Lifetime Income Annuities: The Instant Pension Plan

One of the biggest concerns that people have as they age is that they will not have enough income to maintain a comfortable lifestyle during their retirement years. Having a regular paycheck can certainly remove the fear of outliving your money. Employer pension plans are gradually being phased out and, other than Social Security, you would be hard-pressed to find an investment that will guarantee you income for the rest of your life. A lifetime annuity functions much like a traditional pension and provides you with a steady stream of income that will continue for your entire life.

What is a lifetime annuity?

This type of annuity is also called an immediate annuity. In the simplest of terms, the purchaser of this type of annuity makes a single premium payment and the insurance company agrees to pay the annuitant a regular, periodic payment until his or her death. Payments start immediately, generally, one month after the annuity has been purchased. The normal payment is monthly, but it can also be some other agreed period of time such as quarterly.

Calculating the amount of your monthly payout?

Insurance companies estimate your life expectancy and use that figure to determine the amount of the monthly payout. Several factors that will have an effect on the payout are your age, gender, prevailing interest rates and the payout option you select. While insurance companies are quite good at using mortality tables and actuarial information to determine a person's life expectancy, such calculations are, at best, an educated guess.

Women live longer than men, so other things being equal, they receive a lower monthly payment than men. In addition to your life expectancy, there are a variety of payout options to choose from that will affect the amount of your monthly payouts. Several popular payout options are single life, joint life, and life with a period certain. And since insurance companies are in the business to make money they also take into account operating expenses and profit when calculating payouts.

What is the difference between single life and joint life payout options?

Single life means that you will be provided income for life no matter how long you live. Joint life means that both you and your spouse (or other insurable interest) are covered for lifetime income. If you choose this option and predecease your spouse, your spouse will receive a monthly income stream until his or her demise. In general, a joint lifetime annuity will have a lower monthly payout than a single covered annuitant.

What happens if you die early?

Once you die, the payouts stops. If you buy a $100,000 immediate annuity and only collect $40,000 before you die, the unused portion of your original premium goes to your heirs if you structure the contract properly. This is accomplished with an option that allows you to designate a beneficiary to receive a refund payment, which equals the remaining portion of your initial premium. Or you can structure the contract in such a way that allows a beneficiary to receive payments for up to the first 20 years of the contract by selecting a life with a period certain payout option. Adding one of these guarantee features to the immediate annuity contract can assure you'll receive your premium back, but it will also reduce the monthly periodic payouts you receive. This is because even in the event of an untimely death shortly after taking out the contract, the insurance company will be required to pay the beneficiaries the ongoing stream of payouts or a lump sum payment depending upon how the contract is structured. Contrast that with the “life only” payout, which would cease upon death.

What happens if you live beyond your life expectancy?

If you have a life expectancy of 75 but make it to age 90, you will continue to receive your regular payouts. The insurance company is assuming the risk of you living beyond life expectancy, so if you've selected a life payout option, our payments will continue for the rest of your life even if you live beyond 100.

Protecting against inflation risk

Just as you would lose purchasing power if Social Security did not have a cost of living adjustment, payouts on lifetime annuities lose purchasing power when prices rise. Many lifetime annuities offer an annual increase feature designed to keep pace with inflation. It can be worth your while to include this feature, especially if you live another 20 or 30 years.

A valuable product that fills a need

Very few other financial products can offer what a lifetime annuity can do. If you want to guarantee that you will always have a source of income, no matter how long you live, you should consider moving a portion of your retirement nest egg into a lifetime annuity.