Should You Consider an Immediate Annuity?

By Paul Ruedi      

Newly minted retirees frequently ask me if they should buy immediate annuities for retirement income. The deal is simple. You hand an insurance company a lump sum, and it mails you a check every month for as long as you live. To someone worried about outliving their money, or tired of watching markets bounce, that sounds like a great deal.

Vanguard’s Principles for Retirement Income research paper caused a bit of a stir this year when it recommended two of its five example retirees should buy an annuity. Let’s take a look at some of the numbers in the paper to see the deal folks are actually getting.      

Using rates quoted in Vanguard's own paper, a married couple, both 72, who spend $100,000 on an immediate annuity collect about $6,800 a year for as long as either is alive. The payment never changes until it stops upon the death of the second spouse.      

Collecting $6,800 a year sounds like earning almost 7 percent. It is not. Most of that check is simply the couple's own money coming back to them. They will cash checks for almost fifteen years, until age 87, before they even get their own $100,000 back.      The check also never grows. Vanguard's paper points out these payments "may lose value over time without inflation protection."

Even mild inflation roughly doubles prices over a long retirement, so the $6,800 that pays the property taxes at 72 buys about half as much at 100. You can pay extra for inflation protection, but those features usually reduce the starting payout.

On top of that, the original lump sum is gone. Vanguard mentions that money used to buy an annuity is "no longer available for emergencies or to pass on to heirs." No lump sum to fall back on in case of emergency. Nothing for the children.      

I think it is worth noting that in both cases where Vanguard recommended a person or couple purchase an annuity, they only recommended annuitizing a portion (under 45%) of the entire investment portfolio. The key benefit came from reduced investment portfolio withdrawals that allowed the portfolio to grow larger over time. In both cases the annuity was a complement to the growth of an investment portfolio, not a substitute.

So look closely and think deeply about that guarantee before you buy it. The check is guaranteed. The groceries aren't. If you are tempted to trade a lifetime of savings for a lifetime of level checks, spend an hour with a financial planner first to find out if that is the right choice for you.

 Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.