Financial Literacy - Retirement Income Planning
Guaranteed income for life -- at a price

Anxiety about running out of money before running out of life likely keeps some retirees awake at night. In Bankrate's recent poll, roughly four out of 10 (37 percent) retirees worry about outliving their money. Women fret more than men by a margin of 44 percent to 28 percent.

While modest habits and frugal living can go a long way toward tempering those night sweats, insurance products called "annuities" allow you to hedge the risk that you might inadvertently live too long.

An annuity is a contract between you and an insurance company stating that you will pay the company a set amount, and then it will turn around and pay you back with interest for a set number of years or for life.

The amount you receive depends on a few different factors -- for instance, the type of annuity you buy. Your payout can be based on a fixed amount or it can vary, depending on the performance of underlying investments.

Annuities have a bad reputation for imposing restrictions and piling fees on top of fees, and they have other drawbacks. But they can be a useful tool in the right circumstances.

Whether that tool belongs in your investment toolbox depends on your personal situation.

Lowdown on annuities
4 types of annuitiesBells and whistles
Deferred.Guaranteed minimum income benefit.
Immediate.Guaranteed lifetime withdrawal benefit.
Fixed.Guaranteed minimum withdrawal benefit.
Variable.Death benefit.
Other guarantees.

Deferred annuities

Deferred annuities have two phases: accumulation, where you earn interest on your investment, followed by the distribution phase, when the account is annuitized. The investment gains are tax-deferred until you begin taking withdrawals.

You can purchase a deferred annuity with a single premium or on an installment basis.

"The accumulation period is from the day you open the account to the day you terminate the contract or annuitize. You basically call up the insurance company and say, 'OK I want an income stream. I'm willing on this day to exchange the balance of the account and give it to you (in exchange for regular payments),'" says Mark LaSpisa, Certified Financial Planner with Vermillion Financial Advisors in South Barrington, Ill.

Who they're good for: Investors who have maxed out their qualified retirement plan contributions, such as an employer-sponsored plan and IRA, and would like their money to grow tax-deferred. They're also good for those facing imminent retirement, but who don't want to get an annuity until sometime in the distant future.

"You're not worried about dying tomorrow. What you're worried about is living past 80 and then you'll have a problem. You say to the insurance company, 'I want to buy a payout annuity, but I don't want the payments until I reach 80,'" says Larry Swedroe, principal and director of research at Buckingham Asset Management in St. Louis.

"Now instead of having to put up $500,000, you only have to put up $50,000 or some small number because if you don't live to 80, the insurance company will never pay you a penny," he says. 

In some states, money in annuities is judgment-proof, so deferred annuities can be a good vehicle for people in professions prone to lawsuits, such as doctors, lawyers and Enron executives. Ken Lay stashed millions in annuities shortly before the scandal erupted that left thousands of Enron employees completely broke.

Immediate annuities

Immediate annuities have no accumulation period. Buyers plunk down their payments and go straight to the distribution phase.

"An immediate annuity guarantees you a set amount of income for life -- or for your and your spouse's life. It is similar to a pension-type income stream," says Craig Hemke, president and founder of Buyapension.com.

Who they're good for: risk-averse retirees or those facing retirement who need an immediate source of income for a set number of years or until they die.

Fixed annuities

A fixed annuity earns a fixed rate during the accumulation stage. Generally, the interest rate is agreed upon for the first year and then is reset in subsequent years based on market conditions. But investors can find annuities with a set interest rate that lasts for a number of years. During the distribution period, fixed annuities are regular fixed payments that don't change in amount.

"Fixed annuities are pure insurance contracts. You buy them from the insurance company and they basically make you a payment based upon their expected returns for that period and the mortality credits," says Swedroe.


Mortality credits are the reallocation of monies from those who die to those who survive. They make annuities attractive for older investors. Read more about mortality credits in the Bankrate feature "The pros and cons of annuities."

Variable annuities

The payout from a variable annuity will be based on its underlying investments, called subaccounts. These accounts fluctuate in value.

"Variable annuities are really a lot like tax-deferred mutual funds -- you put money in, you select the funds and you hope over time that it grows," says Hemke.

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