‘‘Give me the money you have in the stock market, and I’ll make sure you have a stream of income for the rest of your life.” If somebody offered that deal to you, would you take it? You might be skeptical, but it could be worth a second look. Such an annuity, a product life insurance companies sell, could bring some certainty to people contemplating their retirements.


What is an annuity? Fundamentally, it is a contract between an individual and an insurance company in which the company agrees to make a series of payments to the individual in return for a premium or series of premiums that have been paid.


Annuities have been around in some form for centuries. Roman speculator and jurist Gnaeus Domitious Annius Ulpianis is said to have been one of the earliest annuity dealers and may have also developed the first actuarial table. The Latin word “annua” referred to annual stipends. During the reign of the Roman emperors, an annua signified a contract that called for annual payments to a given recipient. 


Feudal lords in the middle ages used annuities to cover the cost of frequent conflicts with their neighbors. Annuities were offered as a tontine, a pool of cash from which payments were made to investors. As with most forms of insurance, participants who beat the actuarial tables gained the most. The last living member of the tontine received whatever was left in the pool.


One of the first annuities in the United States was a retirement pool for church pastors in Pennsylvania, funded by contributions from church leaders and their congregations. The pastoral annuity provided a lifetime stream of payments for ministers and their families. 


It was not until 1812 that annuities became commercially available in the United States, but annuity premiums accounted for only 1.5 percent of all insurance premiums collected between 1866 and 1920. As multigenerational, agrarian­-based households dwindled, the popularity of annuities picked up steam. The 1929 stock market crash served as a lesson to those who thought the stock market could only go up and further boosted public favor of the annuity contract.


Stock brokers will still tell you that you can get better returns in the stock market than with an annuity, and that may be true over the long term if you are a disciplined investor. However, the key word in that sentence is “can.” Adults who witnessed the 1929 crash are rarities today, but many saw their 401(k) crater in 2008 and the NASDAQ lose 78 percent of its value as the index fell from 5,046 to 1,114 during the dot-com crash in the early part of this century. Those people know the uncertainty lurking in that little word “can.”


Investors seeking more certainty—and who are willing to pay for it—might want to take a look at annuities. Certainly, consult your financial advisers, and do your due diligence before entering an annuities contract. There are quite a few products on the market, and some are very complicated. In fact, many state laws require a suitability analysis before the sale or replacement of an annuity product, which would include an evaluation of one’s financial position, income needs and the cost of liquidating assets.


There are two common types of annuities: fixed and variable. A fixed annuity provides a locked-in, guaranteed rate of return on the investment and a certain, stable income in the payout phase. A variable annuity, perhaps the most popular today, allows the owner to decide how to invest the money in a range of mutual fund-like investment options called subaccounts.


According to Frank McGovern, founder of Capitol Wealth Management Inc., a financial planning and investment management firm based in McLean, Va., a variable annuity gives the annuitant the opportunity to participate in the higher earning potential of the market while still guaranteeing a stream of income and a return, upon death, of the remaining principal to the beneficiary. The possible earnings from the market made on the principle during the accumulation phase—that is, the period of growth potential that begins once the initial payment is made—are tax deferred until the distribution or annuitization phase, when the owner starts taking payments.


Some experts criticize the fact that these payments are taxed as ordinary income rather than a capital gains rate. But others, such as McGovern, say it can work to the annuitant’s advantage, assuming he or she is in a much lower tax bracket after they retire, as is often the case.


Unlike qualified retirement accounts, such as 401(k) plans and IRAs, there are no yearly limits to the amount of principal that can be put in an annuity. Contributions can be made in both the accumulation and distribution phases of the variable annuity. As with qualified retirement accounts, penalties may apply if the annuitant makes withdrawals before age 59½. Annuity IRA investors must also start taking payments at age 70½.


McGovern said that the ideal candidate for the variable annuity is the young baby boomer, between the ages of 50 and 62. To gain the benefit of time in the market, he or she should be in the position of not needing the money for several years. Indeed, one of the protections the insurance company takes against its own possible loss is the imposition of significant surrender fees in the first several years should the investor have a change of heart and want to opt out. The company may also charge significant withdrawal fees if more than 10 percent of the total amount is withdrawn in a given year. Typical yearly payouts selected by most annuitants are much lower, however, and are in the 5–7 percent range.


Being able to wait a number of years before taking the annuity has other advantages, given the nature of certain products now on the market. Some provide for step-ups in the guaranteed withdrawal benefits if the investments within the annuity do well. For instance, if the annual market returns to outperform the annual guarantee provided in the contract, the base on which annuity payments are made would be reset for the following year at a higher amount. Upon annuitization, payouts would be based on the highest step-up. The median annual gain in the S&P 500 since 1970 is 12.6 percent.


Jason Richards, a certified financial planner with LPL Financial, said an investor has to weigh the pros and cons of annuities as well as any other financial instrument.


“Some people argue that annuities are risky because they are only as good as the health of the insurance company that sells them,” he said. “While on paper, that’s true; in reality, insurance companies are required to hold adequate reserves to meet its obligations to all of its annuity owners. These levels are monitored by state regulators to ensure complete solvency. In any case, if or when insurance companies do get in trouble, there is often a sale of the business unit to another qualified insurance company.”


Historians say that in the 200 years of annuity history in the United States, no annuity owner has ever lost their principle. That may sound like an extravagant claim, but neither Richards nor McGovern know of any such an instance. Indeed, they said that your principal, because of the guarantees offered in the annuity, protects against market volatility.


Craig Hemke, president and founder of Buyapension.com, wrote the following in a Bankrate.com article on the pros and cons of annuities: “That book of annuity business was probably built on actuarially sound principles. The insurance company that is out of business would probably be able to sell that to somebody else, so you as a contract holder would not even see any disruption—the checks would just start coming from somewhere else.”


Richards said that he generally would not recommend annuities for someone younger than 50 or past their early 60s.


“You need some time to make annuities work for you,” he said. “But, younger people should familiarize themselves with the product. They may have seen Grandpa survive on a Social Security check and a pension check, but Social Security is not the sure bet it once was, and there is a quickly diminishing number of people who will ever see a pension check.”


Both financial planners McGovern and Richards said that you do pay a price for variable annuities, and it’s a notable one, but you’re getting a greater deal of reassurance in return. Annuities, like an asset class, they say, should be part of one’s portfolio and not consume the entire nest egg.


If you were wise enough to keep your portfolio in the stock market after the 2008 crash, you might have ridden that bet all the way back to where we are today and recovered all or most of the money you lost on paper during those seven years, which is tantamount to standing still. But many seemingly reasonable people never returned to the market and may still be sitting in cash, which again, is tantamount to stuffing your money in a mattress in this low interest environment. If an investor had purchased an annuity with step-ups guaranteed in accordance with market performance, the outcome would be entirely different.


Investors need to do their homework before purchasing an annuity, much as they should do their homework before purchasing an equity. There are many annuity offers and their prospectuses are just as turgid as those of a mutual fund or a particular stock. Those considering buying an annuity should go to a trusted financial planner for advice beforehand. As with any product sold on commission, the old saying applies: Buyer beware. The National Association of Insurance Commissioners said the best way to protect yourself against unscrupulous salespeople is to stop before writing a check, signing a contract or giving out personal information; call your state insurance department; and confirm that the agent and company are licensed to write insurance in your state.