The Cash Flow Clock: For Retirees - Book - Page 48
The Cash Flow Clock
Annuities
We have discussed annuities to a certain extent, but they deserve their own
chapter. Everyone seems to have an opinion about annuities, but few
actually understand them.
Annuities are investments offered by insurance companies that are not life
insurance. There are several kinds of annuities, each with different features,
benefits, and drawbacks. There are also two primary purposes for annuities.
Annuities were first created to generate an income stream for life. Life
insurance can protect us from dying too soon and leaving a financial void for
our family and loved ones. Annuities can protect us from living too long
(past the time that we have spent all of our assets) and creating a financial
burden for our family and loved ones.
Employers used to provide annuity payouts (called pensions) for retirees but
those are becoming less common. The burden of income planning has been
placed on the individual investor. Assets are transferred to an insurance
company with the promise that the company will pay out an income stream
for either a certain amount of time or for however long we, or our spouse,
are alive. If we pass prematurely, the remaining cash value in the annuity is
passed to our beneficiaries. If the cash value gets used up and goes to zero,
the income continues according to the contract. The longer the annuitant is
alive, the more the insurance company has to pay out. We are paying the
insurance company to manage our longevity risk for us.
Some annuitants need income to begin immediately. Others want to plan for
an income need in the future. Annuities offer different ways for assets to
grow until they are needed for income.
Variable Annuities (VA) are like mutual funds offered by insurance
companies. They have high growth potential but also high risk. Like most
mutual funds, they have higher fees and tend to underperform their
benchmarks.
Fixed Annuities (FA) are like CDs. They pay a fixed rate of return for a
fixed period. They usually offer higher rates of return and better liquidity
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