Immediate and Income Annuities
An Immediate Annuity Guarantees Life-Long Income
Imagine that you and your spouse are finally enjoying the freedom and fun of retirement. Your kids have flown the nest, the pressures of a career are behind you, and you're in good health and able to travel, socialize and pursue interests such as volunteer work.
There's just one nagging worry. You're not sure just how many years of retirement you're facing, and planning a life income that could last to a ripe old age is a challenge.
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Living a long and healthy life is wonderful, but an extremely common concern for retirees is that they may outlive their savings. Americans are living longer than ever. At the same time, issues with corporate pensions, the Social Security system and a volatile stock market do little to allay fears of running out of money. One answer could lie with a little-known insurance product called an immediate income annuity, also known as a life annuity.
One of the great features of life annuities is their ability to provide you with income for the rest of your days - in effect, a lifetime stream of income that you can never outlive. Even if you live to a ripe old age of 120, you are still guaranteed payment from the insurance company if you chose to receive annuity payments for life. (Other payout options are available as well, known as "period certain annuities.") Get a quick, immediate annuity quotation here.
How Can An Immediate Annuity Help Me?
An immediate annuity can solve many of your income needs. The unique guarantee, security and flexibility offered by an immediate annuity make the product an ideal financial solution for many situations. For example, if you're searching for an easy way to manage your retirement income, an immediate annuity can relieve your financial concerns with a simple one-time premium. Or, if you have a qualified plan and want to retire early, an immediate annuity can help you avoid early withdrawal penalties.
An immediate annuity provides protection against outliving your assets. Advances in technology and healthier lifestyles are allowing Americans to live longer than ever. According to the National Center for Health Statistics (1996), if you plan to retire at age 65, you can anticipate managing your assets for income 20-30 more years. But you can relax -- immediate annuity payments are guaranteed for life (or the certain period of time you choose). You can never outlive lifetime benefit payments and they will never fluctuate. With the guaranteed income offered by an immediate annuity, you'll only have to worry about managing your retirement spending.
You may select from several immediate annuity payout options that can be customized to meet your needs. An immediate annuity offers:
- Security - The Single Premium Immediate Annuity is immune to market fluctuations which can put your retirement plans in jeopardy.
- Flexibility - You choose to receive payments as frequently as needed to best meet your situation.
- Stability - Choosing a life option assures you income that you can't outlive.
- Choice - You can choose from several different income payment options for
your immediate annuity. Some of the most common include:
- Fixed period - You decide how many years you want to receive income payments and the amount of each income payment is reported to you.
- Fixed amount - You decide how much you want your income payment to be and the calculation of how long the payments last will be done for you.
- Life - With a life payout option, you will receive payments for the remainder of your life. The risk with this option is that if you die before receiving the full-accumulated value of your investment, you could lose some of the value of your investment.
- Life with period certain - With this option, equal payments are made to you throughout your lifetime or to your beneficiary for a guaranteed minimum period of time.
- Life with refund - Under this option you elect to receive a life income; but if you don't live long enough to receive all your premiums back, it will be refunded to your named beneficiary.
- Joint and survivorship - This payout option provides for payments over the lives of two individuals and can also be combined with period certain options.
How Does an Immediate Annuity Work?
You contribute a lump sum, say $50,000, and receive monthly income for the rest of your life. The income is determined by your age (and therefore life expectancy). Instead of continuing to manage the $50,000 in your 401(k) upon your retirement at age 67, for example, you could instead annuitize it, in effect creating a do-it-yourself pension. In this example, if you chose an immediate fixed annuity today you would receive roughly $670 per month for life if you're a woman; $723 if you're a man. With a fixed annuity, the amount of the payment does not change. If you choose an immediate lifetime annuity, and die soon after signing the contract, generally the money you contributed goes to the insurance company and not to your inheritors. This, however, can be circumvented by utilizing an automatic beneficiary option.
The Two Phases of an Immediate Annuity
There are two phases in the life of a typical annuity: the Accumulation Phase and the Payout (or Annuitization) Phase. If you purchase a deferred annuity (regardless of whether it's a fixed annuity that is invested with a guaranteed interest rate or a variable annuity which is invested in stock mutual fund accounts) your annuity will accumulate earnings on a tax-deferred basis. The Payout Phase begins when you decide to begin receiving income from your accumulated account.
Generally you have two ways to receive cash from an annuity on a regular schedule. One is to set up a Systematic Withdrawal schedule by which you control the amount to take out and you can start or stop the cash flow at your discretion. The second method is called the Annuitization approach.
Annuity Payout Phase
The annuitization payout process works the same for a fixed or variable annuity. When you're ready to start receiving payments, you notify your insurance company that you wish to convert your account into an immediate income annuity. The company actuaries go to work and they consult tables which tell them what your life expectancy is at the time you initiate your payout phase. Insurers must ascertain how long you can reasonably expect to live in order to figure how much guaranteed income your accumulated account balance can generate.
An Immediate Payout Annuity Makes Sense If You Are Concerned About Outliving Your Wealth
An immediate payout annuity is one of the only investments that will continue to make scheduled payments as long as you live. It would make sense to convert your deferred annuity account into an immediate annuity if you expect to live for a long time.
Here's an example of how the annuity payout phase would work: Let's say you're a 70-year-old male with $50,000 accumulated in your annuity. Your company tells you it will provide $387.24 a month for the rest of your life. (This is just an example and is not meant to reflect any one company's rates. Keep in mind that these rates also fluctuate from week to week. When you happen to read this article, rates will probably have changed since the time it was written and the monthly income at that time will be different. For a current annuity quote go to http://www.immediateannuities.com.)
To arrive at this amount, the company actuaries have considered how much return on investment they can get from your $50,000 and how long annuity payments might have to be made. This example assumes the insurance company can get a 5 percent return on the money that it will be investing and that the annuitant will live for another 17½ years.
If you (currently age 70) lived to 103, you beat the life-expectancy odds and the insurer will have made payments far longer than it expected. But if you died two years after your payout phase began at age 70, the insurance company would apply the undistributed account to another policy holder who did live longer than his or her life expectancy. Your insurance company will spread its actuarial risk among as many annuity buyers as possible. In the end, if everything has gone according to plan, the insurer should end up exactly at break even statistically on all its payouts to annuitants, by spreading the money from annuitants who died early to those who outlived their life expectancies.
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In addition to life expectancy influences, your monthly payment will also depend upon the insurance company's expected investment returns on your money. If the insurer can expect to receive a 7 percent return on its $50,000, the monthly payout would rise to $449.96. At a 3 percent return, the payout would drop to $327.05. Insurers base their anticipated return on the performance of their often-conservative investment portfolios. In a fixed-payment arrangement such as this, you're at the mercy of their investment expertise, so to speak. If you're not comfortable with this, you might look into a variable payment. If you have chosen to receive fixed payments, your monthly payout will not change, which means the insurer takes on all the investment risk. (For simplicity sake, we've chosen to use a fixed payment for our example. You can, however, choose the variable payout, which is tied more directly to investment performance.)
Age and Gender are Important Factors in Immediate Annuities
As you've seen, interest rates have a direct impact on how your payout is calculated. Now, say our man is 80 years old instead of 70 and decides to buy an annuity with his $50,000. Because of his shorter life expectancy at age 80, his monthly payment would be $550.42 - 40 percent more than he'd get at 70. This change has nothing to do with investment performance; it's merely because the insurance company expects to make payments for only 11 years. The insurer can make higher payments since it expects to make them for a shorter period of time. Women won't receive as high a payment as their male, same-age counterparts simply because women generally live longer than men. It's not discrimination at work, just differences in mortality. In our example, a 70-year-old female can expect a monthly payout of $353.41; an 80-year-old female can expect $503.83. (A 70-year-old woman is expected to live for about another 20 years.)
A Joint Life Annuity Is A Good Option for a Couple in Good Health
You may wish to continue your retirement income to your spouse upon your death. This is called a survivorship annuity payout, an option commonly chosen. If a husband and wife were both 70 and they want a lifetime income from the annuity, the monthly payout would be $306.37. This is about $80 less per month than without the survivorship benefit. You can see that the insurance company is taking into account that it will be making more payments than it would if just one life were factored into the mortality rate.
As we've said, the life expectancy of a 70-year-old male is 17½ years; but the payment period for a joint annuity covering two 70-year olds is extended to almost 25 years because of the same-age female. It's often true that the financial needs of a senior couple are not as great as the needs of a senior widow or widower, so the lower initial monthly payout of a joint annuity isn't usually a deterrent. Keeping the monthly benefits flowing for the surviving spouse is much more important than receiving a slightly larger monthly benefit initially.
Adding A "Period Certain" Guarantee to Your Immediate Annuity
Instead of a lifetime payout, you can also opt for an immediate annuity which guarantees monthly payouts for a defined period of time, such as 20 years, in addition to paying you income for as long as you live. If you should die during these 10 years, your beneficiary receives payments till the end of the 20th year. This choice would yield $361.38 instead of $387.24 for our 70-year-old male. You'll always get lower payments for "certain periods" when the period you choose is longer than your life expectancy because the insurer expects to make more payments that way. An immediate annuity with a "certain period" added on completely eliminates the chance that the insurance company could pay out for less than 20 years.
Use "Period Certain" Annuities Sparingly!
Many people are reluctant to purchase a life-only annuity (no certain period) because they are sure they will get hit by a truck on the way home from buying the annuity, in which case the insurance company makes out like a bandit. Remember, though, that hindsight is 20/20. You wanted to buy the annuity because you were afraid you might outlive your wealth. That was still the right decision at the time, and your premature demise wouldn't change that. In most cases, your surviving loved ones are more satisfied that you had peace of mind about your financial independence than they are with getting more inheritance.
Percentages of Savings to Invest in an Immediate Annuity
It is generally advised that those choosing this investment tie up only part of their money in annuities, leaving cash available for emergencies and, if possible, something to leave to heirs. In addition, in a few years, if inflation and interest rates should increase, retirees might wish they had not tied up all their money during a low-interest-rate period. Some suggest a good strategy might be to buy annuities in stages over a period of time in the hopes of taking advantage of (potentially) better interest rates
Shopping for an Immediate Annuity
Two issues are key when buying annuities: the payments and the credit quality of the insurance company. Obviously, you want to choose the highest return on your money, and a company that is trustworthy. Unlike variable annuities, which are backed by stock market investments, fixed annuities become part of the insurer's general account and are backed by the insurance company itself. Therefore its creditworthiness is paramount. Look for insurance companies with high ratings from all credit rating companies.