The term “annuity” is pretty scary. Most people do not understand what it is or what it means. And almost everyone has heard of someone who lost money by investing in an annuity. So, with all the bad press, are there any benefits to owning an annuity?
Many people understand their need for life insurance. Life insurance protects their loved ones in the even that they pass away. Sounds good.
But the very real problem for many people in this age of increasing life expectancies is that they will live too long. How long is too long? You’ve lived too long if you outlive your resources.
With people living longer and longer the threat of running out of money at some point posses a great problem. Many people in retirement today had no idea that the life expectancy would be as long as it is now when they began saving for retirement.
So what does this have to do with an annuity?
An annuity is the opposite of a life insurance policy. While a life insurance policy generally collects a premium from you until you exercise the policy (you die) and receive a payout an annuity takes a large sum and distributes it out to you for however long you might live.
Now stop and let’s consider the implications of this. If an individual invests ten thousand dollars into an annuity and the insurance company pays that individual a payment every month eventually that ten thousand will run out right? Yes, it will.
But, didn’t I just say that it would pay out for the rest of your life no matter how long you live? Again, yes it will.
How can both be true?
Just like with life insurance, some people will pay in longer than others and pay for those that pass sooner, in an annuity some will pass sooner and the lump sum the insurance company keeps pays for those that outlive the money.
So an annuity will effectively prevent you from ever running out of money in retirement.
There are four main type of annuities:
* Fixed Immediate
* Fixed Deferred
* Variable Immediate
* Variable Deferred
A fixed immediate annuity will guarantee a specific amount for the rest of the investors life (or a pre-determined time frame) in exchange for a lump some of money.
A fixed deferred annuity will collect payments for a specific amount of time, earning interest, and building up the “lump sum” amount that will be annuitized (when the name annuity comes from, annuitizing something is turning on those guaranteed payments). After this “accumulation period” the faucet will be turned on and a guaranteed payment will be paid every month.
Variable products act the same way, but are not guaranteed at a specific amount. Depending on market conditions the amount of the periodic payments will adjust.
When considering retirement income needs an annuity can guarantee that your money never dries up and that you never run out. Don’t be daunted by the product because of your inexperience with them or because of what you have heard. A good financial adviser will be able to help you navigate the various annuity products and find one that works best for you,