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Immediate Annuities

Immediate annuities are one approach to resolving this issue. They provide an income for life which is actuarially calculated based on your age and the amount of assets that you have. You turn your money over to an insurance company and essentially purchase a “longevity” policy that pays you a monthly income for a period of time, most often for life, but it can be set to a period of years or life plus a period of years. The benefits are obvious, you do not have to manage your money--the insurance company does it for you and pays you a monthly payment (or other set periodic payment, such as quarterly). From a purely investment standpoint, the immediate annuity should offer a lower expected result in the aggregate than that of alternatives that accept greater investment risks.

There are many issues, however, with using immediate annuities to provide your entire retirement income. What if you want to generate a higher income in early retirement so you can enjoy these years with activities you have always wanted to pursue, such as traveling or an expensive hobby? What if you have a predisposition to illness that shortens your life expectancy? What if you plan on making lump sum purchases, such as those for automobiles or a second home? What if you have other goals than just replacing your income? What if you would like to leave a legacy to charity or an estate to your heirs? All of these issues must be considered prior to purchasing an immediate annuity as the decision is irrevocable. Immediate annuities are not flexible, and there is no option to change the arrangement later. There are types of annuities that may let you withdraw a certain amount as a lump sum, but there is always a catch: any time you are allowed flexibility or other options, it will result in a lower payout. Another problematic issue is that these annuities provide a lower payout for younger individuals. This income is even lower for couples wanting income to last over both lifetimes. Therefore, if you are in your early sixties and want to generate your income by turning your assets over to an insurance company, recognize that your payout is dramatically reduced. But the biggest risk to choosing a traditional immediate annuity is inflation. Although inflation has been relatively tame over the past two decades, you only need look to the period of the 1970s and early 1980s for a dose of reality. Income needs could easily double, so if you require $80,000 in income to cover your living expenses, you would need $160,000 to pay those same expenses. If your income is fixed at $80,000, you would experience a drop in your living standard. (Of course, if any of those expenses were locked in [such as a 30-year mortgage], this would not be affected.) There are newer versions of the immediate annuity that provide an inflation adjustment, but these inflation-adjusted immediate annuities come with a cost. They have a much lower up-front payout. If the initial amount of income you receive is sufficient to meet your needs, then this type of annuity may be a very attractive option. It is important to recognize the limitations to immediate annuities before making the irrevocable decision to use this method for generating income from your pool of assets.
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