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After a lifetime of scrimping and saving to build a retirement nest egg, you'll face a brand new challenge once you actually quit working for good: how to turn the money you've accumulated into a regular income you can count on to cover your living expenses and give you the retirement you've always dreamed of. Among the many choices you have to get your portfolio to generate income, one product gives you an easy one-step solution -- as long as you're comfortable with the potential downside.
Build your own pension
In this month's brand new issue of the Fool's Rule Your Retirement newsletter, which comes out today at 4 p.m. Eastern, Foolish retirement expert and financial planner Robert Brokamp continues his series on getting income in retirement. In the previous issue, Brokamp looked at investing in stocks and bonds to generate income. This time, he's turned to a product that many financial advisors argue fervently about, both for and against: buying an annuity.
The most confusing thing about annuities is that there are so many different kinds. On the one hand, many annuities, such as the index annuities that you can buy from ING (NYSE: ING ) , Lincoln Financial (NYSE: LNC ) , and a host of other insurance companies, have a primary objective that combines growth with principal protection -- yet also carry high fees and expenses as well as surrender charges if you need your money back early. Even relatively safe fixed annuities are often sold more for their income-producing potential than for their insurance characteristics.
Yet the true ultimate purpose of an annuity is to provide regular income. Although you can get that by annuitizing products like the ones described above, you can also skip the middle step by buying what's known as an immediate annuity. Basically, the transaction is as simple as this: You make an initial lump-sum investment, and in exchange, the annuity company will tell you exactly how much you'll earn every month for as long as you live.
Why an annuity?
Skeptics often point to the fact that returns on immediate annuities aren't always attractive compared to what you could generate by investing that lump sum yourself. For instance, a standard annuity for a 65-year-old man pays income of a little less than 7% of the amount you invest. With several high-yielding dividend stocks, including rural telecom provider Frontier Communications (NYSE: FTR ) and mortgage REIT American Capital Agency (Nasdaq: AGNC ) yielding quite a bit more than that, you may wonder why you need an annuity at all.
The answer is that annuities make those payments a sure thing, while investing in stocks is anything but. In fact, during the financial crisis a few years ago, many insurers, including Hartford Financial (NYSE: HIG ) , saw significant losses from the guarantees they had made to their annuity customers. In response, MetLife (NYSE: MET ) and the John Hancock unit of Manulife Financial (NYSE: MFC ) made fee increases or product changes in order to recoup some of their losses going forward.
Be smart about annuities
But before you buy an annuity, you need to make sure what you're getting into. As Brokamp points out, you need to consider several additional choices with an annuity, such as whether to take advantage of inflation-adjusted payments and at what age to start taking payments. In addition, if you get Social Security payments, they might well have a big impact on how much you need to get from an annuity. Perhaps most importantly, once you buy an immediate annuity, you won't have access to that lump sum in an emergency -- so you need to be sure about your decision.
As simple as it may sound, annuities can get complicated in a hurry. But one of the things Rule Your Retirement does for its subscribers is to turn complicated topics like annuities into easy-to-follow road maps that tell you exactly what you have to do to make a smart decision. Best of all, you can learn all about annuities in the new issue free with a 30-day trial subscription.
Annuities have a bad reputation, but used correctly, they can help make your financial situation much more secure. In an environment where investment income is hard to come by, the right annuity can give you the money you need to have a happier, more comfortable retirement.