What will it cost you and your spouse to pay your medical expenses after you retire? The research of one investment company says that a 65-year-old couple who retire this year can expect to pay out an average of – hold onto your hats -- $240,000 out of pocket during their remaining years. That equates to about 61 percent of Social Security benefits for the next 15 years. In 2011 the estimate was $230,000 so it is creeping up fast. In fact, in the decade this investment firm has been calculating these costs, the figures have bumped up about six percent per year (and decreased one year), while Social Security benefits have risen about 2.3 percent annually. Believe it or not, some other estimates are even higher.

If you are still working, you might be able to work with your employer to consider retiree coverage of some sort, like a Health Savings Account that allows you to pay for qualified medical expense on a federal tax-free basis. These accounts are portable and go with you if you change employers. But what if you are already retired? You probably know that one possibility for dealing with future medical costs is to purchase an annuity.

So What Is this Annuity Thing?

It’s an agreement between you and a financial institution, which results in you receiving regular payments for the rest of your lifetime or a set number of years, depending on the annuity you purchase.

To purchase an annuity, you give the issuer a lump sum of money up-front, or make a series of payments over time.

Generally there are two types of annuities (though there are some variations out there). A fixed annuity pays a predetermined amount, at regular intervals for a specific amount of time. This type of annuity may be tied to the performance of government-backed securities. Most people purchase fixed annuities as a way to help fund their retirement planning, on a tax-deferred basis. A fixed annuity usually comes with a guaranteed rate of return for some period, and at some point the rate is adjusted.
A variable annuity pays varying amounts, depending on how the underlying investments perform. Unlike their fixed annuity cousins, these annuities invest in a variety of investment products. The upside of variable annuities is that there is a chance of seeing higher returns. Naturally, the trade off is that you have to be willing to assume more risk.

Both fixed and variable annuities allow for:

• Tax deferred growth of earnings.
• A death benefit that will pay the beneficiary the greater of the account balance or a guaranteed minimum amount.
• The option of receiving a stream of payments periodically for a definite period of time (say 20 years) or an indefinite period, such as your lifetime or the lifetime of your spouse).
• Generally for an additional fee you can get a rider that specifies a guaranteed minimum payment and lifetime payment options, subject to certain terms and limitations.

The Downside of Annuities

Annuities can be great tools to help you pay for whatever costs arise in retirement. But be aware, like most things, annuities have their downside.

You are committing current funds for the long-term that will not be available now. If you take a withdrawal from your annuity before age 59 ½, the IRS will generally impose a 10% penalty.

Because the annuity is purchased with before-tax funds, your distributions are taxable when they are received. If you believe taxes are headed upward, of course that means you’ll pay higher taxes when you receive the money than you would on the same funds now.

Questions to Ask Before You Buy

What commission is involved? Some annuities charge high commissions, which are not paid directly by the purchaser, but are taken out of the earnings, therefore, it lowers your return. A commission is generally 5 percent or less. It’s a good idea to ask the salesperson what his or her commission will be.

What is the re-set policy for the interest rate? Some annuities offer attractive rates, but only for a short time. At some point, the rate will be re-set, so find out what the issuer’s prior rate setting policy has been. The re-set is usually based on interest rates at the time.

How much will it cost if you must surrender your annuity? Ask about surrender charges. You shouldn’t purchase an annuity unless you intend to keep it long-term. But there is always the chance that life will intervene and you will have to surrender the policy. Find out ahead of time what the surrender charges will be.

How stable is the issuing company? Payment guarantees are based on the claims-paying ability of the insurance company, so check out a company thoroughly before buying an annuity. Your ability to get payment in the future depends on the stability of the insurer, and as we have witnessed in recent years, the appearance of stability is not enough. Ask the salesperson for a ratings report, or ask at the public library for help.

Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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