Understanding Annuities

Understanding annuities is essential for your retirement income planning as they are probably the most common method for insuring a stable retirement income.

After the recent stock market and financial industry's implosion many baby boomers are reconsidering these retirement instruments. Annuities have been around in one form or another for several hundred years. They were first used in medieval times in Germany and Holland and have now evolved into viable retirement income sources for people all over the globe.

Basically, an annuity is a contract between an annuitant (you) and the annuity provider (usually an insurance company) where you make a lump-sum payment or series of payments and the insurer agrees to give you periodic payments starting either immediately or at a later date.

What I'll do here is give you an overview of some of the key ingredients of these retirement income devices and link you to other websites where you can dig deeper.

Understanding annuities is not all that difficult for we baby boomers as long as you know some basic facts:

  1. As mentioned in the opening paragraph there are two basic types of annuities - immediate or deferred. The immediate is where you purchase a contract from the insurer who will then begin paying you immediately either on a monthly, quarterly, semi-annual or annual basis. With the deferred, you purchase a contract in which you will make set periodic payments for a pre-determined length of time after which the insurer will then pay you on a periodic basis as with an immediate. You may find this article from Money Watch about the 5 Rules for immediate annuities to be useful.
  2. There are also two types of investment returns available - fixed or variable. The fixed annuity has been around since day one while the variable is a relatively recent innovation. The fixed guarantees you an exact dollar amount at each payment period while the variable can fluctuate based on the investment returns of the provider.
  3. There are also various time periods to chose from for the payouts.There's the single life which pays you for the remainder of your lifetime only.The joint life which makes payments for the longer of either your life or the life of your beneficiary(ies).The certain term which makes payments only to you for a certain number of years.The life with certain term that makes payments to you for the remainder of your life, or to your beneficiary(ies) for the remainder of the certain term such as ten years.
  4. They are not insured by the FDIC or FSLIC but many states do insure up to $100,000. It is best to check the AM Best rating of issuing insurance company as well as your state's regulations.

The Wharton School of business has an excellent 11 page white paper entitled "Investing Your Lump Sum at Retirement" that could be very helpful to you. Although it was co-sponsered by New York Life Insurance Company, I think you will find it very useful if you are considering using annuities to fund your retirement. You can down load it here.

As you can see understanding annuities doesn't require a baby boomer to be a rocket scientist to figure them out but it is best to do some homework on your part before making a purchasing decision.

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