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In the past, workers often could rely on having two sources of retirement income: Social Security and the pension that their employer paid them. Having two reliable monthly checks coming in made it possible to have a financially secure retirement without necessarily having a lot of outside savings.
Now, however, most companies don't offer pensions, and it's critical to save money for retirement in order to supplement Social Security payments that, in nearly all cases, are inadequate to cover your living expenses. If you have a retirement nest egg, one thing you can do with a portion of your savings is purchase what's known as an immediate annuity. By doing so, you can essentially build your own pension and get a guaranteed income to supplement Social Security for the rest of your life.
An immediate annuity is a contract that insurance companies sell. To purchase an immediate annuity, you make an up-front premium payment. In exchange, the insurance company agrees to pay you a set amount each month for the rest of your life. You can also add on some other features, such as having the contract pay out not just over the course of your lifetime, but also for as long as your surviving spouse lives after you pass away. Of course, these extras come with a price.
As with any investment, immediate annuities involve risk. The biggest one is that with most immediate annuities, if you die shortly after purchasing the contract, then you'll end up having gotten a lot less in total monthly payments than the premiums you paid. That said, the insurance company also takes on the opposite risk that you might live well beyond your life expectancy, making the amount you initially paid insufficient to cover subsequent payments. When the insurance company averages out all the people buying immediate annuities, it hopes to make a profit overall, even if it loses money on some policies for those who live and collect payments for a long time.
The amount of money you'll receive in monthly payments depends on your age when you buy the annuity and how big a premium you pay, but it also varies depending on prevailing interest rates. Over the past several years, rates have been low, and that unfortunately translates to smaller amounts of monthly income produced by the annuity.
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