Annuity Lifetime Payouts
One of the great features of immediate 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.")
Annuities Come in Two Phases
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.
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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 Make 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.webannuities.com.)
To arrive at this amount, the company actuaries has 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.
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 big factors
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.
We had heard about annuities and were investigating them for our IRAs. We also heard bad things about pushy brokers over the years. So when we went to the ImmediateAnnuities.com site we were skeptical about calling them. But whenever we called their staff was really friendly. They answered all our questions and one of their reps even told us that at our ages there was no advantage to buying the annuity with our IRAs. These guys are really honest!
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 for the 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 Life Annuity
Instead of a lifetime payout, you can also opt for an 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. A life 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.