An annuity can be like a cash machine for you, if you choose wisely. Photo: Bill Selak, Flickr
Unless you're substantially wealthy, you'll need income in retirement. That can come from a variety of sources, and one source to consider is an annuity.
Be careful, though, because annuities can serve you very well or very poorly, depending on the choices you make. Here are some tips for anyone considering an annuity in 2016 -- or beyond.
Choose carefully
First off, understand that there are lots of different kinds of annuities, and choose carefully. For example, annuities can be immediate or deferred (paying you immediately vs. starting at some point when you're older), fixed or variable (certain payouts vs. payouts tied to the performance of the market or part of the market), lifetime or fixed-period (paying until death or paying for a certain span of time), and so on. Some annuities, such as indexed annuities and many variable annuities, are problematic and unsuitable for many people, charging steep fees and/or carrying restrictive terms. They'll often help the people selling them more than they help you.
On the other hand, immediate or deferred fixed annuities are smart options for many retirees or those approaching retirement. You pay an insurance company a lump sum (or installments) and in return you receive payments -- now or later. The payments are often monthly, but can be quarterly, annually, or even a lump sum. They can last for a fixed number of years or for the rest of your life. Pay a little extra (or accept smaller checks) and you can have your payouts last until your spouse's life, too, and/or be adjusted to keep up with inflation over the years. As an example, $100,000 can buy a 70-year-old man about $640 per month, or $7,700 per year. A $300,000 purchase can generate about $23,000 annually.
Consider "longevity insurance"
A deferred annuity (sometimes called longevity insurance) can also be smart. It's a fixed annuity, but one that doesn't start paying immediately. Instead, the insurer agrees to start paying at a future point, such as when you turn a certain age.
A deferred annuity can be a great protection against the risk of running out of money late in life. For example, if you're rather sure that you have sufficient income for at least 20 years, you might buy a deferred annuity today that will start paying you in 15 or 20 years. Deferred annuities cost less than immediate annuities, as they let the insurance company invest your money for a long time before beginning to pay you.
Focus on highly rated insurers
It's important to understand that an annuity is only guaranteed as long as the insurer remains solvent, so if you go annuity shopping, seek highly rated insurers. You can reduce your risk even more by dividing your annuity money between several insurers.
Consider laddering
Another good strategy, especially in our current low-interest rate environment, is laddering. When buying an annuity, you'll get less bang for your buck when interest rates are low, so it can pay to delay buying until rates rise -- if you can. That's not always possible or desirable, though, so you can ladder by dividing your total planned annuity purchase into chunks and buying installments over time. Perhaps, for example, you'd buy a third of the annuity income you want now, and another third in a few years when rates are likely to be higher, and the last third even later.
Explore alternatives
Finally, it's smart to remember that when it comes to retirement income, annuities aren't your only options. Dividends paid by healthy, growing companies, for example, have the terrific habit of being increased over time. Imagine that you have $300,000 invested in a portfolio that generates $6,000 in dividends this year. That's an overall yield of about 2%. If those payouts are upped by an overall annual average of 5% over a decade, they'll approach $9,800 in 10 years. Dividends don't officially offer inflation protection, but they do often grow at a fast rate than inflation, which can be very welcome in retirement.
Social Security is another retirement income source to plan for and expect. As of October, 2015, the average Social Security retirement benefit was $1,338 per month, or about $16,000 per year. By reading more about it and strategizing well, you can likely boost the size of your benefits checks.
Don't leave your retirement income up to chance. Give the topic some thought and come up with a plan for how you'll support yourself in retirement. Consult a fee-only financial planner too, if you're not comfortable planning on your own.
