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Annuities: Facts You Need For Retirement Planning

If you could get a check every month from now through the end of your life, how much would you be willing to pay? Like most other investment decisions, it depends on the size of the check and the initial cost. This is far from a hypothetical scenario, though. Most financial institutions offer this exact deal. They call it an "immediate annuity."

An immediate annuity is like life insurance in reverse. You pay a lump sum up front, and are paid a monthly sum as long as you continue to live. How much it costs is determined by your age, gender, and other lifestyle factors that may impact your lifespan. The more you pay up front, the more you earn. You can use this money just like any other income; pay bills, buy groceries, cover medical expenses, etc. You can even invest it. For a lot of people who are planning retirement, the guarantees of an immediate annuity seem like an attractive option.

Annuities come in several varieties. They can pay out quarterly, monthly, or annually. We talked about "immediate" annuities above, but there are also "delayed" annuities, which start payment at some later date. There are "single premium" annuities that require you to make a lump sum payment, as opposed to "multiple premium" annuities that you make gradual payments on until you've paid for the balance of the annuity. Some annuities offer a fixed payment (these are called "fixed annuities") while others offer a variable payment, usually indexed to the performance of another investment vehicle (called "variable annuities"). Other annuities include survivor benefits, where the annuity continues to pay, occasionally at a reduced rate, to a spouse or child after your death. Some might offer an increase in payout that is adjusted for inflation.

If all of these options seem confusing, it's helpful to focus on the simple economics of the agreement. You pay a lot now and receive smaller payouts for the rest of your life. All the other bells and whistles can change the amount you pay or the amount you receive, but the core mechanic remains unchanged. In general, the more flexibility you want, the more expensive the annuity package will be.

Are annuities right for your retirement planning? Let's take a look at some pros and cons of using annuities.

PRO: Guaranteed income

The money from an immediate annuity will keep coming as long as you're still alive. There's no need to fear uncertainty in the stock market and you can never lose money. Plus, there are no limits on how you may use that money. You can spend it, save it, gift it, or invest it at your discretion.

CON: Your principal is inaccessible

The money you pay into an immediate annuity can never be withdrawn, because it's no longer yours. You have paid it to a company in exchange for the promise of periodic payments. If you have a sudden, unexpected expense, you are unable to access your retirement fund to cover it. If this is a concern for you, a savings certificate (CD) or high-yield savings account might be a better choice for your retirement funds.

PRO: You don't have to think about it

Annuities are "set it and forget it" retirement savings options. You never have to question whether to sell off stock now or wait a week. You don't have to move your money from one mutual fund to another. Once you've made the initial decision of which annuity is right for you, all you have to do is sit back and cash the checks.

CON: Yields are typically fairly low

It's tempting to think of a $30,000 yearly payout on a $500,000 investment (6% is on the high end of typical) as a great return. However, considering that the principal is gone, it would take 15 years of that return to earn back the initial investment. If you started an annuity like that when you were 65, you would be 80 before you saw any profit from your investment. If this lack of return worries you, income-oriented mutual funds or real estate investment funds might be a better option.

PRO: Survivorship rights

Many annuities are sold to couples as well as to individuals. This means that the annuity will continue to pay out in full even if one partner passes away. Your annuity can provide peace of mind in knowing your significant other will be taken care of even after you're gone.

CON: No inheritance

Most annuities won't transfer to a next of kin or enter into an estate upon your passing. This means the money can't be passed on to your family, nor can it be bequeathed to a favorite charity or cause. The principle stays with the financial institution, and they use it to pay annuities for other people. If passing your wealth on to the next generation is a retirement priority, consider college savings plans for younger heirs and trust funds for older heirs.

Whether annuities will work for your retirement depends a lot on your individual circumstances. If you're curious about setting up an annuity or concerned about saving for retirement in general, your first stop should be CDC Federal Credit Union . Our investment advisor, Howie Brown, can answer any questions you might have about the various ways you can plan for a safe, secure retirement. Call, e-mail, or stop by today!

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