An annuity is a contract between you and an insurance company in which you fork over money today in exchange for a guaranteed steady stream of cash in retirement. Whether or not you should choose an annuity depends upon your own financial and tax situation, but an annuity can be one part of a comprehensive retirement investment strategy.
Annuities can be tax-deferred. One reason to contribute to an annuity is that you are concerned about avoiding taxes for yourself. This is especially true if you currently pay more than 28 percent of your money to taxes, but expect to be in a lower bracket in retirement. A second reason is that you've already maxed out contributions to other tax-deferred investments, such as IRAs and your employer's 401(k), but have money you want to put to work toward your retirement years.
If you are afraid of one day outliving your retirement savings, a third reason for setting up an annuity is to spread your payments equally over a set period of time or for life. The risk-averse have three additional reasons for choosing an annuity. You can set up the annuity to provide guaranteed payments even if the stock market crashes. State guarantee pools ensure that you receive your money even if the insurance company goes belly-up. You also will typically earn more with an annuity than with other guaranteed investments, such as certificates of deposits.
A seventh reason for investing in annuities is that they provide an opportunity to invest in mutual funds, rather than individual stocks. Even if you prefer stocks, you might opt to put at least some of your retirement investment in an annuity to guard against losing all your stash because of a volatile stock market.
Because annuities are contracts, you can pay for benefits that you can't obtain from other investments. Thus, an eighth reason to invest is that annuities allow for guaranteed death benefits for your spouse or other heirs. For example, a woman who is older than her husband can buy a rider that guarantees payments to her husband for her lifetime plus 10 years. A ninth reason is a "stepped-up" benefit that allows you to lock in investment performance to guarantee that your heirs receive at least the amount you've invested, minus your withdrawals, regardless of market performance. The tenth reason is that you might also contract for long-term care benefits, or guaranteed payments if you need to be placed in a nursing home.
Read the Fine Print
As with any investment or contract, invest the time to understand the costs before investing your money. You pay for each additional benefit you select, and annuities often have surrender charges. These hit you with fees if you withdraw your money within a certain time, such as 10 years, of investing it. The insurer also may charge administrative fees, as well as charges based on your investment choices.
- USA Today Money: Annuities Are a Retirement Option, but Be Wary of Fees
- Bankrate.com: Invest in annuities for retirement?
- Kiplinger: Real Money - Should I Invest Retirement Savings in a Variable Annuity?
- Motley Fool: Annuities: What's to Like?
- CNN Money: Ultimate Guide to Retirement -- What Is An Annuity
- U.S. Securities Exchange Commission: Variable Annuities- What You Should Know
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