How to get guaranteed retirement income for life

I know that immediate annuities can provide lifetime retirement income, but I would like to understand more about how they work and how to choose one. Can you help? --K.T.

Given how the market's been misbehaving lately, it makes perfect sense that immediate annuities' lifetime payments would hold greater-than-usual appeal to people who are retired or getting ready to call it a career.

Even aside from the obvious financial security that assured monthly income can bring, payouts that are guaranteed not to go down no matter how much the market may fall can also yield valuable emotional and psychological perks. A variety of studies and surveys show that retirees who have guaranteed income in the form of a pension or annuity tend to be happier in retirement than those who don't.

Still, even people who could benefit from an annuity may be reluctant to invest in one because they're understandably wary of investments they don't really understand.

So let's start with the first part of your question -- How exactly does an immediate annuity work? -- and then move on to other issues, like deciding whether you're actually a candidate for an annuity and, if so, how to choose the right one.

Calculator: How much will my annuity payments be?

Although some annuities can get quite complicated, the premise behind an immediate annuity is fairly simple. You turn over a sum of money to an insurance company (even you may actually buy the annuity through a broker, planner or other adviser) and in return the insurer agrees to pay you a guaranteed amount each month for the rest of your life. (If you'd like the payment to continue as long as either you or your spouse or partner is alive, you can choose the "joint-and-survivor" option.)

The size of the payment you receive depends on such factors as the amount you invest, your age and the level of interest rates. If you go to this annuity payment calculator, you'll see that a 65-year-old man who invests $100,000 today would receive lifetime payments of roughly $560 a month, a 65-year-old woman would collect about $535 and a couple consisting of a 65-year-old man and 65-year-old woman would get about $475 a month as long as either remains alive.

To get the highest payment, however, you must give up access to that $100,000 (or however much you invest). So you probably wouldn't want to invest all or even most of your retirement savings in an immediate annuity.

To create a more flexible retirement income plan, you'd also want to have enough savings invested in a diversified portfolio of mutual funds, ETFs and such to generate growth to help maintain your standard of living despite inflation and to provide ready cash for emergencies, unanticipated expenses and the occasional splurge.

Related: 3 things you must do to achieve financial security

At this point, you may be thinking all this sounds fine, but still be wondering why you need to bother with an annuity to create retirement income. After all, you could invest your savings on your own -- or hire someone to do so for you -- and draw on earnings and your original capital as needed. And, unlike with an annuity, if you take this approach you'll have access to all of your money all of the time.

But there are two things an annuity can offer that you can't get by investing on your own. One is a guarantee that you'll receive your payments no matter how long you live and no matter how the financial markets perform. Sure, you can invest cautiously on your own, but there's still the chance you could run through your savings if your investments perform poorly or if you live well beyond life expectancy.

The second thing an annuity can do is provide a higher level of lifetime income than you can generate investing on your own at a given level of risk. That's because of something called "mortality credits." Some people who buy annuities will die sooner than others. As a result, insurers are effectively able to transfer the money that would have gone to those who die early to those who die later. Insurance company actuaries can estimate the size of such transfers, or mortality credits, and factor them into the annuity's payout. Thus, the payment you get from an annuity consists not just investment gains and the return of a portion of your original investment, but these mortality credits as well. In effect, the credits amount to an extra payout or return that you can't create investing on your own.

Related: How much will I need for retirement?

But the fact that an immediate annuity offers such benefits doesn't necessarily mean that you're a good candidate for one. If your nest egg is big enough that your chances of outliving your savings are negligible, then you probably don't need an annuity. (This retirement income calculator can help you determine whether that's the case.)

Similarly, if the payments you'll be receiving from Social Security will cover all or nearly all of your retirement living expenses, then you may already have all the guaranteed income you require.

But if you've decided, whether for financial or emotional reasons, that you would like to supplement Social Security with additional guaranteed income, then the issue becomes how to choose an immediate annuity that's right for you.

Start by comparing payouts from several insurers, as payments can sometimes vary from one insurance company to another by upwards of 10%. You can get information and quotes from a variety of insurers by going to an online site like and by contacting the annuity departments of investment firms like Fidelity, Schwab and Vanguard.

You may be tempted to automatically go with the insurer offering the highest payout. Don't. You're depending on the insurance company's ability to make good on its guarantee of lifetime payments, so you'll want to stick to insurers that receive high financial strength ratings (say, A+ or better) from ratings firms like A.M. Best and Standard & Poor's.

For even greater security, consider spreading your annuity investment among a few highly rated insurers and also limiting the amount you invest with any single company to the maximum coverage offered by your state's insurance guaranty association.

Bottom line: Immediate annuities have some unique features that, in the right circumstances, may very well be able to enhance your retirement security. But like any investment, they also have drawbacks. So take your time (indeed, some research shows you don't have to invest in an annuity early in retirement to reap its benefits) and make sure you understand what you're getting into before you buy.

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