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Surprise! This Annuity Could Save Your Retirement

By Dan Caplinger - Sep 13, 2015 at 9:01AM

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Focusing on the insurance value of annuities can lead to some attractive results.

Photo credit: Got Credit.

Annuities have gotten mixed reviews from the financial community, with some praising their unique attributes while others point to high costs and confusing provisions. Yet even though you can find all sorts of complicated annuities that are open to criticism from skeptical financial planners, there's a much simpler type of annuity that can actually give older Americans the exact protection they need when they need it -- and often at a cost they can afford. Let's take a closer look at the product that one study discovered could have a significant role in saving your retirement finances from potential disaster.

Replacing the private pension
A recent study from the National Institute on Retirement Security For decades in the 20th century, many workers relied on pension plans from their employers to make ends meet during their retirement years. These pension plans featured predictable, reliable streams of monthly income that would last as long as a worker -- and in some case, the worker's spouse -- survived. Retirees didn't have to do anything to manage the investments that backed up those pension payments. Instead, it was up to the employer to make sure it could afford to pay those benefits -- and if it couldn't, the company would have to pony up additional money of its own in order to make up the difference.

More recently, though, many private pensions have disappeared. That has left people with a funding gap in their retirement, and the move toward 401(k) plans has taken the emphasis away from creating monthly income and replaced it with the need to build up large nest eggs to finance a retirement that can often last as long as 30 years or more.

The logical product to replace private pensions is the annuity. More specifically, immediate annuities pay monthly streams of income to the annuity holder, allowing you to trade an upfront premium payment for the right to receive checks for the rest of your life. Yet the problem with immediate annuities is that they're relatively expensive, especially when interest rates are below long-term historical levels. In other words, you'd have to save so much to buy an immediate annuity that would meet your needs that few people can expect to succeed.

Enter the longevity annuity
The reason why immediate annuities are so expensive is that they start paying out income right away. Yet there's another insurance product that the study refers to as a longevity annuity that works a little differently. And, because it does, it isn't nearly as expensive in providing the coverage that many retirees need.

The longevity annuity, also known as a deferred income annuity, differs from a standard immediate annuity in that it doesn't start making income payments right away. Instead, you can set up the longevity annuity to start paying monthly income years or even decades into the future, with many people choosing to trigger payouts beginning in their 80s. After the payments start, they can continue for the person's lifetime, just as with a regular annuity.

There's a big trade-off with a longevity annuity. On one hand, the odds are higher that you'll never collect a single penny under a longevity annuity, because if you die before you reach the triggering age, then the premium you paid won't necessarily result in any payoff at all. Yet because that risk is built into the price, longevity annuities cost a lot less than regular immediate annuities, and the potential reward is therefore larger than with a longevity annuity.

Still, one reason to embrace longevity annuities is that they leave other retirement assets available for other use. By breaking out a big portion of your income needs after you reach a key age, such as 80, you can take the remainder of your retirement savings to focus on your financial needs earlier in retirement. That can allow you to be more aggressive either in spending down your assets or in investing your savings to produce even better long-term returns.

Annuities have earned a bad reputation in some quarters, as the commissions that insurance providers pay to those who sell these products can sometimes lead to inappropriate use. For many, though, considering a longevity annuity is a smart move that can help you avoid the very real risk of running out of money late in your retirement years.

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