Pensions, once a bedrock of our retirement system, are basically gone in the private sector, replaced by employer-sponsored 401(k) retirement plans. Workers must now figure out for themselves how to make their money last.

But most people are not saving enough, despite the fact that they are living longer. A survey by GOBankingRates found that 69% of respondents had less than $1,000 in savings.

As a result, many financial planners today recommend that at least a portion of your retirement savings be invested in something that provides a guaranteed lifetime income – regular income that, like pensions or Social Security, you will receive regardless what happens in the stock market. For many, that means an annuity.

Annuities in the past have had a poor reputation because of inappropriate sales practices and high fees. But financial planners say they have changed and should be an integral part of any retirement savings discussion. 

“For the right client in the right situation, I think annuities can work well,” says Nicholas Abrams, a financial planner and president of AJW Financial Partners in Baltimore, Maryland. “It’s the job of the financial planner to do the due diligence.”

What are annuities? 

An annuity is a contract with an insurance company that offers a fixed stream of payments to an individual, usually for the rest of his or her life. It’s used primarily as an income stream for retirees to help address the risk or outliving their savings. 

Basically, you buy a contract with an insurance company, for, say, $100,000. The insurance company, in turn, agrees to pay you a certain interest rate, and, after a certain period of time, pay you a set amount of money each month, quarter or year, for the rest of your life. Some offer the option of allowing a beneficiary to receive what is left of the money.

There are three types of annuities – variable annuities, fixed annuities and fixed-index annuities. 

• Variable annuities. You receive a higher cash flow if investments do well, and smaller payments if its investments do not do poorly. “They mimic a mutual fund,” says Abrams. “When the market goes up, your account goes up. When the market goes down, your account goes down.” But, “they are loaded with fees,” says Michael Kojonen, founder of Principal Preservation Services in Woodbury, Minnesota. “Most people who have them don’t know the fees because they don’t have to list all of them.”

• Fixed annuities: You get a guaranteed interest rate during the annuity’s accumulation phase and a steady and predictable income stream during its payout phase. “Not many people are looking for fixed annuities today,” says Kojonen. “Mostly the older generation has them. You can get an interest rate better than what you get at the bank, but usually you are just keeping up with inflation.”

• Fixed index annuities: “We are a big fan of the fixed index annuity to complement your retirement account,” says Kojonen. “They offer moderate returns when market is up and when it is down you don’t lose anything. And most don’t’ have fees.” It offers more growth potential than a fixed annuity along with less risk and less potential return than a variable annuity. “This is a hybrid, joining features of the variable and fixed annuities, says Abrams. “It mirrors a stock index, the most common being the S&P 500, but the principal is guaranteed.”

“One of the things annuities provide is guarantees,” says Abrams. “A lot of people like them because we have seen over the last 40 years a decline in defined pensions. Most workers have a lump sum payment when they retire, but they don’t have a plan on how to convert that to an income stream. An annuity will do that.”

Rodney A. Brooks writes about retirement and personal finance issues. His column currently runs in U.S. News & World Report. He has written columns on retirement for The Washington Post and USA TODAY. He has also written for National Geographic, Next Avenue and Black Enterprise magazine. He retired as Deputy Managing Editor/Personal Finance and retirement columnist for USA TODAY in 2015. 

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