Authored by Lee Wright in Investments
Published on 09-30-2009
Many people these days are worried about being able to finance their retirement years. With the uncertainty of Social Security or other government sponsored payments people are looking for safe havens for their savings. Many people turn to annuities as a viable alternative to save for retirement and take advantage of tax savings. Annuities or annuity funds refers to two different investment scenarios.
Individuals can purchase annuity contracts from insurance or other finance companies and receive periodic payments for a certain number of years. An investor gives a company an amount of money today in exchange for a number of guaranteed payments in the future. An annuity provides a monthly payment for a fixed amount of time, for the retiree’s lifetime, or for the retiree’s and a beneficiary’s lifetime. These financial or insurance companies in turn pool many investor’s monies into an annuity fund and purchase equities such as stocks and bonds. They rely on the annuity fund growth and income to make future annuity payments. Because these types of annuity payments are usually at least partly guaranteed, the annuity fund money should be well diversified and invested in relatively safe investments.
Another type of annuity investment is usually managed by an employer. Employers place a certain amount of funds in an annuity or pension fund each year. The pension and annuity fund pays out employee pension benefits to retiring employees. As employees retire they can frequently choose either a lump-sum payout or an annuity. Employee’s can sometimes choose the amount of risk they want to assume with their retirement funds, but usually have little or no control. Some companies choose to allocate fewer dollars to the pension fund, choose extremely risky investment, and depend on high growth rates to fully fund employee retirements. Because employer controlled pension or annuity funds have more control over how much they pay a retiree, they are more prone to gambling on higher risk investments. If the investments do not pay off, then the company simply adjusts retiree benefits lower for a few years to make up the loss.
There are also pension and annuity funds managed by employee associations. They function much like employer controlled plans, but their members usually come from one group such as state employees or teachers. The members of these associations sometimes have more control over their pension investments by directly voting on an investment strategy. Like an employer controlled plan, however, poor investment decisions can lead to a deficit in the plan funds or in extreme cases even bankruptcy, which can wipe out retirement benefits for employees or association members.
Annuities, whether an individual contract with a finance company or as part of a larger group pension and annuity fund, can provide periodic payments for long term financial stability. Like many investments options, however, most types of annuities funds carry the risks inherent with any equity investment. Although annuities can tend to be more stable than other types of investments, the degree of stability depends largely on the philosophy of those managing the fund backing the annuity. A management team that gambles on risky investments spreads that risk to everyone who has a stake in the annuity fund.