by Archie M. Richards, Jr., CFP^®
September 26, 2005

Immediate annuities are great. Not enough people use them.

Many people reaching 65 think they'll have 15-to-20 years of retirement. But there's nearly a 50-percent chance that one of the spouses will live beyond age 90.

With an immediate annuity, you don't have to worry about outliving your income. Depending on the company and interest rates, a man 65 can receive an income stream in excess of 7.5 percent a year - some of it interest and some the return of principal.

You can't outlive the income. The insurance company takes the risk of your living too long. Even if you're still kicking at age 115, the company goes on paying and paying.

It isn't in it for charity, of course. If you buy an immediate annuity, receive income for a year, get hit by a truck and die, sorry, the income stops and the insurance company keeps the difference.

For those who die too soon, the insurance company profits. For those who die too late, it loses. The company tries to pay out just the right amount to everyone so that, on balance, it ends up with a profit. We wouldn't want it any other way. If the insurance company goes busted, everyone loses.

You aren't required to receive annuity income on your life alone (a single-life annuity). You can receive it on the lives of you and another party, presumably your spouse (a joint-life annuity). In case both parties of a joint-life annuity die within 10 years, some people arrange for the income to continue for at least 10 years, to benefit the children (joint-life annuity with 10 years certain - you can make it 20 years, if you like). Naturally, the longer the income is expected to run, the lower the monthly payments from the beginning.

Not enough people use immediate annuities. One reason may be because the word "annuity" has two meanings that are easily confused:

• It can mean a stream of income guaranteed by the insurance company, as above.

• It can also mean the entire annuity policy of which the income stream is a part. You don't have to begin receiving income right away. You can arrange for the money to be invested within the policy, with the earnings accumulated. This is called a "deferred annuity," and it's what most people buy.

The earnings in a deferred annuity are not currently taxable. Not until money is paid out are the earnings taxed. In the meantime, the policy owner earns money on funds that weren't paid out earlier in taxes.

When you reach an advanced age, say, 85, you're required to "annuitize." You must then arrange for funds to be paid out to you. Few people wait this long. Most people withdraw the money (or die) before annuitizing. Of all U.S. annuity policies, less than 3 percent have been annuitized and are paying out regular income.

This is unfortunate. Having an income you can't outlive is comforting. Don't use annuities just to save taxes. Arrange your financial affairs because of the economics, not the taxes. Don't allow the tail to wag the dog.

An annuity can be invested solely in bonds (fixed annuity) or in stocks (variable annuity). In the latter case, many insurance companies offer guarantees to provide some protection against stock prices falling.

Most annuity policies pay hefty commissions. In many cases, the commissions are not charged up front. The salesman can truthfully boast that "all the money goes to work for you."

But don't be fooled. The insurance company pays a commission up front and is reimbursed from the policy over many years. If you redeem within a certain number of years, you're charged extra for the redemption. These costs aren't called commissions; they're called "charges." But they're actually disguised commissions. Be careful. The more that's paid to the salesman, the less you have left.

I recommend Vanguard, which has an affiliated insurance company (800-523-7731) or Ameritas (800-745-1112). These companies offer excellent annuities with low costs and no commissions.

Immediate annuities are terrific. They provide an income stream you can't outlive.