Retirement Income Blog

One of the advantages of immediate fixed annuities is the feature that provides you with income for the rest of your life, for both you and your spouse, or simply to pay you for a fixed number of years. But what’s the best choice for you? Let’s consider some payouts based on annuity type and other factors to get a feel for what to potentially expect.

We’ll hypothetically assume a man has $50,000 to invest in an annuity. He’s 70 years old with a remaining average life expectancy of 16 years. What kind of payouts can he expect to get?

If he wants an immediate fixed life annuity on himself, a hypothetical insurance company  determines a monthly payout for him based on his sex, age, investment amount, and the current interest rate. The current interest rate is particularly important since their profit will be based on how much they’ll get for investing his $50,000. They’re predicting the man will die 16 years later (at least that’s their bet based on the average life expectancy of males age 70) so they know how many monthly payments they must make. They’re obliged to keep paying if the man lives longer, but also get to keep the investment if the he dies earlier than expected.

Life Expectancy
In our hypothetical case, the monthly payout is $385.  Incidentally, if the man were 80 years old his remaining life expectancy would be 11 years. So the insurance company would pay out $554 per month since they’ll be statistically paying for fewer months.

Gender
Women statistically live longer than men. A 70 year old woman has a remaining life expectancy of 20 years. This implies more monthly payouts by the insurance company so her payout is only $352 for that $50,000 investment. And if she were 80 years old, her monthly payout would be $498 – somewhat less that then 80 year old man’s, because of her still longer life expectancy.

Joint Life
A married couple may opt for a joint life annuity where payments will continue until the second spouse dies. In the case that both are 70 years old, the insurance company would pay $318 since statistically it turns out that between the two, the survivor would statistically live longer. The payout remains the same even if only one remains alive 

Finally, if the single 70 year old man chose an annuity for a certain period – 10 years – under the prevailing rates, he’d receive $515. But in this case, the insurance company would pay his beneficiary the remaining payments if he died. The payout is the same for the women since there’s no age or age-related sex difference issue here.

For the most current rates, use the immediate annuity calculator.

Immediate fixed annuities are the payment of a single premium to an insurance company in return for periodic payments over a specific period or life.  Once payments begin, the annuity cannot be surrendered for value (there are a few companies that do allow commutation–the surrender of the annuity for a discounted refund).  Income from annuitization is taxed part as ordinary income and part as return of capital and a 10% penalty could apply if the recipient is under age 59 1/2. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. For other ways to generate income in retirement, visit the retirement planning center.

Bookmark It

While tax-free bonds can be a popular source of tax-free income, some retirees are not aware that they can receive a potentially higher source of cash flow from insurance companies using an immediate fixed annuity.

In exchange for the premium payment, the insurance company pays the annuity owner a cash payment for life or for a term of years. Each of these payments is comprised of interest and principal as determined by an actuarial calculation set forth in Section 72 of the federal tax code. The principal portion is not subject to income taxation. Once the owner has recovered his or her investment, the remaining payments will be taxed as ordinary income.|

Let’s take a look at the hypothetical case of Mr. Jones, age 70 with a $500,000 portfolio of municipal bonds, earning 4.17% tax free. He receives $20,850 of annual tax free income (4.17% x $500,000).

He decides to cash in his tax-free bonds and pay a premium to an insurance company of $500,000 for an immediate fixed annuity. With the immediate annuity, his yearly cash payment from the annuity would be $48,000 per year of which 65% is tax free (the tax free portion of an immediate annuity is the part the IRS considers return of your principal and is based on your life expectancy and the expected return). After taxes, he will have $43,800 to spend. His spendable cash increases by $22,950 annually ($43,800-20,850) over the tax free bonds.

You can see how much you could obtain form an immediate fixed annuity using the immediate annuity calculator.

So in this particular example, the yearly cash flow has increased by using the fixed immediate annuity. Of course, your results will vary based (among other things) upon your age, health, and premium payment. The payments in the example shown above are calculated on the life expectancy of the annuitant and the spot interest rates effective for the month of purchase under the contract. The spot interest rates can vary from month to month. The payments shown above are not subject to mortality fees, administrative charges, or other expenses. However, actuarial calculations, life expectancy assumptions, and interests rates can vary from insurer to insurer. Therefore, your results will likely vary from the examples shown above.

An immediate fixed annuity will usually not leave anything for your heirs unless you purchase from a company that offers a refund feature. This refund feature will typically reduce the size of the monthly annuity payments. The amount of the refund could also be reduced by surrender charges in some cases. Therefore, the fixed immediate annuity is generally better suited for people who place more importance upon increasing lifetime cash flow rather than leaving an estate to heirs.

Of course, an immediate fixed annuity or tax free bonds would only be a portion of a retirement portfolio and resources in the retiremenmt planning center can help you plan your entire portfolio.

Bookmark It