Annuities...Today's Way To Save For Retirement.

Bottom line: For many people, investing a portion of their money in annuities is a good way to diversify investments and guarantee a steady source of income in retirement. But make sure you fully understand the terms, cost structure and possible penalties before you sign on the dotted line.

Annuities 101: Demystifying an Important Retirement Tool

If you're like most people, you've heard of fixed annuities but don't quite understand what role they can play in a retirement plan. Read on for an introductory course that explains how they may be able to help you with your retirement income goals faster and give you an income in retirement.

Most people use annuities for retirement savings.

Tax-deferred annuities, or savings annuities, serve people both before and during retirement, and they have a big advantage: They allow you to save money on a tax-deferred basis. Plus, you'll earn interest on your money and interest on your gains.

In addition, you won't owe taxes on the interest or earnings until you make withdrawals. By waiting until retirement to make withdrawals, if you're no longer working full-time, you may find yourself in a lower tax bracket and may potentially be able to keep more of that money for yourself. But make sure you're at least age 59½ or older or you may be subject to IRS penalties.

You can withdraw your money from a savings annuity in a lump sum or with periodic withdrawals. You can also convert the annuity to an income stream, which can provide fixed monthly payments. Each type of withdrawal has its own tax implications which you need to consider.

Like IRAs, withdrawals from savings annuities before age 59½ are subject to penalty taxes, as mentioned above. Unlike IRAs, however, there are no limits on how much money you can invest, there are no income requirements to prevent you from buying one, and you are not required to begin taking your money out when you turn age 70½. In addition to such tax considerations, surrender charges may apply to withdrawals, but typically do not apply if you convert the annuity to an income stream.

Another kind of annuity, the income annuity, offers guaranteed income.

Social Security, military benefits, and pensions are the traditional sources of guaranteed income in retirement. But some people find these options cannot cover monthly expenses. Should you tap into your savings or sell off investments to make up the difference?

Here's another solution: Consider giving yourself additional guaranteed income with an income annuity. The most popular "retirement income" annuities give you monthly, fixed income for as long as you live. And you can set it up so that all the money you put in will be paid out — if not to you then to a designated beneficiary.

Three trends have made annuities an increasingly important piece of America's retirement puzzle.

§                            Americans are living longer. U.S. life expectancy has hit a new high of nearly 78 years, according to the most recent number from the Centers for Disease Control and Prevention released in 2007. And many Americans are living well into their 80s or 90s.

§                            Fewer Americans are covered by traditional pension plans. Pension-only retirement plans have gone from covering 62 percent of U.S. workers in 1979 to only around 10 percent this decade, according to figures from a study released in 2007 by the Employee Benefit Research Institute. In essence, an income annuity may be considered as a self-funded private pension.

§                            The minimum age for taking Social Security has risen. Those born after 1960 won't be able to draw full benefits until they're 67. And with persistent rumors of dwindling government funds in Social Security coffers, the government may consider raising the minimum age requirement again. If you plan to retire in your early to mid-60s, a fixed income annuity might help fill the income gap until the Social Security funds become available to you.

The bottom line? Plan on being around for a long time, and recognize that retirement income has become more of an individual responsibility than a company or government one. Annuities can serve as one tool in your toolbox for building your own personal pension plan.

As with any little-understood topic, annuities have generated many myths. Here are two of the most common:

§                            If you die, the annuity company keeps all your money. Annuities can pass on the account value to the beneficiaries you select.

§                            Annuities are expensive and complicated. You can find better values and simpler features by working with a company that can walk you through the options.