It is likely that you have heard of annuities. In fact, if you are already preparing and planning for retirement, you may even have one. But, you may be fuzzy on the details of what exactly a lifetime income annuity is and how it works.
Lifetime income annuities are insurance products designed to provide income throughout your retirement. If you’re about to retire or have already, you may want to consider this financial product as a stable, guaranteed source of income.
Lifetime annuities can also be called “immediate lifetime annuities” or “payout annuities.” The product is designed to protect a retiree from longevity risk, which is the risk of outliving your savings.
People who buy annuities are called “annuitants,” and the way they select payment of the annuity is called the “mode.” Lifetime annuities come with many options. Annuitants can select their mode of payment to be monthly or quarterly. Annuitants can also select policies that are inflation-protected, and some annuities are variable, meaning the payment may go up or down based on an underlying investment.
Life insurance works by paying regular premiums to an insurance company in exchange for your heirs a receiving lump-sum payment when you die. Annuities, on the other hand, are bought from insurance companies with a lump-sum of cash. In return, you get regular income payments until you pass away, in the case of lifetime annuities, or for the amount of time you’ve agreed upon in the case of term-based annuities.
Your payments are made on a monthly, quarterly, or annual basis, depending on the mode of payments you select.
The size of your payments depends on a few variables, including how many payments you scheduled to receive in a given year and the length of your payment period. Another huge factor is current interest rates, as your initial lump sum investment that you spent when buying the annuity accrues interest that is then distributed in your payments.
Like all types of insurance, annuities are like a wager between you and the insurance company. In the case of auto insurance, you’re betting that you do get into an accident someday, and you’re willing to pay to protect yourself when it happens. The insurance company is betting you’ll pay more to avoid risk than they will have to pay for the accident. In essence, they are betting you’re a better driver than you’re afraid you are.
A lifetime annuity is a bet between the insurer and you that you don’t live longer than the term you and they settle on in your contract. The insurance companies feel confident setting the terms of the bet because they have a lot of data on mortality, and they can predict with a high degree of certainty how long you’ll live, how much they should charge you, and how much money they can make from your annuity.
Let’s do a lifetime income estimate for a 67-year-old woman with $150,000 to invest. If this woman opts for 12 monthly payments, she could receive between $304 and $669 each month, according to the NewRetirement Lifetime Annuity Income Calculator and based on current interest rates.
Over 20 years, that amounts to about $160,000, $10,000 more than her initial $150,000 premium. And the longer she lives past age 87, the more money she’ll get, as she’ll receive that payment each month for the rest of her life.
Of course, there’s no such thing as free money, and annuities do come with some initial upfront fees. For example, most lifetime income annuities are purchased from an insurance broker who will typically take a commission. The amount of that commission varies but could range up to about 10%. On a $150,000 annuity, that translates to a $15,000 payment to your broker.
However, if you buy an annuity from an investment company rather than a traditional insurance company, you may be able to avoid a broker and thus steer clear of paying a commission.
Likewise, if you work with a fee-only financial planner who is acting as your fiduciary, you won’t pay a commission.
The more complex the annuity you want to purchase, generally the more expensive it is. Because annuities are essentially insurance contracts, you can add riders to them. For example, you may add a long-term care insurance rider to cover the possibility you will need assisted living in the future. Or you may want a more complex, inflation-protected product. These additions increase the cost of your annuity.
With an immediate lifetime annuity, you start getting your payout right away, making it a good option for someone who’s already retired. You can also buy a deferred lifetime annuity where you pay now, but start the income at some date in the future.
The first, most obvious reason to buy a lifetime annuity is to protect yourself from longevity risk. Life expectancy has increased from 47 years in 1900 to 79 years today, and according to the Census Bureau, life expectancy in the U.S. will increase to 85.6 years.
Lifetime annuities become most valuable when you live beyond your assumed life expectancy. Other benefits include protecting your savings against inflation and bundling your annuity with other types of insurance. Of course, the more protection you buy, the more expensive your policy is.
Learn more today. Use the Lifetime Annuity Calculator for an instant estimate.
