Investment Updates
Annuities Provide Stability, But You Pay A Price For It
Published Tuesday, January 6, 2009 at: 7:00 AM EST
Many retirees, worried that they’ll outlive their savings, are turning to fixed and variable immediate annuities, which can guarantee a lifetime of income. But beware of their fees and inflation susceptibility.
With a fixed annuity, you trade a lump sum of cash to an insurance company. In return, the insurer promises you regular income payments for a defined period or for life. Your income payments are mostly determined by your life expectancy and how much the insurance company believes it can earn on your money. Because the insurer fixes payments based on the longevity of its entire pool of annuity customers, some of whom will die early, your monthly payments tend to be larger than you could earn on your own from similar interest-bearing vehicles.
An immediate annuity’s fixed income stream means no more worries about securities markets or interest rates—seemingly just what the doctor ordered to get you sleeping at night. But in today’s interest rate environment, the fixed nature of payments is also a potential drawback to an immediate fixed annuity. You’re locking in a relatively low interest rate for years to come, and a future brush with inflation could put you right back pacing the floor. This is what happened to retirees who retired on fixed-income pension plans in the early 1970s. Inflation of the late-1970s and early 1980s dramatically eroded the value of their income.
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