Is there a place in your retirement planning strategy for an annuity? Depending on your point of view, annuities may be a great tool for providing a guaranteed income stream in retirement or a confusing old-fashioned idea to be avoided. Granted, some annuities have received a certain amount of bad press in recent years as the media exposed high-cost variable annuities that were being sold by salespeople more interested in their commissions than in the welfare of their clients.

That doesn’t necessarily mean that all annuities are bad. In many instances they can serve a valuable purpose. Indeed, the primary form of payment in a defined benefit or pension plan is a monthly annuity. If you are a participant in a defined benefit plan, you are already familiar with the concept of receiving a steady stream of payments from an annuity. Such an arrangement can provide a solid foundation for your retirement planning.

An annuity is a contract between you and an insurance company where you give the insurance company a sum of money (principal) and they agree to send you payments on a regular basis (income) for a set period of time—sometimes for life.

If you’re considering an annuity, you have a growing number of options and features to explore, including fixed or variable investment and payment options, and a payment start date that is either immediate or deferred. Annuities can be paid out over your life or for a specific period of time, like 10 or 15 years, for example. You can choose payments that are payable to just you or, if you want to provide for coverage that continues after your death, you can elect an annuity to be paid out to you and a joint annuitant or beneficiary.

Fixed annuities offer guaranteed rates of return and safety of principal¹, somewhat similar to a bank CD. The amount of the monthly payout in a fixed annuity is also fixed and doesn’t change. This can give you a hedge against market volatility, and that’s a good thing. The downside is that, over time, inflation may eat into the buying power of this fixed amount. A loaf of bread used to cost about $.35 back in 1975, but costs about $1.50 today, and who knows what it will be in 20 years? If the cost of living rises steadily but your monthly payment stays the same, your annuity income may not go as far next year as it did last year. This is considered one of the fixed annuity’s chief drawbacks.

If a fixed annuity behaves like a CD and a variable annuity behaves like a mutual fund, why not just invest in a CD or mutual fund and make periodic withdrawals on your own? You could, and certainly some people do. But buying an annuity takes the pressure off your shoulders and puts the investing and payment responsibilities in the hands of the professionals, giving you peace of mind. For many people, that’s worth the extra expense of the annuity.

And you can do both. By spreading your retirement savings among a variety of investments, you can take advantage of the best features of each, without committing your entire savings to any one of them. For example, using a portion of your savings to buy a fixed annuity could provide stable income to use as a base. A variable annuity has the potential to rise over time, and may be a good idea for some of your money. Now you’ve got stability and some growth potential².

Because buying an annuity means trading your money now for income into the future, you need to make sure that you have access to other resources in case of financial emergencies or unexpected expenses before tying up all your money in annuities. In order to keep up with inflation, you may need to invest some of your assets for growth that will hopefully outpace inflation and give you access to the principal if necessary.

Investment or stream of income? Annuities are both. Some people see annuities as a way to accumulate additional money for retirement on a tax-deferred basis, above and beyond any money they’re already saving in a workplace-based retirement plan, IRAs or other investments. Take full advantage of those options first—if you still have money left over to invest for retirement, consider using some of it to buy an annuity.

As with any major investment decision, any discussion of annuities should include a word of warning: don’t buy anything until you fully understand what you’re getting yourself into. Annuities have various limitations, withdrawal charges, other costs, and terms for keeping them in force. Check out the credit-worthiness of the company providing the annuity carefully, because any guarantees are subject to the claims-paying ability of the issuing company. In plain English, if that company goes bankrupt, your annuity could be worthless. The annuity industry is constantly creating new products with more exotic features—be diligent in doing your homework before signing anything. Read the fine print carefully, ask a lot of questions, and discuss the matter with a trusted financial professional. Walter Updegrave of MONEY Magazine calls annuities “among the most complicated, confusing and downright confounding investments I have ever come across. But . . . they also have some advantages.”³

Is there a place in your retirement planning strategy for an annuity? Maybe so. Check them out—carefully.