An Annuity That Pays Now and Forever

EDITOR'S NOTE: This article was originally published in the May 2009 issue of Kiplinger's Retirement Report. To subscribe, click here.

In financially uncertain times, nothing sounds better than a guaranteed income stream that lasts as long as you live. If you are in or near retirement with little time for your nest egg to recover from market losses, an immediate fixed annuity could give you peace of mind.

When you buy an immediate annuity, you give an insurance company a chunk of money and it promises to send you a check for the rest of your life. Payouts are based in part on your age and interest rates at the time of purchase.

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The older you are, the higher the payout. For example, a 65-year-old man who invests $100,000 in a New York Life Insurance annuity will receive a lifetime monthly payout of $675. A 70-year-old buyer will get $748 a month. You're best off buying an immediate annuity if you're in retirement or close to it.

Sales of immediate fixed annuities have soared as retirees, facing shrinking investments, hunt for a regular source of income. Sales grew by 23% in the fourth quarter of 2008 compared with the same period a year earlier, according to LIMRA International, an insurance research group.

Despite their growing popularity, immediate fixed annuities, also known as income annuities, have their drawbacks. If you buy an annuity today, your lifetime payment will be based in part on current low interest rates. If the market begins to recover, you could miss out on better returns. But what if the market performs poorly, as it has recently? As with a pension, you will "protect yourself against the risk of living so long that you run out of money," says Frank Todisco, senior pension fellow with the American Academy of Actuaries, in Washington, D.C.

Because payments start immediately, such an annuity "only makes sense for someone who needs income right now," says Hersh Stern, who runs ImmediateAnnuities.com. One way to figure out how much you should invest, he says, is to add up your monthly expenses, and then subtract your guaranteed sources of income such as Social Security and any pension payouts. If you still fall short, you can invest enough in an annuity to plug the gap.

For tax reasons, you're better off buying an annuity from a taxable account. A portion of each payout is a return of principal and is therefore tax-free. If you buy an annuity within your IRA, all of your annuity payments will be taxed at your ordinary-income tax rate.

Life Expectancy a Factor

A big disadvantage is that the annuity ends at your death. If you live a long time, it's a good deal. That means you should find out the "break-even" age for your annuity -- the point at which you would have recouped your investment. The 70-year-old in the previous example would need to live past his 81st birthday. If you're in poor health, an immediate annuity may not be the way to go.

If this 70-year-old is married, though, one option is a joint life annuity, which would continue to pay his spouse after he died -- at a lower monthly payout. For two 70-year-old spouses, the monthly payout for the New York Life annuity would be $618 -- 17% lower than the $748 payout with the single annuity.

Those who worry that rising costs will diminish the value of the payments should consider an inflation-adjusted annuity, which offers a smaller payout initially but increases each year. It takes about ten years for the annual payout on the annuity with a 3% increase to reach the level of the fixed payout, so this type of annuity is best for younger buyers.

To hedge your interest-rate bets, you could split up your money among several fixed annuities. "Consider buying them gradually over several years," says Chris O'Flinn, president of ELM Income Group, a Washington, D.C., insurance agency.

Even if interest rates don't rise, an annuity ladder enables you to capture higher payments because of your age. You should buy annuities from more than one company to spread your risks in case one insurer goes under. To get quotes, go to www.immediateannuities.com.

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