Your Financial World:  Annuities                                                                     

Most college students don’t have to worry about annuities; at least not immediately. But it is very likely that when it comes time to retire, you will turn your defined contribution retirement plan accumulation into an annuity.   And, in the meantime, someone may try to sell you one.  Here’s what they are and how they work.

An annuity is a financial instrument in which a person (called the “annuitant”) makes a payment in exchange for the promise of a series of future payments.  It’s similar to a bond. Annuities are typically sold by insurance companies, and they come in many forms and have many names.  There are fixed period vs. lifetime annuities.  A fixed period annuity makes fixed monthly or annual payments for a specified period like 10 or 15 years.  By contrast, a lifetime annuity guarantees periodic payments for the remainder of the annuitant’s life (and possibly, that of the person’s spouse as well).   It is the reverse of life insurance.  A life insurance policyholder pays the insurance company each year or month, with the beneficiaries receiving a lump sum when he or she dies.  An annuitant makes a lump-sum payment and then receives a stream of payments until death.

Then there are deferred vs. immediate annuities.  An immediate annuity starts right away, while with a deferred annuity, contributions are made and investment returns accrue for payment at a later date.

Once you realize that annuities are a type of investment, things get even more complicated.  Insurance companies offer fixed vs. variable annuities.  Fixed annuities guarantee the principal value plus a minimum interest rate, like a bond.  Variable annuities can be invested in a variety of mutual funds offered by the insurance company, and the growth depends on the performance of the funds.  Variable annuities are complicated, and insurance companies will combine them with life insurance products. 

Where does this leave us?  Annuities are useful, but you should probably hold off buying one until you are ready to retire.  Invest your retirement savings in index mutual funds with low expense ratios, and buy term life insurance. When the time come to retire, then call an insurance company and by an annuity.  That’s going to be the cheapest, easiest, and simplest way to go.

http://www.iii.org/individuals/annuities/