A few months ago, I advised you in these pages how to stay calm during a bumpy stock market. (See "Your Money: Bumpy market? Stay calm," in our June 15, 2007 issue). Since then we've seen some big plunges. Market-weary clients are asking me whether they should get out of stocks and buy annuities, which can guarantee them income for life. While annuities aren't right for everyone, in certain situations they can be useful, no matter what your age.
What are annuities, anyway?
Fixed and variable annuities are contracts between you and an insurance company. You fund the annuity through either a lump sum or periodic payments, and in return, the insurer agrees to "annuitize" your assets, paying you a stream of income starting either immediately or at some future date. The earnings on your money grow tax-deferred until you start taking distributions, which can begin well after the age required by most retirement plans. Distributions can last for a specific period-20 years, say-or for your (or your spouse's) entire lifetime.
The major advantages of annuities include: tax-deferred growth; the option of lifelong income; and the guarantee you won't lose any of your fixed annuity principal regardless of market movements (you can lose with variables during your lifetime). But the disadvantages stop many investors in their tracks. Most annuitized payments don't increase over time, so inflation eats away at your real return as you age. Besides, the guarantee of principal becomes irrelevant as stocks advance, so while some fixed annuities do offer minor increases as an inflation offset, you'll pay extra for that feature. Earnings are taxed at ordinary income rates, so you may do better with other investments taxed at the lower rates for qualified dividends and long-term capital gains. And, it'll likely take years for tax-deferral benefits to overcome the steep fees that many insurers charge for annuities.
Who should invest in annuities, and when?
If you're already contributing the maximum allowed to your 401(k) or IRA, and want additional, long-term tax-deferred growth on your investments, a fixed or variable annuity could be the ticket. If you're in your 30s or 40s and can manage to come up with enough to fund an annuity, just be sure to stick with it for a good 20 years, to offset and overcome its high expenses. Otherwise, instead of fixed annuities, you may be better off with the security and tax-free income of municipal bonds, for example.
A fixed annuity works well when you want a guaranteed income in retirement, no matter what your current age and regardless of stock market crises. If your retirement date is imminent, you can purchase an immediate fixed annuity with a lump sum payment and start collecting right away. For instance, someone who's 55 and hands over $100,000 can expect to receive about $600 a month for life, depending on the insurer. Annuities can also save you from yourself if you can't control your spending, since the money's essentially locked up for an extended period.