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When to Pay More For Financial Bells and Whistles

This story is part of a bigger MoneyWatch package on when to skimp and when to splurge. Click here to see other stories in the package.

When you're out shopping for financial services products, it's good to have an idea of when it makes sense to splurge on some bells and whistles, and when to just go with the basics.

It's like shopping for other things in life. Sometimes you need the premium model and sometimes you'll do just fine without all the extras.

I'm going to touch on two insurance products for retirement, one where I think it's fine to skimp on additional features and one where I think you should consider splurging a bit.

Immediate Annuity. Lots of people are hot on the idea of buying an immediate annuity for retirement income. Well, if you're interested in one, it may be a good idea to go with the most basic annuity you can find. In a sense, an annuity is a very simple insurance product. You give a lump sum to an insurance company, and they tell you how much they'll pay you for the rest of your life based on your age and current interest rates. This is called a single premium immediate annuity.

  • Or, you ask them how much it will cost to get say $2,000 a month of income for life, and then they tell you how much that will cost in a lump sum payment.
The highest income payment you'll get is with what's called a life-only annuity, meaning it pays you for as long as you (or you and your spouse) live. If you want to guarantee payments for a term of years, such as 20, that serves to reduce your income because the insurer knows it must pay you or a beneficiary for at least 20 years.
  • Remember, if you buy a life-only annuity, and you die within let's say four years (as a few people will), the insurance company gets to keep all that money. By bearing the risk of an early death, you can boost your annual income payments from an immediate annuity.
Assuming your goal is to secure the highest immediate annuity payment for your life (or the joint life of you and your spouse), then a no frills immediate annuity may be the way to go. There are a number of very high quality financial services firms that offer direct annuities, without the commission drag of an annuity broker.

All else being equal, once you introduce additional features to the annuity, or extra people who have to get paid, those extra costs can reduce your potential income. So if you're seeking maximum income from an immediate annuity, then a stripped-down product may do the trick.

Long Term Care Insurance. This is one of the least understood types of insurance in the market. It's unfortunate because many people will probably need it. LTC insurance pays for the cost of long term care, which generally includes nursing home care and home care. LTC expenses are in general not covered by Medicare, and thus many retirees will need some coverage for these potential costs.

  • If you haven't checked yet, nursing home care, or comparable home health care, can easily cost $80,000 a year (or $160,000 if both you and your spouse need it). So this is a big financial risk that many people can't afford to self insure.
The reason I think you should consider some bells and whistles is because the product is complicated and the risks you're trying to insure against are also difficult to get your hands around. You need to understand what isn't covered by Medicare, how much of the LTC expense you might be able to handle on your own, and then what dollar risk you should consider insuring for both you and your spouse. This is also an area where you should consider getting help from a qualified and trusted insurance agent. If the agent is good, he or she can help you sort through the various types of plans and features.

LTC policies come in all different shapes and sizes, and you'll need to make decisions about how long a benefit period you want (such as three year or maybe even lifetime payments), how much of a waiting period you can handle and how much of a daily benefit you need, just to name a few.

There are policies that provide for straight monthly benefits and then others that allow spouses to tap a pool of benefits over their lifetimes. And there are policies that require certain types of claims procedures, such as verification of all costs, and then others that pay the monthly benefit once you qualify for LTC services. Moreover, the policy features are evolving and changing every year as health care needs change and insurers gain a better understanding of the risks involved.

Then, you also need to understand the risks that your premium payments might rise over time. That has a lot to do with the carrier you select and in general how much costs rise to care for all of us as we age. Factoring in those possible increases is an important planning step.

LTC insurance is complicated, and additional bells and whistles customized to your needs, along with the guidance of a good insurance agent, is probably a good idea.

Bottom line. Consider skimping on the stuff that's easy to understand, but splurging on the things that are more complicated.

The above material is for information purposes only. Consult your individual advisor prior to making any financial decisions.

Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.

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