What Are Income Annuities?

Income annuities enable you to convert a large sum of cash into a monthly, quarterly, or annual paycheck. You give the lump sum to a reputable insurance company, and the insurer issues a contract that promises to pay you (or someone you choose) an income for an agreed-upon length of time.

Income annuities are attractive to many people for two basic reasons: First, they deliver more income than a comparably safe investment in U.S. government bonds. Second, they provide an income that you can’t outlive.

In this way, income annuities protect you from the following risks:

• Timing risk. Just before or after you start drawing down your savings, a sharp market downturn will take a huge bite out of your portfolio and increase the chances you’ll run out of money too soon.

  
  



• Investment risk. The returns on your portfolio won’t be enough to support you in retirement.

  
  



• Longevity risk. You’ll outlive your income.

  
  

An income annuity transfers these risks to an insurance company. In return for your purchase payment —usually $100,000 or more — you receive an income (monthly, quarterly, or annual) that’s immune to bond defaults, resistant to stock market crashes, and can last for as long as you live.

A “life” annuity guarantees that you will receive an income as long as you live (or as long as either you or your spouse is living). But this guarantee assumes that the insurance company will remain financially strong enough to meet its obligations for the next 30 years or more. If the insurer fails, your payments will be in jeopardy. That’s why you must buy your annuity from a gilt-edged, A-rated company.

The simplest type of income annuity is known as a SPIA (spee-ah). Income from a SPIA begins no later than one year after you purchase it. When brokers and advisers talk about SPIAs — and they rarely do — they usually mean annuities that offer a fixed payment every month. But you can also buy a SPIVA (a single premium immediate variable annuity) whose payout rate fluctuates with the stock market.

There are dozens of possible combinations of options. And each of them will produce a different monthly payment from the same initial premium. Keep in mind, however, that you’ll get the highest monthly payment if you relinquish all control over your money. The more control you retain, the lower your income will be.

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Source:http://www.dummies.com/how-to/content/what-are-income-annuities.html