I’m retired and thinking of buying an annuity to add to my monthly income, but I’m not sure which type of annuity might be right for me. Any suggestions? –Elaine
Confused about annuities? You’re not alone. Lots of people like the concept of devoting a portion of their savings to an annuity in return for the financial security and peace of mind an annuity’s guaranteed income can bring, only to have their eyes glaze over and paralysis set it when it comes to actually choosing one.
Which isn’t surprising, since the types of annuities most often touted by people who sell annuities for a living — i.e., fixed index annuities and variable annuities — tend to be chock full of complicated provisions and expensive bells and whistles that can turn your mind to mush and sap the value of your nest egg.
So I suggest you start with this fundamental principle: When it comes to annuities, simpler is usually better (and cheaper). And if you accept that premise, then the choice really comes down to two candidates: an immediate annuity or a longevity annuity.
Here’s how they work. When you invest in an immediate annuity, you’re essentially handing over a lump sum of cash to an insurance company (although you’ll typically buy the annuity through an investment firm or financial adviser) in return for the promise of monthly payments that begin immediately and last as long as you live. The amount you receive depends on, among other things, how much you invest, the current level of interest rates, your age and your sex.
So, for example, a 65-year-old man with $ 100,000 to devote to an immediate annuity today would receive about $ 560 a month for life, while a woman the same age would collect about $ 535 a month. If you want to ensure that the payments will continue to your spouse or partner if you die first, then you can choose a “joint life” (aka “joint and survivor”) option. A 65-year-old couple (man and woman) investing $ 100,000 in a joint life annuity would receive about $ 470 a month.
A longevity annuity works much the same way in that you turn over a sum of money to an insurer in return for guaranteed lifetime payments. But instead of those payments starting today, they begin at a later date, maybe 10 or even 20 years in the future. Deferring the income allows you to put up a smaller amount of cash than you would with an immediate annuity and collect sizable payments down the road.
Thus, a 65-year-old man who invests $ 50,000 in a longevity annuity today that will begin making payments 20 years from now would receive just under $ 2,000 a month for life starting at age 85. A 65-year-old woman would begin collecting roughly $ 1,600 a month for life at age 85 and a 65-year-old man-and-woman couple would collect about $ 1,100 a month.
So if you want guaranteed payments you can use to cover living expenses right now, an immediate annuity is the way to go. On the other hand, if you’re okay relying on Social Security (and a pension, if any) plus withdrawals from your savings for income for now, but would feel more secure knowing those guaranteed payments will kick in later in life should you spend down your nest egg too quickly, then a longevity annuity may be the way to go.
(If you plan to buy a longevity annuity with money from a 401(k) or IRA, be sure to get a specific type of longevity annuity known as a QLAC, or Qualified Longevity Annuity Contract.)
You can see what size payment you might qualify for from an immediate or a longevity annuity based on the amount you have to invest, your age and sex (and the age and sex of your spouse or partner if you want the joint life option) by going to an annuity payment calculator.
The point, though, is that, unlike with more complex annuities, with an immediate or longevity annuity you can pretty easily see how much money you’re giving up and what you’re getting in return. That makes it easier to compare one insurer’s annuity to another’s (although you do have to take an insurer’s financial condition into account, which you can do by checking out the financial strength ratings different insurers get from firms like Standard & Poor’s and A.M. Best).
That’s not to say immediate and longevity annuities don’t have drawbacks. They do. If you die soon after buying, you’ll have doled out a lot of money and gotten few payments (or possibly none, in the case of a longevity annuity) in return. So it wouldn’t make sense to buy one of these annuities if you’re sure you’ll have a short lifespan (although that may not be a deal breaker if your spouse or partner is likely to live a long life). This longevity calculator can show you the probability that you and/or your spouse or partner will live to a given age.
And don’t forget that once you invest money in an immediate or longevity annuity you no longer have access to it, say, for emergencies or unexpected expenses. So if you do go with an annuity, you’ll want to be sure you have enough savings left over that you can invest in a diversified portfolio of stock and bond funds (plus a cash reserve). That stash can cover unanticipated outlays and also provide the long-term capital growth you’ll need to maintain your purchasing power in the face of inflation.
You also don’t want to buy more guaranteed income than you really need. After all, Social Security already provides guaranteed lifetime payments. And if you qualify for a pension (and take it in monthly payments as opposed to a lump sum), that will also provide you with assured income throughout retirement.
If, after toting up your living costs using an online retirement expenses worksheet, you find that you’ll have enough assured income flowing in to cover most or all of your essential living expenses, then you may already have all the guaranteed income you’ll need.
Similarly, you may not need an annuity if your nest egg is so large — or the amount you’ll need to draw from it to cover your expenses is so small — that it’s unlikely you’ll run through your savings during your lifetime. This retirement income calculator can help you assess your chances of depleting your assets at different withdrawal rates.
Finally, go slow. Even if you decide turning some of your savings into guaranteed income via an annuity is right for you, consider doing so gradually — i.e., buying two or more annuities over time rather than investing your money all at once. This will give you a better chance to gauge what your actual retirement expenses will be and thus how much guaranteed income you really need. As I pointed out in this earlier column on tips for choosing the right annuity, buying in phases will also reduce the chance that you invest your entire annuity stash when interest rates, and annuity payments, are at or near a low.
Of course, you’re free to ignore my simpler-is-better approach and spend your time instead sifting through all the different types of annuities out there in an attempt to puzzle out how each works. Just be aware that if you go this route, you could end up blowing more of your money than necessary on commissions, fees and other expenses, and find yourself nursing a whopping headache to boot.