Immediate Annuities And Life Expectancy

by Rob Phillips, CPA

Annuities come in many different shapes and sizes. There are plenty of options that can work great for a variety of people. But each person’s situation is unique.

In this post we are going to take a close look at what is called an immediate annuity. We will walk through the pros and cons and discuss some situations where they work great. So let’s dive in.

In its simplest form, with an immediate annuity you make an initial deposit with an insurance company and in return, the company pays you a guaranteed monthly income for the rest of your life.

In order to calculate the payment you will receive, the insurance company will estimate your life expectancy according to your age and gender. The income payment you receive is usually referred to as a “payout rate”. For a $100,000 investment paying $5,000 per year, you would therefore have a 5% payout rate.

It’s important to note, the Rate of Return on this as an investment has NOTHING to do with the payout rate. The rate of return can only be calculated at the end of the payment stream.

These payout rates change with the overall market conditions. In general, the older you are the more income you will receive. Conventional wisdom would have you wait till your latter years to buy your immediate annuity.

But there is a catch. The thing about life expectancy is, the older you get, the more likely you are to live longer!

About Life Expectancy

According to the statistics of mortality first quantified by Benjamin Gompertz in 1825, in any given year mortality rate increases by approximately 9%. So with every passing year, your chances of dying are roughly the same, but the pool just gets smaller.

Insurance companies know this, and so an investor age 65 may find an immediate annuity to be a ‘better deal’ than a 75 or 80 year year old investor… The 80 year old investor has passed the gauntlet of 15 years of mortality probability and is proven to be long lived, whereas the 65 year old, and his peers in the same pool of insured customers, has many more years of probable mortality ahead.

Therefore the offer the insurance company makes to the 65 year old may be a better deal in the long run than the offer the same individual gets if they wait 15 years to buy their lifetime income.

Who do they work best for?

Immediate annuities can work very well in the right situation. For example, consider the following situations:

  1. A person wants a fixed monthly payment and does not want to worry about stock market volatility. They just want stable and predictable cash flow.
  2. A person is concerned that they might just spend the money. In essence, the money is tied up and the individual is not able to spend it on frivolous expenses like new cars, clothing, etc. The money is also kept separate from heirs and beneficiaries. I have seen situations where family members will often “borrow” money from their parents.
  3. A person has no interest in managing the money.
  4. A person has limited financial resources and does not want to outlive their money.

About Longevity Protection

There is no doubt that longevity protection is a valuable benefit, especially for people with long life expectancy history in the family, great health, or other considerations. But don’t wait too long to put it in place if you know you need it. Don’t forget about a solo cash balance plan.

To find out for sure, the best thing to do is to look at quotes. There are plenty of online resources where you can input your age and state and see payout rates. Look at the payout for yourself now, and in 3 years, 5 years, 10 years, etc, to see what suits you best.

Pure Longevity Insurance

The most efficient way to ensure against outliving your money is through the use of Deferred Income Annuities. Be sure to explore that section. When high yield, fixed term Secondary Market Annuities are combined with Deferred Income Annuities, you have a nearly perfect and optimal plan.

Final Thoughts

Immediate annuities will not work for everybody. In fact, there is a select group of peiple and investors who will be able to reap the benefits. If someone is looking for stable monthly amounts and predicts a long like then it might make more sense.

Make sure you consider your longevity and your family history. The insurance companies are well aware of your life expectancy and will use actuarial tables to calculate the immediate annuity payments. Make sure that you understand your options and consider all investment options.

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