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 life insurance for seniors 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.
Joseph Salvemini says
FACT: Retirement is all about monthly Cash Flows Received to cover living expenses for the remainer of your life. No other Investment can match the monthly cash flow rate of Immediate Income Annuities nor can any other investment be as predictable. Your Rate of Return Calculation is Flawed you can’t assume date of death. If you’re annal about rate of return then Buy a 15, 20, 25 or 30 Year Period Certain Annuity. You know your UP-FRONT the Total Dollars Received for the length of the deal selected.
It is best to shop around for the Highest Immediate Income Annuity Payout… You can do that with one service and making only one request… Go to JDSAnnuities.com
What is an Immediate Income Annuity?
The FACTS:
It is an exchange of a Lump-sum of money for a Monthly Income Stream guaranteed for Your Life, the joint life of you and your spouse or for a Specified Period of Time 10 Year to 30 Years. Contrary to what you read and hear, you can add guarantees to the Life Options. This can be in the form of an Installment Refund Guarantee or a Certain Period. The trade off is a lower monthly income stream and is not as low as you may think. The younger you are the less the trade off is.
Here is a listing of the payout options:
Life Only
Life with Installment Refund
Life with 20 Years Certain
Joint and Survivor Life
Joint and Survivor Life with Installment Refund
Joint and Survivor Life with 20 Years Certain
Joint and 75% to Survivor Life
Joint and 67% to Survivor Life
Joint and 50% to Survivor Life
10 Year Period Certain
15 Year Period Certain
20 Year Period Certain
25 Year Period Certain
30 Year Period Certain
Safety, Simplicity and No Fees: You know up front how much of a Lump-sum you need to exchange for the Monthly Payment you receive. Nothing else is charged to you nothing is deducted from your payments. It is what it is!
Immediate Income Annuities are all about Guaranteed Fixed Spendable Monthly Cash Flows that you receive each month for life. When you’re in Retirement these Cash Flows are what’s important to you. Nothing else comes close in importance.
Having a Guaranteed Monthly Income Stream as part of your Portfolio improves the performance of your Entire Retirement Portfolio. How? It allows you to focus on investing long-term for maximum compounded return without having to worry about your monthly spendable funds/cash flows.
A point that is unique, very important and never discussed in buying a lifetime annuity… The waiting for Higher Monthly Payouts. Remember Immediate Income Annuities are based on how long you live even when you add a guarantee. We all know that you will die at a point in time in the future. We just don’t know when that point in time is. So, weather you Buy an Immediate Income Annuity today, 1 Year for now or 2 Years from now is not going to change the point in time payments will stop (Your date of Death).
Therefore, each month you wait to Buy this annuity is a month of cash flow you forgo. Wait a Year and it may take years to make up that loss of cash flow and you may never make it up. My point… Once you are at or near the point when you need monthly cash flow and you have made the decision that Immediate Income Annuities are what you want to help meet your retirement income needs then it simply makes no economic sense to wait. In the last 10 years, the Payouts in Immediate Income Annuities are not materially different from the high point to low point especially on the Life Options which are based on the very long end of the Yield Curve. As an example the 30 Year Treasury Bond Yield today is 4.66%. The two peak yields in the last 10 years were ~ 5.35% in June of 2007 and ~ 6.23% in February 2000 (moved quickly in the mid 5%’s after). Not much of a range If you really think about it.
Yes, Immediate Income Annuities, Fixed Rate Annuities and Index Annuities when honestly reviewed should play a role in everyone’s portfolio for a percentage of your investable long-term assets from age 50 up and until the day you die. They provide safety, predictability, an attractive rate of interest and Cash Flows during Retirement that can’t be safely matched by other investments you may allocate into.
Evan says
FS,
With deferred annuities you have an beneficiary who would receive the $100K. But with the product that Neal is talking about you already turned on the income stream, and then depending on the product if you die the next day your assumption is correct.
Financial Samurai says
Neal or whoever teach me this. What If I deposit $100,000 with the insurance co, and I die TOMORROW. Is there really such a thing where the insurance co just keeps everything and gives themselves high fives?
Isn’t there an heir to the money, ALWAYS? If not, what kind of bafoon would sign up for some sort of thing?
Assuming there is always an heir, I guess the secret is to just out live their expectations.
LeanLifeCoach says
For any finance/insurance product there are the rare cases that the consumer benefits – annuities to extended warranties. But for every one that benefits how many do not? Insurance companies are in business to keep more than they spend. At its most fundamental level they are just taking your money and investing it, so why not cut out the middleman!
Kirk Kinder says
Neal,
Great post. I am glad to see there are voices out there discussing what a horrible investment annuities can be. They aren’t in all cases, but I find they are more often than not.
If you know you are going to live well beyond the life insurance company’s actuary tables, then it may be beneficial. Of course, who knows how they they will actually live.
Also, counterparty risk is rarely mentioned as another risk to these products. Sure, the states audit insurance companies and have reserve requirements, but that doesn’t guarantee that a company won’t mismanage their assets or reserves.
Overall, I think you hit the key points on fixed annuities, and this will really help your readers.
Jackie says
I’ve never even considered annuities or had more than the vaguest notion of what they do. But generally I imagine insurance companies are pretty good at ending up with a profit on average, so I’ll stick with only using the products I need to insure against a loss.
Evan says
Jackie,
What about insuring against loss of principal? Or insuring against future possible flucuations in the market? If you had 100K in 2007 you CERTAINTLY did not have 100K in 2008 nor did you have the income produced by that 100K. What if you were already retired? and were depending on that income?
I am not saying they are for everyone, but your blanket statement indicates you might not understand the product
Evan says
Neal,
I have to disagree with you in this case, and it is only because you are using terms that indicate it is never a good idea. If life insurance is a bet that you’ll die then this is just a bet that you’ll live.
Think about all those people that got in on a SPIA (Single Premium Immediate Annuity for your readers) when applicable interest rates were hovering around 5%? Think about their montly check coming in today, think they are upset about it?
What if your 65 year old lives to 95? and receives $240K in payments GUARANTEED WITH ZERO WORRIES about Monte Carlo runs, crashes, recessions. The zero worry part has to do with who you are buying from, some insurance companeis have been around longer than some states lol.
Again, I am not disagreeing with you that in some instances its a bad call, but to use the words like never, horrible, etc., just makes it seem like that in some cases the product wouldn’t work in favor of the person purchasing.
Thoughts?
There is also an advanced design to use a SPIA to purchase a life insurance which is then owned by a Trust. This sort of design can only be used if the client has absolutely no need for the cash.
Neal@WealthPilgrim says
Evan,
You are right. Absolutely. I did mention
“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.” and your example is spot on. Over the last 10 years, a SPIA would have kicked butt compared to every alternative. However, when you sign up for the SPIA, you are doing so for (hopefully) more than 10 years.
It certainly depends on the situation and I may have gotten carried away a bit. But in 25 years, I only remember 1 time when the purchase of this investment made sense.
My fear is that many people are sold these investments because of the salesperson’s need for a commission rather than from a client-needs standpoint.
Having said all that, Evan, your point is well taken.
Evan says
“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.”
I don’t think I saw that part, sorry! There also may be cases where you use it for estate tax purposes. Example: $100K SPIA paying that 8K….the 8K is used to purchase a LI policy in a Trust. Person dies – that 100K is out of their estate and the LI policy which hopefully replaces the 100K is outside the estate for estate tax purposes. Rare case but it does work.
“My fear is that many people are sold these investments because of the salesperson’s need for a commission rather than from a client-needs standpoint.”
A VALID VALID FEAR! Actually just read a great article you may be interested in about how Planners SHOULD act (but as we both are well aware don’t):
http://www.myjourneytomillions.com/articles/financial-planners-act/
Neal@Wealth Pilgrim says
Thanks Evan…I’ll check it out…
MR says
I got 2.37% for the interest when I did the TVM calcs. Where did I go wrong?
N=15, PV = -$100,000, PMT = $8,000, and FV = $0
I/YR = 2.37%
Neal@WealthPilgrim says
Hey MR, you are correct if you calculate the return on a cash flow basis and that is the preferred method.
As I mentioned in the post, I calculated the return on a simple basis…I wrote this last night and didn’t have my calculator and I figured that the difference wouldn’t matter all that much. But thanks for pointing this out. I’ll keep my trusty TI with me from now on!