Immediate Annuity Options & Trade-Offs

These days, everyone has a regained respect for stock market volatility. One way to maintain a more stable income in retirement is to take part of your nest egg and buy a single-premium immediate annuity (SPIA). With an SPIA, you pay a lump-sum upfront to an insurance company in exchange for a guaranteed stream of income payments for life. You’ll usually get a much higher income than from bonds or dividend-paying stocks. However, once you die, the payments stop and your upfront payment is gone.

How much income can you get?

The two main factors that affect your actual payout are your age and the current interest rate environment, but there are also additional options to consider. Here are a few of the biggies:

  • Single vs. joint life. Will the payments be guaranteed for only one life, or the longer of two lives? This is a popular option for couples living together.
  • Minimum guaranteed payout period. Some folks may hate the idea of losing your entire lump-sum in the event of an early death, or want a minimum payout amount. With this option, you can guarantee that payments will be made for a specific minimum period (i.e. 5 or 10 years) no matter what.
  • Inflation-adjusted payments. With this option, your monthly payments will increase or decrease by a certain percentage each year, as pegged to inflation. This will protect you from decreased purchasing power in the future due to inflation, but will significantly decrease your initial payout.

Below, the July issue of Money magazine included a nice graphic that helps show how each affect your possible payouts based on a $250,000 investment. Data is from ImmediateAnnuities.com, a handy site to get free quotes.

Comments

  1. These annuities seem like a rip off to me. A $250K investment in Treasury Bonds today could generate at least $10,000/year, which is 833/month AND you won’t have to worry whether your insurance company goes under AND your relatives get something after you pass away.

    Of course if you purchase dividend stocks, you will not only be able to get competitive yields, but also enjoy strong dividend growth to compensate for inflation.

    Just my 2 cents.

  2. JoetheBankgeek says:

    Why buy an annuity? If you have $250,000 then just take out $1582 per month. It would still last about thirteen years even if the money earned zero. But you should be able to get a return of about 7% to 8% if you shop around.

  3. Patrick says:

    funny, we were just offered a single premium mortgage after the typical refi went bust. The PMI costs went so high that it negated our interest savings. They gave us the option continue the refi but with a single premium mortgage. It equated to a $3700 up front payment, but in turn, eliminated PMI. Our 20% equity rolls around 6 years from now and would equate to $5400. While this would have been a savings in the long run, the real savings between $3700 now and $5400 over 6 years is only $20. For that I would rather have the money in the bank. What do you all think?

  4. Annuities are a rip off. Five minutes with the calculator that was linked should be all anyone needs to swear off annuities for life.

  5. Why are they rip offs? I always hear this but do not understand why? Is it fees, ROR or all of the above? Is it the same with whole life insurance?

  6. Variable annuities, I believe, are total rip-offs. But there’s something I like about the above payouts in a fixed annuity with an inflation adjustment. Your bonds aren’t going to be indexed to inflation, unless you buy TIPS, which offer a much lower return. I’ve been espousing that people should sell off 4% of their investments annually upon retirement, because that’s a sustainable amount when adjusting for inflation (at least, it should be).

    But one of these annuities allows for a higher payout. And it becomes a bit like a pension.

    My fear would be the solvency of the annuity company. I’d probably be inclined to spread the risk and buy 3 separate annuities from 3 separate companies, while keeping the rest of my investments (the other half) in stocks and bonds (where I’d draw down 4% annually).

    Variable annuities are a different animal from most financial institutions. Because of their fees, they’re a total rip-off–unless bought from Vanguard or TIAA Cref.

  7. Part of the rip-off is with fees. Clark Howard sure does hate these things because they are usually used by salesmen to make a big commission and they could care less about your future (fee-based). The fact that your investment just goes away if you die is enough for me to not put my money into one.

    Don’t be suckered into purchasing variable annuity

    Read the above article or just google “why variable annuities suck”.

  8. Ken in Georgia says:

    All I know about these things is what I’ve read about them on sites like this and in financial magazines, newsletters, etc. Having said that I had a few comments in relation to some of the other posts.

    First it has to be remembered what is being talked about here is buying an annuity with a large lump sum to begin getting a monthly payout almost immediately — the “annuitization” phase. This presents a whole set of different issues from the accumulation phase, that is purchasing an annuity and possibly adding it while you’re still years away from retirement. Anyone who is handy with a spread sheet can pretty quickly calculate what your rate of return might be for different income options. Generally they are pretty mediocre in the “minimum guarantee” periods, and indeed you could probably do better elsewhere.

    As I see it these things esssetially have two purposes. One is two provide part of an income stream in retirement that has some predictability in relation to a bigger portfolio of more aggresive investments. No one should ever put their whole retirement savings in an immediate annuity, but — for some risk adverse investors — it might be a prudent choice for part of their money. Secondly, when you buy one of these things, you’re betting — whether you realize it our not — that you are going to live long enough to beat the insurance company at its game. Again some calculations with a spread sheet can tell you how many years have to live to get all your money back plus a decent return — and then really start making a good return from the insurance company. Some I’ve done in the past indicate 20 years or more. As such I think that those investors that have a good history of longevity in their family trees might consider these. I don’t, so I would never buy one. Indeed the insurance companies have done a lot of research on average lifespans, etc. and factored this into their interest rate assumptions.

    As to the comment that the money you place in a variable annuity just “goes away” if you die, that’s the kind of blanket statement Clark makes that is just a half-truth. There are options the investor can choose to make sure his hiers get some benefit from the annuity. I like Clark, but his only professional credential is as a travel agent. He’s not a financial planner and would do well not to talk so much about things he’s not really qualified to.

    I’ve heard it said that annuities are life insuance in reverse — that is a pooling arrangement in which the contributions of those who died pay the income of those who live. Something to thing about.

  9. This post is not on the subject of variable annuities, but on immediate annuities. Yes the former generally entail really high fees (although you can get cheap ones from Vanguard if that’s what you want) but there is probably a role for immediate annuities for some retirees.

    Yes, you can get a 4% 30-year nominal Treasury, but if you want a 30-year TIPS the real yield is going to be below 2% right now, which on $250k is less than $400 per month which will grow with inflation. These annuities are paying much more than that. Yes you have the credit risk of the underlying insurer but these are pretty highly regulated and I would assume (but I’d verify before I’d purchase) there is some kind of federal insurance on immediate annuities and the assets behind these products are pretty highly regulated.

    Not saying I’d invest in one, but for some people it is a good option to lock-in retirement income.

  10. Steve Bonds says:

    Annuities aren’t always a rip-off. Variable ones– usually, but only because they make it pretty much impossible to determine your actual returns due to hidden fees and other trickery.

    The 5-year annuities quoted by the linked site work out to 2% interest per year. Not so good. As others have noted, you’d probably be better off with a CD ladder.

    However, the factor that’s missing, and the reason these were started in the first place is… insurance. Getting a single or double life annuity means that you’ll ALWAYS have that income. Should this be ALL your income? Probably not… But don’t underestimate the utility of having a known amount FOR THE REST OF YOUR LIFE. Unless destroyed by inflation, this is a very powerful planning tool.

    Pretty much all the other options are less useful and seem geared around trickery to reduce the usual single/double life payment amount. If you care what your beneficiaries get, then an annuity is NOT THE RIGHT CHOICE. If your beneficiaries care what they get, then maybe it *is* the right choice. Heh, heh… :-)

    — Steve

  11. Ken in Georgia says:

    Just out of my own curiosity, I did some rough calucating with my Excel spread sheet (using the RATE function) for the two largest payouts. Here’s what I found:

    For $1,583/month, you start to see a positive annualized return in the 14th year, about .9%. If you die before then, you’re in the red, and with this option your heirs get nothing. By year twenty, age 85 in this example, you’ve eaked out an average annual return of 4.55%.

    For $1,528/month, it also takes to year 14 to be on the positive side — an average return of .38%. By year 20 you’ve earned an average return of 4.14% But the important thing to note for this option is that if you die in the ten year guarantee period, you end up on the negative side — you and your hiers only getting out about $183,000 of the $250,000 put in. Better than losing it all, but still quite a loss.

    So if you were age 65 and considering one of these things, I guess you have to decide if you’re comforable betting that you’re going to live 20 more years to earn a return of just a little more than 4%. I doubt this is something your friendly insurance agent would ever discuss with you.

  12. I’m wondering about annuities for younger people. I’m 32, and at this age I’d consider an annuity a pretty good gamble for a lump sum of cash. I’ve looked into this before and never was able to find anything for people younger than 45. And of course this makes perfect sense, but I’m wondering if there is anything like an annuity out there for people in their 30s who’ve got a large lump sum of cash. Perhaps a lower payout for the longer term, but still I could see the possibility for this. The younger person doesn’t have to spend time worrying about investments and the investment company can probably make more over the long term with the money than what is paid out.

    So anyone heard of any company out there doing this?

  13. Just looking at these figures it seems rates are much better in the US compared the UK.

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