The goal of saving for retirement is a constant battle to find sources of income that will remain steady — and hopefully grow — for the long term.
Annuities can provide a steady stream of income well into your retirement years, yet they don’t show up on the retirement radar screen as often as you might expect. Why? Well, in one man’s opinion, it’s because while annuities seem like a simple concept, it’s a little bit more complicated than just saying, “I’ll give you my money today in exchange for you giving it back to me down the road for the remainder of my lifetime.”
Still, once we pore through the basics, you might find an annuity makes good retirement sense to you.
Annuities generally come in two flavors: deferred and immediate.
- Immediate Annuities: These offer “guaranteed” (we’ll get to that later) income for either a set period of time or your remaining lifetime. Immediate annuities generally are funded all at once with a lump sum and are more suited to investors at or near retirement. Investment advisers pitch them to people who have, say, accumulated a large sum of money in one stock as a way to diversify and guarantee income later down the road.
- Deferred Annuities: These allow you to invest as much as you want, and your money grows — tax-deferred — inside the investment until you start to take it out. These are more appropriate for investors with a long time horizon, and should be considered once you max out 401k and IRA contributions. Young investors are the target here and rightly so, since you can start saving in the annuity vehicle early, continue to fund it and (with any luck) watch it grow — tax deferred — until the annuity payments begin.
Then, they’re divided into two other categories: fixed and variable.
- Fixed Annuities: A guaranteed (there’s that word again) and predictable payment, whether you’re in the immediate or deferred group. In some ways, they’re like a certificate of deposit, although you might be able to write in a cost-of-living increase to keep up with inflation. If you have a short-term horizon or have less tolerance for risk, this might be the ticket.
- Variable Annuities: Whether deferred or income, these provide you with income for the life of the term, too. However, the payments are subject to “market” conditions because your money is invested across a range of markets and investments. That means there’s a possibility payments will come out higher than originally planned … but they also could come out lower. If you have the time and the stomach to take some risks, this one might be right for you.
So, these are the basic flavors most investors can choose from. There are more complicated ways to slice and dice these vehicles, but I suspect simpler is better.
Should you choose to go this route, keep these things in mind:
- Nothing is guaranteed. (And if you don’t believe me, read the small print at the end of any annuity you get.) The good news here is that for the most part defaults are rare, and state regulators force insurers to set aside reserves to cushion losses.
- Unlike CDs, annuities are not government-insured, so if you lose the money, you can’t get it back.
- Withdrawals from tax-deferred annuities are just like IRAs — subject to 10% tax if withdrawn before age 59 1/2, and distributions are taxed as ordinary income.
None of this is really too bad if you make sure to spend time with your adviser to understand the mechanics, risks and outcome of an annuity.
Remember, too, that you can buy any number of annuities to even spread that risk around … and any good adviser will tell you not to put all your retirement eggs into this one basket.
Marc Bastow is an Assistant Editor at InvestorPlace.com.