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Three Types of Immediate Annuities


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I often find articles asking if annuities are right for the audience reading them.  There certainly is no clear cut answer to that question, but the AARP did a great job of simplifying the answer for their readers in their version of “Is An Annuity Right For You?”  Jane Bryant Quinn’s article for the AARP Bulletin says that making your money last over your lifetime is the single most important concern in retirement.  For those nearing retirement or already in it, have you planned well to ensure that your money last over your lifetime?  Half of retirees will live longer than their life expectancy.  Social Security and pensions are the most familiar items that pay you for the rest of your life.  Since most people do not have company pensions anymore, annuities are a great substitute for that guaranteed monthly income.  The AARP recommends immediate annuities to their readers, so this blog will summarize these particular annuities and their benefits.

Immediate fixed annuities pay you a fixed amount each month for the rest of your life after a one-time premium payment.  They offer the highest starting payment amount, but the other types catch up and even surpass that depending on how long you live.  Some people prefer to have a fixed payment and know that amount will be coming in each month for the rest of their life.  If you want some market exposure, an immediate variable annuity offers that.  Your monthly payments are based on a percentage of your portfolio’s value, something that changes with the stock and bond markets.  Inflation adjusted annuities increase your payment yearly to account for inflation.  The amount may be fixed each year or it may vary based on the actual inflation rate in the country.

To make it simple for readers, AARP refers to one of the arguments against annuities as the “sucker factor”.  Some people worry that if they buy an annuity with $100,000 and die within a year, or even sooner, they were a sucker for purchasing such a product.  First of all, you have to get past that mental image and realize that you won’t be concerned with anything after you have died.  What is important is that you were protected by your annuity in case you had actually lived beyond your life expectancy, something that many people do.  If you use the example of a 65-year old woman with $100,000 to invest, you can get a good illustration of how her choice of investment will affect her monthly payment.  By opting out of an annuity and drawing her money down using the 4% rule, she could take $333 per month starting out, adjust it annually for inflation, and have it last for around 30 years.  This of course is not guaranteed.

An inflation-adjusted annuity would offer her $379 per month starting out, increase yearly, and be guaranteed to last as long as she lives.  With a fixed annuity, her payments would increase to $579 per month, but they would stay the same for the rest of her life.  The variable annuity payments would be different depending on the carrier and product at the time of purchase.  One financial expert put it bluntly when asked “what if she dies too soon” and answered “who cares.”  The annuity did what it was supposed to do and insured her against running out of money.  It also offered higher monthly payments than if she had used the drawdown method anyways.  If you are concerned about leaving annuity money to your heirs, there are products that offer death benefits tied to your annuity.

You have to weigh the benefits and costs when looking at the different immediate annuity choices.  Moshe Milevsky believes that the potential gains you could receive with an immediate variable annuity make up for the downside risk.  He recommends starting out with lower payments and having them increase over time.  Chances are good that stock values will grow over the long term.  One financial planner in the article recommended inflation-adjusted annuities to preserve the long term value of your money and what it will purchase.  She cautioned against using all of your savings to purchase your annuity though.  This is important because you should have some money that is easy to access as cash in case of emergency.  Another financial planner recommended using stock and bond funds and drawing money from your bonds only for the first ten years of retirement.  He admitted though, that this strategy is not best served for those who do end up living into their 90’s.  They are better off with inflation-adjusted annuities.

Written by Rachel Summit

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