potential of annuities to help assure individuals never run out of money.

“Retirement requires a change in how people think about their money. Annuities can, and in many cases, should, play a big part in generating and guaranteeing retirement income,” said Maliz Beams, Executive Vice President, Individual Client Services, TIAA-CREF. “A life annuity is often the clear choice for maximizing and guaranteeing retirement income.”

According to the Centers for Disease Control, 77 out of every 100 people who reach age 65 will live to age 80 or older, and almost a quarter will surpass age 95. While a low-cost annuity backed by the solid claims-paying ability of an insurer can help to guarantee lifetime income, some individuals hold off on purchasing an annuity for fear that they will not live long enough to see a positive return on their investment.

MYTH: I am interested in an annuity, but worry that the insurance company will keep all my money if I don’t live to life expectancy after annuitizing my contract.

Annuities can offer a guaranteed income for life, which is a key feature for those worried about outliving their retirement assets. While annuities, like any investment product, offer certain risks and rewards, one risk that can be overestimated is the risk of an annuitant not living long enough to have their principal returned to them in annual payments, with the insurance company keeping what remains.

While certain annuities can work that way, that view takes a very narrow and negative view of an annuity’s potential. Most reputable insurance companies will only recommend annuities for healthy individuals who have no reason to expect a shorter life. Annuities can also come with options that can minimize or even eliminate this potential negative.

FACT: Investors can minimize or eliminate the risk of losing unused principal by purchasing a joint-life annuity with survivor benefit, or a guarantee period.

The concern regarding a shorter retirement (and early loss of principal) can be managed and even eliminated by selecting a life annuity with a “guarantee period”, which assures the annuitant that payments will continue to the estate for a minimum number of years (either 10, 15 or 20), or for the duration of the annuitant’s lifetime, whichever is longer.

The Guarantee Period

When you choose a guarantee period, you are effectively buying “insurance” on the annuity. The price of this insurance is that annuity payments will be somewhat lower. For most people, adding the guarantee period will not lower payments significantly.

The cost of such a rider depends on the age of the annuitant, and can, in some cases, be a very good value. For instance, you may find that a 20 year guarantee period for a single-life annuity for a 55-year-old might only reduce income annuity payments by about 3 percent.

A life annuity with a guarantee period can eliminate an annuity’s most commonly quoted risk, and can therefore be a very conservative investment that can play a stabilizing role in one’s overall retirement plan.

To learn more about life annuities accompanied by a guarantee period, investors may want to read: "Life Annuities: What They're Saying Isn't So," by Mary Pat Campbell and Benjamin Goodman.

Plan Your Retirement Finances Efficiently

While a guarantee period can help ease concerns about the risk associated with annuitization, it is important that such an option be chosen for the right reasons. Many people choose a guarantee period to ensure that if they live only a few years after annuitizing, their beneficiaries will receive the remainder of the invested principal.

However, planning an inheritance based on the principal that may or may not be available at your passing is not very efficient. Say you purchase a life annuity for yourself with a guarantee period of 20 years, with the idea of guaranteeing that your children get any unused remainder of your principal. If you live for only ten years after purchasing the annuity, the children receive the remaining ten years of payment or can receive the present value of the remaining payments in a lump sum. However, if you live past 20 years, payments cease upon your passing, the original principal would have been used up by the 20 years of annual payments, and there would be nothing to leave to heirs.

Of course, individual situations may vary, and estate planning is something you want to discuss with a professional, objective advisor. The easiest way to help ensure an inheritance for your heirs may be to consider it separately from the assets you would use to set up your retirement income. That way, your heirs can receive the amount you set aside plus earnings regardless of how long you live, and you can annuitize separate assets to provide the most amount of guaranteed income during retirement.

Improving Your Odds with a Joint-Life Annuity

Another way to address the concern regarding annuity value is to purchase a joint-life annuity with benefit to the survivor. These come with a variety of options which can be explored in the brochure Receiving Retirement Income from TIAA-CREF.

If an individual’s life expectancy does not persuade them to purchase an annuity, they should consider the combined life expectancy of themselves and a spouse or partner.

Based on TIAA mortality tables, a 65 year old male has a 50 percent chance of living 25 years or more. But a 65 year old couple has a 50 percent chance of one of them still being alive in 30 years. By purchasing an annuity as a couple, an investor can greatly increase the chance of receiving payments for long enough to get a valuable return on their annuity, even without the addition of a guarantee period.

For example, with an initial investment of $100,000 at today’s rates, a 65-year-old might expect a monthly annuity payment of around $633. That retiree would have to live a little over 13 years to ‘break even’ on his or her original investment. A couple age 65 might expect a monthly payment of about $555, so they would need to have the annuity for around 15 years to ‘break even’. While there is about an 85 percent chance a 65 year old is still alive in 13 years, there is a 97 percent chance that at least one of the couple age 65 is still alive in 15 years and still receiving payments.

Furthermore, because a couple has such a high probability of living longer, they could probably add a guarantee period as discussed earlier for a very low cost. For this 65 year old couple, a 20 year guarantee may only lower the payment by about 1.24 percent - to around $548 per month. At this payment level the buyer is guaranteed of getting about $131,520 ($548 x 240 months) on the initial $100,000 purchase regardless of how long they live.

A guarantee period and the joint-life option are strategies that enhance the protection of an already effective risk-management tool. Riders and options like those in the illustration not only further reduce risk, but can effectively customize an annuity to the unique needs of each annuitant.

Be sure to look for the next article in the series:

Myth vs. Fact: Annuities and Retirement Income Flexibility

Read the first article from the series in the news section of tiaa-cref.org.

Consider Investing with TIAA-CREF

TIAA-CREF offers annuities with low cost 1 investment accounts as well as professional, objective advice services that can help retirees navigate the many options of retirement income.
Over 70 percent of TIAA-CREF’s mutual funds and variable annuity accounts have exceeded their Morningstar median over the past three and five years, as of March 31, 2008. 2
For the second year in a row, TIAA-CREF ranked in the top ten mutual fund families according to the annual Lipper/Barron’s Fund Family Survey. 3
TIAA-CREF Institutional Growth and Income Fund wins 2008 Lipper Fund Award as “Best Fund over Five Years in the Large-Cap Core Funds.” [out of 565 funds] 4
Seven out of a total of ten TIAA-CREF Lifecycle Funds with a full year’s performance beat their benchmarks in 2007.

Annuity Basics

Annuities are contracts sold by insurance companies that are designed to provide regular payments to the contract holder (also known as the annuitant) and his or her annuity partner (if there is one). The basic principle behind annuities is simple: a number of different annuity purchasers provide funds, either in a lump sum or through regular premium payments, to an insurance company which issues the annuity contracts. This creates a pool of assets that the insurance company manages to generate payments to the annuity owners. With any annuity, all payments are based on the claims-paying ability of the insurance company.

TIAA is one of only three U.S. insurance companies to hold the highest ratings from all four major rating agencies, meaning TIAA has the claims paying ability individuals count on to provide lifetime income. 5

The two primary types of annuities are fixed, or guaranteed, and variable. In fixed or guaranteed annuities, the funds are invested in the insurance company’s general account, which typically contains fixed-income securities like bonds. The issuer, not the contract owner, assumes all investment risk. Fixed annuities offer a guaranteed payment, with the payout amount based on the assumed future returns of the investments and the annuitant’s life expectancy. Variable annuities provide the contract owner with the ability to invest in both fixed-income and stock-based accounts whose values change depending on the performance of their underlying investments. While variable annuities offer the potential for higher long-term returns than fixed annuities, generally their payouts will fluctuate more dramatically from year to year. Unlike a fixed annuity, the contract owner of a variable annuity assumes the investment risk.

About TIAA-CREF

TIAA-CREF (www.tiaa-cref.org) is a national financial services organization and the leading provider of retirement services in the academic, research, medical and cultural fields with $420 billion in combined assets under management. (3/31/08).

You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 1 877 518-9161, or go to www.tiaa-cref.org for a current prospectus that contains this and other information. Please read the prospectus carefully before investing. Investing in securities products involves risk, including possible loss of principal.

Past performance cannot guarantee future results.

Investing involves risk, including possible loss of principal.

TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services, Inc., members FINRA, distribute securities products.

Annuity products issued by TIAA (Teachers Insurance and Annuity Association), New York, NY.

Advice and Planning Services is a division of TIAA-CREF Individual & Institutional Services, LLC.

©2008 Teachers Insurance and Annuity Association-College Retirement Equities Fund, New York, NY 10017.

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1 Morningstar Direct (February 2008) based on Morningstar expense comparisons by category.

2 The Morningstar median represents the midpoint of an index of comparable funds/accounts grouped on factors such as investment objective and asset class.

3 The 2007 survey results, which rank TIAA-CREF ninth out of 67 in a highly competitive field, appeared in the February 4, 2008, issue of Barron’s. Due to the fund merger in April 2007, the TIAA-CREF mutual funds are no longer eligible for inclusion in the 5-year ranking. Ten-year rankings are not yet available. The Lipper/Barron’s Fund Family survey uses an asset-weighted ranking system. Each fund’s return was measured against all those in its Lipper category, and the resulting percentile ranking was then weighted by asset size relative to the fund family’s other assets in its general category. The family’s overall ranking was then determined by weighting the five fund categories in proportion to their overall importance within Lipper’s fund universe.

4 The highest Lipper Leader for Consistent Return (Effective Return) value within each eligible classification determines the fund classification winner over three, five, or ten years.

5 A++, A.M. Best Company (as of 6/07); AAA, Fitch Ratings (as of 5/07); Aaa, Moody’s Investors Service (as of 5/07); AAA, Standard & Poor’s (as of 7/07) – the highest possible ratings from these independent analysts. These ratings do not apply to variable annuities, mutual funds, or any other product or service not fully backed by TIAA’s/TIAA-CREF Life’s claims-paying ability.