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Saturday, May 14, 2011

Investing 101 - Annuities

Is it time to buy an annuity?

The above link is an article on Its a decent start, but doesn't discuss all the types of annuities available.

Longevity is a big problem for Americans. People are living longer in retirement. The life expectancy for a male is around 86. If you retired at age 60, you would have 26 years of not working. Retirement is longer than it used to be. Being alive for longer is a great thing, but you also have to have the money to be able to live. Having money in your 401k is great, but there is a possibility of depleting all your funds in a 401k. The burden is on Americans to fund their own pensions. Annuities are a good way to supplement and protect your income stream. There are many uses for an annuity. One of which is protecting your retirement account and helping you create a self-funded pension. Before we begin to delve too deep on to the subject matter lets define what an annuity is.

An annuity is defined as a fixed sum of money paid to your for the rest of your life. This is a pretty generic definition of what an annuity is. Times have changed and so have annuities. Traditionally people bought annuities and "annuitized" them to get a payment for life. Annuitizing means giving the insurance all your money in that contract and in turn the insurance company will give you money for life - this was a hard decision to make because you weren't sure how long you'd live. On one hand if you lived a long time and the sum of the payments the insurance company paid you was more than you put in to the contract then you would have possibly made a good investment. On the other hand, if you died before getting your initial premium back then that would have been a terrible investment. Thankfully things have evolved for the better. There are now ways to possibly get lifetime income and your money back.

There are two major categories of annuities - Fixed and Variable. Typically a fixed annuity is guaranteed by the insurance company's credit worthiness and in the worst case a certain amount is guaranteed by the state. The fixed annuity in general increases by a fixed percentage a year and allows you to take out a fixed percentage a year. A fixed annuity is similar to a CD except that it isn't FDIC guaranteed and is tax deferred. A variable annuity isn't guaranteed by the insurance company. A generic variable annuity allows you to invest in the stock market and allows you to defer the taxes. The value may go up and may also go down so there could be risk there. However, over the last 10 years the marketplace for annuities has evolved a lot and has more value to add than years before.

The purpose of this post was to introduce the idea of the annuity. Just like there are different models and trims and brands of cars, annuities come in all different types of brands, models and trims. Next time I'll dive deeper into the different types of variable and fixed annuities.

Disclaimer: The above post does not constitute as investment advice. If you need investment advice please see the professional advice of a financial advisor.