While perusing through old magazines in the dentists office, I came across an ad for annuity with the usual headline “Get a monthly income check GUARANTEED for life”. I took a picture of the ad, the payout rates are below:
The specific product is a fixed immediate annuity where you pay them a lump sum and received regular monthly payments until you die. It is called the AARP Lifetime Income Program (guaranteed by New York Life and only endorsed by the AARP). There are two options to protect you in case of an early death – either a “cash refund” or “20-year guarantee” feature:
- “Cash Refund”: if you die before your total payments equal your annuity purchase price, your beneficiary will be paid the difference.
- “20 Year Guarantee”: if you die before 20 years has passed, your beneficiary will receive the remaining monthly payments during the 20-year guarantee period.
DIY Early Retirement Pension?
Since my wife and I don’t have any pensions to look forward to, one way to create our own pension is to buy a fixed immediate annuity. I used their quote calculator to see what I could get right now if I was 50 years old and with the 20-year minimum payout.
So with a lump sum of $100,000, I could get $445 a month for life. That works out to a 5.34% payout rate.
The “guarantee” for annuities are only good as long as the issuing insurance company stays in business, but many states have a guaranty association that provides an additional backstop. For example, in Florida the total annuity cash surrender protection per owner per member company is $100,000, and the maximum aggregate benefit for all insurance lines is $300,000. I am not a lawyer, but from what I read that means I can buy three $100,000 annuity policies from three different insurance companies, and have it all backed by the state if any or all of those insurers goes bust.
That means if we were both 50 years old right now (which we aren’t), both my wife and I could put $300,000 across different insurers and both get about $1,300 a month in lifetime that is about as safe as one can make it. Together, that’s a cap of $2,600 a month. I don’t want to annuitize our entire portfolio, but I imagine that it would relieve a lot of my stress if our basic needs could be met with a monthly annuity payment that doesn’t depend on the performance of the stock market.
Now, these numbers above do not adjust for inflation, and so will buy less and less goods each year. This is important, especially if I am going to be buying so early at age 50. Inflation-adjusted annuities are available but the payouts are significantly lower and I feel the competition is not as good. One alternative is to start small and ladder additional annuities as you age.
There are many of these types of annuities available out there. I’m not recommending this one in particular, I was just using it as a handy example for some rough number calculations. A good comparison site is ImmediateAnnuities.com.
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Thanks for the writeup, but a far better alternative is a 30-year T Bond. You nearly match the yield (4.64% vs. 5.34%), it’s at least as secure, and you can get in and out on far better terms. You or your heirs will get the full principal back at the end of 30 years instead of nothing (or near-nothing) under the annuity at your death. That more than makes up for the small difference in yield. If you are worried about inflation, another option is a 30-year TIPS paying 1.90% plus inflation.
If you want to beat the annuity yield-wise, you could also get a 30-year municipal bond from your state, earning roughly 4.77% tax-free, though a case could be made in today’s environment that munis are riskier than annuities.
Note that all these products carry rate risk. Except with the TIPS, you’re hosed if inflation spikes.
Annuities are far better than reverse mortgage because you cannot pass it on to the heirs. Annuities has lot of options to pass to heirs and also lot of different annuities to serve different people requirements. Also you have your house with you which you can pass it on as well.
You mentioned in the example that you like to put the immeidate annunity when you are 50 years which I think may be right age but as our life span increases and we are looking live longer than normal. People are retiring in 70s instead of 60’s this days. I think you need decide properly and take decision on when to retire depending on your health and work nature. That should drive the timeline for putting the annuities and reap better rewards. Just my 2cents.
ken,
you mean simply buy the etf tlt?
I think immediate annuities can have a place in one’s retirement income portfolio as a conservaitve instrument, but they should be approached with a good amount of scruntiny. The actuaries at the insurance companies that design these things are no fools. They have the statistics to know that most people will die early enough that the insurance company will be the “winner” in these transactions. Things like cash refund or 20 year guarantees may provide some peace of mind to the annuity holder, but at best it’s just generally a break-even situation then. Very few customers probably live long enough to get all their money back and actually make a worthwhile return on it. So if you have a history of longevity in your family, it may be a worthwhile gamble. But I think most of us should probably just place a small portion of our assets at retirement in these things, letting it serve as one tactic of an income generating strategy that includes the usual list — dividend paying stocks, TIPS, other bonds and bond funds, etc.
Immediate annuities can be a useful tool in a retirement portfolio. Sometimes they get painted with the same brush as variable annuities, which can be a total rip-off, but immediate annuities are different.
Actually Ken the appropriate comparator would be to price out buying 20 treasury zero coupon bonds with maturities of 1, 2, 3,…, 20 years. At each of those bond’s current market yields how much equal annual income could you receive for 20 years? This way you are consuming both interest and principal each year, as is the case with the annuity. If it is higher than these annuity rates, you are certainly better-off doing it yourself because the credit risk of this strategy (Treasuries) is less than that of the insurance company. On the other hand, the insurance company is taking a bit of spread for putting this together for you and assuming the mortality risk of you living much longer, which you don’t have by just buying the bonds yourself.
Whenever I’ve looked at this in the past it was generally better to use the annuity because the rates were higher. Today’s 20-year bond yield (coupon bond, not the zero) is just over 4%, and the 19 shorter bonds in your ladder will have lower yields, so I think this will also be the case today.
BTW you could construct a similar ladder using nominal bonds (not TIPS) that provided smaller initial but increased annual payouts by allocating more of the funds towards the later bonds, so that your annual income would increase by 2%, 3%, or whatever you expect inflation to be. That way you could hedge your exposure to your expected inflation, though you’d still have the risk of unexpected inflation.
I don’t think you can (should) buy these immediate annuities until you’re over 60 (in this case the illustration shows age 65).
@Ken Feyl – Good points. Immediate annuities are all about dealing with longevity risk and reducing rate risk. If I am 50 and live well past 80, then the 30-year bond may or not be a good fit. But as you get older the rates are significantly better than the 30-year T-bond rates.
I agree it should be a small part of the portfolio, definitely under 50% I would say.
@Ken in Georgia – I agree that if we were in a high rate environment, I’d be much more comfortable buy an annuity at such a young age as 50. The fear would be that when I have to roll over any bonds, it would be at a much lower rate. But rates are already pretty low right now historically. Even in 2007, these annuities offered a 1-2% higher payout (every year until death).
@LEH – This specific AARP annuity is available from ages 50-89, per their site. (77 for 20-year payout.) Immediateannuities.com gives quotes for them from age 40, I’m assuming from the insurers that sell them for those ages.
I generally like the idea of immediate annuities for a portion of your retirement. The major benefit in my mind is that they are guaranteed paycheck for life. It removes the longevity risk.
Vanguard also sells annuities. I’d bet you can get a little better rate via Vanguard than AARP. But thats just a hunch.
Please consider the current behavior of the Fed in “printing” more money to increase growth, inflate the stock market and pay increased government debts.
If things continue the way they are, it won’t be long until the Dollar stops being a world reserve currency and hyper-inflation kicks in. In 20 years, your annuity payouts won’t probably be enough to buy you an aspirin.
Best kept secret: instead, protect yourself putting a portion of your net-egg on Gold and Silver for the future.
Clark Howard hates annuities with a special kind of passion. I trust his advice and will never own one.
@Robert – You may have missed this article by Clark Howard. (I think it’s by him, but it is on his website.)
“Longtime listeners know that annuities are a four-letter word in Clark’s mind. Most annuities have massive commissions and massive expenses. That’s why they’re pushed by commissioned salespeople, especially those in banks who target customers complaining about low CD interest rates.
But there’s one annuity that may be a great deal for a lot of people. It’s called an immediate payout annuity (aka life annuity).”
http://www.clarkhoward.com/news/personal-finance-credit/investing-retirement/-best-providers-of-immediate-payout-annuities/nFL5/
There are many different kinds of annuities, the vast majority are to be avoided by most people, but single premium immediate annuities are among the more straightforward and potentially useful.
I know Hersh Stern at ImmediateAnnuities.com and have used his services for several of my clients in the past.
You generally find that CFP’s like Clark Howard and Suze Orman are against annuities. That is because they have great faith in the future growth of securities and the power of the stock market to perform compound interest miracles over time.
But as anyone who has bought and sold stocks in the past 5 years can attest, the volatility may be too much for many retiree’s to handle. Even with their long term investment horizon in mutual funds, or bonds, annuities represent a good way to diversify away from other more volatile asset classes, and create a kind of ‘private pension plan’ for folks going into retirement.
Just found, and LOVE your blog btw.
i think an immediate annuity is a very good idea. retirement should be carefree and free from investment risk. safe, guaranteed lifetime income is the way to go. unfortunately, rates are low. i plan on purchasing an immediately annuity with my 403B, when rates are higher, hopefully within 2-3 years.
please remember, retirement is not a time to put any of your money at risk. i want a secure, carefree retirement and wish that for all of my fellow retirees.
The Current Payout Rates (AARP Magazine Sep/Oct 2011 pg.37) are indeed higher.
The calculations and conclusions based on need updating by previous commenters.
Immediate annuities sound great. Supposedly you’ll receive a certain percentage for 20-30-40 years from a lump sum investment. The problem is that they are not guaranteed by the US Government. An insurance company can be here one day and gone the next. Sounds impossible? Here’s our story.
As part of an agreement from a divorce settlement, my wife was issued an annuity from the largest insurance company in California that was supposed to guarantee a return of $5000 a month for life starting at age 65. About the time she was scheduled to start receiving the monthly payment, the company declared bankruptcy, Executive Life of California. There was a mismash for several years as the state insurance commissioner tried to make up the losses for subscribers by involving a French company into the frey. But the reality was she lost the majority of her annuity. Interesting thing about these insurance company bankruptcies is that over time they are swept under the rug. The bottom line, she lost out on her retirement income receiving a settlement of 30 cents on the dollar. Based on initial return that amounts to a huge loss of initial investment.
After this experience I realized there is only one way to have a secure retirement fund with no risk or worry, Treasury Bonds. We were fortunate to have I-Bonds at a decent fixed rate so we receive about 5-6% a year, resulting in a doubling every 12 years. Sounds slow, but the stock market has returned about 2% a year on average for the past ten years. So…in summary…Annuities sound great but they also have their problems and can crash just as the stock market.