Is an annuity right for you? One of Americans’ biggest fears is running out of money in retirement. In fact, one survey says that 40 percent of Americans fear retirement more than death.

It makes sense, then, that people who have the benefit of guaranteed lifetime income are more confident about a successful retirement.

Retirement income strategies

A pension is one way to achieve that. Today, though, they are mostly limited to federal, state and local government employees. Only about 14 percent of corporations offer pensions today, down from 60 percent in the 1980s.

Slightly more than 40 percent of Americans participate in a 401(k), but they are built to help you save for retirement, not about how to withdraw your savings without depleting them.

How about Annuities?

For some the answer can be annuities. Be aware, though – they aren’t for everyone, and some financial advisors are still wary of them. Annuities can be complicated, so before you decide, you should talk to a financial professional. But let’s start with some basics.

What’s an Annuity?

An annuity is a contract with an insurance company that offers a guarantee in the form of a steady stream of income or a death benefit. You can purchase an annuity with a lump sum payment or make payments over a set number of years. The agent is paid a commission, depending on how much money you invest. That’s one reason some unscrupulous agents have in the past sold them to people who should never have gotten into them.

Annuities: Immediate vs. Deferred

• An immediate annuity is funded with a lump sum payment, such as money from a retirement account or savings. You can begin to withdraw funds usually within 30 days.
• With a deferred annuity, “you don’t start taking the money until some future date, because otherwise it would be an immediate annuity,” says Robert Gilliland, managing director and senior wealth advisor at Concenture Wealth Management in Houston, Texas.

“There will be some form of a guarantee on the money,” said Gilliland. That that could be a guarantee in in the form of a stream of income, or a death benefit.”

In a sense, annuities act much like pensions. You money is annuitized over a certain period, generally your lifetime.

Types of Annuities

There are basically three different types of annuities.

 Variable annuities allow you to invest in mutual funds or Exchange Traded Funds (ETFs), offering the opportunity to grow with the market. They will either have a death benefit guarantee or some sort of income guarantee.

Fixed annuities pay a specified interest rate on your funds while they are invested. The challenge is inflation.

Indexed annuities offer guaranteed minimum rate and a maximum rate. For example, you might have a minimum rate of 2 percent and a maximum of 6 percent, said Gilliland. Your return depends on the market.

As with traditional 401(k) and other traditional retirement accounts, contributions to annuities are tax deferred. Your investments grow tax free until withdrawal, including reinvestments and dividends. The amount of the tax depends on whether you funded the annuity with pre-tax or after-tax dollars. They are taxed as ordinary income. And like other retirement accounts, withdrawals before 59 ½ will result in a 10 percent penalty.

And for the most part, gone are the days when someone dies early, and the heirs lose whatever benefit was left in the annuity. “At a minimum, the annuity contract will provide some type of residual benefit,” says Peter J. Landry, director of insurance and annuities at Wells Fargo. “That’s typically the amount that’s been put into the contract less distributions. That’s the sort of the baseline minimal amount.

In a sense, annuities act much like pensions. You money is annuitized over a certain period, generally your lifetime.

A single-life annuity would generally have the biggest payout, but payments end if the annuity holder dies. Joint and survivor annuity would continue to the spouse or survivor if the annuity holder dies. However, the payments are lower considering the risk of paying over two lifetimes instead of one. A period certain annuity pays benefits for a set period rather than lifetime – typically 10 to 20 years.

Rather than annuitizing, a holder can choose the option of taking withdrawals. Like other retirement accounts, they may be subject early withdrawal, called surrender charges, and tax penalties. However, many annuity contracts allow withdrawals without surrender charges,  as long as it is not an early withdrawal.

Annuity pros and cons 

Among the cons: the price. “The cost of annuities it’s not for everyone, but there is a degree of value certainly provided in the inherent benefits of having that annuity contract to allow allow the peace of mind,” Landry says.

And the top pro: the tax benefits and the lifetime income guarantee that annuities can provide.

Rodney A. Brooks is the former deputy managing editor/Money at USA TODAY. His retirement columns appear in U.S. News & World Report and Senior Planet.com. He has written for National Geographic, The Washington Post and USA TODAY. The author of “Fixing the Racial Wealth Gap,” Brooks has testified before the U.S. Senate Special Committee on Aging. His website is www.rodneyabrooks.com

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