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Pros and Cons of Immediate Annuities
(Updated 2/23/09)
Pros
1) Income You Can’t Outlive
An immediate annuity with a lifetime payout option will provide an income that you cannot outlive.
2) Provides Highest Predictable Income
For example, an Iowa man aged 65 can obtain a fixed immediate annuity with a payout rate of 6.02% with annual CPI-adjustments. Or he can obtain a payout rate of 6.18% and graded at 3% (meaning that the payout amount increases by 3% every year). These quotes were obtained from Vanguard on December 24, 2007.
These payout rates are higher than the standard 4% CPI-adjusted rule-of-thumb that many retirement experts feel can last 30 years from a balanced retirement portfolio.
3) Improves the Odds of Portfolio Survival
By combining the higher payout rates from a fixed immediate annuity with a balanced retirement portfolio, the odds of sustaining inflation-adjusted withdrawals are improved. A detailed discussion can be found HERE.
4) Less Money to Personally Manage Can Be a Plus
For example, investors can make mistakes when they manage their own investment portfolio. They may panic in bear markets, thereby permanently locking in losses. Also, as retirees reach an advanced age, their mental abilities might diminish, thereby resulting in poor investment decisions. So with a portion of the nest egg producing predictable income from an annuity, errors, should they be made in the investment portfolio, won't be so damaging.
Cons
1) Insurer Could Fold
The insurance company could fold. This could be mitigated by splitting the annuity purchase among a few different providers. Plus, each state’s guaranty association is charged with coordinating continuing coverage up to a certain amount, typically $100,000. See Note 1.
2) Decision is Irreversible
You give up access to the committed money which might have been otherwise available to use in an emergency or for other pressing needs.
3) Payout Cannot Step-Up Even If Interest Rates Go Up Later
Once you buy a fixed immediate annuity, you are locked into the payout rate. This might be mitigated by purchasing an annuity in stages (smaller chunks separated by a few years). However, one annuity provider is offering an option that might step-up the payout. See Note 2.
4) Insurance Company Keeps Your Premium - Nothing For Your Heirs
When you self-manage withdrawals from a retirement portfolio, your heirs get the remainder of the assets after you die. In contrast, if you die shortly after buying an annuity, your heirs get nothing. This concern could be eliminated by having a minimum guarantee period of, say, 20 years. So even if you die early, your heirs would receive payments till the end of the contract period. The trade-off is that the payout would be somewhat lower.
5) Gains Are Taxed at a Higher Rate
In a taxable account, gains that are long-term are taxed at the favorable 15% rate. But if those assets were instead used to purchase an annuity, gains would be taxed at ordinary rates at the retiree’s marginal tax bracket.
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