Immediate Annuities: The Pros and Cons

by Rob Phillips, CPA

Immediate annuities are the simplest kind of annuity, and are perhaps the oldest form. A “Single Premium Immediate Annuity” ( Often referred to as a SPIA ) is nothing more than the exchange of money for income.

With your purchase price premium, you turn over to the insurance company all risk of longevity. In turn, the insurance company guarantees you an income for life gambling that your life expectancy combined with all the other policyholders in their portfolio will be average, and that they will make a positive return on your principle.

How Immediate Annuities Work

Insurance companies are in the business of measuring risk. And risk can come in many forms – for property insurance companies, risk can be a hurricane or an earthquake. For life insurance companies, risk is longevity. When they sell life insurance, especially term life insurance, the company is gambling that you will not die before the end of the policy.

When the same company sells an annuity, they calculate the amount of principal you are investing, and your age, state, and marital status, and arrive at an estimated lifespan. They calculate their expected return on investment of your principle during that expected lifespan and make you an offer for monthly income based on those calculations.

For healthy people with long-lived genes in their family, immediate annuities can be a fantastic investment as you can potentially leave the insurance company on the hook for income payments many many years after their calculations predicted.

Unfortunately, the opposite is also true. If you are not healthy or have a history of health problems, it is quite possible that you will not get even your principal back from an immediate annuity.

Problems with Immediate Annuities

The primary issue with an immediate annuity is that no one truly knows how long they will live. Making an investment with a significant amount of money that you cannot recover and your heirs cannot benefit from is a big gamble. that said, attempting to manage your money on your own and potentially running out and therefore leaving your heirs to take care of you, is also a significant gamble and burden.

Using Immediate Annuities

While every situation is different, immediate annuities make the most sense for older investors, preferably investors who for health or family reasons expect to live a long time. Immediate annuities also make a great deal of sense for couples who wish to ensure that they will not be a burden on their children or ever face the possibility of running out of income.

As with most annuities, immediate annuities have contract riders and provisions that can have dramatic effects. It’s important to work with an annuity expert to identify your needs and find the highest immediate annuity yield possible.

How Immediate Annuities Work

In its simplest sense, 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 $5000 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, and 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.

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.

To find out for sure, the best thing to do is to look at quotes. Click on for a live Immediate Annuity Quote tool you can input your age and state and see payout rates. On that page, use the back button on your browser to see how the payout rates vary with age. 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.

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