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By Walter Updegrave
November 1, 2016

Almost half of the 1,000 adults polled for TIAA’s 2016 Lifetime Income Survey said the primary goal for their retirement plan was to provide guaranteed money to cover their living costs in retirement. Yet when they were asked whether they owned or planned to buy an annuity—the only investment that can actually guarantee income no matter how long you live—only 23% answered yes.

There are any number of reasons for this apparent disconnect, but one is that many people have mistaken notions of how annuities work. Here are five major misconceptions about annuities that may keep you from even considering making one a part of your retirement income plan when perhaps you should.

1. Annuities are just too damn complicated. Many annuities can be confusing. With their byzantine methods of calculating returns (daily average, annual point-to-point, monthly point-to-point), for example, fixed indexed annuities can get mind-numbingly complex. And trying to get a handle on the different layers of fees in some variable annuities (mortality and expense charges, subaccount fees, annual levies for death benefits and various guarantees), not to mention the ins and outs of their add-on income riders, can give you a migraine.

But there are also annuities that are pretty straightforward, and fortunately they also happen to the ones that are well-suited for generating lifetime income in retirement. With an immediate annuity, for example, you invest a lump sum with an insurer in return for monthly payments that start at once and continue as long as you live. Today, a 65-year-old man investing $100,000 in an immediate annuity would receive about $525 a month for life.

A longevity annuity works the same way, except that payments don’t begin until, say, 10 to 20 years down the road, which allows you to lock in a substantial future monthly payment for a smaller investment. A 65-year-old man who invests, say, $50,000 today would receive about $610 a month for life starting at age 75 or roughly $2,020 a month if he holds off receiving payments until age 85.

You can see how much you might receive each month from an immediate or longevity annuity based on your age, sex, how much you’re willing to invest and when you want payments to begin by going to ImmediateAnnuity.com’s annuity payment calculator, which you’ll find in RealDealRetirement’s Tools & Calculators section. If you want the payments to continue as long as either you or your spouse or partner is alive, you can choose the “joint life” option.

2. If you die soon after investing in an annuity, you’ll have thrown your money away. It’s true that if you buy an immediate or longevity annuity and don’t live very long afterwards, you’ll have shelled out a considerable sum and received little in the way of monthly payments. Which is why buying an annuity for lifetime income probably doesn’t make much sense if you have good reason to believe you’ll have a shorter-than-average lifespan (although if you’re part of a couple, you’ll also want to consider how long your spouse or partner may be around).

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But even if you are in good health and end up dying early because of some fluke of fate, that doesn’t mean you’ve squandered your money by buying an annuity any more than people who pay homeowners and auto insurance premiums are wasting their dough if their house doesn’t burn down or they don’t have a horrific car accident. When you put savings into a lifetime income annuity, you’re buying more than monthly payments, you’re also buying insurance—specifically, insurance against outliving your assets should you live a very long time.

3. Annuities aren’t appropriate investments if you think you’ll need access to your savings for emergencies. When you buy an immediate annuity or a longevity annuity, you typically give up access to the funds you invest in order to get that guaranteed monthly income for life. So, yes, the savings you devote to such annuities are no longer available to cover any emergencies or pay extra expenses that may pop up.

But that doesn’t necessarily mean an annuity can’t play a role in your retirement planning. What it means is that you should consider putting only a portion of your savings into an annuity, say, 10% to 25%, or enough so that your annuity income combined with Social Security covers all or most of your essential living expenses in retirement.

You can then invest the remainder of your nest egg in a diversified mix of stocks and bonds that jibes with your tolerance for risk. By taking this two-pronged approach, you’ll be able to take advantage of the benefit that only an annuity can offer (guaranteed income no matter how long you live regardless of how the financial markets perform) while having the rest of your retirement stash invested for long-term growth and accessible should you need to tap it.

4. You can get a higher payment than an annuity offers by investing in a portfolio of stocks and bonds. It’s pretty much impossible to beat, or even duplicate, an annuity’s payments investing on your own or with the help of a pro, unless you’re willing to take more risk. And even then there’s still the chance that you could deplete your assets too soon.

The reason is that when insurance companies create an annuity, they pool the money of thousands of annuity owners, some of whom will die sooner than others. So when setting annuity payments, insurance company actuaries are able to include what are known in insurance circles as “mortality credits,” essentially money that would have gone to annuity owners who die early but that’s instead transferred to those who live longer.

Thus, each annuity payment effectively includes three elements: investment gains; the return of a portion of your original investment; and the mortality credits, which you can think of as an extra piece of income or return. Mortality credits aren’t available to you when you invest as an individual, which means the only way for you to get the same level of income an annuity offers is to invest more aggressively. That may or may not work, and in any case still leaves you vulnerable to depleting your assets if you live a very long time.

5. You shouldn’t buy an annuity if you want to leave money to your heirs. This might be the case if you were to put every single cent of your savings into an immediate or longevity annuity. But if you follow the strategy I mentioned above and put only a portion of your savings into an annuity, you would still have assets that you could pass along to your heirs, assuming you manage withdrawals from your investment portfolio so you don’t deplete it too soon.

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Besides, if you just can’t handle the idea that none of the money you devote to an annuity will be available to your heirs—even if your annuity investment represents a small part of your nest egg’s total value—there are ways to ensure at least some of your annuity investment can go to others after you’re gone.

For example, if you choose the “life payments with 10-year period certain” option, your annuity is guaranteed make payments to you or your beneficiary for at least 10 years. So if you die two years after buying it, your annuity will continue to make payments to your beneficiary for eight more years. Fifteen-, 20- and 25-year period certain options are also available. Some annuities also offer a cash-refund option, which guarantees that if the payments you’ve received at the time you die are less than the amount you invested, your beneficiary will receive the difference. Just remember that you’ll have to settle for a smaller monthly payment if you choose such options.

Of course, misconceptions or no, there are plenty of valid reasons for saying no to an annuity purchase. If your retirement nest egg is so large that your chances of depleting it are minuscule, you probably can get along just fine without an annuity. The same may be true if you get enough income from Social Security and pensions to cover all or most of your basic living expenses. And if you simply prefer managing your investments on your own and are confident you can develop a withdrawal strategy that will give you the income you need without running through your savings too soon, an annuity is probably not a good fit for you.

But if you’re going to eliminate annuities from your retirement income strategy, just be sure you’re doing it for a good reason, not because of some misconception.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com. You can tweet Walter at @RealDealRetire.

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