Annuities

There’s a type of annuity that pays you more if your health profile is not good.  This may sound strange, but here’s how it works:

SPIA, which stands for Single Premium Immediate Annuity (also referred to as health adjusted immediate annuity), has long been a popular investment for obtaining a fixed income which cannot be outlived (income for life).  With the income for life option, the issuing insurance companycalculates the size of your monthly payment based on standard life expectancy tables, based on an analysis of your health.  Once calculated at the beginning, you continue to receive the same monthly amount, regardless of how long you live.  It’s almost like getting a second social security check.

companies take into account your individual health condition and use that information to calculate your life expectancy.  If your health records indicate conditions that could lower your life expectancy, this is factored into the monthly payment you receive and increases the monthly payment.  You then receive this fixed monthly amount no matter how long you live.|

Take this hypothetical example.  A man age 70 decides to obtain a SPIA.  He deposits a $100,000 premium and based on his standard life expectancy of 16 years, his monthly payment is $871.05 (a 10.4% annual payout rate).  He will receive this fixed monthly amount regardless of how long he lives.  However, if he has a negative health profile and the insurance companies calculate his life expectancy at only 10 years, his monthly payment will jump to $1393.68.  Because of the negative health history, this annuitant receives more income for life.

SPIAs have been most popular with single individuals who are not concerned with leaving an inheritance.  That’s because, once the initial premium is paid, the SPIA cannot be surrendered for value.  Rather, you receive a fixed monthly income for life.  For those people who like the idea of increasing their monthly income and do want to leave funds to heirs, remember that you would use only a part of your assets for a SPIA and other assets can be designated for heirs.

If you’ve been relying on other sources for tax-sheltered income such as municipal bonds, you may find that an SPIA will increase your monthly tax sheltered income.

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The word “annuity” brings to mind different meanings for many investors.  That’s because there are different types of annuities designed for different purposes.  One of these is the immediate fixed annuity, which can provide an immediate stream of cash payments over a lifetime or a defined period of time.

If the investor has chosen a lifetime payout retirement option, he or she typically pays a single premium to an annuity company. In return, the company agrees to pay the investor regular and ongoing cash payments for life, or for a lesser amount to continue over the life of both spouses. Although many investors choose to receive monthly payments, it is also possible to receive quarterly, semi-annual, or annual payments as well.
Assuming the payments are structured over a lifetime, the investor is provided with a lifetime income he or she cannot outlive. Such an investment is useful for investors requiring additional retirement income, for support of a community spouse in the event the other spouse is in need of nursing-home care and is seeking to qualify for Medicaid (immediate annuities can be treated as exempt asset in some states), for making lifetime payments to cover long term care needs, or for paying long term care insurance premiums.

A portion of each payment is considered a return of premium and therefore not taxable to the investor. The remainder is considered interest and will be subject to federal and state income taxes.  For example, for a male investor age 70, 68% of each payment is nontaxable to age 86 (then all amounts thereafter are taxable).

One drawback to these products is an early death. In such a case, the annuity company keeps the funds and the income ends. This early-death financial risk is sometimes perceived as a negative feature among some investors. However, there is a possible solution to this concern as some annuity companies will guarantee a return of the investment to heirs in the case of an early death.  The feature is referred to as a “refund” provision.  Other companies offer “commutation” which allows the investor to change his mind and recover his initial investment (usually with a surrender charge), for example, in the case of a terminal illness.  These features make the immediate annuity more flexible and remove the chance of having one’s investment disappear in the case of untimely death.

Please note, that annuities are long-term investments that are designed for retirement purposes. Annuities are also subject to administrative fees, mortality charges, and surrender charges that can apply to early withdrawals, and these fees tend to vary from company to company. Annuity premium payments and any other guarantees are subject to the claims-paying ability of the issuing company. For this reason, it is very important to consider the financial standing of the issuing company before you purchase an annuity.

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Could underestimating your longevity mean you’ll run out of retirement money?

At age 65, the average life expectancy is 81.8 years for a man and 84.8 years for a woman. At age 75, the average life expectancy is 85.5 years for a man and 87.6 years for a woman. Note that as you grow older, you’re expcted to live longer!  With recent advances in medical science, it’s no longer a stretch to think that you could live to be 100. In fact, the US Census Bureau projects that by 2050 there will be nearly one million centenarians.

No one wants to die sooner, so that’s great news. The problem: If your retirement plan doesn’t recognize the possibility of a long retirement, then you could potentially outlive your money. But read on for a solution.

Consider the following hypothetical example. Assume you’re 64 years old and earn $60,000 per year. You plan to retire next year at age 65. You’ve accumulated $1,000,000 in retirement savings, which you think will return a hypothetical six percent per year throughout your retirement. And, you have a $60,000 annual retirement need (excluding Social Security). If you have a 15-year retirement from ages 65 to 80, you’ll have no shortfall in retirement funds; in fact, you’ll end up with almost $696,000 to pass on to your heirs. On the other hand, if you have a 30-year retirement from ages 65 to 95, you’ll run out of money at age 83 as the table below illustrates. Of course, this example  is hypothetical and for illustrative purposes only. It is not meant to represent the performance of any particular product.

Source: Burling Bank. Assumes $1,000,000 in retirement savings has already been accumulated; another $60,000 is added. The money grows at a hypothetical 6 percent pear year; $60,000 (in today’s dollars) in withdrawn each year. This example above is hypothetical and for illustrative purposes only. It is not meant to represent performance of any particular product.

Because the risk of outliving your funds is real, annuitization may be an option.  Annuitization is the process of converting your assets into an income stream.  For example, maybe you plan to leave your heairs$250,000.  You could turn that $250,000 into an income stream you cannot outlive with an immediate annuity.  For example, a femaelage 70 could invest $250,000 into an immediate annuity and get $1765 a month for life – an income she cannot outlive.  To see the amount you can receive, use the immediate annuity calculator.

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Stability and safety are important to many seniors, and these are only two of the reasons why immediate annuities are popular retirement income choices. A check arrives every month and part of the annuity income is considered a tax-free return of your principal. As long as the immediate annuity company is financially sound, the payments will continue for the life of the contract (annuities are guaranteed by the claims-paying ability of the issuing company).  You can get an estimate of monthly income using the immediate annuity calculator.

However, consumers sometimes believe that immediate annuities are illiquid, irreversible investments, and cannot provide for future lifestyle changes. Nonetheless, there are some immediate annuities with options that may add flexibility to your financial plan.

Immediate annuities can possibly include an option that would allow you to receive extra cash at specific anniversary dates. For example, this might be at the 5th, 10th, or 15th anniversary of your investment. Exercising this option will reduce your current payments (the distribution may be fully taxable, so consult with your tax professional).

Suppose you needed money to cover an emergency, like paying for caregivers or a home repair. Some immediate annuity companies will let you take up to six payments at once. You would not, however, receive checks for the following six months (payments may be fully taxable so consult with your tax professional).

You may also have the ability to provide a cash benefit from your immediate annuity to your heirs. This would be a pre-determined percentage, such as 25% or 50% of the amount of your initial investment. Selecting this option will reduce your monthly annuity checks and may have tax consequences.

Another option, immediate annuity commutation, allows you to cash in the remaining “balance” on your immediate annuity at a discounted buyout.  Yet another option insures that all of your principal is recovered for your heirs in the case you pass away before you personally recover your entire premium.

Immediate annuities can provide a lifetime income you cannot outlive and also provide flexibility of which few consumers are aware.

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