Single Premium Immediate Annuities are like buying a pension
Annuity has become a dirty word in the financial press. Well, except among insurance sales folks. And it is true that many (not all) of the variable annuities and indexed annuities that are being sold to investors today are overpriced, needlessly complicated, and just plain bad investments.
But let’s get back to annuity basics.
The basic idea of an annuity is to replace a sum of money with an income stream. You have $100,000, you give it to an insurance company. You get a certain amount of income for life. In the simplest kind of annuity, this happens immediately. You give your money to the insurance company, and they immediately start giving you a “paycheck” every month. It is essentially buying a pension.
Is this the best use of your money in retirement? Well, it depends. There is certainly comfort in knowing that you have a certain amount of income that will continue as long as you live. You are passing off the risk that you will outlive your assets to the insurance company. If running out of money is a worry – for instance, if your financial plan suggests a substantial risk that you may run out of money later in life – then a single premium immediate annuity may be a useful financial planning tool.
I also look at it this way. When a client comes to me with both a 401k and a pension benefit, they often have the option of taking the pension benefit as a lump sum. We will very often end up recommend that the client choose the monthly payment option (annuity) after analyzing the offer. This is driven by several considerations. 1) By increasing income, there will be a lower demand on savings in retirement, which makes it easier to weather ups and downs of the markets. 2) Annuity payouts from corporate pensions are usually more attractive than offers from commercial annuities offered by insurance companies and 3) the effective rate of return on the fixed income like annuity is often better than alternative fixed income investments like CD’s or treasury bonds.
Annuities give those of us without employer pensions the ability to buy one. But very few of our clients when presented with the option are willing to part with any of their savings to purchase an income stream – even though the decision is almost the same. Perhaps there is some fear that if they die early, the insurance company somehow benefits at their expense. This can be overcome with a “ten year certain” option in which payments will be made for at least 10 years even if you die the next day.
Rates of Return on Annuities. An annuity by its nature is a very conservative instrument. There is usually some level of guarantee – by the Pension Benefit Guarantee Corp. for private employer pensions or by insurance companies (backed up by state insurance guarantee funds) for commercial annuities issued by insurers. Whenever risk of loss is minimal, we can expect returns to be modest as well. Pensions and immediate annuities rarely quote a “rate of return” because they are technically not “investments” but are contracts. Thus annuity quotes simply tell you how much money you will get. Us finance people can compute an imputed rate of return by discounting the payment stream over an expected lifespan – and we find that most private pension offers are using a rate of about 3.0% – 4.5% in computing their payouts. Not too bad in today’s low rate environment.
Commercial annuities you purchase on your own however, are often less generous. I compute returns of only about 2% on many commercial annuity quotes.
NAPFA and Income Solutions provide institutional pricing for fixed immediate annuities available only through fee only advisors. Income Solutions by Heuler Associates is a program which provides institutions (pension plans, employers, etc.) access to annuities for their members. Payment rates seem comparable, in my estimation, to what private employer pensions are providing, and better than most insurance brokers provide on commercial annuities. As a client of a fee only advisor (that would be me) – and by taking commissions out of the loop, we can obtain annuities from major insurance companies at very competitive pricing. Here is an example of monthly income estimates I recently found online for a 69 year old male investing $100,000 in an immediate annuity:
I can’t vouch for any of these sites or companies, and these are not really quotes but merely income estimates provided off the respective firm’s websites, but still it gives a good idea of what is possible (and perhaps a good reason not to automatically jump at whatever AARP offers!)
Income would be lower if the individual were married and wanted income to continue for both his own life and his wife’s, or if the quote were to include an annual COLA.
So if recent market volatility has you reconsidering the risk associated with stock and bond investments, and if stable income for life sounds appealing, give us a call. We can help you see how (or if) an immediate annuity can fit into your overall retirement plan and weigh the pros and cons. Remember, we do not sell annuities – so we do not have a horse in this game. We are compensated by fees (retainer, hourly, etc.) – not by a payment from the insurance provider. Our goal is to see that none of our financial planning clients ever runs out of money – and if this is a tool that can help achieve that goal, we will use it!
Note: annuities are often sold as “guaranteed income” – but it is important to realize that the guarantee is the guarantee provided by the insurance company itself, not by the federal government. It is therefore important to check creditworthiness of an insurer before purchasing any annuity or life insurance product.