Should You Invest Your Retirement Savings in an Immediate Annuity?

In a world of complex financial products, immediate annuities are refreshingly straightforward. You hand over a lump sum to an insurance company and you get a monthly check, usually for the rest of your life.

The drawback? Once you've purchased an annuity, you can't get that money back, so you should never hand over all your savings. One strategy is to add up regular expenses, such as utilities and property taxes, subtract Social Security and other guaranteed sources of income, and buy an immediate annuity to fill the gap. Keep the rest of your savings in an investment portfolio that you can tap when you need the money for other, less-predictable costs, says John Scherer, a certified financial planner in Middleton, Wis.

Choosing an immediate annuity isn't as simple as identifying the one with the highest monthly payout. Do you want a single life annuity, from which payments will end at your death? Or a joint-and-survivor annuity, which guarantees lifetime income for you and your spouse but also costs more? For example, at Immediateannuities.com, a 70-year-old man can buy a single life immediate annuity that pays $2,000 a month for about $314,000. If he buys a joint-and-survivor annuity that continues to pay $2,000 as long as he or his wife is alive, it will cost about $395,000.

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Another option is an annuity that guarantees payments to you or your heirs for a specified period. For example, with a single life with 10-year period certain contract, if you die within 10 years after you start receiving your monthly payments, your heirs will continue to receive payments for the remainder of the 10-year period. In the case of the 70-year-old man who wants income of $2,000 a month, the guarantee would add about $22,200 to the cost of the single life annuity.

Some insurance companies will let you add a cost-of-living rider to your annuity, either at a set annual rate (typically 3% a year) or one pegged to the consumer price index. The downside is that your monthly payments during the first few years will be smaller than those from an annuity without an inflation rider.

Dealing with low rates. The biggest drawback to immediate annuities is something you can't do much about: low interest rates. If you can afford to wait for higher rates, you should get a better deal. And delaying will pay off because the older you are when you buy an annuity, the higher your monthly payment.

The second option is to purchase a ladder of immediate annuities. Say you have $300,000 to invest in an immediate annuity. You would invest $100,000 this year, another $100,000 in two years and the remaining $100,000 the year after that. By spreading out your purchases, you'd potentially benefit from higher rates.

Invest with an insurance company that will survive at least as long as you do. Only six insurers licensed to sell annuities and life insurance have entered receivership since 2008, and most were small, regional companies. Even so, protect your investment by narrowing your search to insurers rated A– or better at www.ambest.com. Find out how much of your investment is covered by your state's insurance guaranty association, recommends Artie Green, a CFP in Palo Alto, Calif. Most state guaranty associations cover $250,000 or more in annuity benefits per insurer. (You can check your state's guaranty limit at the National Organization of Life and Health Insurance Guaranty Associations, at www.nolhga.com.) If you plan to invest more than your state's limit, divide your money among several companies.