Q. Is annuity a bad choice in today's low interest rate environment?
A. Contrary to popular thinking - annuities could be very valuable even when interests are close to zero, as a MarketWatch article shows -
Could annuities be more valuable when rates are low?
In the above article, the author considered a typical scenario - a 65-year old annuitizes $100,000 cash and receives guaranteed $5,048 payment per year, this is even assume the insurance company takes 15% marketing cost out of the money.
How about other options this retiree could pursue? The author identified 3 alternative options:
1. Self-annuitization.
Without using an insurance company, this retiree could withdraws $5,048 per year by himself. The problem is he would deplete his money after 18 years (at age 83), however, he will still have 54% of chance being alive at that time!
2. Long-life strategy
Now if this retiree assumes he would live to age 100 and do the annuitization by himself, while money could last till age 100, unfortunately he could only spend $2,857 per year, a lot less than what the insurance company would pay him.
3. Life-expectancy withdrawal strategy
In this case, the retiree spends a fraction of assets each year based on expected remaining years of life. For example, average male life expectancy at age 65 is 19 years, so the person would spend one-nineteenth of the $100,000, or $5,263. Income under this option is initially higher than that provided by an annuity, but the withdrawals fall with age, creating a significant chance of impoverishment in old age.
The Bottom Line
So the insurance company's annuity seems to be the best option, even when interest rate is zero. How could this be? The key reason is insurance companies could pool experience and use assets from deceased annuitants to pay those who still survive, producing a “mortality premium”.
A. Contrary to popular thinking - annuities could be very valuable even when interests are close to zero, as a MarketWatch article shows -
Could annuities be more valuable when rates are low?
In the above article, the author considered a typical scenario - a 65-year old annuitizes $100,000 cash and receives guaranteed $5,048 payment per year, this is even assume the insurance company takes 15% marketing cost out of the money.
How about other options this retiree could pursue? The author identified 3 alternative options:
1. Self-annuitization.
Without using an insurance company, this retiree could withdraws $5,048 per year by himself. The problem is he would deplete his money after 18 years (at age 83), however, he will still have 54% of chance being alive at that time!
2. Long-life strategy
Now if this retiree assumes he would live to age 100 and do the annuitization by himself, while money could last till age 100, unfortunately he could only spend $2,857 per year, a lot less than what the insurance company would pay him.
3. Life-expectancy withdrawal strategy
In this case, the retiree spends a fraction of assets each year based on expected remaining years of life. For example, average male life expectancy at age 65 is 19 years, so the person would spend one-nineteenth of the $100,000, or $5,263. Income under this option is initially higher than that provided by an annuity, but the withdrawals fall with age, creating a significant chance of impoverishment in old age.
The Bottom Line
So the insurance company's annuity seems to be the best option, even when interest rate is zero. How could this be? The key reason is insurance companies could pool experience and use assets from deceased annuitants to pay those who still survive, producing a “mortality premium”.
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