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Buying Annuties for a Steady Income

InvestorEducation / Pensions & Retirement May 26, 2009 - 07:07 AM GMT

By: Money_and_Markets

InvestorEducation

Best Financial Markets Analysis ArticleNilus Mattive writes: Last week I talked about Social Security. And given the problems with that program, along with the toll the bear market has taken on many portfolios, it’s clear why there has been a renewed interest in annuities lately.


Since I specialize in income-producing investments, annuities are right up my alley. In fact, I covered them extensively both in my special report on retirement and in a recent issue of my Dividend Superstars newsletter.

Obviously I can’t share all that material with you here today … I don’t have nearly enough space. Nor would that be fair to my paying subscribers. However, because I am getting so many questions on these investments, I do want to at least spend today going over the basics, along with a quick overview of things to consider if you’re in the market for an annuity right now.

The Better Way to Bet on Your Life …

When you buy a life insurance policy, you are basically betting on your demise. Sad but true.

What I mean is that you regularly shell out a small sum of money so that your beneficiary will get a payout upon your death. If you live too long, the policy will likely be a losing investment. Talk about a Catch 22!

In contrast, annuities are a bet on your longevity. You hand over one big lump sum and then receive regular payouts, either immediately or at some other predetermined starting date. If you die too soon, the company that’s holding your lump sum will likely make out pretty well, though some annuities have various types of survivor benefits.

Sound like a bet worth making? Well, it could be. Much depends on the exact terms of the arrangement. Let’s start with the basics …

In the United States, all annuities (expect for private ones) are sold by insurance companies, but that’s where the similarities end. In fact, the terms and labels have mushroomed in recent years.

Some of the most popular flavors include:

Immediate annuities start paying out right away, though the length of the payouts can vary from a fixed number of years to the lifetime of you or your spouse.

Deferred annuities allow you to save money and begin withdrawing the amounts later, either in installments or as a lump sum. While the account is growing, you will not pay taxes on the gains.

Fixed annuities make set payments at a guaranteed rate. If your account is earning interest, it will do so at a guaranteed minimum amount. It’s akin to holding a certificate of deposit (without FDIC insurance).

Variable annuities allow you to choose how your lump sum will be invested, and the interest rates and payments are generally dependent on how those investments perform. Mutual funds are the most common investment choices. Variable annuities are considered securities, and as such are regulated by the SEC.

Equity-indexed annuities are another unique category. The money you put in is linked up to an equity index like the S&P 500. But the insurance company will also typically guarantee you a minimum return (rates can vary substantially). Thus, while they sound like variable annuities, they are often categorized as fixed annuities and not registered with the SEC.

Oh, and some of the titles above are used in combination. For example, you could buy a deferred, variable annuity. Pretty confusing, eh?

It is. And I’m sure the issuing companies like it that way. But with a little legwork, you should be able to sort through the mess and find out what specific offerings — if any — work for your particular situation.

That brings us to the all-important question …

What Are Some Basic Things You Can Look for When Annuity Shopping?

As with just about any financial product, there are legitimate reasons or individual situations for using just about any of the various annuity types.

But by and large, for the majority of investors, I think only fixed annuities fit the bill. After all, they are the truest version of the original annuity concept — i.e. handing over a lump sum and knowing exactly what you stand to get back, when you will get it, and how it will be paid out.

And if you’re close to retirement, or already enjoying your golden years, you will likely be most interested in an immediate fixed annuity. That’s because you’ll want to turn at least part of your nest egg into instantaneous regular payments that can help supplement the money you’re receiving from pension, Social Security, etc.

You can get a rough idea of how much income an immediate annuity might generate by using an online calculator such as the one found at http://immediateannuities.com. From there, you can begin shopping around with individual providers.

However, be sure and take the following four points into consideration before you make any final decision:

#1. Your health. This is probably the biggest factor, especially when it comes to fixed annuities. Remember, you’re betting on your own lifespan. If your mom and dad both lived to 100, a fixed annuity might make sense as part of your overall financial plan. If you have reason to believe you won’t make it that long, think long and hard before committing any money.

#2. The insurer’s credit rating. In this market, it’s extremely important that you get your annuity from a stable company. After all, a guarantee from a bankrupt company isn’t a guarantee at all!

While state guaranty associations regulate and cover annuity losses, there are caps in place. Note that assets in sub-accounts of variable annuities are legally separated from the insurer’s assets, so that money is never at risk in the event of company failure. Still, these are the last things you want to worry about with an annuity.

#3. The fees involved. I would start your search with the usual low-fee suspects such as Vanguard, Fidelity, T. Rowe Price, and TIAA-CREF as good starting points.

#4. The terms of the contract. Remember, many annuities come with a whole slew of add-on options, coverage limits, important dates, and more. Plus, the payouts on fixed annuities can vary considerably from company to company.

Bottom line: Annuities can be a great tool for investors seeking steady income from a lump sum. But you must be absolutely certain to shop around and carefully review all the annuity’s materials before you sign anything!

Best wishes,

Nilus

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