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Does an Income Annuity Make Sense for You?

by: Jonathan D. Pond, from: AARP, March 13, 2009

Key Decision Points

Possible reasons for choosing an income annuity:

You're entering retirement or are already retired.

You have retirement resources (pension distributions, retirement accounts, brokerage accounts) that you would like to convert into an income stream.

You're concerned about outliving your income.

You want a guaranteed source of income in retirement.

You have other retirement investments that can be invested for growth in order to offset the loss in purchasing power of a fixed annuity later in your retirement.

Possible Solution. The strategy here, one that all annuity buyers should heed, is to make sure the insurance company with whom you are contracting for your annuity is in tip-top financial shape. Look at its marks from the various insurance-company ratings agencies. Even if you can get a better deal from a lower-rated company, for instance, one whose ratings grades look like my grammar-school report cards, don't be penny-wise and pound-foolish.

If you’re thinking of putting quite a bit of money into a fixed income annuity, consider spreading the money around among a few top-rated insurance companies. The money you have in a variable income annuity is actually held in a variety of mutual funds of your choosing. Since the insurance company is required by law to keep the funds separate from the company’s books, the demise of the insurance company should be of less concern, but the fund values themselves could decline. Even with the protection of your money being held in separate accounts, opt for financially strong insurance companies.

Drawback Number 5: It’s an irreversible financial commitment. After considering all of the drawbacks I have described, you may still be uneasy with what is, after all, a major financial commitment that usually can’t be undone. Certainly, income annuities are not crucial, nor do they need to be acquired in a single purchase.

Possible Solution. Annuities are by no means an essential retirement income tool. If you simply are turned off by any annuity, fine. There are many ways to generate needed retirement income. For example, you can create your own income annuity by investing in dividend-paying stocks, bonds, and other interest-earning securities. Alternatively, you could give an income annuity a test run by initially investing only a portion of the money you might ultimately put into annuities and then deciding later on if you want to purchase more.

“Gradual” is the word. A stage-by-stage approach to income annuities has other advantages besides beginning by investing a reduced amount in an annuity. By waiting to commit additional money to an annuity, you can increase your income considerably. For example, a male purchaser of a $100,000 fixed-payment annuity would receive about $7,800 if he bought it at age sixty-five, $8,900 at age seventy, and $10,500 at age seventy-five. Delaying an annuity purchase can also be advantageous if current interest rates are very low, as they are now.

Since fixed annuity payouts are partially tied to the interest rates prevailing at the time the annuity is purchased, waiting until interest rates have risen can make good sense. Deferring the decision for all or part of the money you may earmark to an annuity also allows you to modify your plans based on your changing financial or health circumstances. Say, for example, that you purchased a small annuity when you retired, with the intention of buying more later. If your or your spouse’s or partner’s health status takes a turn for the worse, you can adjust your annuity choices accordingly. If your health has taken a turn for the worse that could diminish your life expectancy, then you probably don’t want to take out a lifetime annuity.