Annuities: Why the Experts Are Wrong About This Investment

by Miranda Marquit

One of the scariest things about retirement is the volatility of the market. What happens if the market crashes while you are drawing down your retirement portfolio? Even if you build up a good nest egg, you might still end up running out of money during retirement, especially when it comes to your monthly cash flow.

The goal for many retirees, then, becomes securing a steady income stream that can be relied on, no matter what.

While it can be tempting to go with cash, this might not be your best option. A better choice might actually be an annuity.

How Does an Annuity Work?

An annuity is a contract, usually offered through an insurance company, that agrees to provide you with a payout (i.e. a stream of income). You might agree to a specific amount of money, paid to you regularly, for a set amount of years.

It's also possible to purchase an annuity that pays a regular amount to you indefinitely. Realize that if you opt for an annuity without a definite term, you are likely to see a smaller income stream. However, a set payout term, such as 10 or 20 years, might not be long enough to ensure that you receive enough income to outlive your money.

What's Wrong With Annuities?

In the past, annuities have gotten a bad reputation due to their high fees, low yields and onerous terms when it comes to taxes and survivorship. And many annuity products deserve the bad names they have been given. You do need to be very careful when choosing an annuity.

However, if done right, an annuity can be a way to secure some portion of your retirement income.

Immediate Annuities vs Deferred Annuities

One of the popular choices in annuities is the immediate annuity. With this arrangement, you take some of the money in your retirement account and use it to purchase an annuity that begins payouts immediately. Your lump-sum investment purchases you cash flow that you can count on.

This is in contrast to a deferred annuity, in which you make payments to the annuity over time and receive benefits at a later date.

When it comes to retirement planning, it is usually better to choose the immediate annuity. After all, it's more about making sure you have a reliable source of retirement income than it is about building wealth.

The low yields associated with a deferred annuity aren't likely to help you build your nest egg; instead use high-yielding investments to build a retirement account that is large enough to purchase an immediate annuity later.

Investing in Annuities to Diversify

As with all investing, make sure that you have sufficient diversity in your portfolio. Don't take your entire nest egg and use it to purchase an annuity -- even if it is an immediate annuity. You'll still want some of your retirement portfolio money in a “bucket” that still has the potential to provide inflation-beating returns.

Note that your annuity is only as good as the company backing it; if the company folds, you could lose out.

If appropriate, take a portion of your retirement account and use the money to buy an immediate annuity. It doesn't need to provide for all of your income needs; often, just having half or three-quarters of your required retirement income provided for can make a big difference in how you feel about your financial security.

The income from the annuity can provide you with a certain amount of stability, and help you get through the difficult times in the markets.

Are Annuities Good for Retirement?

Don't assume that all annuities are bad. There are some immediate annuity products available with reasonable, straightforward fees and survivor benefits.

Talk to a financial professional (who isn't earning commission on your choice) about your situation. Discuss whether an immediate annuity could be incorporated into your retirement financial plan to provide a degree of stability with your cash flow. Explore companies with solid ratings, in order to reduce the chance of losing out through a failed company.

Also, check your state's guaranty program. In some cases, a portion of your annuity money might be insured through the state.

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