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I never thought I'd be interested in an annuity. But I've become fascinated with this financial product and its potential for dealing with longevity risk. Certain types of fixed annuities can provide a stream of income for as long as I live, even if I live to be 90 or 100 or even older.
One of the reasons I hadn't yet delved into annuities is my desire to make an informed decision without interference from a sales representative. I like to analyze a product offer, define as many of its benefits and risks as possible, do my own calculations to determine whether a purchase is worth the price compared to alternatives, and then make a decision. But I wasn't aware of how to take these steps without pressure so I avoided them.
When Lauren Minches, vice president of Product and Marketing at Blueprint Income, contacted me and asked me to look at the personal pension and annuity products offered through the company's platform, I immediately said “yes.”
Annuities Available through Blueprint Income
Blueprint Income offers a quick and easy way to get a quote on an income annuity offering fixed income for life. Through its platform, I can find out how much monthly income could be generated by buying one big annuity, say for $100,000; alternatively, I can specify a monthly amount desired, then discover the size of a one-time payment to generate this level of income.
In addition, I can determine how much monthly income could be generated by purchasing multiple annuities over time for smaller payments of say $5,000 to start with additional contributions of $100 or more.
Blueprint Income serves as a broker between annuity buyers (people planning for retirement) and annuity providers (insurance companies). Like an investment broker, the company also tracks holdings and values (expressed in the form of income payments) so that annuity owners can view expected income, which it calls a “personal pension.” Note that this “pension” isn't meant to be the sum of your retirement savings but a portion that's not subject to traditional market risk.
Generally, the types of annuities offered through Blueprint Income represent a periodic income for life. This arrangement helps to manage longevity risk, the risk of living a long time and running out of money.
How To Get Quotes from Blueprint Income
It's easy to use Blueprint Income to get annuity quotes. One reason for this ease: the platform yields results for income annuities only, not ones that deal with market risk like variable annuities or fixed-indexed annuities.
These numbers can help you determine whether an annuity could possibly make sense for you. But they are starting points. At Blueprint Income, I received estimates with the offer to apply for an annuity, not ready-to-sign contracts on the first pass. The initial estimate and the actual offer may differ because of changes in actuarial tables as well as state-specific requirements or limitations not integrated into initial quotes.
Still, it's a quick and painless process to get going and determine how a guaranteed annuity might be useful for your retirement planning. You can start on the quotes page and respond to the questions asked and/or blanks to be filled in:
- How you'll fund the purchase of the annuity:
- personal investments and savings
- 401(k), IRA, or other tax-deferred plan
- another way
- When you want your income to start in general (the later you start, the more money you'll get):
- Your birthday including the year you were born
- Male or female
- State of residence
- The age at which you want to start collecting income (generally up to age 85)
- Who you want to generate income for:
- me only
- my spouse and me
- Amounts of money
- the one-time purchase amount, which will yield a result of monthly income OR
- the amount of monthly income you want to generate, which will tell you how much you'll need to pay to buy the annuity
To see the results, you'll need to sign up for an account or sign in if you've already created an account. You can set up an account for free. Though I've gotten follow-up emails offering assistance, I've never had a sales representative call me.
Factors that Affect the Price of an Annuity
There are many factors that affect pricing: some can be controlled while others are more difficult (or impossible) to change.
For example, women pay more for annuities because they have longer life expectancy, which means that the insurance company will pay more over time to women. Similarly, an annuity that starts issuing monthly income in your 80s will cost less than one that begins in your 70s because chances are the insurance company will pay less.
Here are some factors that affect pricing that aren't controlled simply:
- state of residence
- date of birth (age)
Here are some elements that may be controlled or specified:
- age at which you'll start receiving income
- time between now and periodic payments begin
- if married, whether both spouses will receive lifetime income
- contributions (annuity purchase amounts)
- inflation protection
- death benefit rider
- return of premium rider
If you are looking simply to protect yourself in case you live a long time, you may not want to pay extra to get a death benefit or return of premium just if you die early before collecting income from the annuity. However, if you'd like an annuity that benefits your family in multiple scenarios, then you'd likely want various riders and will pay more to get these features.
Also, it's important to note that the quotes offered by Blueprint Income are typically for life (with and without the return of premium). However, insurance companies also offer various options such as income for a specific period, such as 20 years only, which are also available through Blueprint Income if you contact them directly.
In general, the fewer demands you make on the insurance company, the less you'll pay for a specific monthly income. The more that's required, such as income for a spouse or a cash payment if you die before the monthly checks start, the higher the cost of the annuity.
Before going further, let's talk about what an annuity is: a contract with an insurance company. It's like a life insurance policy. But instead of buying a policy in order to receive a cash payment upon your death, you receive a series of cash payments while you're living. Also, like a life insurance policy, it's only as good as the insurance company that guarantees payments. An annuity is not insured by the FDIC or regulated by the SEC.
In addition, just as there are many ways to structure a life insurance policy, there are many ways to design an annuity. Prices are based on actuarial tables as well as policy riders and other factors.
Types of Annuities
There are many types of annuities. Here's how the SEC describes them:
- fixed (the insurance company agrees to pay a specified rate of interest or more during the time the account is growing; it also agrees that periodic payments will be a specific amount per dollar in the account for a defined period)
- variable (annuity payments are invested among a menu of investment options; the periodic payments received vary based on the performance of the investments)
- indexed (periodic payments meet a specified minimum but could earn more depending on changes in a market index)
Another way to categorize annuities is based on the starting time frame of payments:
- immediate (periodic payments start immediately or within the year; see Blueprint Income's guide to immediate annuities)
- deferred (paychecks start later; see Blueprint Income's guide to deferred annuities)
- longevity (payments start much later, such as age 85, and are designed specifically to manage longevity risk)
Further, there are special types of fixed annuities, such as:
- MYGA (multi-year guaranteed annuity, which offers a fixed rate of interest during the accumulation phase; see Blueprint Income's guide to MYGAs)
- QLAC (qualified longevity annuity contract, which enables the deferment of required minimum distributions or RMDs when purchased through a qualified retirement plan; see Blueprint Income's guide to QLACs)
Annuities could likely be segmented in more ways but these categories seem most relevant to me.
Taxes, Fees, and Other Things to Consider
There can be tax benefits associated with certain types of annuities. For example, interest accrued in an MYGA is deferred until paid out. A similar financial product, such as a bank CD, is taxed in the year interest is credited to your account.
As mentioned earlier, QLACs allow you to defer RMDs. These annuities are purchased with funds held in a qualified retirement account, such as an IRA or 401(k). You might choose this path because 1) you have money inside your retirement accounts but no money in investments or savings accounts in which to make the purchase and 2) you like the idea of delaying part of your RMDs through the purchase of an annuity (see expert opinion on this topic).
More things to know … fees associated with annuities may include:
- sales commissions
- surrender charges (fees charged if you change your mind about the annuity and ask for cash back)
- annual fees, which are typically associated with variable (not fixed) annuities
Other noteworthy aspects of annuities is their role in qualifying for Medicaid. In some cases, annuities are purchased as a way to reduce countable assets to qualify for Medicaid.
In general, there's no limit specified by the IRS regarding the size of an annuity, unless you're buying a QLAC.
Key Terms to Understand
If you're wanting to dig more into annuities, here's a link to a list of terms (scroll to “Key Annuity Definitions” at the bottom of the page). Blueprint Income has also published an excellent glossary.
Here are a few terms to know:
- Annuitant: the person who receives income from the annuity and upon whose life expectancy rates are calculated, generally the contract owner
- Joint annuitant: co-owners of an insurance contract (husband and wife, for example)
- Period Certain: a payout that's for a certain period, such as 10 years or 15 years
I've noticed that terms aren't consistently used among industry experts, insurance companies, and finance journalists. In addition, slight differences in wording can mean big differences in meaning. For example, a fixed annuity could be a fixed-rate annuity that's similar to a bank CD or a fixed-indexed annuity that accumulates value based on market performance. So be sure to understand these terms and what you're buying before making a decision.
How Annuities Are Designed
It makes sense to possess a working knowledge of annuity definitions and product designs, though it may be impossible to stay on top of the entire universe of annuities. Rather than develop an encyclopedic knowledge of annuities and industry terms, I've set a goal of understanding the features of an annuity I might buy.
Here are design features I'll consider:
- whether periodic payments are guaranteed (and how they're guaranteed)
- how much fluctuation, if any, could occur in periodic payments
- whether I can access the principal after I purchase the annuity
- when payments begin and end
- whether payments increase when the cost of living increases
- how payments are taxed when I receive them
Before buying this type of product, I'd want to know how the various features affect my bank account for the short and long terms.
Why Consider an Annuity
My plan all along was to develop a portfolio to generate cash in perpetuity, not one that I spent down over 30 years or so in retirement. There are a growing number of centenarians so my idea of living off the principal of my investments, rather than depleting them, seems smart. The challenge is building and managing a portfolio to accomplish this goal.
I've been investing in stocks for over 30 years now, so I have an idea of how to handle the equity portion of my portfolio. The fixed-income piece hasn't been as clear to me, especially as I've watched interest rates on savings accounts dwindle to nearly nothing.
So, as I've planned for retirement, I've been considering my choices and now see how an annuity could possibly fill a void.
I felt validated about this approach when I read in the April 2018 edition of the HumbleDollar newsletter published by Jonathan Clements, longtime personal finance columnist at The Wall Street Journal:
In the end, what we need is a strategy that’ll work even if markets are miserable and even if we live an extraordinarily long life. My personal plan: Delay claiming Social Security until age 70, use a portion of my bond-market money to purchase an immediate fixed annuity that pays lifetime income, and each year withdraw 5% of my portfolio’s beginning-of-year value. With this last strategy, I’ll be compelled to spend less if markets perform poorly—and I’ll never run out of money, because I will always be withdrawing a percentage of whatever remains.
Likewise, if you're nearing retirement or already retired, you may be interested in trading a large chunk of cash for a promise of a steady monthly income by purchasing an annuity. This arrangement could fill a need for fixed income, complementing Social Security retirement benefits and a company or government pension. Combined, these streams of income could pay for basic living expenses for groceries, property taxes, utilities, and more.
If you're younger and working without access to a pension, you may be interested in buying more than one annuity contract. By purchasing multiple contracts over a period of time and possibly adding to various contracts, you can build multiple streams of fixed income for retirement. At Blueprint Income, this approach is being called a “personal pension.”
Considering the Return on an Annuity
After I developed an understanding of how annuities work, I decided to run some numbers to compare this product to possible alternatives.
First, I wanted to get an idea about the rate of return on an annuity. The return of a lifetime annuity can't be pinpointed because the longer an annuitant lives, the better the return. This website presents a well-thought-out illustration of the rate of return, showing how this internal rate of return (IRR) increases as you live longer.
I can also use IRR function in Excel to model the cash flows associated with paying for an annuity and then receiving income over time. In this scenario, a $100,000 purchase of an annuity at age 60 with payouts of $18,000 per year could generate a return of more than 4% if I lived to 96. I'd have to give up my rights to the $100,000 in order to get this return, though I could add a rider that would offer a benefit if I died before collecting payments.
A wildcard, then, seems to be inflation. If inflation is stable, then the money I'll receive in my 90s will help pay my bills adequately. Of course, I could hedge my annuity bet by getting inflation protection but that would lower my annual paycheck. There are trade-offs in annuity features that need to be considered.
Still, I remind myself that the purpose of a longevity annuity is to provide a source of income in my 90s and 100s, not to deliver a strong return. If I want to get pricing on these possibilities and study my choices, I can access tools like the one provided by Blueprint Income.
Are you considering an annuity to generate income in retirement? Have you purchased an annuity? How did you decide your best course of action?