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An Annuity Can Be a Paycheck for Life

Weigh the pros and cons carefully before you invest

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Annuities have a pretty bad reputation, and I certainly have written my share of negative articles about them. But now there are some more appealing annuity options with much lower fees. One such option is a single premium immediate annuity, or SPIA for short. That’s where you hand over some money to the insurance company in return for a promise of a monthly payout for the rest of your life. It’s like creating your own pension.

​Rather than talk about annuities in theory, I’ll use a real example on a recent quote I received. Here are the pros and cons, as well as my conclusion. (I will be getting payments from something that offers lifetime income but isn’t an annuity: You’ll have to read on to see what that will be.)​

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My paycheck for life

SPIAs are often pitched as guaranteed income for life, which is very appealing. Annuity.org states that “Immediate annuities guarantee an income stream within a month of purchase.” It’s very easy to get quotes online, and most of the big brokerage firms, such as Fidelity and Schwab, can give you online quotes. I went to ImmediateAnnuities.com for myself. (AARP also has an annuity quote service.) I’m a male who will turn 65 this June.

​If I forked over $100,000 today, the highest quote was a $535 monthly payment for life, with only $118 of that amount being taxable. The monthly payment would be about $78 lower if I bought a joint annuity that would continue as long as either my wife or I were alive. For this illustration and simplicity, I’m sticking to just myself. The $535 monthly paycheck translates to a 6.42 percent payout.​

I’ve seen many in the industry pitch products like these as a 6.42 percent income payout that’s mostly tax-free. ImmediateAnnuites.com did not pitch it as income. Most of the payment from the SPIA is just returning the money I paid for the annuity, which is why the IRS doesn’t tax that portion. It’s not tax-free income; much of it is a return of principal. I’d have to live nearly 16 years just to get my original $100,000 back.

Pros

There are many reasons to consider a SPIA. First, there is a sense of security knowing you can’t outlive this monthly paycheck. That amount coming in every month feels good, and that set amount helps us budget our living expenses. This is especially true if you don’t happen to have a pension from a company you worked for. And when the rest of one’s portfolio plunges in a bear market, there’s comfort in knowing this payment is safe. One benefit I don’t see talked about much is that the annuity gives protection against possible cognitive decline. With this money held by the insurance company, we can’t do something foolish if our mental acuity fades. ​

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Finally, as far as annuities go, SPIAs have a relatively low commission rate paid to the agent. As a general rule, the more you pay in fees, the less for you. ​

Cons

As mentioned, annuities are not without downsides. The biggest risk is inflation. Over the past year ending in March, inflation ran at 8.5 percent. Had I bought this paycheck a year ago, I’d have lost that much spending power in that one year alone. What will my paycheck buy in 25 years? Well, if inflation goes back to the 2.2 percent long-run average since 2013, my $535 monthly paycheck will buy me about $311 of goods and services. If inflation stays at 8.5 percent, it buys only about $70. Not too long ago, insurance companies did sell SPIAs that adjusted with inflation, but they have since withdrawn that product. Although you can buy a SPIA that has a fixed annual increase, those actually have more inflation risk, since your paycheck is less in the early years but the larger payments in later years buy far less. ​

You also wouldn’t want to buy a SPIA if you think you have a short life expectancy. Finally, if leaving a legacy to your children is important, then I wouldn’t consider a SPIA. Although you can buy the product that has what’s known as a period certain that would pay out even if you died in the earlier years, the monthly payment is far less than a lifetime payout. I don’t think it makes sense to buy a product to pay to protect for both a long life as well as a short life.

My decision

I decided not to explore this product further. Insurance companies stopped offering SPIAs adjusted for inflation because they see the risk as too high. Not that we know what inflation will run over the next 25 years, but it’s an ever-present risk. So if you buy a SPIA, make sure it’s only a piece of your retirement plan and understand the check is mostly return of your own money. And remember that the real buying power of the annuity a couple of decades from now could vary greatly.

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​Rather than take Social Security at age 65, I’m going to wait until I turn 70, when I’ll get nearly an extra $1,159 a month. Unlike the SPIA, I get inflation protection and my wife will continue to get this paycheck as a survivor benefit should she outlive me, which, of course, women typically do.

​SPIAs can sometimes make sense for part of one’s retirement plan. The fact that you may not have been pitched one is because commissions aren’t as juicy as many other annuities. But proceed with caution and understand the risks.

Allan Roth is a practicing financial planner who has taught finance and behavioral finance at three universities and has written for national publications including The Wall Street Journal. Despite his many credentials (CFP, CPA, MBA), he remains confident that he can still keep investing simple.

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