One of the greatest dangers we face as we get older is the risk of running out of money. One way to put such a worry to rest is with a certain kind of annuity. On top of providing you with a steady stream of income, this annuity can simplify your finances and lower your risk of mismanaging your money as you age.
Intro to immediate annuities
First off, let's go over what annuities are. They involve contracts with insurance companies, whereby you typically hand over a significant sum of money and receive regular payments immediately or in the future -- for the rest of your life (and, if you want, for the rest of your spouse's life, too).
There are lots of different kinds of annuities: immediate versus deferred (paying you immediately versus starting at some point when you're older), fixed versus variable (fixed payouts versus payouts tied to the performance of the market), lifetime versus 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 unsuitable for many people, as they charge steep fees and/or carry restrictive terms. But immediate or deferred fixed annuities are smart options for people who are in or near retirement.
Your annuity strategy
The average Social Security benefit, as of September 2015, was $1,338 per month, or about $16,000 per year. That's not enough to provide you with a secure and comfortable retirement, so you'll need to establish other income streams. Investment accounts and retirement accounts (especially those that generate significant dividend income) can grow your wealth the fastest, but they can also fall in value if the economy goes through tough times. That risk might keep you at night, and when you're living off your retirement savings, a market crash can be devastating.
Enter the annuity. Prevailing interest rates will influence how much insurers are willing to pay you, and these days rates are extremely low. Still, if you're a 70-year-old man, $100,000 may get you an immediate annuity that pays about $640 per month, or $7,700 per year. A $300,000 purchase would generate about $23,000 annually. (Women can generally expect lower payouts, because women tend to live longer than men.) If you have that kind of money, an annuity can be a major complement to Social Security income.
Keep in mind that fixed annuities can start immediately or can be deferred. If you think you have sufficient income for 20 years only, then you might buy a deferred annuity today that will start paying you in 15 years or so. That way you'll be assured of income later, too.
Declining financial skills or interest
Another great benefit of annuity income, like Social Security income, is that once it starts, it can keep paying you for the rest of your life -- with little effort on your part. Most other investments demand that you monitor them closely and regularly, occasionally buying into new investments and selling out of others. That's no big deal for some people, and some even consider it a pleasure. However, as you get older, you'll be less able -- and perhaps less willing -- to oversee your finances.
Our cognitive abilities decline over time, whether we're aware of it or not. Some studies have even suggested that mathematical and financial skills are among the first to go. According to a 2010 study by the Center for Retirement Research at Boston College, "Individuals make the most effective financial decisions in middle age, resulting in lower fees and interest rates on credit and loan transactions." The study found that financial decision-making peaks near age 53, noting, "Financial performance declines for older adults, raising a potential concern as the retirement system has shifted more decisions to individuals." A more recent study from the same center found that while financial decision-making skills decline, confidence about them often does not.
To combat your declining financial skills or interest, you might enlist a trusted loved one to help you, but even that can present some risks if they're not good at managing money or have any ethical shortcomings.
With annuity income, once you buy the annuity, you can rest assured that as long as the insurer is solvent (always buy from highly rated insurers), your checks will keep coming, no matter how the stock or bond market is performing. You can also spend a little extra (or accept a little less) in order to have your annuity checks adjusted to keep up with inflation. Whatever your needs, there's a good chance you can find an annuity to meet them.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article. 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.