Is An Annuity Right For Me?


Is an annuity right fore me?

Sinking Feeling


As I checked the markets this morning, the Dow starting off in the red and began a swift plunge down some 200 points.  I don’t know about you, but whenever that occurs, it feels like my stomach goes along for the ride.  Sure I expect to incur some losses from time to time, but my fear is I’ll get caught losing a huge chunk of my savings if the markets take a nosedive.


Trying To Stick To The Plan


Intellectually, I know that as the markets swoon I should (a) try not to panic, (b) avoid the tendency to sell and thereby try to time the market (which rarely works), and (c) stick to a well-diversified investment strategy.  The trouble is big losses in the market on any given day also hit me on an emotional level, not just an intellectual one.  After all, it’s not hard to envision a major market correction—especially with so many people out of work, the housing market still in a major slump and an ongoing government deficit beyond our ability to comprehend it.  This means it’s relatively easy for me to panic, want to pull out of certain stocks or funds at the slightest hint of trouble, and thereby mess up my diversification strategy.


Another Way To Diversify


It's hard to find the right mix of investments.

Diversification is the best way to manage risk.

You might say investing in stocks and bonds is tricky business, but it’s made more complicated when an investor’s tolerance for risk and loss are low.  Now, some investors have a high tolerance for risk so deciding whether to ride the market out in a downturn isn’t even a consideration.  For these people, annuities may not provide the kind of returns they seek.  On the other hand, for those who want to minimize the effect of broader market gyrations, it may make sense to convert at least a portion of their portfolio into an annuity.


The Basics


Annuities are a type of investment that provides the holder with a guaranteed payout—these can come in the form of a lump sum or a series of monthly checks.  The words to pay attention to here are “guaranteed payout”, since the whole reason to buy an annuity is to reduce the risk of loss, and what better way to do that then get a guarantee.  Let’s not forget:  (a) guarantees imply loss prevention, and (b) avoiding large losses as an investor is critical because it can take far too much time to make up for them.  See “A Key Secret To Winning As An Investor” for more on this topic.


How It Works


When you buy an annuity, you basically fund an investment that an insurance company manages for you.  Understand, the insurance company (not the government) guarantees payment—basically, the company guarantees you get a chunk of your money back plus interest each time a payment is made.  If you find this confusing, it may be helpful to think of buying an annuity as setting up your very own individualized pension plan.


Now, because the monthly payment you receive is guaranteed by the company, the return on the investment is lower than you might receive on stocks—the insurance company has to profit on this, right?  However, when you buy an annuity you should generally expect the return being offered to be better than the current rates you might get for bank CD’s or government bonds.



Immediate Annuities


Annuities come in two basic varieties:  The first is an immediate annuity.  Once you purchase an immediate annuity, the company managing it will start paying out a regular sum, either monthly, quarterly or annually (depending on how you set it up).


Note the word immediate a bit of misnomer in that you might have to wait a month, a quarter or up to a year to get your first payment.  This delay gives the company managing it time to invest the funds.


Deferred Annuities


The second type of annuity is a deferred annuity.  Deferred annuities are more like an Individual Retirement Account (IRA).  You set aside funds prior to retirement on a tax-deferred basis and then withdraw them in a lump sum or as a series of equal monthly payments upon retirement.  Depending on your situation, there may be significant tax advantages for buying a deferred annuity over an immediate annuity.  You’ll want to check with a tax adviser.


Pitfalls To Be Aware Of


Though annuities are considered safe as investments go, they still carry a certain amount of risk.  Let’s break the risk down:


Long Term Financial Strength: It’s well worth investigating the long-term financial strength of the company that manages any annuity you intend to purchase.  Note that the company selling the annuity (say your bank) may not be the company managing it (some insurance company).  You’ll want to find out who manages it to see how they compare to the competition.  After all, the value in any guarantee is only as good as company that stands behind it.  To get a company’s rating you can check Moody’s, AM Best, or Standard and Poor’s.  Just be aware that these firms have their own standards for rating companies.


No Backing Out: It’s important to understand that buying an annuity is a permanent decision.  Unlike stocks or bonds, which can be resold at any time, once you buy an annuity there’s no turning back.  When is this important?  One example might involve healthcare—suppose you were suddenly ill with a serious condition and needed a large chunk of change for an operation.  If all your funds were locked up in an annuity, you wouldn’t be able to access them.  This makes it well worth your time to thoroughly consider all your options before diving in.


May Not Be Passed On To Heirs: Unlike the investments held in a brokerage account, most annuity benefits usually die with you.  In other words, unless it specifically says so in the contract, you won’t be passing on either the monthly payment or the sum you originally invested to your heirs.  There are some annuity contracts that handle this issue differently, so be sure to check the fine print.


Inflation: Inflation can also pose a risk to annuities.  True, you many earn more on an annuity than a bank CD, but the interest on either can fall behind the rate of inflation and thereby cut into your purchasing power.


Because of the potential pitfalls, most advisers suggest holding no more than 25% of your assets in the form of an annuity.


For a good article on the pros and cons of annuities see this one at


References: Immediate Annuities: Do-It-Yourself Pensions
Wikipedia: Annuity (U.S. Financial Products)
Internal Revenue Service: Publication 575: Pension and Annuity Income

For more ideas of protecting your investments see:
12 Strategies For Successful Investing


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