The takeaway: Immediate and longevity annuities pay you income for life, charge the lowest fees, and charge the lowest commissions. If the stock market is making you a teensy bit nervous, they might be worth a second glance. They’re about the cheapest annuities you can buy. As always, you’ll need to weigh the pros and cons.
This is the fourth post in a series on annuities that appears here from time to time.
Strangely, but with perfect timing, two friends of mine are considering purchasing annuities. Peggy’s eyeing them after a 40-year career of steady paychecks. During those 40 years, she spent less than she earned and invested the difference in low cost index funds. She’s now got enough for a comfortable retirement.
Still, the shaky economy and the whipsawing stock market are playing havoc with her nerves. She misses her steady paycheck and is contemplating an annuity.
In contrast, Joanie couldn’t care less about market machinations. Most of her nest-egg is in cash. When her company eliminated her pension mid-way through her career, it also eliminated how she’d been planning for her retirement.
She’s now worried she’ll outlive her money and wonders if an annuity is the answer.
Immediate and longevity annuities: the in-crowd of single premium annuities.
Both Peggy and Joanie have begun investigating the world of single premium annuities; namely
- immediate annuities and
- longevity annuities.
Immediate annuities are also called SPIAs (single premium immediate annuities), income annuities as well as paycheck annuities.
Longevity annuities are also called deferred income annuities, which are not to be confused with deferred annuities–a topic for a different post later in the series.
How do immediate and longevity annuities work?
These annuities are an insurance policy you buy that guarantees you’ll not outlive your money. Depending on the company, you can buy these annuities with a lump sum purchase of at least $10,000. Then, either immediately, or at a later date, the annuity company begins distributing payments to you.
Over time, these payments reimburse you for the purchase price of the annuity, plus interest. How much interest depends on:
- prevailing interest rates;
- your age;
- your life-expectancy; and
- other actuarial factors designed to ensure the annuity company stays profitable.
What’s the appeal of immediate and longevity annuities?
These annuities have become popular because:
- They are, compared to other types of annuities, “easy” to understand; and
- You don’t want to set your hair on fire after reading one of their contracts (at least not immediately).
From here, the advantages of immediate and longevity annuities diverge.
Immediate annuities: how do you buy one and when does it start paying you back?
With your lump sum purchase, an immediate annuity starts paying you back as soon as one month after you buy.
To write the policy, the immediate annuity company will generally only write for one-half the value of your liquid assets. (Liquid assets are assets other than your your house(s) and car(s)).
For your own protection, and as discussed here, it’s best not to spend more than $250,000 on an individual annuity.
How much will an immediate annuity pay?
It depends on how big a policy you buy. Use this annuity calculator and plug in your age, state, and the amount of money you want to spend to see how much you can get back.
At press time, the above immediate annuity calculator showed a single, 65-year-old Floridian female, buying a $75,000 bare bones annuity, would get a payout of roughly $4,140 a year at today’s interest rates.
That’s a lifetime 6% payout on your money ($4,140 annual payment made to you ÷ $75,000 annuity value = 6%).
How does an immediate annuity payout compare to the 4% Rule?
Long time readers will recall that the 4% Rule is the gold standard for preserving your nest-egg. However, a lifetime 6% payout is higher than what you’d earn–at least initially–using the 4% Rule. Over a 30-year retirement, research suggests you may well make more with the 4% Rule.
However, you’d have to live through the ups and downs of the market and monitor inflation rates.
If you’re willing to wait, even higher payouts are available with longevity annuities.
A longevity annuity is like an immediate annuity, in that you buy it with a lump sum payment and you’re paid back with interest. However, unlike an immediate annuity, which starts paying you right away, a longevity annuity doesn’t pay you back until later—sometimes a decade or two later.
You can typically buy a longevity annuity with a minimum payment of $30,000.
Unlike an immediate annuity which starts paying you back immediately, a longevity annuity doesn’t pay you back until later–much later.”
Why would you buy a longevity annuity?
There are three primary reasons you might buy.
First, longevity annuities provide a you a larger payout than immediate annuities. Since you buy the annuity and then wait a decade or two to collect your payment plus interest, the annuity has time to build up interest and increase in value.
That increased value comes back to you the the form of a larger payout.
Second, if you’re keen on deferring your taxes, the longevity annuity fits the bill. When you buy an annuity that defers payout for 20 years, that’s 20 years of deferred interest you’re accumulating. As such, you’ll be deferring taxes on that accumulating interest until you finally begin collecting on the annuity.
Finally, you might buy a longevity annuity because, although you feel confident you’ve got sufficient income to last until you’re, say, 85, you want some income guarantees for your sunset years.
How much will a longevity annuity pay?
How much you get depends on how big an annuity you buy.
Using this annuity calculator at press time, a 65 year-old female Floridian, buying a $75,000 longevity annuity that kicks in 10 years from now, would get $7,884 a year.
That’s an 11% payout! (7,884 ÷ $75,000 = 11%) It ignores the opportunity cost of not having access to your money for 10 years.
But before we get too caught up in these payouts, let’s consider the disadvantages.
Immediate and longevity disadvantages: what are they and can you get around them?
There are four main disadvantages to these annuities.
- They don’t automatically provide for a beneficiary or heir after you exit stage left.
- They don’t keep pace with inflation.
- They provide less flexibility than some other types of annuities.
- Payments made to you are only as dependable as the company standing behind those payments.
Immediate and deferred income annuities don’t automatically provide for a beneficiary or heir.”
#1. They don’t automatically provide for a beneficiary or heir after you exit stage left.
With immediate and deferred income annuities, you receive the largest payout if you simply insure yourself. That means you make no provisions for a spouse or heirs. It means if you buy an annuity on a Monday and get hit by a bus on Tuesday, the annuity company pockets however much you paid for the annuity.
If you go this route, you may well leave your spouse short on cash and living in reduced circumstances. If you have a special needs child, this would leave the child high and dry.
Working with your sales agent, you may get around these problems if you:
- Buy a joint-life policy that pays you and your spouse or you and your heir until all of you have exited stage left.
- Structure your annuity so that, even if you pass early, the annuity will continue to pay your spouse or heirs for a specific number of years.
- Buy an annuity that comprises only a small part of your total nest-egg and leave the rest of your assets–like life insurance or stock and bond mutual funds–to your heirs.
The bottom line is that if you include your spouse or heirs in the purchase of the annuity, you’ll pay more for the policy and get a smaller payout. In sum, you’ll pay more and get less.
Why do annuity companies operate this way?
When you leave money for an heir or beneficiary, the company must hold back money that would ordinarily be paid to you to make sure they have enough for your heirs or beneficiaries. It costs the company extra to administer annuities with these provisions, and those extra costs are passed along to you in the form of reduced payments made to you.
Working with a sales agent, you can determine if the peace of mind you get compensates for smaller payments you’ll receive.
#2. Immediate and longevity annuities don’t keep pace with inflation.
Immediate and longevity annuities pay you a fixed rate until you leave this mortal coil. If interest rates rise, as they inevitably will, the company will be making higher payments to newer customers. You, tiny dancer, will still be enduring the lousy interest rate rate you originally agreed to when rates were low. (This is called “interest-rate risk.)
Assuming a 3% inflation rate, we know from the Rule of 72, that an annuity payment you receive in year 24 of your retirement will have only half the purchasing power that the payment had when you bought your annuity 24 years earlier. This is the result of inflation. The cost of goods and services goes up.
As yours truly delightfully chronicled, the Bureau of Labor Statistics compiles data showing that people spend less after age 65. Weigh your longevity odds and don’t buy an annuity too soon. In her book, Making Your Money Last, Jane Bryant Quinn recommends you wait until you’re between age 70 and 80. (Chapter 6.)
Alternatively, you could buy some smaller immediate annuities every few years. For example, if you want to put 20% of your nest-egg in an immediate annuity, you could put the first 10% of the nest-egg in an annuity and 10 years later put the remaining 10% in a second annuity. This would enable you to capture higher interest rates that are a bi-product of inflation.
Another alternative is to purchase a longevity annuity. As noted earlier, longevity annuities pay you higher payments. These higher payments may pay enough to cover increases due to inflation.
#3. Immediate and longevity annuities have little flexibility.
Consider these annuities to be like an ironclad marriage: till death do you part. Unlike other kinds of annuities, these annuities don’t generally allow you exchange your annuity for a better one via a 1035 exchange. Nor do they usually offer a surrender period, after which you can exit the annuity with minimal penalty.
The workaround. None.
Immediate and longevity annuities are like iron-clad marriages: till death do you part.”
#4. Annuity payments are only as dependable as the company standing behind those payments; some annuities have gone bankrupt.
To help ensure you don’t put your retirement nest-egg in an annuity headed for bankruptcy, you must protect yourself by taking take the three simple steps I described here. Don’t let what happened to me happen to you, savvy Boomer.
What would P & J do?
Peggy (P) ultimately decided to put 20% of her nest-egg in an immediate annuity. She says just knowing she has enough to cover her every day expenses helps her sleep at night. To preserve the rest of her nest-egg, she practices the 4% rule and is comfortable with the inherent volatility of the stock market.
As for Joanie (J), she’s never been an annuity fan since buying a bad one earlier in her career. (Like my younger self, she didn’t know the 11 critical questions to ask before she bought.) She’s now betting that she can get by on an all cash nest-egg. Given current abysmal interest rates, her money is essentially earning 0%.
Time will tell how she makes out.
What about you?
Boomer, from the minute you place one foot out of bed each morning, until the instant you plop back in bed each night, you’re confronted with risks. Whether you buy annuities, practice the 4% Rule, or store all your money under the mattress–it all has risk.
But as you already know, your risks reduce with information. Information is knowledge. Knowledge is power.