Retirement Planning with Immediate Annuities

While planning and saving for retirement, the biggest question that haunts the retirees is ‘Is my nest egg enough for my retired life?’ No one can answer this question confidently due to uncertainty of rate of return on investments and the length of post-retirement life span. Between his income and himself, a retiree cannot be sure who will outlive whom. This uncertainty makes the retirees look for a steady flow of income for the rest of their life. Single Premium Immediate Annuities (SPIAs) are intended to address this need.

To begin with, there are various types of annuities and each one of them has its own merits and demerits. Here we are discussing ONLY about SPIAs, a type of fixed annuity, where the premium is paid in one lump sum at the beginning of the contract. To make things clear, let us first understand the facts and features of SPIAs:

  • One lump sum payment: The annuitant has to make one single premium payment upfront
  • Benefits start immediately after purchase: The annuitant starts getting the benefits immediately after purchasing the annuity
  • Available with various income payment options: The annuitant can opt for various income payment options such as Life Annuity, Certain Period Annuity, Life Annuity with Choice of Certain Period, Life Annuity with Cash Refund, Joint & Last Survivor Life Annuity and Joint & Last Survivor Life Annuity with Choice of Certain Period. Moreover the annuitant can choose to receive payments on a monthly, quarterly, semi-annual or annual basis.

Though with SPIAs the annuitants get a fixed amount every year, it is possible to take an annuity where the withdrawal amount gets adjusted with inflation. But initial premium to be paid will be higher with such inflation insulated annuities.

“…people always live for ever when there is an annuity to be paid them…An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it.” ― Jane Austen, Sense and Sensibility

Why one should opt for SPIAs over other type of annuities? Mike Piper, author of ‘Can I Retire?’, answers that many annuities are a raw deal for the investors. They usually involve high expenses and heavy surrender charges. Moreover, many a times – especially with variable annuities – these annuities comes with different bells and whistles that make it even more complex to compare and difficult to choose the best deal. On the other hand, SPIAs are helpful for two reasons:

  • Makes retirement planning easier, and
  • Allows for a higher withdrawal rate than you can safely take from a portfolio of stocks, bonds and mutual funds over the course of a potentially lengthy retirement.

Following are a few important merits of SPIAs:

Safety of principal

One of the foremost important factors to consider while making saving and investment for retirement is safety of the principal. For retirees, safety is important and losing the principal is not an option. Retirees who find it too difficult to withstand the stock market fluctuations in their retired life, can buy SPIA (and peace of mind too) with their savings and thus can enjoy steady flow of income with no investment risk in their retired life.

Guaranteed returns

Along with the safety of principal, another factor to consider is growth. It is true that safety and high returns do not co-exist. Though the rate of return one can expect from annuities is lower than what one could get from stock market, it provides higher returns when compared to CDs, U.S. treasury bills or municipal bonds. An SPIA maximizes your cash flow since each payment constitutes both an interest payment and a return of principal.

Hedge against longevity risk

The biggest attraction of annuities is that it gives a hedge against longevity risk. Retirees who are worried about outliving their income, can purchase Life Annuity with a chunk of their retirement nest egg and can thus insure themselves against outliving their income. Certain income payment options (Joint & Last Survivor Annuity) can cover both annuitant and the spouse for their lifetime.

Simple and easy

Last but not least, SPIAs are pretty easy and simple to understand. For the lump sum amount on hand, one can approach an insurer, get a quote, consider various payment options and then decide about purchasing the annuity. There is only one payment to be made and then he can be sure of the amount that he will get every year for a certain period or until his death. Too simple, right?

Bottom line

A retiree should take full responsibility for planning his golden years, especially in these challenging times of withering social security system and dwindling defined benefit plans. It is up to the individuals to do proper planning for their retirement, learn and understand the various investment products and make a prudent decision.

In this regard, SPIA is one investment product that is easy to understand and worth considering. Unlike traditional stock and bond portfolios, where retirement planning stands on many guesses and assumptions, fixed SPIAs are predictable and thus make the retirement planning easier. Retirees who do not want to lose their sleep over stock market volatility and want to be sure of steady flow of cash during their retirement should seriously consider SPIAs.

A word of caution: Even if there is no intention of leaving anything behind to the heirs, it is not advisable to annuitize the whole portfolio. Its better to keep a portion of the portfolio in the form of stocks, bonds, deposits or cash etc., to meet any emergency need of heavy expenses and annuitize only a portion of the portfolio.

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