One aspect to living is that we never know when we’ll die. Having saved money for their retirement income, retirees often worry that they’ll outlive their savings since life expectancies are increasing.
An annuity is an investment that is uniquely addressed to providing income for life. This article shows how you can use an annuity to assure yourself a future income if you live longer than you planned.
What is an annuity?
An annuity is a contact with insurance company. For a given lump sum, the company will pay you a monthly income for a term of years – or for life.
When the company begins paying you, the contract is said to be ‘annuitized’. A ‘fixed annuity’ pays a fixed monthly payment which depends on the current rates that the insurance company can earn of your lump sum when you annuitize.
If the company allows you to invest that lump sum in its market accounts which can vary, you’ll have a ‘variable annuity’ whose monthly payments to you will vary also.
Before annuitizing, you can accumulate a lump sum in an annuity contract with either a single payment (i.e. premium) or through a series of premium payments over time. The earnings on those premium payments grow tax-deferred. Before you annuitize, you have a ‘deferred annuity’.
You actually have a variety of options for what you want to do with what you’ve accumulated in your deferred annuity.
Typical options are:
* Surrender your annuity and receive a lump-sum of all the money. You used it as a savings vehicle.
* Receive payments from the annuity (annuitize) over a specific number of years. If you die before this ‘period certain’ is up, your beneficiary will receive the remaining payments.
* Receive payments from the annuity for your entire lifetime -as long as you live. Typically, there are no survivor payments after you die.
* Some combination of the above two.
* Elect a joint and survivor annuity so that payments last for the combined life of you and your spouse. When one of you dies, the survivor receives payment for the rest of his or her life.
Age-based annuity payments Because an annuity company has many clients, it can confidently count on mortality statistics to allow them to guarantee lifetime payments to clients. At each age, there is a certain remaining life expectancy. Some clients will die earlier that that and some will die later.
But the mortality statistics also allow the annuity company to offer larger monthly payments for life to people that are older when they begin (i.e. annuitize) their annuity. That’s because the longer you wait to begin your annuity, the shorter will be your remaining life expectancy.
So waiting until later in your retirement before you start receiving your annuity, will give you – for the same interest rate in the case of a fixed annuity – a larger monthly payout. You get more monthly income for the same lump sum the older you begin.
At 65, you statistically have a remaining life expectancy of about 20 years. But you have a 50% chance of living longer than that. Because of this extended possibility, retirees, with savings to carry them to 75 or 80, worry they’ll run out of money if they live much longer. They can alleviate much of this worry by using an annuity as a form of insurance against living too long.
Strategy: Use an Annuity as insurance against living too long
If you’re worried that you haven’t enough savings to carry you into your 80s, you can take a portion of those savings now to buy a deferred annuity for annuitizing when you’re 80 or 85. For whatever lump sum you would have accumulated by then, you’ll get a sizeable monthly payment since you’re remaining life expectancy then would be short.
Buying at age 65 and arranging to annuitize it at 85 can be relatively inexpensive. That’s because not only does your investment compound (tax-deferred) over some 20 years to build your lump sum, but the annuity company makes money with your money, and statistics are against you making it to age 85! So buying this future income at today’s prices may take only a small portion of your retirement savings – perhaps as little as 10 to 15 percent.
If you wait until age 85 to purchase an immediate annuity for a given monthly income, you’ll find it much more expensive. That’s because buying it at 85 means you’ve reached age 85, and, therefore, statistically have a remaining life expectancy of at least a certain number of years. So the annuity company knows it has to make some payout with virtual certainty. That makes the cost high for waiting to buy.
Annuities can help you solve retirement income problems if you know how to use them.
