Are annuities the right tool for your retirement?

by Jim Sloan

With recent fluctuations in the stock market, low interest rates on even a high yield savings account and the prospect of living for a long time, many consumers contemplating retirement investments are starting to take a closer look at annuities.

Part of the impetus for the annuity revival results from a General Accounting Office (GAO) report that suggested annuities be combined with other safe investments--such as a certificate of deposit, a money market account or a retirement savings account--as part of your retirement investments strategy.

How annuities work

Annuities are essentially individual pension plans that pay you a set amount each month. You purchase an annuity from an insurance company, and in return you get a monthly check--either for the rest of your life or for a set period of time. Some annuities provide payments to a single person, but other annuities can be purchased that continue to make monthly payments to a beneficiary, such as your spouse.

For example, a 70-year-old man with a 60-year-old wife would receive about $960 a month from a $200,000 annuity. If he dies, his wife would continue to receive the payments until she dies. If the man chooses to receive the annuity only until he dies, his monthly payment would be around $1,400. The more expensive the annuity, the higher the payment.

Of course the couple loses any claim to that $200,000 investment--that money is gone.

Immediate vs. deferred annuities

There are two types of annuities--an immediate annuity, which is when you purchase the policy with a lump sum and start receiving payments right away, and a deferred annuity, which is when you pay into the account over a period of time and start receiving the payments at a predetermined age. Until you convert the deferred annuity into a revenue stream, you have the option of withdrawing from your account or closing it altogether--minus any surrender fees.

With many retirees worried about outliving their savings accounts, annuities can provide valuable peace of mind. Some annuities will increase with inflation, although those products cost more than simple immediate annuities. Annuities aren't guaranteed by the Federal Deposit Insurance Corporation (FDIC), but most states have a guaranty fund that will cover your account up to a certain amount if your insurance company goes out of business.

According to CBS' moneywatch.com, some deferred annuities come with high fees, complex rules on interest rates and earnings, and stiff early surrender fees that make them difficult to compare. Immediate annuities, on the other hand, are simpler and much easier to shop for because there are fewer variables.

What the GAO found

In addition to living longer, retirees are sometimes faced with drawing down their retirement investments at a time when stock prices are low. This is a double whammy because it leaves you with fewer stocks to replenish your wealth when prices climb again.

When faced with situations like these, fixed-income investments, such as certificates of deposits, bonds and immediate annuities, can save you from depleting your stock market investments.

The GAO noted that financial experts recommend retirees convert a portion of their savings accounts into an income annuity while drawing down their other investments at a rate of about 4 percent a year. That strategy, combined with delaying Social Security benefits until full retirement age, decreases the likelihood that you will run out of money during your retirement.

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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