One way to get retirement income for the rest of your life
Posted May 1, 2018 2:36 p.m. EDT
NEW YORK (CNNMoney) — I often hear people who want monthly payments in retirement refer to immediate annuities. Can you tell me what an immediate annuity is and how it works? -- Susan
Winston Churchill once described Russia as "a riddle wrapped in a mystery inside an enigma." Well, many people feel the same is true of annuities. And justifiably so. Not only can many of them be maddeningly complex, they also come in a dizzying array of types and variations -- fixed, variable, indexed, deferred, immediate -- each of which operates in its own way. I'd go so far as to say that annuities may be the least understood of all the retirement investments out there.
Fortunately, the type of annuity you're asking about -- an immediate annuity -- is (by annuity standards at least) the easiest to understand and, to my mind the type with the greatest potential for helping people who want more guaranteed lifetime income than Social Security alone will provide.
The premise behind an immediate annuity is simple: You invest a lump sum of money with an insurance company (although you would actually do so through an adviser, a broker or insurance agent) and in return you receive a guaranteed monthly payment for life regardless of how the financial markets perform. The size of that payment depends mostly on your age and the level of interest rates. The older you are and the higher interest rates are, the higher the payment you'll receive.
Today, for example, a 65-year-old man who invests $100,000 in an immediate annuity would receive about $550 a month for the rest of his life, while a woman the same age would collect about $530 a month. By choosing a "joint and survivor" (aka "joint life") option, a 65-year-old man-and-woman couple would get about $470 a month as long as either one of them is alive. You can see what size payment you (and a spouse or partner if you have one) might receive based on different ages and amounts invested by going to this annuity payment calculator.
You should be aware, though, that an immediate annuity involves some tradeoffs. For example, in return for the guarantee of lifetime payments, you typically give up all or most of your access to the savings you've invested in the annuity. This means you may no longer be able to dip into that money for emergencies or unexpected expenses or leave it to your heirs.
Similarly, the payments stop when you die (or, if you've taken the joint life option, when you and your spouse or partner are no longer alive). So if you shuffle off this mortal coil soon after buying the annuity, you'll have shelled out a considerable upfront some for a smaller number of payments, which is why an immediate annuity probably doesn't make sense for people who believe they'll have a shorter-than-average lifespan.
Some immediate annuities attempt to address such issues by offering limited access to a portion of your investment while you're still alive or by stipulating that the annuity will make payments for a certain number of years (five, 10 or whatever) whether you're still living or not. Some immediate annuities may in some circumstances refund a portion of your original investment to your beneficiary after your death.
But such features typically reduce the size the payment you'll receive, which means you'll be diluting the benefit of buying an annuity in the first place. Which is why I contend it makes more sense to think of an immediate annuity as part of a comprehensive retirement income plan that works as follows: Put a portion of your savings into the annuity and opt for the highest monthly payment. Then invest the rest of your nest egg in a diversified portfolio of stocks, bonds and cash that can provide liquidity, long-term growth and, if you haven't spent all your savings by the time you die, a legacy for your heirs.
Just to be clear, though, not everyone needs an immediate annuity. Remember, you'll already be receiving annuity payments in retirement in the form of Social Security. If the amount of guaranteed income you'll receive from Social Security and any pensions is enough to cover all or most of your basic living expenses in retirement, then you may not need an immediate annuity. You may be able to get by just fine by drawing on your retirement investments to pay any other expenses you incur. The same goes if your nest egg is so large that your chances of running through your savings during your lifetime are negligible.
But if you feel you want more guaranteed income than you'll collect from Social Security and any pensions -- and you're willing to take these prudent steps to ensure you're getting a competitive payout and that you can truly rely on the annuity's promise of income for life -- an immediate annuity is at least worth considering.