I was going through my e-mails the other day when I received another e-mail from an insurance company (I say that because I receive a lot of e-mails from various insurance companies) advertising some change in their current offerings. I breezed over it when something jumped out at me. The thing that really caught my eye on this e-mail was that it was advertising a rate increase. The current economic environment isn’t leading to very many rate increases. It seems like nowadays all I’m seeing is rate decreases, so it was refreshing to see an increase.
This got my attention so I read on. The e-mail was promoting an immediate annuity. The big hook that the e-mail had was that a 65 year old male could get 7.2% income from this particular immediate annuity. In a world of the 4% rule this caught my attention. What this company is saying is that $100,000 could be turned into approximately $7,200 per year for as long as you live.
I’m not someone that says everyone needs an annuity but it does give you some advantages:
- Guaranteed stream of income – The company that sent me the e-mail has a Comdex of 98 which means that they are financially rated in the top 2% of all insurance companies. That’s a pretty strong guarantee.
- No down years - One of the biggest killers of retirement withdrawals is years like 2008. When you withdraw money during a down year, your accounts will never be able to recover. You are not depending on the market.
- Diversification – Everyone talks about it. People talk about diversifying your streams of income. Here is a great way to do that.
- Leave something behind – This is probably the second biggest argument against annuitization. I looked into it closer and a 65 year-old male in average health can guarantee an insurance policy for the $100,000 he just annuitized for about $2,000 per year. This means that he would still be receiving 5% income guaranteed for the rest of his life.
- Control – The number one reason against annuitization is that you are giving up control of your money. This is true. So don’t annuitize all your money. You only want to annuitize a portion of your money. Usually this will be a portion that will cover fixed expenses that you know are going to be there. Bills such as property taxes, insurance, utilities; these are bills that are always going to be there regards less. If you’re not sure where your money goes I recommend using personal finance software to help track your spending.
What about inflation?
I have not mentioned inflation. I know what you are thinking the 4% rule is indexed for inflation. Well the advertisement they sent me never even mentions inflation. I would be willing to bet money that some stupid people that call themselves financial advisers are going to go out and try to sell 7.2% income and never even thought about inflation. It’s the first thing I thought about so I went into my software and started to dig around quickly. When indexed for a 2% inflation the payout was about 6%. But this is where your other assets come into play. Here is where your investments would be used to hedge against inflation. Diversification is key. There’s no perfect fix. Your investments would be part of your income rather than all of it.
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{ 13 comments… read them below or add one }
Very good news and very interesting!
Just to clarify, if I die 1 yr after i sign up for my $100k annuity, does the insurance co. keep the 100k, or is there a clause where i designate a heir? The later right?
What are the penalities for deciding to ask for the principal back if after 10 year syou change your mind for example?
.-= Financial Samurai´s last blog ..Where Americans Pay The Most To Live And Why =-.
@Financial Samurai
Now that’s a good question. Maybe I need to take a step back and explain annuities and how they work. For now I’ll do my best to answer your question as simply as possible.
The 7.2% income is an income only annuitization. This means that there is no beneficiary and the insurance company would keep the money. That is why I made reference to the life insurance policy.
However, if you choose an income with a period certain(i.e. 5, 10, 20 years). The period certain is the amount of money you or your beneficiary is guaranteed to receive. To give you an example, life with 10-year period certain would pay just over 7% income. In fact, with today’s immediate annuities you can also access this guaranteed amount of money if you need to. Though, doing so would reduce your future payouts and there may be fees for this which can vary quite a bit from company to company.
Also, there really is no changing your mind with annuities. That is why it is key to use this as a tool for only a portion of your retirement income. It can provide more flexibility for other pieces of your financial puzzle.
EOW, then a annuity underwriter is just hoping we all die as soon as we sign up and fork over the money.
Who in their right mind would just do an income only annuity, if the spread is only like 3% vs. the risk free rate? MAYBE I might do one at 10%, but noway 7%.
You?
.-= Financial Samurai´s last blog ..Where Americans Pay The Most To Live And Why =-.
@Financial Samurai
Insurance companies are a business. I would make the guess that instead of hoping you will die as soon as possible they look into people’s life expectancy and determine the payouts based on that. This way if you live to the average life expectancy you get your money back plus credited interest. If you live shorter you probably aren’t going to get all your money back and if you live longer you will get more than you money back.
Why would a 3% spread not be enough? 3% is a pretty high number. Why would you need 10%? Where else can you get a 7% income guaranteed for life?
Hey EoW, it’s great someone also has the 4% rule to investing:
http://investorjunkie.com/the-4-percent-rule-to-investing
I also agree most people (also pros for that matter) don’t think about inflation. Last year the CPI was 2.9% so any investment that made less than that means you lost money in inflated dollars.
I’ve always thought about them as targeted more to people who don’t have much savings and need a more secure return. Also, this part I’m not sure of, don’t some annuities have inheritance options?
For me personally I’m not so sure about annuities and will have to think about them more as I get closer to retirement.
.-= Investor Junkie´s last blog ..Expect Even Lower Bank Rates =-.
Sorry CPI was 2.7%, not 2.9% and that is also if you trust the government’s number.
.-= Investor Junkie´s last blog ..Expect Even Lower Bank Rates =-.
@Investor Junkie
Thank you for the comment…to your question. Yes, most annuities offer a few different options when it comes to passing money on. The 3 main ways to accomplish it are cash refund, installment refund and period certain. Each option has an indirect cost associated with it, you receive less income than you would would income only option.
I read a great study about a little over a year ago how having a portion of your money in an annuity can really help your financial situation due to the fact that you don’t have to withdraw as large of a percentage from your nest egg in down years. I’ll have to see if I can find it.
I would say diversifying your income streams is thee most important financial move you can make. Having one income stream from, for example, a job is a bad financial move. For some people they can’t do too much until they have more money to invest or options available. I definitely agree, though, that the annuity is a good option.
.-= David@noisecake´s last blog ..Sleeping At Last Sing-A-Long =-.
@David
You make a great point on the importance of diversifying your income during your working years as well. Thank you.
What do you guys think about variable annuities?
.-= mike´s last blog ..Mutual Fund Monday: Morningstar Announces their Choice for Fund Managers of the Decade. =-.
I think they do a great job for the purpose they serve. I wrote an earlier post on it:
http://evolutionofwealth.com/2009/12/variable-annuity-can-work/
Let me know what you think. If you still have questions or more specific questions I will do my best to answer them.
Sorry if this is a dumb question but when you purchase an annuity, who is your money guaranteed by? The government or the institution you buy it from? Is it an insured investment?
.-= SFaith´s last blog ..Why Write A Business Plan? =-.
@SFaith
Not a dumb question at all. Annuities are guaranteed by the claims paying ability of the insurance company. Insurance is regulated on a state level so there is a state guarantee fund set up to step in and provide some protection for you if the insurance company were to go under. However, these protections vary by state.
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