Income for life...a good deal?

By Walter Updegrace, CNN/Money contributing columnist November 15, 2005

This article appears at the following website: money.cnn.com

Q. I'm retired and in my 70s and considering buying an annuity. I don't need it for myself, but I want my wife to have it in case I die before her. Do you think I should buy one?

-- Lou, Marietta, Georgia

A. Before I answer your question, let me explain for those uninitiated into the mysteries of annuities -- and that includes almost everyone -- what type of annuity you're talking about.

Annuities come in two basic flavors: deferred annuities and income annuities (also known as payout or immediate annuities).

With a deferred annuity, you invest your money (or pay your premium, in annuity-speak) and whatever gains you earn escape taxes until you withdraw them. So your earnings are tax-deferred, hence the name deferred annuity. Some people use deferred annuities to save for retirement, though I question that given their generally high fees.

Income or payout annuities, work like this: You give an insurance company a lump sum and the insurer agrees to pay a certain income, usually monthly, for certain period of time.

There are plenty of ways to set it up: You could, for example, hand over your retirement nest egg and arrange for monthly payments for the rest of your life or for 10 years, whichever is longer. That way if you die, say, two years after buying the annuity, your beneficiary will receive payments for eight years.

People turn to this type of annuity to provide a guaranteed income in retirement. I think an income annuity can be a good choice for this purpose. (To see why, see a column from the Ask the Expert archive.

One last wrinkle. Both deferred and income annuities also come in two versions:

There are fixed-annuities -- that is, annuities with a fixed return much the way the return of a bank CD is fixed.

And there are variable annuities, or annuities that allow you to invest in mutual fund-like investments known as "subaccounts" whose returns can go up and down with the financial markets.

More variations

Okay, now that we're all on the same page, let's get to your specific issue. Although you don't specifically say, it seems to me you're talking about an income annuity. You want to be sure your wife will have a guaranteed income even if you're not around to provide it.

As I see it, you've got two choices. One is to buy a lifetime annuity for your wife now. She'll begin collecting money immediately and will continue to do so until she dies. If she doesn't need the income while you're alive, you can always reinvest it for her.

The disadvantage to this approach is that you're buying the annuity before your wife needs it. If she dies before you, you'll have invested in an annuity you didn't really want or need. The advantage to this approach is that once you buy the annuity, you and your wife know that no matter what happens, your wife will have an assured income until the day she dies.

Your second choice is to have your wife buy the income annuity right after you die. You can help her pick one out beforehand or, for that matter, instruct a trusted and knowledgeable friend or adviser to help her choose the annuity after you've departed for the great beyond.

The advantage here is that your wife gets the annuity only if and when she's ready to put it to use.

Another advantage is that the longer your wife holds off buying the annuity, the larger the amount of monthly income she'll get for the same sum of money. That's because annuity payments are based on life expectancy.

The disadvantage to this approach? Well, suppose that you live another 20 years and during that time you run through most of your nest egg.

Another possible downside is that if your wife waits until you're gone to get the annuity, you won't be there to guide her through the process.

You'll have to decide which is the better way to go. But with a bit of planning and careful monitoring of your nest egg, I think you should be able to pull off plan two -- that is, hold off until your wife needs the annuity.

Whichever route you go, it's probably a good idea if you start boning up now on how annuities work and to comparison shop for the best deals.

You can start that process by checking out this earlier column.

Remember too that the financial stability of the insurance company is also a factor you should take into consideration when choosing an annuity. For more on that issue, click here.

Finally, if you'd like to get an idea of how much lifetime income you can get for your wife from different insurers for a given sum -- $100,000 or whatever -- check out the annuity calculator at Immediate Annuities.com. By doing this, you and your wife will at least have some sense of just how much income she may have to live on after you're gone.