By Joanne Cleaver, Paul Curcio, and David Tony, CNN Underscored Money, featuring James Ahn, CFP®, AIF®, Senior Wealth Advisor
For some retirees, annuities offer the appeal of guaranteed income for a specific amount of time. That time could be a few years or a lifetime, however long that turns out to be.
But annuities can be hard to understand. How much money do you have to commit to get an income that’s worth sacrificing flexibility? How can you figure out if the guaranteed return of an annuity complements your other money management tools?
In short, how do you weigh the pros and cons to determine if annuities are a good investment for you?
Understanding annuities: What they are and how they work
Annuities are insurance products that pay you while you are still alive. In exchange for a lump sum or a series of payments, the insurer provides you with a guaranteed monthly income. The insurer invests the money you hand over — almost always in conservative vehicles like bonds, as dictated by the state insurance departments that regulate insurance companies. It’s up to the insurance company to extract sufficient returns from the money to support the monthly income it must send you. If the investments don’t deliver, the insurance company absorbs the hit. You still get your income. But, if the insurance company strikes gold, you don’t get a bonus, either.
Or do you?
Different types of annuities
Consumers understandably hesitate to hand over a big chunk of money in exchange for monthly income, with no opportunity for upside or to recapture any of the funds after a period of time or after they die, noted James Ahn, senior wealth advisor with advisory firm Halbert Hargrove.
Insurance firms have concocted a variety of annuities to offer variations on the theme. Buckle in: “The landscape is complex and only continues to get more complicated,” said Ahn.
Fixed annuities
Plain vanilla is the fixed annuity: You hand over a pile of money, and the insurer pays you back with monthly income — for a predetermined period of time, such as the rest of your life. If you die before you’ve received many monthly payments, you’re out of luck. So are your heirs. The insurance company keeps it all. But, if you live on and on — so long that the insurance company pays you more than it started with or earned — you get more than your money’s worth. “Your job after you go into the contract is to live as long as you can,” quipped Ahn.
But what if you want to get in on some of the market gains that the insurance company reaps? Can you have your annuity cake and eat some market gains, too?
Variable annuities
Maybe, with a variable annuity. A variable annuity, explained Ahn, ties the amount funneled to your monthly payments to market performance.
“The risk of the payment is based on underlying performance of those investments, and there’s a higher upside potential,” he explained.
You can pay extra to assure a minimum monthly payment — in a way, an insurance on the insurance.
