Personal Thoughts on Immediate Annuities



I started age-laddering immediate-annuities with inflation-adjustments a number of years ago but stopped when the payments from a new policy did not go up (on a real dollar basis) when I looked into buying in successive years.Normally, the payments for an age 66 policy with inflation-adjustments will be higher than a policy for age 65 because your life-expectancy goes down as you age, so the insurer expects to have to make fewer payments to those who buy at more advanced ages.


However, I may start buying some more again when I see inflation starting to increase at something higher than about 3% even if the underlying rate (ex inflation) will be low.The reason is that I believe that we cannot escape high inflation considering the amount of government debt growth.


I like the idea of inflation-adjusted immediate-annuities better than those with a fixed payment even though the initial payments are less.However, when I get to my eighties, I'll change to age-laddered fixed-payment immediate annuity because there may not be enough time to recoup my investment even though both my wife and I have longevity in both our families.


On there are two programs to evaluate whether an immediate annuity is for you considering what you think will happen to future inflation, returns, etc.Of course none of us can predict the future.That's why I have some investments that will do well in a low-inflation economy and some that will do well in high-inflation economic situations.The same goes for my assumptions about returns and taxes.


That said, I think a person has to be cognizant of what appear to be very strong possibilities of high taxes, inflation and low real returns.This is particularly important for younger people who will have to bear the burden of our decades-old consumerism binge that has left a large part of the aging population without sufficient savings for their retired life.


Whereas equities will not do well in the initial part of a highly inflationary and highly taxed environment, they represent ownership and will ultimately do better than debt securities which are poor investments in such economic conditions.That's why one can't go overboard in biasing allocations too much.


There are some peculiar tax effects for immediate-annuities.Of course, ones bought as qualified investments will be taxed at ordinary income-tax rates, but those bought with non-qualified funds are taxed for many years with an annual deduction based on the amount of the initial principal divided by the life-expectancy at the time of purchase.However, once a person exceeds that life-expectancy, the entire payment is taxed at ordinary rates.Of course, exceeding that life-expectancy means that you have won the bet against the insurer--but you lose the bet with the IRS.My free annuity programs take this into account.Highly taxed people must consider this effect.


One good thing about getting the immediate-annuity in a qualified account is that you don't have to account for the required-minimum-distributions.Whatever part of your qualified investments went into the immediate-annuity does not require this computation and associated taxes.


The thing to consider in deciding whether to invest part or all of your qualified account into immediate-annuities is that the required-minimum-distributions (RMD) for the qualified portion of the account actually encourage you to spend more annually in your early eighties than in your early seventies.That's because the RMDs are based on the average person's life-expectancy plus about ten years.However, depending on your returns, by the time you reach your later eighties, the payments start to go down because you've withdrawn so much of your principal.This pattern may suit some but not me.


Fixed-payment annuities have an age problem too.Each year that goes by, the payments are worth less.For that reason, people are wise to put part of their payments into savings to be drawn down later to counteract inflation.Although there is a fancy mathematical way to show how much this should be if you knew what future inflation would be, it's easier and more practical to simply multiply the after-tax payment about by your age divided by 100 to determine how much you can spend.Then save the rest.


Now, having said all of that, I've come to the conclusion that it's generally better to buy an immediate annuity in a qualified account, and, for younger retirees in reasonably good health, it's better to buy an inflation-adjusted immediate-annuity than one with fixed-payments for very simple reasons:You buy an immediate annuity so that your income will last your lifetime.You donít want to run out of income if you happen to be in the 50% of the people who will live longer than the life-expectancy calculated from the year they bought the annuity.Further, if one has good health habits, the chance of being in those living beyond their initial life-expectancy gets much better.See


The reason to buy an inflation-adjusted immediate-annuity rather than one with fixed payments again comes back to the fact that you donít want to run out of income if you are in the 50% that have longevity.The fixed-payments are likely to have lost so much to inflation that by that time you wonít have much real income from the fixed payments.


Finally, there is the matter of what you will leave to your heirs.Some people say that buying an immediate annuity means that you wonít have anything to leave behind after your death (and the death of your spouse if you have survivor benefits).Thatís not true if you really make a decent retirement plan because the immediate-annuity payments mean that you donít have to draw as much from the rest of your investmentsóand that becomes extraordinarily important when you get into your eighties or nineties and have great uncertainty how much longer you will live.


Henry K. Hebeler 4-25-10