Annuities have been around for centuries. In early Roman times, citizens would make a one-time payment to a contract known as an annua in exchange for income payments received once a year for the rest of their lives. Today an annuity is an insurance agreement that comes in a number of different forms and can (1) help individuals accumulate money for retirement through tax-deferred savings, (2) provide them with monthly income that can be guaranteed to last for as long as they live, or (3) do both.

An annuity is often viewed as life insurance in reverse. Whereas life insurance protects an individual against premature death, an annuity protects an individual who lives a long life from running out of money. Similar to life insurance, annuity contracts are based on the principle of risk pooling. The burden of not knowing how long one will live is shifted from the individual to the insurance company, which spreads the longevity risk among all annuitants, some of whom will die sooner than expected while others will live longer than expected.

Annuities can play a vital role in helping investors save for retirement. Unlike other investments, annuities provide a wide variety of benefit options that can protect against an untimely death, provide principal guarantees, assure a specified amount of income when the contract is annuitized, and guarantee withdrawals for life.

What Role Can Annuities Play in a Comprehensive Retirement Plan?

Annuities are the only financial instruments available today, other than Social Security and pensions, that can guarantee a lifetime stream of income during retirement. Along with giving retirees the peace of mind that comes from knowing that they will not outlive their assets, annuities provide another important benefit-a way to increase current income.

Many of today's retirees are faced with the challenge of withdrawing enough money from their portfolios to live comfortably during retirement without depleting their funds if they live a long life. Pulling money out of a portfolio may not present a problem in the early years, but as retirees age, the risk of running out of money can increase dramatically. This risk is reduced when retirees put a portion of their assets in one or more annuities.

As part of a comprehensive retirement plan, annuity payments (along with Social Security and pension income) can be used to cover essential living expenses. The amount of each annuity payment reflects the fact that some annuitants will not live as long as others. This "risk pooling" allows insurance companies to make annuity payments that are larger than would be possible through a systematic withdrawal plan where an individual retiree periodically withdraws funds in amounts that give reasonable assurance that he or she will not run out of money. Thus, annuities can serve to both reduce the risk of running out of money in retirement and increase the amount of each income payment received.