What Are Annuities?

The current crisis on Wall Street illustrates just how volatile the market really is. Tons of people who have been socking away their retirement money in 401(k)s and IRAs have seen their portfolios suffer under the weight of increasingly bad news. The closer you are to retirement, the scarier it is. But these aren’t the only retirement vehicles that are available. An annuity can help you protect yourself from a market crisis.

Annuities, also called personal pensions, create a guaranteed source of income during retirement. You pay an insurance company a lump sum of money (or installments over time) in exchange for a guaranteed payout each month in retirement. The payout can be guaranteed for a specific amount of time (like 10 or 20 years) or it can be for the lifetime of the annuitant.

There are two basic types of annuities: fixed annuities and variable annuities. Fixed annuities guarantee a set payout each month. With variable annuities, payments fluctuate depending on the performance of the annuity-holder’s investments. Fixed annuities are safer, but the payment doesn’t typically rise with inflation. Variable annuities allow the potential for a higher payout, but also carry the risk of a lower payout.

The main advantage to having an annuity is that can provide income for as long as you live. A shaky market means that 401(k) and IRA investors are rightfully nervous that market losses could mean they’ll outlive their retirement savings. With the right kind of annuity, that is avoidable.

How is that possible? Based on your age and actuarial tables that predict longevity, insurers determine how much of a monthly payout your annuity will buy. Essentially, they are betting that you'll die before you use up all of the money in the investment. They keep the difference. This is called a single-life annuity. Married retires may prefer joint-life annuities, which continue payouts until your spouse dies as well.

Annuities should be used as part of a diverse retirement portfolio - you shouldn’t put all your nest eggs in this one basket. An annuity will help hedge against a suffering market, but you’ll want some money in the market so it can grow and protect against inflation. You also want money on hand for emergencies.

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