Q. My employer doesn't offer pension. Should I buy retirement Income through Deferred-Income Annuities sold by insurance companies?
A. It requires lots of calculations and the answer most likely is NO.
Instead of purchasing the new breed of annuities offered by insurers to baby boomers hungry for retirement income, you might be able to build as good a stream of income—or better—on your own.
What is "Deferred-Income Annuity"?
It allows buyers to convert a lump sum into a pension-like series of payouts for life. In contrast to an "immediate" annuity, which starts issuing checks almost instantaneously, a deferred annuity requires owners to pick a start date for payments—typically from 13 months to 40 years or even longer in the future.
The Insurer's Pitch
Buy a deferred annuity in, say, your early 50s, and begin monthly payouts—your "pension"—when you retire.
The Downsides
As with most fixed annuities, you must surrender your principal to the insurer, which keeps the balance when you die. To ensure any remainder goes to heirs, most buyers elect to take a death benefit. But adding such a feature can reduce payouts by as much as 10%, leading policyholders to sacrifice much of the annuity's advantage.
An Example
A 55-year-old man who wants an income of $17,000 a year starting at age 65 can put $150,000 into a deferred-income annuity. His internal rate of return (annual return adjusted for waiting for his payments) based on his life expectancy is approximately 4% before taxes. A 65-year-old man who wants an income of $17,000 a year starting at age 65 can put $260,000 into an immediate annuity. His internal rate of return based on his life expectancy is approximately 3% before taxes.
The Conclusion
From 1926-2012, the internal rate of return of large company stocks has been approximately 10% and approximately 6% for government bonds. Can you earn a higher return outside of an annuity and still own your principal? In all likelihood, the answer is yes.
A. It requires lots of calculations and the answer most likely is NO.
Instead of purchasing the new breed of annuities offered by insurers to baby boomers hungry for retirement income, you might be able to build as good a stream of income—or better—on your own.
What is "Deferred-Income Annuity"?
It allows buyers to convert a lump sum into a pension-like series of payouts for life. In contrast to an "immediate" annuity, which starts issuing checks almost instantaneously, a deferred annuity requires owners to pick a start date for payments—typically from 13 months to 40 years or even longer in the future.
The Insurer's Pitch
Buy a deferred annuity in, say, your early 50s, and begin monthly payouts—your "pension"—when you retire.
The Downsides
As with most fixed annuities, you must surrender your principal to the insurer, which keeps the balance when you die. To ensure any remainder goes to heirs, most buyers elect to take a death benefit. But adding such a feature can reduce payouts by as much as 10%, leading policyholders to sacrifice much of the annuity's advantage.
An Example
A 55-year-old man who wants an income of $17,000 a year starting at age 65 can put $150,000 into a deferred-income annuity. His internal rate of return (annual return adjusted for waiting for his payments) based on his life expectancy is approximately 4% before taxes. A 65-year-old man who wants an income of $17,000 a year starting at age 65 can put $260,000 into an immediate annuity. His internal rate of return based on his life expectancy is approximately 3% before taxes.
The Conclusion
From 1926-2012, the internal rate of return of large company stocks has been approximately 10% and approximately 6% for government bonds. Can you earn a higher return outside of an annuity and still own your principal? In all likelihood, the answer is yes.
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