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Question:


Lately I have heard a lot of talk about annuities and how they are an important tool for retirement. What are annuities and how would they help with retirement?
-CSmith


Answer:


An annuity is a long-term contract between an individual, called the annuitant, and a life insurance company in which the annuitant makes regular payments or else hands over a lump sum. The money generally accumulates with tax advantages and is used to pay regular future income, say in retirement, often for the rest of the annuitant’s life.
 
Although annuities must be sold through insurers, they are the opposite of insurance policies in a key way. Insurance is there to provide financial security for your family when you die, while the purpose of an annuity is to ensure security especially for those who live very long lives.
 
The traditional type of annuity, called a fixed deferred annuity, holds very safe investments like bonds and sets rates based on actuarial tables, so that the insurer has an idea of how long you and its other customers will live and therefore how much it will have to pay out. Another key factor is expectations of interest rates. That allows the insurer to estimate the income that its annuitants’ money will produce.
 
Another type of product, called a variable annuity, is like a hybrid of an annuity and a mutual fund. It allows account holders to invest in riskier assets like stocks that tend to generate higher long-term returns. There can be guaranteed minimum payments to blunt the impact of ups and downs in the markets, but the investor will pay for that guarantee in one form or another, perhaps through higher premiums.
 
If you eat your Wheaties, exercise regularly and come from a long line of hearty folk who live to be 100, an annuity may be for you, but there are significant drawbacks that should cause you to think twice before buying one. Because the process for calculating payments is opaque and hard to fathom for anyone not in the insurance business, commissions, management fees and other costs can be quite high. What may make annuities an especially poor value now is that interest rates are very low; until they go up again, any new annuity is likely to provide meager long-term income.
-Conrad de Aenlle



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