Both 2008 and 2009 were tough years if you rely on a fixed income and investments to pay the bills. While 2007 was a relatively good year, 2008 began with market declines that led to a disaster by the end of the year. If you were heavily invested in interest-earning devices such as bonds and bank certificates, you saw tremendous income decreases. At time, there were even negative yields on U.S. Treasury securities. Is there anything you could have done to protect yourself from these calamities? What investments might have given you an advantage over this market drop?

Among the fixed-income crowd, one group had at least some protection against the 2008 roller coaster ride: owners of annuity products who had some of their retirement assets in fixed annuities. Though not investments in the classic sense of investing and expecting significant growth, annuities offer protection from the ups and downs of the market.

So what is a fixed annuity? In simple terms, it is a vehicle offered primarily by insurance companies that is designed to provide you with an income stream beginning on a specified date and ending at a predetermined time or upon your death. Typically, you place your funds inside the annuity product, they grow during the accumulation period of the contract and when you are ready you withdraw the funds.

In the context of this article, assume that the way you withdraw the funds is to annuitize the contract. When you annuitize a contract, you tell the insurance company how long you want to receive payments. You may hear phrases such as "10-year certain and life," "10-year certain," "pure annuity" or any number of variations on the period you will receive payments. The key is in determining exactly what your needs will be in the future because once the funds are annuitized, you will only receive your payments according to the contracted schedule.

Why were fixed annuities a good deal over the past year? They typically have a minimum guaranteed interest rate. Since the guarantee was based on market conditions at the time the contract was established, those with annuities had at least part of their money earning higher than market interest rates. This means that some people were and still are receiving a guaranteed rate of 5 percent, for example.

Many naysayers of annuities became reluctant fans when their money market funds and certificates of deposit were earning less than 1 percent annually while their friends in annuities were receiving returns of 5 percent. Unfortunately for the skeptics, once they lost half the value of their retirement funds in the market, putting their money in annuities also became a losing proposition. Investments worth $500,000 in 2007 might have dropped by more than 50 percent in some cases. Putting the money in an annuity today would lock in that loss and minimize the chance of recovering much of that loss in the future.

The good news is that the market seems to be in recovery mode today, and with a little luck some of the losses of the past year will be recovered. When you reach the point where your investments have recovered, putting a portion of your retirement funds in an annuity might be wise - but there are drawbacks.

Perhaps the greatest drawback to annuities is that withdrawal of funds in the first few years carries with it very high surrender charges. It is not unusual to find that if you withdraw your funds within a year or two of the policy's inception, it will cost you 7 percent of the account balance. For example, you invested $100,000 in an annuity with a guarantee of 3 percent and decide in a year to withdraw the full amount. You would receive approximately $95,800. The $3,000 interest would be offset by a surrender charge of $7,200 (7 percent of $100,000). While there are some options you can add on the contract, you need to accept that any funds in an annuity will be there for awhile.

One of the attractions of annuities is that funds build up tax deferred, meaning that taxes are not paid until the funds are withdrawn. Unfortunately, if you have an emergency and need your money before age 59 1/2, you will pay a 10 percent early withdrawal penalty. There are some exceptions, but this is another reason you have to be confident that the money invested will not be needed anytime soon.

Annuities are not necessary, or even desirable, in all cases. However, in light of the past year, perhaps it is wise to investigate putting a portion of your nest egg in these relatively safe assets. Give us a call and let's discuss your alternatives.

Have a wonderful Labor Day weekend!