You might be very tempted to buy an income annuity right now, but if you do, you’ll regret it. Income annuity is just another name for an immediate annuity.
First, what is an income or immediate annuity?
You make a “deposit” with an insurance company and they immediately start sending you a monthly check. That’s what’s known as the annuity payout. Depending on what type of immediate annuity you set up, you can get monthly payments for five years, 10 years or whatever…even for the rest of your life or the life of you and your spouse.
The monthly payment you receive will be based on two things:
a. How old you are now.
b. What prevailing interest rates are.
Generally speaking, the older you are the more you’ll get. Why? Because the insurance company knows that as soon as you die, they can stop sending the check. The older you are, the less time you have to collect. That’s why senior term life insurance might be better for you if you are focused on your beneficiaries.
Mean and calculating SOBs, those insurance companies. Lower interest rates impact the payments because if the company earns less, they get to pay you less.
For most immediate annuities, the payments you get never change and you don’t have access to your lump sum payment either. That means if you suddenly need $10,000 for an emergency trip to Paris or quadruple bypass, you’ll just have to find the money elsewhere. Your investment is irreversible.
I told you they are mean and calculating SOBs.
Still, the financial services industry is touting immediate annuities right and left as the answer to low bank interest rates and volatile stock market returns. Don’t fall for it. Think about your long-term needs – and the needs of your life insurance beneficiary. Don’t just think about what might feel good over a long series of short-term periods strewn together.
Let’s look at an example.
Let’s say you could invest $100,000 in an immediate annuity and receive $8,000 a year for life. Let’s further assume that you decide to make this investment at the age of 65 and you live another 15 years. Here’s why the investment stinks.
You invested $100,000 and you receive $8,000 a year, but your return isn’t 8%. If you live for 15 years you’ll receive a total of $120,000 in payments (15 years at $8,000 each year). If y0u calculate the total return (on a simple basis), it’s about 1.67% per year. That’s because the $8,000 the nice big insurance company sends you is mostly your own money.
Now how hard is it going to be to beat 1.67% (average) over 15 years? Nobody can predict the future, but my opinion is that it shouldn’t be that tough.
The people who market these products appeal to your natural inclination to only think about the short term. They play to your fears of short-term volatility, and if you fall for it, it will cost you big time over the long run.
Immediate annuities stink – especially now. There might be some cases where the investor doesn’t care about total return and only cares about cash flow…and in that case, they might be OK. But with interest rates as low as they are, I stand by my recommendation.
Have you had a different experience with immediate annuities?
You might also be interested in reading the pros and cons of immediate annuities for a different perspective.