Let’s say you are someone in your mid-to-late 60s who has thought more than once about buying an annuity but always found a reason not to. Their fees are relatively high, you thought, and they are not liquid. Even many annuities with equity participation offer only limited upside potential. The list of real or imagined drawbacks can go on and on.
On the other hand, you’re not getting any younger and the current stock market sell-off is making you nervous. It is highly unlikely to be catastrophic, as it was a decade ago, but your net worth is nonetheless declining on paper — and who knows how the market will fare in coming years? Maybe you would also like to pay your bills with more breathing room.
It might be time to consider reallocating some funds to buy an immediate annuity, also called a single-premium immediate annuity or an income annuity, which pays a guaranteed income for life and starts almost immediately. The annuitant should be in relatively good health. The longer he or she lives, the better the return will be.
In effect, immediate annuities function as a risk management tool that works like a mirror image of life insurance, which pays a benefit not in life but in death. Moreover, they are simple, easily understandable products offering nary a worry about payout distribution timing.
Think Hard Before Buying an Immediate Annuity
This is not to say that immediate annuities should be purchased without serious consideration. There are some drawbacks, including total illiquidity and payments typically frozen for the rest of your life — a troublesome prospect for those concerned about inflation. A key consideration, in particular, is how much of your financial asset pie to invest in an immediate annuity.
Nonetheless, the case for immediate annuities is strong, arguably more so than ever. People today live longer. In fact, medical advancements and generally healthier lifestyles have led to projections of most baby boomers living longer than they expect. And inflation, while rising somewhat, is still tame and expected to remain so.
In addition, most seniors, fearful of losing a sizable chunk of their savings at an inopportune time, tend to overweight investments in bonds once they reach roughly their mid-70s. These generally pay less than immediate annuities. The certainty of annuity payments is also very strong. Most annuities are backed by re-insurance companies – large companies that back up annuity provider defaults – or state guarantee funds or both.
A Deeper Look at what Immediate Annuities Pay
A deeper dive into the relative attractiveness of immediate annuity payouts is instructive. For a lump sum payments of $250,000, for example, a man and wife, both 65, can buy an income annuity today that will pay about $1,240 per month until they both die. The key question is this: Can this couple generate the same or higher income by keeping the $250,000 and investing it?
Assume that at least one of them lives to age 89 – a fair assumption based on life expectancy tables. They would need a steady return of 3.15% a year to receive $1,240 a month for 24 years before running out of money. With an immediate annuity, this couple avoids the risk of not achieving this return and, more important, of living “too long” and running out of the cash to continue investing.
Immediate annuity owners make more money in two ways. One, as discussed, is living longer. The other is patience. The longer you wait to buy the immediate annuity, the higher your annuity payouts will be. This is because the insurance company will generally not be making payments for as many years.
According to ImmediateAnnuities.com, a 65-year-old man who invests $100,000 in an immediate annuity can currently receive about $6,700 annually in payouts for life. A 70-year-old man would get about $7,600 annually; a 75-year-old man about $9,300. Many people wait until their early 70s to buy an immediate annuity, and when they do typically invest about 25% of their assets in it.
Spouses and Beneficiaries Impact Payouts
Immediate annuity buyers receive the largest amount if the purchase covers just themselves. If the contract covers a married couple, the payment drops about 15%. Joint-life payouts decline roughly that much again if the contract comes with a cash refund – i.e., some money to beneficiaries if both annuitants die before their payouts equal the amount invested.
Some insurers offer immediate annuities with a cost-of-living provision to help keep up with inflation, but very few buyers opt for this because payouts drop drastically.
In general, prospective insurers should be rated A or better.
If you decide an immediate annuity is your cup of tea, you should first take a hard look at your cash flow and break down your spending into essential needs, such as property taxes, insurance, food, clothing and prescription drugs, and discretionary spending. Then add up other sources of guaranteed income, such as Social Security. If there is a gap between your essential needs and your guaranteed income, an immediate annuity at minimum should cover it.
Still unsure as to whether an immediate annuity is best for you?
One way to help make a decision might be to compare your annual Social Security income against the income and appreciation you receive over time by investing in the stock market. In the end, which do you prefer – the certain stream of Social Security payments or the periodic thrill of higher returns in the market?
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