FPA Financial Planning Perspectives
IMMEDIATE FIXED ANNUITIES IN TROUBLED TIMES
Retirees or near-retirees jittery about whether they’ll have enough income for retirement in the aftermath of the long decline of the stock market may want to consider an overlooked option: immediate fixed annuities. Although they have their drawbacks, many financial advisors say they’re at least worth a look.
The idea of an immediate fixed annuity is simple. You pay a one-time lump sum and the insurance company, mutual fund, bank or brokerage firm begins making immediate fixed monthly payments (or quarterly, semi-annually or annually if you want) for life or what other payment period you choose. In short, an immediate fixed annuity acts much the same as a traditional pension plan (which fewer workers have access to these days). How much the company pays you each month depends on such factors as your age, sex (some companies don’t differentiate between sexes), payout rates for that carrier, interest rates at the time, and the payment option you choose.
For example, a 65-year-old man who pays $200,000 would receive approximately $1,570 a month for life, according to a recent estimate by Annuity Shopper. A 65-year-old woman would receive $1,450 (women on average live longer, so they receive less each month).
Immediate annuities also come in a variable form, where payouts will fluctuate depending on the performance of the investment options you choose. However, if market fluctuation is what you want to counter, you’ll want to stick with fixed payouts.
For skittish investors, the idea of the annuity provider promising fixed payments even if you live to 105 probably sounds great. And for some of them, an immediate fixed annuity is undoubtedly a good choice. But there are some drawbacks to be aware of.
As with most investment products, the greater the safety, the lower the return. Annual returns for immediate fixed annuities are running four to six percent—below the potential returns for stocks and even some types of bonds.
There’s also no inflation adjustment. The buying power of fixed annuity payments decreases over time, eaten away by inflation. That’s why many financial planners recommend that if you do buy an immediate annuity you don’t put your entire portfolio into it. Keep something in stocks, which have a history of outpacing inflation.
One of the biggest drawbacks cited for annuities is that if you die early, typically your heirs receive no refund of the investment premium that you didn’t earn back from the payouts. If you pay $200,000 for an immediate fixed annuity for life, and die the next day, the insurance company, not your heirs, keeps the $200,000.
One way around this dilemma is to choose a different annuity payout option. For example, you can buy an immediate fixed annuity that will pay income for life with “ten years certain.” That means that if you die before the ten years are up, payouts will continue to your heirs until the ten-year period ends. If you outlive the ten years, payouts continue for the rest of your life, but your heirs receive nothing. Most companies offer plans with a variety of certain-year periods (not to exceed your life expectancy). You also can choose an annuity that pays out only for a certain number of years, but not for life.
Naturally, there are trade-offs for these alternative features. In the case of life plus certain, the payouts are lower. In our earlier example, the 65-year-old man would receive $1,500 a month instead of $1,570 if he chose life plus ten years certain. For a 15-year period certain only, the payout would be higher—$1,663 a month—but if the man lives longer than 15 years, the payouts would stop.
Immediate annuities are not for everyone. The general advice is that if you have plenty of investment assets to weather market downturns, or you have sufficient pension and Social Security income to cover monthly expenses, you probably don’t need a fixed annuity. Also, check for investment alternatives that might perform better with reasonable safety. If your life expectancy is less than normal, an immediate fixed annuity may not be a good fit.
There’s much more you should investigate about immediate annuities, preferably with the help of a financial planner. And shop around carefully. Payout rates for identical amounts and options can vary substantially from company to company, and there is always the issue of company solvency.
December 2001— This column is produced by the Financial Planning Association,
the membership organization for the financial planning community, and is
provided by Rich Chambers, CFP™, a local member in good standing of the FPA.
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