Why Buy Immediate Annuities
In light of the recent turmoil in the financial markets, pre-retirees are facing some difficult choices as they approach retirement. Many pre-retirees have relied upon the forces of the market to put them in a position to retire on time with enough assets to generate the income they need to live comfortably. For those people who anticipated retirement in the spring of 2009, and who had stock investments in their retirement accounts, their plans may have had to change significantly.
A rule often applied to ensure that your assets can generate a life time of income is to withdraw no more than 5% a year. If a person was basing that plan on having a million dollars in assets on the day of his retirement, the plan would have to drastically change if he arrived with only $750,000. Either he would have to delay retirement or withdraw far less each year.
As more pre-retirees arrive at retirement’s door in similar situations, serious consideration should be given to immediate annuities as way to stretch the value of their assets to compensate for market losses or slower than anticipated growth of their assets. An immediate annuity provides a guaranteed lifetime income and provides protection against market risk. Also, because the income payout is based on actuarial and interest rate assumptions, immediate annuities can generate a higher monthly payout over a longer period of time.
Let’s use the example of the pre-retiree who incurred a loss of $250,000 on his $1,000,000 retirement plan. He had planned to retire, with his wife, at age 65 with $1,000,000. Applying the 5% withdrawal guideline, he was expecting to withdraw $50,000 a year which would have lasted for 29 years assuming his assets continued to earn a 2% return. This would work out well if they both were to die by the end of the 29th year.
Now, with only $750,000, he would have to choose between retiring later, and withdrawing a lesser amount of money in order to make the asset last longer. If he chooses retirement now, his withdrawal amount could not exceed $37,500 a year and, again, his assets would be depleted in 29 years.
In both cases, the retiree would have no protection against living too long. Plus, his income would have no protection against inflation. In either of these situations, they would have to reduce their lifestyle in order to stretch their assets. Once their assets have been depleted, there would be nothing left for their heirs.
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Immediate Annuity Solution
If the retiree were to, instead, place his $750,000 into an immediate annuity his monthly income would be $3711 or, $44,500 per month which would get them back closer to their desired goal of $50,000. Under a joint life arrangement, this income would continue until both of them died. This payout rate also provides for their beneficiaries to receive a return of their initial premium should they both die prior to their life expectancy.
Because a portion of the monthly payment is a return of principal, only the interest portion is taxable which, in effect, leaves the retiree with more money to use each month. The fact that annuity income is exempt from the Social Security tax computation is an added tax bonus.
An immediate annuity can also provide protections against inflation through the addition of an inflation rider. These riders can guarantee an annual increase in income based on fixed percent or tied to the Consumer Price Index. While there is an added cost for this protection it is offset initially by the favorable tax treatment of the income and it then begins to pay for itself after 5 or 6 years.
Immediate annuities are obligations of a life insurance company. The promise to pay a guaranteed amount of income for a lifetime is backed by the financial strength and claims paying ability of the company. As such, it is important to select a life insurer that stands up to the rigorous standards of the financial rating agencies such as A.M. Best. There is no reason to work with a company with anything less than an A+ rating.
An immediate annuity is not for everyone. As with any investment decision, full consideration needs to be given to your complete financial situation. If you already have a guaranteed pension plan through an employer you may not need an immediate annuity. And you certainly shouldn’t commit all of your assets to any one investment. An immediate annuity is an irrevocable commitment so it would be important to have some liquid assets available for emergencies.
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