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Is an Immediate Annuity Right for You?

directory-1334441_640Even though the stock market is winding down another good year, there are still many reasons why many retirees are concerned about outliving their savings. The recent rise in interest rates have undermined bond prices, and with additional rises expected, it isn’t hard to understand their uncertainty. One popular option to help calm those concerns and provide stable, guaranteed income in retirement is the immediate annuity. For a single, upfront payment, this financial product provides a monthly income for life. When you consider that it’s likely to beat what you could get from alternatives like bonds and dividends, it’s worth at least investigating whether these products are right for you.

For example, according to a recent article from U.S News and World Report, a 65-year-old woman can purchase an immediate annuity for $100,000 and receive $512 per month, or $6,144 a year. That’s about a 6% yield, which is much more generous than a bank savings account, and 10-year U.S. Treasury bonds are only paying about 2.5%. Of course stocks may provide a better rate of return, but only if you’re willing to take the risk.

As attractive as that sounds, there are drawbacks associated with immediate annuities. For instance, the payout from the above example looks generous, but it’s important to understand that it comes in large part as a return of the premium paid. It would take more than 16 years before the payments received equalled the $100,000 she paid for the policy. She’d come out ahead only if she lived to be older than 81. It’s because of this that many industry experts recommend cautious shopping around, or even avoidance of these products.

President of Potomac Wealth Advisors in Rockville, Maryland, Mark Avallone, stated that immediate annuities are a good choice for some, like “if you have genetics on your side and you lived a healthy lifestyle.” In this situation, there’s a good chance you’ll get more money back than you put in.

But Paul Ruedi, CEO of Ruedi Wealth Management in Champaign, Illinois, disagrees. He thinks that immediate annuities are inferior to investing in a diversified mix of low-fee stock and bond index funds. “The downside of most immediate annuities is that most offer a fixed payment,” he said. “Over a multi-decade retirement, most retirees will face rising costs. At a minimum, their costs will double.”

While an immediate annuity can be more generous than other fixed-income options, it’s important to understand that a bare-bones policy can not be cashed out or left to heirs. If you pass away before receiving all of your premium back, you’re out of luck. There are, however, provisions that can be added to your policy that guarantee income for a set number of years, assure payments grow with inflation, pass along benefits to a surviving spouse, or guarantee payments equal to the premium even if the policyholder dies early. But these add-ons reduce the payout.

Another option, often preferred by financial advisors, is the fixed index annuity. This tool also provides a lifetime income stream, but with a bit more flexibility and the opportunity for growth that an immediate annuity doesn’t have. In the end, the decision about which type of annuity to purchase is all about the individual’s needs and view on investing and risk.

“Older retirees who want certainty and don’t want stock market risk will find some comfort in these vehicles,” Avallone said. “If you can tolerate stock market and other investment risk, then these might not be as attractive to you.”

And it is always recommended to shop around carefully before committing to one insurer/contract. In some cases, investors might find that a variable annuity is a better choice for them. These offer a variety of investing options in securities like stocks and bonds, and payouts can rise if the holding do well.

“Annuities often times can have significant costs to investors including sales commissions, surrender charges and (for variable annuities) annual fees,” said Mara Derderian, finance professor at Bryant University. “With that said, not all annuities have high costs. Investors should shop around to find an annuity that offers them the benefits they are seeking at the most reasonable cost.”

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