How an Immediate Annuity Payout Really Works

by Neal Frankle, CFP ®

An annuity payout might be very attractive to you if you are looking for retirement income, but you should really think twice. Even though I’m not a big fan of this idea, I have to admit it has some attractive benefits:

 

annuity payout

 

Immediate Annuity Payout Pros:

1. High Payout

Let’s say you invest $100,000 and request an immediate payout. Depending on your situation and the choices you make, you might receive as much as $700 a month. That’s better than an 8% return. Very attractive in the current market environment. (More on this “high payout” in a minute…)

2. Security

Your income isn’t FDIC-insured, but it is backed by the insurance company you bought the annuity from. (Today, that’s not saying as much as it used to, but it’s still something.) At least your income is “guaranteed” by the insurance company and not subject to the ups and downs of the stock market.

High payout and security are the major benefits. Now let’s consider the flip side of the coin.

Immediate Annuity Payout Cons:

1. No Access to Capital

Once you invest in an immediate annuity, that’s it. Say goodbye to your capital. And don’t think of this as emergency funds. You’ll receive the income (assuming the company stays in business), but you can never change the monthly amount or get more money if an emergency comes up.

2. Your Payout Isn’t the Return Your Money Earns

It’s a combination of principal and interest. So, in the example above, while this person might be receiving a payout of 8%, most of it could be the investor’s own money.

Let’s take a look at our example. Assume you could invest $100,000 in an immediate annuity and receive $700 a month for the next 15 years. Your annual cash flow is $8,400 ($700 x 12 months). That’s 8.4% – but it’s not your investment return because a big part of that $8,400 is your own money. It turns out that the return is about 3.2%.

Now 3.2% isn’t bad in today’s market – but it sure isn’t 8.4%. And remember, you tie your money up for the next 15 years if you go this route. Interest rates might be much higher much sooner. Why take the risk?

In summary, an immediate annuity payout might look really attractive (and it might actually work if all you care about is maximizing your retirement income and you don’t need your capital.) But for most of us, it’s another investment that looks great but really isn’t.

 

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