Not all annuities are
alike, and some may not be appropriate for you. How much do you know about
these investment products?
by: the editors of Kiplinger's Personal Finance July
17, 2020
Annuities aren't new. The annuity concept
dates back to early Rome, when citizens would make a lump-sum payment to a contract
called an annua in exchange for income payments received once a year for the
rest of their lives.
As traditional sources of guaranteed
retirement income -- such as pensions -- disappear, many retirees are wondering
where to turn. An annuity may be the answer, but not all annuities are alike,
and some may not be appropriate for you. Learn about these products and
whether you should invest in them.
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Immediate Annuities vs. Deferred Annuities
There are two types of annuities: immediate
annuities and deferred annuities. Immediate annuities are best for
retirees who want to receive payouts right away.
If you invest money in an immediate
annuity, an insurance company guarantees that you will receive a fixed
payment every month for as long as you live (or as long as you or a
beneficiary are alive). But, in most cases, your money is locked up after you
hand it over to the insurance company, although some insurance companies allow
one-time withdrawals for certain emergencies. So you don't want to tie up all of
your money in an annuity.
Deferred annuities are better for people who
are still saving for a future retirement. The money they invest grows
tax-deferred until it is withdrawn later.
A deferred annuity, also known as a longevity
annuity, requires a smaller outlay of cash. With this annuity, you get
guaranteed payments when you reach a certain age.
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How Much Do Annuities Pay?
Even in today’s low-rate environment, a
65-year-old man can buy an annuity that pays more than 6% of his initial
investment annually for the rest of his life. That's because your payouts
are both from earnings and a return of your principal, and you pool your risk
with other policyholders. You'll receive the highest payout with an annuity
that stops paying when you die.
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Annuity Payouts: Single Life vs. Joint Life
If you buy an immediate annuity, you’ll get
the highest annual payout if you buy a single-life version—one that stops
payouts when you die, even if your spouse is still alive.
But if your spouse is counting on that
income, it may be better to take a lower payout that will continue for his or
her lifetime, too. (Some annuities are guaranteed to pay for a certain number
of years, even if you and your spouse die during that period.) The annual payouts
for a 65-year-old man who invests $100,000 in an immediate annuity would shrink
from $5,928 for a life-only annuity to about $5,004 per year if he buys a joint
life annuity that continues payouts as long as either he or his 65-year-old
wife is alive.
You can compare how much you’ll receive for
different types of payouts at immediateannuities.com.
4 of 10
Annuity Payouts: Men vs. Women
In general, annual immediate annuity
payments are higher for men because men usually have a shorter life
expectancy. Now a 65-year-old man who invests $100,000 in an immediate annuity
can receive about $5,928 per year, while a 65-year-old woman could receive
about $5,628 per year.
5 of 10
Annuity Payouts: Older Buyers vs. Younger
Buyers
The older you are when you buy the
annuity, the higher your annual payout because your life expectancy is
shorter. Currently, a 65-year-old man who invests $100,000 in an immediate
annuity can receive about $6,700 per year, while a 75-year-old man can receive
about $9,350 per year. For this reason, some people ladder their annuities --
investing some money early in retirement to cover expenses, then adding more
when they get older to boost payouts.
6 of 10
Consider an Inflation-Adjusted Annuity
Standard immediate annuities guarantee that
you’ll receive an annual fixed payout that will never decrease for the rest of
your life , but inflation could erode the value of your payments over
time. Some companies offer cost-of-living adjustments that boost the payouts to
keep up with inflation—3% a year, for example—but that will lower your initial
payouts by up to 28%.
7 of 10
Low Interest Rates Will Sink Your Annuity
Payout
When interest rates are low, payouts from
annuities are depressed, too. Payouts are usually tied to rates for 10-year
Treasuries, and that rate is historically low. If you’re worried that interest
rates could go lower—or you’d like to start receiving at least some guaranteed
income now—consider building an annuity ladder. With this strategy, you spread
the amount you want to invest in an immediate annuity over several years. For
example, if you want to invest $200,000, you would buy an annuity for $50,000
this year and another $50,000 every two years until you have spent the entire
amount. If rates rise, you’ll be able to capture them, and if they fall, you’ll
have locked in payments at the higher rate.
8 of 10
You'll Pay Fees for Cashing Out Your Annuity
Although deferred annuities let you cash out
at any time, you may not get all your money back. You generally have to
pay a surrender charge that starts at about 7% to 10% of the account balance in
the first year, and gradually decreases every year until it disappears after
seven to ten years. Also, if you take the money before age 59½, you generally
have to pay an early-withdrawal penalty of 10%. However, this year, because of
the CARES act that penalty is waived for annuities held in IRAs if the money is
needed to cover a coronavirus-related health emergency or hardship. If your
employer allows COVID-related distributions from an annuity in a savings plan
like a 401(k), the penalty is waived then, too.
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Deferred Annuities: Fixed vs. Variable
Most deferred annuities allow you to invest
your money in mutual-fund-like subaccounts. Many of these products, known
as deferred variable annuities, allow you to add, for an extra fee, guarantees
that you won’t lose money even if the underlying investments decline in
value. If the market tanks, you can still withdraw about 5% of the guaranteed
balance each year. And you can withdraw the actual account value at any time
(after the surrender period expires) if your investments increase in value.
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Your Annuity Is Protected Even If the Insurer
Goes Bankrupt
If you have a fixed deferred annuity or are
receiving fixed immediate annuity payouts, then your payouts are protected by
the state guaranty association. The level of protection varies by state. Find
your state limits at nolhga.com.
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