If You're Buying a Fixed Annuity Then You Might NOT Want To Wait For Better Interest Rates

Right now interest is low and this is causing the payout on fixed annuities to be low too.   I figure if you're considering buying a guaranteed life fixed annuity right now then it might make sense to wait a little while and see if rates go up so you can get a better monthly payment.   But after looking at the numbers a little, I'm not sure if it will pay off to try that.

I tried to find historical rates for fixed annuities and couldn't come up with much.   The ImmediateAnnuities site has a chart going back to 2003.    Thats not very far but it does show how annuity rates do seem to track in proportion pretty well to AAA corp. bond rates.  

Today if you're buying a fixed annuity then a 65 year old male can get about $534 per month for $100,000.   A 70 year old would get about $598.   So simply buying later will get you more which is based off the lower life expectancy for a 70 year old versus a 65 year old.  

Lets say that you simply lived off of your savings and spent the same $534 per month for 5 years.    You could take about $32,000 and put it in a 1% savings account and drain that down over the 5 years.   The other $68,000 you could put in CDs for 2% and end up with about $75,000.    At 70 years old that $75,000 will only get you about $448 at todays rates.    Now the idea with waiting is that you should be able to get a better annuity rate in a few years if or when interest rates go up.    But in order to get back to at least the $534 a month you'd have had if you bought at age 65 you'd have to have rates go up about 20% from where they are now.    This is actually relatively likely.    But its no given.  

I'd figure roughly that interest rates will need to go up about 2% in that 5 year period just for you to get back to the break even point.   Thats not a safe bet.   Its not a bad bet but its not something you can really count on either.  
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Single Life Annuity Rates as of April 2015

I got the annuity rate here out of the Annuity Shopper Buyers Guide April 2015 posted at ImmediateAnnuities.com


Average single life annuity rates from a $100,000 premium :

	Life	3% cola	20 year
50 M	$397	$249	$387
50 F	$380	$233	$374
55 M	$430	$280	$412
55 F	$409	$263	$398
60 M	$474	$324	$441
60 F	$447	$300	$426
65 M	$534	$383	$472
65 F	$499	$352	$458

I have listed the average rates for people 50, 55, 60 and 65 years old either male or female.

So for example if you're a 65 year old male and buy an annuity with a 3% cola you'll get $383 a month for the first month with a $100,000 premium.

The 3 columns are : a simple single life, life with 3% cost of living adjustment (cola) and a 20 year certain payment which guarantees to pay out at least 20 years or life whichever is longer.

Annuities with the 3% cola pay about 30-40% less than a regular life annuity.

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Period Certain Annuity Payout Rates

A period certain annuity (AKA term certain ) is an annuity that lasts for a fixed number of years.    It does not last your lifetime and really has no relation to your age or health.    This arrangement is pretty simple.  You pay the insurance company $100,000 today and buy a 10 year period certain annuity and they pay you $890 a month for 10 years. 


I got the rates right out of the Annuity Shopper Buyers Guide April 2015 posted at ImmediateAnnuities.com

I also then used this calculator to estimate the equivalent interest rate you'd have to earn to equal the annuity payments.

Here is the table for a $100,000 premium :

Period	Monthly	Total	% rate
5	$1,680	$100,800	0.31%
10	$890	$106,800	1.32%
15	$643	$115,740	1.99%
20	$524	$125,760	2.38%
25	$454	$136,200	2.61%
30	$407	$146,520	2.73%

The rates are the average monthly payments and then I summed up the total that you'd get out.

Given the low rates they're quoting there for the shorter term annuities you should really NOT buy a 5 year annuity.   You'd come out ahead just laddering CDs from Ally bank.    You could spend out about $1707 a month if you just bought 4 laddered CDs of 1,2,3,4 years.    I didn't do the math but I am guessing you can beat the 10 year annuity with CD ladders too.    This assumes you don't have tax reasons that make the annuity preferable.



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Immediate Annuity Rates September 2014

I actually hesitate to post this since I'm in doubt about the accuracy of the numbers.    I got the figures below from the Annuity QuickQuote website.   I'm suspicious of the accuracy since some of the numbers aren't linear.  e.g. there is no reason I can think of that the annuity rate of a 54 year old would be marginally better than a 55 year old.  Unless its just different quotes from different insurers but I don't know why insurers wouldn't quote all ages.

So anyway, big fat disclaimer, that I"m not sure all these figures are really accurate.   It doesn' matter anyway, you'd have to get a real quote from a real insurer so the numbers here are just meant for reference.

Here are the rates for a married couple with 100% survivor benefits.  Male age is on the rows and female is in the column. :

	50	55	60	65	70
50	3.60%	3.63%	3.85%	3.93%	4.10%
55	4.59%	4.75%	4.90%	5.31%	5.36%
60	5.14%	5.28%	4.53%	5.55%	5.65%
65	4.22%	4.30%	4.58%	4.72%	4.84%
70	3.59%	3.70%	3.74%	4.82%	5.15%

So if for example you've got a 65 year old man and a 60 year old wife then they can get 4.58% payment rate.

Note that I"m not sure why the payout rates aren't always linear in that table.  For example why is the payout rate for a 60 year old man and 50 year old wife better than a 70 year old man and 50 year old wife?  I'd assume the 70 year old man and 50 year old wife would have lower payout.  I'm not sure if the numbers are inaccurate or if theres something going on with the mortality rates or how insurance companies quote the figures that I'm not aware of.  

Single life annuity rates are :

	M	F
50	4.45%	4.55%
51	4.55%	4.57%
52	4.60%	4.59%
53	4.65%	4.62%
54	4.75%	4.65%
55	4.70%	4.76%
56	4.98%	4.82%
57	5.11%	4.85%
58	5.20%	4.89%
59	5.28%	4.95%
60	5.25%	5.08%
61	5.32%	5.15%
62	5.10%	5.20%
63	5.34%	5.23%
64	5.70%	5.25%
65	5.73%	5.29%
70	6.60%	6.25%
75	7.85%	7.30%

Again I'm not sure why the numbers aren't always linear.  I'm sure its not mortality tables doing that since.   I suspect there may be something wrong in the database.

These annuities would not have any kind of cost of living adjustment so keep that in mind.
It may be worth it to get an annuity with 10 or 15 year certain return.  Sometimes the 10 year certain return annuities are the same payout and the 15 year can be marginally lower.   Its kind of like an insurance policy for your heirs if you want just to feel confident that the money won't be wasted in the worst case that both spouses pass prematurely.

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Value of Cost of Living Increase in an Annuity

Fixed immediate annuities are often quoted without any kind of cost of living increase.  However it might be a good idea to buy one with a increase built in to account for inflation in the long term.  I usually use the immediateannuities.com  website to get quick quotes on fixed immediate annuities but they don't have any options for inflation/COLA increase options on the annuities.

Fidelity has an estimator for fixed immediate annuity payouts.  One nice feature of their estimator is that it also gives an option to get a 2% annual increase for the payments.   I used their calculator and plugged in different ages and tested for single versus joint and with or without the 2% annual increase.

Here are the monthly payouts for an investment of $100,000 comparing different ages for 65, 55 and 45 years old as well as single versus 100% joint survivor and with or without the 2% annual increases :

	65	55	45
single	$594	$485	$423
single+2%	$484	$371	$310
joint	$495	$427	$386
joint + 2%	$390	$319	$273

That gives differences in payouts of :

	65	55	45
single	19%	24%	27%
joint	21%	25%	29%

A 2% annual increase is worth around 20-30% difference in thee value of the annuity.    A higher cost of living increase would be worth more.


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Should You Buy an Annuity Now or Wait?

As I right this interest rates are still generally very low.   Mortgage rates have gone up about 1% in the past month or two.   However Treasuries, munis and corporate bonds are still pretty low.   It is almost inevitable that sometime in the next couple years that interest rates will go up.   Annuity rates are based on interest rates at least in part.  The insurance companies that sell annuities base the payout rates on how much money they expect to get from their investments which is tied to interest rates.    When interest rates go up you'll see annuity payout rates go up as well.    Given that we're at very low interest environment right now it would follow that right now is not a great time to buy an annuity. 

I went looking for historical data on annuity payout rates.   I couldn't find much.   The Immediate Annuities site has data going back 10 years to 2003.    I think thats a good enough time period to see a good trend.   If you look at that site and find Chart 7 you can see the trend for a fixed immediate guaranteed life annuity for someone aged 65.   From 2003 to 2009 the monthly payment was around $600 give or take.   As of 2013 their data shows payouts around $500 range.   You can see in that chart how the corporate bond yields and the annuity payout rates move in the same direction.    I think its a safe conclusion that if corporate bond rates go up a couple % points then we'll see annuity payout rates go back to the rates we saw 5-10 years ago.  Just a few years ago annuities were paying out about 20% more than they are now.   It would follow that if you wait a few years and interest rates recover that annuity rates will also rebound.

Lets look at an example of how this might work.   Say you're 65 year old male and you've got $100,000 that you want to use to buy a fixed life annuity.

Option 1: Buy today. 
If you buy right now you'll get $545 a month for life.

Option 2:  Wait.
Lets say you decide to instead wait two  years before you by and hope that interest rates go up.  You could keep your money in safe bank CDs.   You could spend $545 a month in the meantime.  Thats $6,540 a year or $13,080 total.   After two years you'd be left with only $86,920 left.  If you bought an annuity with $86,920 at age 67 then todays rates would give you $492 a month.  However if interest rates go up 2% in the next couple years and annuities end up paying 20% more then you'd get $590.


If you want to take a little risk then waiting till rates recover may very well be worth it.   Of course it might backfire and maybe two or three years from now we could still be seeing relatively low interest rates.   However that doesn't seem very likely to me.

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Don't Play Russian Roulette With Your Retirement

I've talked about fixed annuities on and off in the past.   Generally I think that an immediate fixed annuity can be a pretty good way to provide some guaranteed income during retirement.

A lot of people are generally wary of annuities.   Sometimes people are legitimately worried about high fees or just confused about how annuities work.    Most people have an understandable cautious concern about handing over large amounts of their money to an insurance company and thus feel they are losing control of their finances.   However I also think a lot of people feel they can simply do better by managing their own money and investing in stocks and/or bonds.

Investing Your Lump Sum at Retirement, David F. Babbel and Craig B. Merrill,  August 2007

They made this analogy between investing your money for retirement and playing Russian Roulette :

"Financial planners sometimes say that a particular favored system may give you a good chance of significantly higher investment returns if your savings are placed in equities or some other favored investment. That may be true. But such homemade systems also carry a risk of running out of income long before one runs out of life. Their sponsors may counter that the risk of such an eventuality, if everything goes according to assumptions and the plan is followed tightly, may be only 15%. That is roughly equivalent to the 16.7% odds of losing in a game of Russian roulette, and few people are prone to participate in such games! Why, then, are people so prone to bet their own income security when it comes to retirement?"

What if I told you that you have an 85% chance of outliving your retirement funds if you self managed the money in stock/bond investments.   Doesn't seem too bad if you put it that way.   The vast majority of time people will do fine.

But the opposite of that is the 15% failure rate.   Which is quite close to the 1 in 6 chance (16.7%) rate of losing  a game of Russian Roulette.    Would you take those odds?

Of course I'm not saying that buying stocks is analogous to putting a gun to your own head.   But its an interesting way to think about the numbers.   When the negative consequences of failure are very high then it gives us much more compelling reason to take lower risks and seek a much higher success rate.    The consequences of running out of money in your old age are pretty bad if you ask me.

Note: The cynical side of me forces me to point out that the study in question is partially funded by an insurance company which makes profit off of selling annuities.   Which I think is bad cause peoples natural cynicism in distrusting studies funded by profit seeking companies can can undercut what is a very good retirement strategy.  

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Why a $1,000,000 Prize Is Often Only Worth $725,000

McDonalds is starting up their Monopoly game soon.  Doughroller let us know  McDonald’s Monopoly Game is Back!    while Jim at Bargaineering also told us  How To Win McDonald’s Monopoly Game
The grand prize for the Monopoly game is $1,000,000.     But there is an ( * ) asterisk by that $1,000,000 prize.   You don't get a lump sum of 1 million dollars.  The prize is actually paid out in $50,000 yearly for 20 years.   This is not uncommon for major prizes.  Most lotteries pay out prizes like this.  

Getting paid $50,000 a year for 20 years is not the same as having $1,000,000 today.   First of all its common sense, everyone can see more value in having $1M today than $50k a year.   (Some people may prefer to get the money spread out so they don't blow it all at once, but thats a different matter.)    Inflation and the effects of interest are the main reason that money in hand is worth more than money spread out over years.   Lets look at the $50,000 paid out on year 20.   Thats not worth $50,000 today.  Clearly $1 in 2031 will not buy as much as it does today due to inflation.   If you assume 3% annual inflation then $50,000 in 2031 will be equivalent to about $27,683 in todays dollars.   Nearly half as much.


One simple way to figure out how much equal payments over time equates to in todays dollars is to find out how much an annuity would cost.    You can buy an annuity that pays you $50,000 a year for 20 years.   This kind of annuity can be bought with guarantee that each year will be paid regardless of how long you live so its not like other immediate annuities that depend on your lifespan.   The cost of that kind of 20 year fixed annuity is a good approximation for the value of that kind of payout.

You can get quotes on annuities at immediateannuity.com

From there we can see that a Guaranteed Income for a 20-Year Period Certain Only ("20PC")
paying $50k a year (4167/mo) would cost  = $724,696.


The $1,000,000 prize from McDonalds Monopoly game is equivalent to a 20 year period certain annuity paying $50,000 a year which would cost $724,696.   Therefore the McDonalds Monopoly grand prize of $1,000,000 really has a cash equivalent value of $724,696.

But its still a fun game.

Example Variable Annuity Return

A while ago I caught an episode of Suze Orman's show and she had a caller with a Variable Annuity.

The caller had invested $600 a year for 24 years. That is a total of $14,400 paid in premiums. The value of the annuity was $13,200. So she lost money in the investment over a 24 year period. That is a pretty bad investment return.

Its possible that they had made very poor investment choices to cause the losses. But what if you'd simply thrown $600 into an S&P 500 index fund every year for 24 years? You'd have around $27,000 dollars. That is on top of the S&P500 dropping nearly half its value from its highs 2007. We all know how poorly the stock market has done lately and if even an S&P 500 index fund can get you twice the returns of a variable annuity then why pay for something like a complicated annuity?

Some might think that the annuity is tax protected so it would have benefits in that way. That may be true in some situations but the gains on annuities can be taxed at the full income tax rate while investing in a simple stock fund can get you the lower capital gains rate. You might come out ahead as far as taxes are concerned simply buying stocks directly. But in the case of the example they actually lost money with the variable annuity so any tax benefits of an annuity are unhelpful.

If you aren't familiar with Variable Annuities The SEC has a page on the topic of Variable Annuities with all sorts of useful information. They give a good basic explanation of what Variable Annuities are so check out that page for more if needed.

What if the Insurance company holding your Life Insurance or Annuity fails?

I've been looking at annuities as part of a retirement plan. One of the concerns that I've occasionally heard about annuities is the fear that if the insurance company that you buy the annuity contract from fails that you might lose your retirement money. Say that someone retired 5 years ago and had bought an annuity from AIG. What would happen to that persons investment if AIG went bankrupt? Thats a scary idea isn't it? I'd hate to buy an annuity with an insurance company only to see them go under some years down the road and then lose all my money. Thankfully you don't need to worry too much.

There is a guarantee on life insurance and annuity contracts issued by insurance companies that is backed by a state guarantee association. Each of the 50 states and D.C. has a guarantee association. They are organized nationally as the National Organization of Life & Health Insurance Guarante Associations (NOLHGA)

Each states guarantee association acts a little differently. But generally the idea is the same. The state guarantee association acts to back life insurance policies and annuities much like the FDIC backs bank accounts. In the case that an insurance company becomes insolvent the state guarantee association will step in to help cover it.

Here is their informational brochure that addresses consumer questions about how it works.

Quoting from the brochure, here are a couple key points:

"What happens when my insurance company goes out of business as a result of insolvency?
Insurance companies that experience severe financial difficulties are taken over by the insurance department of the state in which they are based,and that state’s insurance commissioner becomes the “receiver.” If the company is determined to be insolvent, it may be liquidated. When a liquidation is ordered by a court, state guaranty associations work with the receiver to pay covered claims directly or transfer the policies to a financially sound insurance company."

"How much protection do I have?
Like the FDIC, state guaranty associations have maximum benefit limits. These limits are established by state law and can vary from state to state, but most states provide at least:
• $300,000 in life insurance death benefits
• $100,000 in cash surrender or withdrawal values for life insurance
• $100,000 in withdrawal and cash values for annuities
• $100,000 in health insurance policy benefits"

Those are the minimums and some states offer higher coverages maximums.

Basically the bottom line is that if your insurance company goes bankrupt then you will be covered up to the amounts listed above. This is certainly some protection so that we all don't have to worry so much about an individual insurance company failing. If for example you had a $75,000 annuity with AIG and you were worried about them failing then you shouldn't sweat it since that amount is guaranteed by your state guarantee agency.

If you have amounts above the limits in an individual insurance company then it would be a smart move to diversify with multiple insurance agencies. Instead of buying a single $200,000 annuity from one insurance company consider buying two $100,000 annuities via two separate insurance companies. That way if one of them fails then you'll be covered to the maximum value of the annuity.

Again, each state is a little different so for the exact details on your state go to the NOLHGA site and find the link to your states agency. Depending on the state, you're going to have at least the protections listed from the QA above but you might have more than that.

Bottom line: Life insurance and annuities are guaranteed by state agencies up to $100,000 for cash value or annuity policies and $300,000 for life insurance death benefits.

Pay out rates for Immediate Annuities

Thanks to a link over at Lazy Man and Money I found this Immediate Annuities site that gives easy and quick quotes on annuity payouts. The site gives you quick figures on payout rates for immediate annuities. Previously I've looked at annuity figures on the Vanguard site but its a little hard to find their annuity quotes there.

I ran the calculations for a few ages on an premium of $100,000 and came out with sample figures for a few ages. For a $100,000 purchase you would get monthly payout rates in the $500-$700 range. It varies based on age and sex. If you get a joint payout for a married couple then it will pay out less but it will pay benefits for the life of both spouses. For the joint payout I assumed that the spouses are the same age. Spouses of different ages will have different payouts but you can run the numbers yourself at Immediate Annuities site. These are just sample quotes and theres no guarantee you'll get these payouts. You may find better or worse payout through other sources. Your exact health condition and state you live in may impact the quote you get.

Monthly payout figures for $100,000 annuity purchase:

Age	Male	Female	Joint
40	$534	$523	$506
45	$552	$537	$516
50	$576	$558	$529
55	$610	$585	$544
60	$656	$623	$573
65	$723	$676	$593

Or as a % annual payout from the initial premium cost:

Age	Male	Female	Joint
40	6.4%	6.3%	6.1%
45	6.6%	6.4%	6.2%
50	6.9%	6.7%	6.3%
55	7.3%	7.0%	6.5%
60	7.9%	7.5%	6.9%
65	8.7%	8.1%	7.1%

So in other words if you are a 40 year old male and buy a $100,000 immediate annuity then you could get $534 a month. That is $6,408 annually which equates to 6.4% payout from your initial $100,000.

Keep in mind that these annuities have no inflation adjustment. Personally I'd recommend looking into annuity with a cost of living adjustment built in. Also the joint payouts are for 100% payout to surviving spouse. I don't think 1 person needs 100% as much as 2 people so you could go with a 66% or 75% payout rate instead and get a better benefit payout.

Is a fixed immediate annuity a good thing to buy?

Previously I discussed what annuities cost and what benefits they provide. But I didn't examine if its a good investment to buy one. So.. is it?

First of all lets discuss why you might want to buy an annuity. A fixed immediate annuity provides 3 key benefits: it provides guaranteed return with virtually no risk, it lasts for the rest of your life and it requires no work on your part.

But how does this compare to other options? For example you could simply put your money into CDs at a bank and roll them over annually. This would provide a guaranteed return with virtually no risk and very little work. So other simple investments are both safe and low work. But the annuity has the unique benefit that it lasts for the rest of your life no matter what your life span is. The difficulty in comparing an annuity to other investment options is accounting for the variable life span. We simply don't know in advance if we'll live for 1,2,5 or 25 more years.

How can we go about estimating the value of a lifetime annuity without knowing how long you'll live? We can only take a guess really. One way would be to determine the average remaining life span for the annuitant and then value the annuity for that period. For example, when you are 65 years old, your life expectancy is approximately 19 years. (from CDC data and additional CDC information source) So if we buy an annuity at age 65 then we could compare it to expenditures for another 19 years to cover the average case. This would only be the average case though and you may live longer or shorter. If you bought an annuity at another age then you would need to find the life expectancy for that age person.

The annuity we discussed previously bought at age 65 for a cost of $100,000 paid out $428 a month with inflation increases. We can estimate in the future inflation to be about the same as historical CPI average. The BLS has historical CPI data. From 1913 to 2008 the CPI inflation rate was 3.25% annually. If we start with $100,000 in the bank and pay out $428 a month with annual increases of +3.25% and also earn 3% on your savings then your balance will be depleted in a little over 18 years.

For a 3.25% inflation rate and starting with $100,000 balance at age 65, here is how long your savings will last in years based on savings interest rates of 3,4,5 & 6%:

Savings Rate	3%	4%	5%	6%
# Years Savings Last	18	20	24	29

If you can get a save 6% return then it would be a lot better off overall to simply invest your money on your own at that rate instead of getting an annuity. Bonds can historically give you returns of this level.

Another important consideration for annuities is the fact that generally with a fixed immediate annuity after the death of the annuitant and survivor there is no value left to the estate. On the other hand if you save your money on your own then anything left over can be passed in your estate. For example say you buy an annuity at age 65 for $100,000 with monthly payment of $428 and then you pass away 10 years later. After your death the money is gone and there is no value in the annuity. On the other hand if you had put your money into savings and gotten interest of 3% and paid yourself the same $428 a month with inflation adjustment and passed away after 10 years you would still have over $66,000 in your savings that would be left to your heirs.

What happens if you live a very long time? If you have an annuity then it will pay out for as long as you live. So if you live to be 100 then the annuity will still pay you. The longer you live, the more the annuity is worth. That $100,000 annuity bought at 65 would be better than a 6% savings rate if you live over the age of 95.

In my personal opinion I think overall the annuity isn't the better investment for retirement. However, if the certainty of guaranteed lifelong payments regardless of your life expectancy is important enough to you then an annuity might be your preferred choice. That's basically what it comes down to: whether or not the lifelong certainty is worth paying a premium for.

What do annuities cost and what benefit do they provide?

Continuing the discussion of annuities I'm curious if these would work as part of a retirement plan. But I don't even know what they cost or how much monthly payment they can provide. I'm looking at the Fixed Immediate annuity with inflation adjustment here.

I have done some research on Vanguard's annuity page. From that page click on the 'Learn More' link under Fixed Payment Option. This opens a popup window. On that window scroll down a little and click the 'Get an Instant Quote' link. I'll go through a couple examples...

Consider someone who wants to retire early:

From the Vanguard Instant Quote page you can figure the costs of an annuity or the payment from a lump sum. For example I put in information for a 50 year old man and a 46 year old woman and selected an inflation adjusted annuity with 100% joint survivorship. If I paid a lump sum of $100,000 then the annuity would pay out $318.45 a month for the rest of the life of the man and wife. That basically means that the annuity would pay out the $318.45 amount monthly for the life of both the man and the woman and since its inflation adjusted it will increase the payment based on the CPI rate. If I drop the survivor benefit down to 75% instead of 100% then the payout is $332.16 a month. So $100k will buy a married couple a $318 monthly annuity at age 50.


For a 50 year old man and 46 year old woman it would cost $202,281 to get a 100% survivorship joint annuity that paid $7,500 a year for the rest of their lives. The tool doesn't let you figure annuities for very large amounts, so I'm estimating larger figures by multiplying by 10. Multiplying by 10 I figure that in order to get an annuity $75,000 annual income with inflation adjustments you'd need to pay $2,022,810. For a 75% survivor annuity paying $75,000 a year the cost is $1,940,793.


So if you had about $2M in the bank and are 50 years old and married to someone 46, then you could buy an annuity that would give you $75k annual income with annual inflation increases for the rest of your lives.


Now lets look at someone age 65 retiring now.

Lets say you've worked all your life and saved a lot of money in your 401k. You make a decent living and have accumulated $700k in your 401k total. You are now ready to retire and considering buying an annuity with your retirement funds. You have a spouse who is also 65. If you take that $700k and buy a 100% joint survivorship annuity with inflation adjustments then you would get a monthly payment of $3000. If you had just $100k saved then you would be able to afford an annuity with a $428 monthly payment. So $100k will buy you a $428 monthly annuity at age 65.


These examples give some idea of how much annuities cost and pay out. The exact numbers will vary and depend on the exact age of the annuity owners and the details of the annuity. I'm only looking at Vanguard here of course so other vendors would have other options with differing prices.

Is this a good buy? I'll discuss that in the future.

What are annuities and how do they work?

One way to provide for you retirement is to buy an annuity. An annuity is a contract which you pay a lump sum in return for future periodic payments. There are many varieties of annuities with different options you can get. Basic definitions of some annuity terms:

Immediate or deferred

An immediate annuity will start paying regular benefits immediately. Its basically opposite to a mortgage in the respect that you pay a lump sum now to get periodic payments over the future. A deferred annuity will pay you out payments at a future time and will let you accumulate funds until then.

Fixed versus variable annuities

A fixed annuity pays a fixed or guaranteed amount over its term. A variable annuity will pay out a variable amount that may or may not have a minimum.

Period versus life

Period annuity will pay a regular sum for a specified period of time such at 5 years, 10 years, 20 years, etc. A Life annuity will pay a regular sum for the lifetime of an individual. With a life annuity the annuity will pay the person the regular sum regardless of how long they live. So a life annuity could pay more or less depending on exactly how long you live. Use of a life annuity avoids the uncertainty in your life span for your retirement planning. To plan for retirement you have to account for how long you expect to live and a life annuity will remove that variable from the planning.


Single life or Survivorship

You can buy an annuity for a single person. The annuity pays for the life of that person only. Or if you are married then it would normally make sense to have your annuity cover the life of both people. An annuity that covers a person and their spouse is called a survivorship annuity. A survivorship annuity will cost more than an annuity on a single individual because it is covering the lives of two individuals either of which may live longer.

Full or partial survivorship

With a survivorship annuity the surviving spouse will be paid benefits. A full survivorship annuity will pay 100% of the payment sum to the survivor. However one person can live for less than two people so it would make sense to plan to pay less than 100% of the value

Pure life annuity versus life-with-period-certain annuity

Normally a life annuity will pay benefits until the death of the annuitant. If the annuitant dies prematurely then the annuity would only pay for a short period. Consider if you are 65 and spend $500k on an annuity and then retire. The annuity is paying you a nice monthly sum until you die. But if you were to pass unexpectedly at age 66 then that annuity would only have paid benefits for 1 year. Your annuity would have paid out very little compared to the amount you bought it for. To account for this possibility and ensure that your annuity pays a minimum amount to your estate in the case of an early death you can buy a period with life certain annuity. A period with life certain annuity will pay for a certain period of time minimum.

Loads / Commissions and fees

Be aware that annuities are typically sold with commissions and can have relatively high fees. This is one reason why annuities might be a poor choice of investments. The commissions (or loads) on annuities can be several percent. Expenses can run you over 2% annually.


Further information about annuities:

• AnnuityTruth
• Truth about Annuities by Suze Orman
• Variable Annuities: What You Should Know from the S.E.C.
• Vanguard's Annuities
• The Problems with Variable Annuities by Morningstar