One of the financial products getting a little more play is the annuity. While annuities can be complex and troublesome, some of them work for certain people. However, there are a number of annuity products that are less difficult to understand, and that might provide a good choice for some investors/retirees.
There are products, like indexed annuities, that are somewhat straightforward, and that can help you earn a better return over time. Some annuities, when you are careful about them, can be good choices, depending on your circumstances. One of the annuity products that is getting a little more attention lately is the deferred annuity — which is also sometimes called a longevity annuity.
Deferring Your Payouts
The idea behind the deferred annuity is that you make one lump sum to purchase the annuity, and then wait at least 10 years to begin collecting on the payouts. Some retirees, looking for fixed income for retirement, buy immediate annuities, which means they pay a lump sum in exchange for a regular monthly payout. However, these payouts can be somewhat small for what you pay in a lump sum — especially if you get the variety of annuity that pays out indefinitely, rather than over a set period of time.
With the longevity annuity, the point is to help reduce the risk of outliving your nest egg. If you expect to live 25 years in retirement, but instead live 35 more years, that longevity can be a drawback. Recent stock market crashes underscore the problems with hoping that your more traditional nest egg and asset allocation plan can be problematic in terms of ensuring that you outlive your money, while still enjoying a comfortable lifestyle.
This is where the longevity annuity comes in. You could conceivably take a portion of your nest egg and use it to buy a deferred annuity. You spend the next 15 to 25 years living off the remainder of your nest egg, and then you start receiving payouts. Payouts are based on current interest rates, as well as other factors. So, you do need to pay attention. However, payouts for deferred annuities are often better than what you receive for an immediate annuity. This is because there is the possibility that you will die before payouts begin — so life insurance company can use your unpaid annuity money to send payouts to those who actually live to begin collecting.
Your larger payout can ensure that you get more bang for your buck, and it also means that you are guaranteed a certain income. So, if the rest of your nest egg performs poorly in the intervening time, shrinking to less than you expected, you still have the fall back option to keep you from outliving your money.
Risks Associated with Longevity Annuities
The biggest risk is, of course, that you will die before the payouts start. While there is a way to add a death benefit (reducing your payout), it isn’t very efficient with a deferred annuity. As a result, the entire amount is forfeited if you don’t live to begin collecting.
Another risk, of course, is inflation. Like other fixed income products, annuities can be diminished by inflation. If inflation grows at a rapid rate, the payout you thought would be sufficient when you bought the annuity might no longer provide you with the purchasing power you expected.
Also, make sure you carefully review any annuity (or other financial product) before signing on the dotted line. Many annuities are complex, and have high, hidden fees. Review your situation as well, since annuities aren’t appropriate for everyone.
Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.