What Is The True Value Of An Immediate Annuity?
Question: I need an additional income stream for me and my wife and am looking at a Single Premium Immediate Annuity as a possible solution. How do I figure out the return? What is the true value? Fred from San Antonio, Texas
Answer: Thanks for the question Fred. This is a topic that is becoming more and more prominent of an issue as baby boomers retire and need more guaranteed income.
As a short history lesson, Immediate Annuities (also called – Single Premium Immediate Annuities) are the original annuity design from the Roman times. In my opinion, this annuity type is still one of the most efficient and most pro customer annuity types available.
How it works
The guaranteed lifetime income stream from a Single Premium Immediate Annuity comes from a combination of return of principal and interest.
At the time you decided to take income, your income stream is based on your life expectancy. In essence, you are making a bet with the annuity company. They are basing your lifetime income stream on when they think you are going to die, and you are taking that bet. If you live longer than your life expectancy based on the insurance company’s mortality table, the insurance company is on the hook to pay you regardless of how long you live. As a side note, I recommend structuring the contract so the 100% of the money goes to the listed beneficiaries if you pass away early. The annuity company will not keep a penny, which is a common fallacy with this type of strategy.
If the annuity is held outside of an IRA (i.e. non-qualified account), your income stream will only be taxed on the interest part, not the principal. In the annuity industry, that benefit is called the “exclusion ratio”, which means that a large majority of your income stream will excluded from taxes. This is very important when calculating the spendable or “real money” part of your income stream.
If the annuity is held inside of an IRA, there is no exclusion ratio, and all of the income is subject to taxes at ordinary income levels. That’s not a bad thing, it’s just the rules of our friends at the IRS.
Too many agents make this value assumption far too difficult and complex in my opinion. Annuities are transfer of risk products, and in your specific case, you are transferring the risk to the annuity company to provide a guaranteed income stream for you and your wife regardless of how long you live.
I always tell people that if you tell me when you are going to die, then I can tell you the real ROI (Return On Investment) percentage. Until then, it is a pure transfer of risk. Simply put, it’s a pension plan. Most people don’t ask ROI number on their Social Security or pension payments, and Single Premium Immediate Annuity payments should be no different from a conceptual standpoint.
Wear it fits
This type of income annuity is a non-correlated (i.e. not attached to the market) asset that should be placed right beside your pension and Social Security payments. Annuities are not investments, and definitely not growth products in my opinion. Most annuities sold today (variable and fixed) are pitched as growth strategies, which they are not and never will be.
Annuities solve for 4 specific things, of which I use an easy to remember acronym to explain. That word is P.I.L.L. In my world, if you don’t need to solve for one of these 4 items, then you don’t need an annuity.
- P stands for Principal Protection
- I stands for Income for Life
- L stands for Legacy
- L stands for Long Term Care
In your case, you are solving for “I”, or Income for life.
It’s a commodity
Single Premium Immediate Annuities are a true commodity product. There are over 50 highly rated companies that are competitive in this annuity strategy, and you should quote them all if possible because the goal is to purchase the highest income guarantee for the least amount of money. It’s really that simple and basic.
My advice is to find an agent that represents all of those companies so that you can get the best quote for your specific situation.
Originally published 12/7/2013 by Annuity123.com – http://blog.annuity123.com/what-is-the-true-value-of-an-immediate-annuity/