What are annuities? Everyone's heard the term, but few of us know for sure just what annuities really are. They can play an important role in your retirement nest egg, but it's important that you recognize their advantages and limitations, and plan accordingly. Here goes…..
Annuities are essentially insurance policies, though they don't seem that way when you first learn about them. When you invest in an annuity you sign over a set amount of money (say $200,000) and receive a periodic check or direct deposit that represents earnings on your principal (say $500 per month). In most annuity agreements you receive those periodic payments for as long as you live; if you purchase a Joint Life Annuity the payments continue as long as your partner lives as well. Some annuities are immediate -payments begin as soon as you invest; others are deferred (payments don't begin until some agreed-upon period of time has passed….say 5 or 10 years). In general deferred annuities pay a higher monthly percentage than immediate annuities because the funds have been invested longer and had more time to accumulate. Most annuities also have a "term"-a period of time during which payments continue even if the holder of the annuity dies. Oftentimes the term is 10 years (so even if you died a year after investing, your heirs would receive payments for the remaining 9 years), but terms vary from policy to policy, and you'll want to confirm this in writing up front.
As you can see, annuities get complicated pretty quickly. But there's more. Some annuities (called equity indexed annuities) are linked to the performance of a portfolio of stocks; other annuities are linked to other types of financial instruments. In a fixed annuity the amount of the monthly payment is guaranteed-it's spelled out in the contract between you and the seller of the annuity. In a variable annuity the payment is not guaranteed-it can increase or decrease depending upon how well the investments that comprise the annuity perform.
The best advice we can give is that you consult with a Certified Financial Planner and an attorney experienced in elder law before you purchase any sort of annuity. Annuities are regulated by state laws, though because they are technically insurance policies they are not regulated by the Securities and Exchange Commission (so you lose that layer of protection).
The bottom line: Annuities can be an important part of your retirement portfolio, and your post-retirement income stream, but because they are so complicated it's easy to misunderstand the details, and where finances are concerned, details make all the difference.