With the oldest U.S. baby boomers staring down retirement, the financial industry is betting sales of annuities will take off.
Many boomers haven't saved enough for retirement, and fewer of them are in line for traditional pensions.
In response, annuity providers are rolling out new products and features aimed at enticing people who worry that they might outlive the money they have been able to save. Product expenses in some cases are being driven down by competition, and features are getting beefed up to include, in some cases, better guarantees.
The catch: Annuities still come with some baggage, and investors who don't examine every inch of their contracts could easily make the wrong move.
And yet annuities' appeal is compelling. Investors nervous about relying too heavily on a volatile stock market at or in retirement can use annuities, essentially insurance contracts, to trade a pile of money for an income stream, beginning right away or down the road.
What price the peace of mind? Significant fees, penalties for early withdrawals, lack of access to principal and, in the case of deferred annuities, debatable tax benefits.
"The `pro' is that clients can sleep at night because they're managing longevity risk, but the `con' is their tax inefficiency and higher fee structure," said John Nersesian, a financial planner and managing director of the Wealth Management Services Group at Nuveen Investments in Chicago.
With an immediate, fixed annuity, an investor can trade a lump sum for guaranteed monthly lifetime income. But you give up control of that sum for investment returns that essentially are very low over long stretches of time.
Variable annuities, on the other hand, blend in market forces that let investors try for better returns, with some basic guarantees. Equity-index annuities peg returns to a market index.
After the accumulation period, the payout phase begins, and the investor chooses to take the money as a lump sum or at regular payment intervals.
Variables also typically carry a death benefit, which generally guarantees that heirs receive a payout at least equal to the owner's purchase payments.
It is with these kinds of annuities that things get complicated.
"I always say, `Friends don't let friends buy annuities,' " said financial planner Jennifer Cray of Menlo Park, Calif., who said she has spent hours trying to help clients decipher their variable annuity contracts purchased before she became their adviser.
"Annuities have a bad reputation, and for the most part it has been self-inflicted because of the cost and complexity," said Edward Mercier, vice president for insurance services at Charles Schwab & Co.
Pricing pressure is moving down base rates among annuity providers, experts said, while some full-service firms are offering more customized products for higher fees.
Among the more popular deferred-variable annuity features are guaranteed minimum withdrawal benefits, which are contract riders that allow minimum withdrawals, either for a lifetime or for a certain period.
Last year, 64 percent of variable-annuity purchases included one of these so-called living benefits, such as the guaranteed minimum withdrawal, said Michael DeGeorge, general counsel for NAVA Inc., formerly known as the National Association for Variable Annuities.
Despite their popularity, investors may be buying features they don't need, consumer advocates warn.
Retirees who want only to exchange a lump sum for a guaranteed lifetime income, for example, could be far better off with a simpler immediate annuity, said Jeffrey Dellinger, a Fort Wayne, Ind., actuary and author of The Handbook of Variable Income Annuities.
He advocates a strategy of using immediate annuities to guarantee retirement income, keeping other investments in stock and bond accounts for liquidity and using separate life insurance for funds to pass on to heirs, if desired.
Deferred-variable annuities attempt to do all those things in one product, but the result is watered-down benefits and higher fees, he said.
Facing retirement in a few years, Sandy Hitchin, 62, started worrying about whether her savings of about $200,000 would be enough, with Social Security, to pay her living expenses.
So in August, on the advice of a financial adviser, she used $130,000 to purchase a deferred annuity that promised lifetime income.
Good idea? Hitchin isn't so sure.
"After I took this out I read a lot of negative comments about annuities," said Hitchin, of Clarendon Hills, Ill. "I'm wondering if other people are doing this, and whether it's the right thing."
The answer to the first question is yes. Sales of variable annuities, like the one Hitchin purchased, jumped 17 percent in 2006, to $160.6 billion, according to industry association LIMRA International, while sales of fixed and indexed annuities declined.