Is It Time to Annuitize? It Just Might Be
Here’s Why Baby Boomers Are Choosing Immediate Annuities
Worried about outliving your money? You share that fear with many baby boomers. No one wants to spend their last dollar before the last day of their life. Since you can’t tell when that day will be – and since you may need more income long before that day arrives – you may want to look into an immediate annuity.
An immediate annuity provides “immediate” income. In fact, immediate annuities are income contracts issued by insurance companies. They have been around for decades, and actually trace their roots back to the Roman Empire.1
The classic immediate annuity is the single-premium indexed annuity (SPIA). Establishing an SPIA is a pretty straightforward matter. An individual pays a single premium (lump sum) to an insurer. The lump sum becomes the principal of the annuity. The insurer invests the money and it earns interest that reflects the performance of an index fund, usually the S&P 500. (Even if the linked index performs poorly, there is usually a minimum guaranteed return for the annuity.) The insurance firm subsequently makes monthly payments to the annuity holder, payments that it guarantees will last a lifetime. (The insurer makes the guarantee, not any financial industry regulatory agency or state life insurance guaranty association.)2,3
How much income are we talking about? Broadly speaking, if you're in your fifties or sixties and put $100,000 in an immediate annuity today, you could receive monthly payments in the $450-550 range, or around $5,500-$6,750 a year for the rest of your life.2,4
The payments are a combination of principal, interest, and what insurers term a “mortality credit” that increases with time. Essentially, you get “bonus points” for living longer. As you age, the payments grow incrementally larger.2
You also have payment options. Some SPIAs feature joint payouts (they pay a couple instead of an individual). Some are termed life with cash refund (whatever is left of the principal when you die goes to a beneficiary in a lump sum), others life with installment refund (the same, except the remaining principal goes to a beneficiary in installments). Some offer a period certain only option (the payments to the annuity holder are arranged to go on for X number of years and then cease). Some are life with death benefit (with X% of the principal dedicated to the death benefit for your heirs). If you have absolutely no heirs, there is even a life only payment option, whereby you get the highest possible annuity payments but the insurer gets to keep 100% of any remaining principal if you die.1
Immediate annuities differ from deferred annuities in a key respect. There are two phases to a deferred annuity: the accumulation phase and the income phase. Assets grow during the accumulation phase. Years later, the income phase begins and payments are made to the annuity holder out of the accumulated principal. If you opt for a deferred annuity, you may have to wait 5-10 years for that first income payment to arrive. With immediate annuities, the income stream starts immediately (or if you prefer, within a year).3,5
Immediate annuities can provide a tax advantage. Most deferred annuities are held within traditional IRAs, and therefore the earnings and investment results grow tax-deferred during the deferral phase. But when the income phase starts and the tax-deferred earnings are paid out, the IRS wants a fair share.4
Immediate annuities can also be used in IRAs that require minimum distributions beginning at age 70½. Since an immediate annuity pays back both principal and tax-deferred interest to the annuity holder, a portion of each payment is considered to be income in the eyes of the IRS, and a portion is considered to be tax-free return of principal. The shorter the payout period, the greater the amount that can be excluded from tax.6
Traditional IRA withdrawals are calculated to encourage the distribution of IRA balances over a person’s lifetime. With longer lifespans, the tables the IRS uses for this calculation risk fast becoming obsolete – and that raises the very real threat of outliving your IRA assets. However, if those assets are invested in an immediate annuity, a lifetime income stream can be assured and as noted above, the IRS will accept that income stream amount as an acceptable required minimum distribution (RMD).6
What are the opportunity costs of setting up an immediate annuity? For one thing, you’re handing over a chunk of your savings to an insurance company. You will lose access to it. What if you need it for long term care or an emergency? You also don’t know how much of it will be left for your heirs. You’ll pay a significant surrender charge if you want out of the annuity contract soon after it is signed.2
If you have substantial retirement savings to begin with, buying an immediate annuity may be likened to outfitting your car with a fifth wheel – it may be nice, but not necessary. Finally, there have been insurance companies that have gone belly up – it rarely happens, but it has happened before.
So, does it make sense to annuitize? If you’re healthy, active and mature, an immediate annuity can potentially be a great income source for you. But before you arrange an annuity contract, talk to a financial advisor or insurance agent who understands these investments thoroughly, one who can explain your options.
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
1 - marketwatch.com/story/the-6-best-ways-to-collect-on-your-annuity-2014-09-09 [9/9/14]
2 - tinyurl.com/otjbqlg [7/4/14]
3 - insurance.ca.gov/0150-seniors/0600informationguides/seniorannuitiesguide.cfm 
4 - nasdaq.com/article/new-income-annuities-for-retirement-accounts-cm387611 [9/5/14]
5 - nytimes.com/2013/09/10/business/retirementspecial/annuities-to-buy-now-and-collect-on-later-maybe-much-later.html [9/10/13]
6 - tinyurl.com/kwxyk9o