Home  >  Financial Articles and Q&A  >  How much of your retirement money should you use to...

How much of your retirement money should you use to purchase an immediate fixed annuity?

A friend's advisor recommended that she use between a 1/3 and 1/2 of her savings to buy an immediate fixed annuity when she retired. Is this good advice or should she run for the hills?

Apr 26, 2012 by Agnes from Orlando, FL in  |  Flag
3 Answers  |  6 Followers
Follow Question
15 votes

There is not set rule or answer to this question. While a single premium immediate fixed annuity (SPIA) can give an investor an income stream that he or she cannot outlive, most of the SPIAs have pretty low payouts and internal rates of return because interest rates are so low. So this may or may not be a good idea for her. There are certainly other alternatives that may give her better guarantees like a fixed indexed annuity with a guaranteed income rider. Of course any fixed annuity option will require her to make make long term committment with those dollars. She should probably sit down with a fee-only advisor first and pay them for an analysis. It is way too easy to simply hand your money over to a salesperson with little or no thought of suitablity. I have no problem philiosophically recommending a fixed annuity product with a "portion" of a client's money as long as it is suitbale for them.

Comment   |  Flag   |  Apr 26, 2012 from Atlanta, GA

1|600 characters needed characters left
10 votes

Great question, Agnes. Since there is no one solution fits all in my business, the answer depends on your circumstances. If you have a traditional pension that in effect is annuity, if that is the case you may not need to purchase an immediate annuity. It get's tricky if you don't have a pension! If that is the case one idea is to look at your fixed expenses and let's say that is $3,000 per month and your Social Security benefit is $1,500 per month. One can make an argument to purchase an immediate annuity which would provide income of $1,500 per month. The amount needed will depend on your age and what type of annuity payout you receive. Also be advised that most fixed annuities do not adjust for inflation and the ones that do have lower initial payouts. But we are living longer and every year we lose about 3% of our purchasing power to inflation.

Longevity Insurance is a relatively new type of annuity which is becoming popular. The basics are that you give an insurance company a lump sum of money when you retire which you do not collect to age 85. (Hence the word insurance!). This insures income at a later age and the initial amount is significantly less than purchasing an immediate fixed annuity.

So as you can see Agnes, the guaranteed retirement income landscape is filled with many trade offs. Sit down with an objective advisor and discuss what would work best for you.

Comment   |  Flag   |  Apr 26, 2012 from Cleveland, OH

1|600 characters needed characters left
9 votes
Don Level 19

Agnes, the answer will depend very much on your individual circumstances. Generally, the only reason to purchase this product is to address the risk that you will outlive your savings. If you have sufficient assets and/or guaranteed income from other sources (e.g., social security, pensions), then you wouldn't want an annuity at all. Assuming you are more like the majority of Americans for whom that is not the case, you might want to put some portion of your retirement savings in an annuity that provides a lifetime benefit, but I would recommend that you discuss this with a fee-only financial planner first. Your retirement security is too important to make an important, permanent decision like purchasing an annuity without having sufficient information. Working with a fee-only advisor is important since annuities tend to pay very high rates of commissions and this could bias the advice you receive from an advisor who earns money off those commissions.

Assuming, you and your advisor determine that an annuity is in your best interests, I would consider the following rule of thumb: never put more than 20% in an annuity with any one insurer and not more than 40% in aggregate. While annuities are "guaranteed" they are not risk-free. First, the guarantee is only as good as the insurer. Before the financial crisis, I think the idea that large highly rated insurers could fail would have seemed a stretch. Now you can't be so sure. Also troubling to me is the financial bind that this extended period of low interest rates has caused for insurers. Keep in mind, until a few years ago they were selling immediate annuities to new retirees with 7-8% payouts. That was fine when they could invest in Treasuries at 5% and count on mortality to take out a significant portion of their long-term obligations. Now their investments are earning 2-3%. Worse yet, actuaries found that they underestimated life expectancies. As a result, insurer risk is higher and payouts today are much lower, on the order of 4-5%. This brings another risk seriously into play - inflation. If inflation picks up to historical norms of 3-4% as many expect, a fixed payout in 20 years will have half the purchasing power it does today. One strategy to deal with today's low payouts is to stagger your purchases. Buy half the annuity you want now and wait at least a few years before committing the other half.

Comment   |  Flag   |  Apr 26, 2012 from Middlebury, VT

1|600 characters needed characters left