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Retirement 101: How annuities work

The last thing a retiree wants is to run out of money. That's why many boomers are turning to annuities as a way to make sure they have enough cash to last through their golden years. What's an annuity, you ask? We explain.

Get paid every month

Basically, the idea of an annuity is that you pay a financial institution -- often an insurance company -- a sum of money and they give it back to you in regular monthly payments. Typically, you invest money in an account. The money grows and then, when you retire, you get a regular income stream made up of interest and principal.

Guaranteed income

In most cases the monthly payments are guaranteed. There are two types of annuities, term and life. Term annuities guarantee payments for a certain number of years, like five or 10. Life annuities guarantee payments for your entire life. The cost of the annuity depends on factors including your age, your sex and how many years you want guaranteed income for.

Keep the money coming after death

Some couples opt for a joint life annuity. That allows the regular, guaranteed payments to continue after the beneficiary dies. The surviving spouse would continue receiving the same payouts. Joint life annuities usually pay less per month than other annuities because the guaranteed income has to last longer.

Cover the cost of inflation

Guarantees are great and all, but when you factor

in inflation, then your regular payments will buy less groceries every year. Inflation has been low in recent years, so retirees haven't had to worry too much about their purchasing power eroding. But if you start getting payments at 65 and live to 90, there's a good chance inflation will increase significantly during that amount of time. As the name suggests, the payouts from inflation-index annuities rise by the rate of inflation ever year. Keep in mind that you'll likely have to pay more or take less money per month than you would if you bought a regular annuity.

Play it safe

There was a time when no one would ever have thought that a guarantee wouldn't get paid. But after we saw financial companies go bust during the financial crisis, we've realized that anything can happen. Buy annuities with a company that has strong balance sheets and can weather an economic setback. Make sure they're investing your money wisely. Fortunately, if something does happen, Assuris, a not-for-profit organization that protects Canadian insurance policy holders, will keep the payments coming. They'll give you $2,000 a month or 85 per cent of the promised benefit, whichever is higher.

There are other annuity options available, so call your insurance company for more information. Annuities aren't right for everyone, but if you want safe, steady income every month, this may be the product for you.

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