If you think about your investment options as a closet full of footwear, annuities would be the pair of battered rubber boots you only wear for gardening -- and even then, only when the neighbors can't see you. Annuities are the most unloved and unfashionable of investments, but like your rubber boots, they meet a specific need and do it well. With medical science improving in leaps and bounds, and post-retirement lifespans increasing accordingly, a lifetime annuity is one retirement income you can't outlast.
Annuities are a form of investment issued by insurance companies. You can think of an annuity as the exact opposite of a life insurance policy: you pay a large sum of money at the beginning, and get back a steady stream of monthly payments. An annuity can start paying immediately, or can be deferred to start at a given age or date. Some pay a fixed amount each month, while others have a variable market-investment component that can go up or down. Some pay out only for a specified time, while others make payments for life.
A lifetime annuity means exactly what you think it means: it'll pay you for as long as you live. In fact, many companies offer what are called "joint and last survivor" annuities, which will provide income to two people until the second dies. The payments are based on their estimate of your potential lifespan, so ill health actually works in your favor. Other factors affect the payment, such as your gender and age. A fixed annuity contractually guarantees you a level payment for the rest of your life. Some even contain riders that will increase your payments, to offset the effect of inflation.
Traditional fixed annuities are among the lowest-risk approaches to retirement income. As long as your insurer remains in business, your income will never fluctuate. However, the fees are often higher and returns lower than in other investments. Variable annuities address those criticisms by incorporating a standard investment, such as mutual funds, within the annuity contract. This offers the prospect of better returns, but unfortunately it also means your investments can lose money. Some insurers offer a guaranteed minimum payment, protecting you from a significant drop in your income.
Finding a Fit
For most young families, deciding on an annuity is decades away. However, if your employer's pension plan gives you a lump sum to invest at retirement, it's prudent to familiarize yourself with the options in advance. Funds in an annuity can grow without taxation, so they're also useful if you've maxed out your IRA and have a windfall or additional income you'd like to shelter from the tax man. If you have a child who's physically or mentally impaired and will require lifelong care, a lifetime annuity might be a good way to meet that need.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.