After you retire, one of the biggest challenges you'll face is figuring out how to turn your retirement nest egg into the cash you need to pay your living expenses. Having spent a lifetime accumulating wealth, it takes a major shift in your thinking to switch gears and think about spending that wealth.
If you could just move all your money into a bank account and have enough to spend it down gradually over time, that would be simple. But most people need to have their retirement investments continue to grow over the 20 to 30 years or more a typical retiree might live after stopping work. At the same time, though, making the same sort of long-term investments you did while you were working doesn't address your need for income.
That's why the financial products that many are increasingly turning to are annuities. And while annuities have their benefits, they aren't a perfect slam-dunk investment.
Looking for a sure thing
In a world of uncertainty, annuities offer the promise of guarantees. Exactly what annuities promise depends on which type you choose, but the gist is that at some point, you can go to the insurance company that sold you the annuity and have it convert your money into a stream of regular income that will last for as long as you live. Doing so not only potentially takes care of your immediate income needs but also gives you some certainty about a very uncertain thing: whether your money will run out before you die.
There are various types of annuities:
- Immediate annuities have you pay a sum of money to an insurance company in exchange for monthly payments that you start receiving immediately. You can arrange to get payments for a fixed period or throughout your lifetime.
- Deferred annuities don't start making payments right away. Instead, they accumulate income and investment gains until you choose to start receiving payments. You can choose fixed annuities that pay interest like bonds and other fixed-income securities, or indexed and variable annuities tied to particular combinations of stocks, bonds, and other investments.
If all that sounds complicated, that's because it is.
The insurance industry is constantly changing to address the shifting needs of potential customers, and lately, that has involved making annuities more flexible. Moreover, the risks involved for insurers are very real; during the financial crisis, MetLife (NYSE:MET) was just one of many companies that had to raise fees to cover the unexpectedly large cost of providing annuity guarantees.
No longer do you have to settle for plain vanilla annuities that can leave your loved ones with nothing if you die shortly after buying an annuity. With a host of different options, you can tailor your risk exposure in almost countless ways, including minimum death benefits and guaranteed income levels during retirement.
Of course, such flexibility comes at a price. Not only do annuity investments typically carry higher base fees than mutual funds, but they also impose extra costs for those additional options that so many customers want. That can turn an otherwise attractive investment vehicle into one that's doomed to underperform its benchmarks.
Still, just as some fund companies charge less in fees than others, so too can you find bargains on annuities. And with fixed annuities offering higher rates than bank-insured CDs with only marginally more risk in some cases, they can be an attractive alternative, especially when rates are low.
Think about it
Annuities have a reputation for being suboptimal investments, and in some cases, they've earned that reputation. But with financial markets refusing to cooperate with investors who need to see better returns in order to keep income levels stable, adding an annuity to your retirement portfolio mix might give you not only guaranteed investment results, but also the peace of mind you need to be happy in retirement.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.