Retirees are at more risk than ever of outliving their savings. People are living longer, and it's becoming harder to rely on either social security or traditional, defined-benefit pension plans as a safety net.

Annuities, insurance contracts that pay a guaranteed stream of income, can help. But they are a tough sell.

According to the Fidelity Research Institute, an affiliate of

Fidelity Investments

, there is "considerable academic research" showing that having a secure, guaranteed income stream has a positive impact on retirees' wellbeing -- both financially and psychologically. Yet most people would rather manage their retirement assets on their own as a lump sum than purchase an income annuity.

Fidelity wanted to find out why. Its recent survey of retirees and pre-retirees sheds light on the many reasons -- both emotional and logical -- that prevent people from investing in annuities

These are all valid concerns. Of respondents in the pre-retiree group, which represents the largest potential growth for the annuity business, 84% said they "want more flexibility on withdrawals." It's true that many annuities charge a hefty fee to withdraw money in the first seven to nine years, but there are also many that don't. You just have to shop around for them.

The next biggest barrier for retirees, "Need my savings to grow," is also a valid concern. The fees associated with annuities are one of their biggest drawbacks. The rates of return on fixed annuities are generally set at levels below those of either stocks or bonds. Variable annuities let you take on more risk in hope of generating bigger returns; the investments options (typically mutual funds) are generally designed to mirror similar products available outside of annuities. Still, their returns will always hampered by the expense and insurance fees associated with them.

Both fixed annuities and variable annuities with guaranteed minimum withdrawal benefits allow you to rely on a guaranteed income stream. The monthly payments you receive are defined by the amount of premium you paid in for a fixed rate annuity, or, in the case of variable annuities, to the performance of the underlying investments. While these products hamper your flexibility, you also get peace of mind from knowing that the payment will come in month after month.

The potential need for these products is enormous. On January 1, 2008, the first baby boomer will turn 62, the average age of retirement, followed by 76 million more over the next 15 years.

Consider this: If you are 65 years old, you are just as likely to live another 30 years as you are to die before your 70th birthday, according to data from the Society of Actuaries cited in the Fidelity

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At the same time, research shows that the Social Security system is on track to replace less than 30% of pre-retirement income for retirees by the 2030s. That's a slow but significant decline from today's 39% replacement rate.

Finally, U.S. Department of Labor statistics, cited in the Fidelity report, indicate that only 37% of workers in 2005 (the most recent data available) were covered by pensions, down dramatically from 84% in 1979.

"Many of today's retirees have the luxury of knowing that even if they overspend in their early retirement years, they still have a broader safety net of guaranteed income sources to help them get through," Van Harlow, managing director for Fidelity Research Institute, said in a press release accompanying the study.

"However, pre-retirees will have a much smaller net to catch them if they make a planning mistake, and even if they accumulate additional savings to compensate, they will still need to determine how best to structure their portfolio to reduce their personal guaranteed income gap," Harlow said.

The Fidelity study outlines basic building blocks of complete retirement income portfolios:

  • Lifetime income annuities with fixed or variable payments (some inflation-adjusted). These lifetime payments represent longevity insurance. Social security is an example of an inflation-adjusted fixed annuity.
  • Variable annuities with guaranteed living income benefits. The study focuses on variable annuities with guaranteed minimum withdraw benefits for life, which, again, represents longevity insurance. These annuities allow allocations in stocks and bonds that provide some protection against inflation.
  • A traditional systematic withdrawal plan. This is the traditional way of self-funding retirement by withdrawing a percent of the total assets per time period. It provides the greatest liquidity and access for withdrawals. It has higher growth potential than the other two options but has no protection from longevity risk or market risk. Financial Strength Ratings of the largest annuity providers are:

Melissa Gannon is director of insurance and bank ratings for Ratings, formerly Weiss Ratings, where she directs the operations of the company's insurance and bank ratings division.

In keeping with TSC?s Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

While Gannon cannot provide investment advice or recommendations, she appreciates your feedback;

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