When is the Best Time to Buy An Immediate Annuity
Humberto Cruz

HOME > WEALTH

A white-knuckle stock market ride since May has rekindled interest among readers at or near retirement age for immediate annuities that turn a lump sum premium into a guaranteed income for life.

But many wonder, is this a good time to buy?

"Do prevailing interest rates affect the price of an immediate annuity?" asked a reader from California in a typical e-mail. "With rates so low, I am thinking the price is relatively high right now."

Yes, it is. The lower interest rates are, the higher the annuity premium will be because more money is needed to generate the income.

Other factors that affect the premium include age and gender, which determine average life expectancy (women tend to live longer than men). The longer you're expected to live -- and therefore, the more payments you're expected to receive -- the higher the premium will be, others things being equal.

Determining the premium for a particular income stream may involve 30 different calculations for an annuity expected to pay out for 30 years, said Dick Duff, a chartered life underwriter who lectures and writes extensively about immediate annuities, including in his new book "Retirement Breakthrough" (Greenleaf Book Group Press, 2010). As a rough guide, assume the interest rate implied in the annuity payout -- and therefore, the amount of the premium -- is tied to the 10-year U.S. Treasury note rate at the time of purchase.

Do not confuse immediate annuities with variable deferred annuities, which are complex products that offer mutual-fund-like investments in a tax-deferred insurance wrapper. Many variable annuities -- although not all -- charge high fees and should be avoided.

By comparison, immediate annuities are recommended by many financial professionals and academicians, and are relatively low-cost (administrative costs and the insurance company's profit margin are factored into the quoted premium and payout). A recent paper by the Center for Retirement Research at Boston College, "Making Your Nest Egg Last a Lifetime," concluded people approaching retirement should consider "annuitizing sufficient financial assets to secure at least their minimum standard of living." (In other words, buying an immediate annuity that covers minimum basic expenses for life.)

But do it now or wait for rates to rise?

The case for waiting: In July 2008, when I was 63 and my wife, Georgina, was 64, I paid $100,000 for an immediate annuity that pays us $585 a month until we both die, with 20 years of payments totaling $140,400 guaranteed even if we die sooner (any remaining payments would go to our beneficiary). Today, even though we are older, a $100,000 premium would give us only $496 a month, and it would cost $118,000 to receive $585 a month. By waiting, we also increase the future payout even if rates don't rise because we'd be older. Assuming we were two years older today, $100,000 would get us $507 a month.

The case for not waiting: Rates may stay down or even go lower, and the money we need to set aside and keep safe for the future premium would earn next to nothing while we wait. Also, medical advances may lengthen average life expectancy in the future, lowering annuity payouts. A better solution may be "laddering," or buying smaller immediate annuities periodically (every year or two, for instance) rather than buying a large one when rates are so low.

This is a complex topic and I have run out of space. I'll address a multitude of other issues about the decision to annuitize or not in a future column.

Available at Amazon.com:

The Seven Deadly Sins of Investing: How to Conquer Your Worst Impulses and Save Your Financial Future