Don't outlive your savings: How annuities can help

NEW YORK (CNNMoney) -- Given advances in medicine, I'm worried my wife and I might outlive our retirement savings. I've started reading about annuities, but I'm confused about the difference between immediate annuities and another type I've heard referred to as a deferred income annuities. Can you explain the difference? -- Daniel R.

Immediate annuities have been around since the days of the Romans, when someone with cash could purchase "annua," or annual payments for life.

For the most part, immediate annuities work pretty much the same today (except the payments are usually monthly): You hand over a lump sum to an insurance company (or a financial services firm that represents the insurer) and in return you receive lifetime monthly payments, the size of which depends on the amount you invest, your age, gender and the prevailing level of interest rates.

Currently, a 65-year-old man investing $100,000 in an immediate annuity would receive payments of about $585 a month for life, while a woman would receive $540 or so (because women have a longer life expectancy).

There are a number of variations to this basic immediate annuity formula. If you want to be sure that the annuity payments will continue -- not just for your lifetime, but as long as a spouse or other loved one is alive -- you can choose a "joint-and-survivor" option. The trade-off is that the payment will be smaller than an immediate annuity for a single life.

But be aware that in return for the guarantee of lifetime payments, you typically give up all access to the money you put into the annuity. It's no longer available for emergencies.

That said, in exchange for a smaller guaranteed payment, some immediate annuities will refund a portion of your money to your heirs if you die before you receive monthly payments equal to your original investment. I don't think that option makes much sense, though, as it undermines the purpose of an annuity, which is to assure you have lifetime income.

You're better off putting whatever money you want to leave to heirs -- or have available for unexpected expenses -- into more liquid assets like stocks, bonds or cash. And then go for the larger payment with whatever amount you decide to put into the annuity.

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As for the deferred income annuity you mention, it goes by many names. Some people refer to it as an advanced life delayed annuity. I've even heard people use the oxymoronic term "deferred immediate annuity" to describe it.

But the most frequently invoked name for this type of annuity is a longevity annuity, and it works as follows: You turn over a lump sum to the insurer just as with an immediate annuity. But unlike with an immediate annuity, the longevity annuity's payments don't start until much later, say 10 or 20 years down the road.

So, for example, a 65-year-old man who invests $50,000 in a longevity annuity that doesn't make payments for 20 years would begin receiving $2,489 a month at age 85 for the rest of his life, while a 65-year-old woman would receive payments of $1,977, according to figures run by The Hartford.

By postponing the income for many years, you can protect yourself against outliving your dough late in life while devoting fewer of your assets to an annuity today. By assuring you'll have something to fall back on later, it can also help you maximize your retirement spending -- even if you run through all or most of your assets in the meantime.

Should I contribute to a traditional or Roth 401(k)?

The downside is that if you don't live to 85, or whatever age you stipulate the payments to begin, you get nada. So if you think you might run through your other assets before you reach the age when the annuity's payments start -- or if you are uncomfortable with the idea that you could die before payments begin and so never see any of that dough -- then a longevity annuity probably isn't for you.

Some longevity annuities do have refund options, but their payments are lower and, in my opinion, erode the true value of such an annuity. For more on the pros and cons of longevity annuities -- and why they're better suited for taxable accounts or Roth IRAs, click here.

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While an annuity's payments are guaranteed, that guarantee depends in large part on the financial strength of the insurer issuing the annuity. State insurance guaranty associations also provide a safety net of sorts if an insurer fails, but the coverage guaranty associations offer varies from state to state.

There are a few simple steps you can take to reduce the chance of your annuity payments drying up in the future, which include diversifying your annuity stash among several insurers, limiting yourself to insurers that get high ratings from A.M. Best and other ratings firms and restricting the amount you invest with any single insurer to the maximum coverage offered by the guaranty association in your state.

I recommend you check out the Annuities section of our Ultimate Guide To Retirement as well as this MONEY Magazine story, which lays out a reasonable strategy for turning savings into reliable income for life.

Bottom line: Under the right circumstances, either of these may be able to help protect you against the risk of outliving your assets. Just be sure to take the time to understand and evaluate them before you decide to buy.

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