2 ways to get guaranteed retirement income

Willie Grace | 5/6/2015, 12:40 p.m.
Ask advisers this question and the answer may depend on how the adviser makes his living. If he or she ...
It's easy to live for the moment and leave planning the future to another time. But when it comes to planning for your retirement, it is never too early.

NEW YORK (CNNMoney) -- My wife and I have about $1 million in stock and bond funds in 401(k)s, IRAs and other retirement accounts, but are wondering whether to buy an annuity when we retire within the next few years. Do you think that's a good idea?--Scott C.

Ask advisers this question and the answer may depend on how the adviser makes his living. If he or she sells annuities, you'll probably hear how wonderful annuities are and why you should have one. If, on the other hand, the adviser charges a fee to invest retirees' savings for retirement income, you'll likely get an earful about annuities' shortcomings and reasons why keeping your savings in stocks, bonds and other investments is the better way to go.

The problem is that these answers may reflect what's best for the adviser rather than what's right for you.

So, let's try a different approach. Let's weigh the pros and cons of annuities, and then consider why you might want to put a portion of your retirement savings into one or more annuities, or why you might decide to exclude them from your investing strategy altogether.

The single biggest advantage annuities have over other investments is that they can pay income that won't run out no matter how long you live. They're also able to generate a higher level of sustainable income than you could generate investing on your own taking comparable risk. How are they able to do this? Simple.

When insurers create annuities, they pool the money of thousands of investors. Insurers are then able to base payments not just on a projected investment return, but on their actuaries' estimates of how long the annuity owners will live. Knowing that some annuity holders will die sooner than others, insurers are able to boost annuity payouts beyond what investment returns alone can support by in effect transferring money from those who die early to those who die late. These payment enhancements are known as "mortality credits."

Of course, annuities also have drawbacks. If you want to maximize the size of the annuity's payment, you usually lose all or most access to the money you invest an annuity. So it won't be available for emergencies and such, or as a legacy to your heirs. And if you die earlier rather than later, then the total value of the payments you receive may not be much more (or could even be less) than the amount you invested. So an annuity wouldn't make much sense if you've got serious health issues that might result in premature death.

There's also the chance that the insurer might not be able to fund those payments, although that risk is relatively small since insurance regulators require insurers to set aside reserves to meet obligations. You can further protect yourself by sticking to annuities issued by insurers that get high financial strength ratings from companies like A.M. Best and Standard & Poor's, by spreading your money among two or more highly rated insurers and by limiting the amount you invest with any single insurance company to the maximum coverage offered by the state insurance guaranty association in your state. By investing smaller amounts over the course of a few years rather a large sum than all at once, you can also avoid putting all your money into an annuity when interest rates and annuity payouts are at or near a low point.