Who Should Buy An Annuity?

Ok, so we all know variable annuities are usually better deals for the annuity salesman than the customer.  But let’s ignore all that for a moment.  Surely there must be certain circumstances when an annuity makes sense, right?  Indeed, I’ve already written about some of the few (very few) ways you can use a variable annuity intelligently but in that particular article my focus was on variable annuities.  There is another, far more useful, type of annuity I’d like to pound the table about today:  the good ol’ fashioned immediate, or income annuity.

According to Investopedia, an immediate annuity is an annuity contract purchased with one upfront payment and has a specified payment plan, which starts immediately.  You can purchase these with or without inflation protection, guaranteed payout to heirs, for life or just for a specified term, and a million other varieties but there is one thing they all have in common:  unlike with variable annuities, when you buy an immediate annuity you know exactly what you’re getting upfront.  You know exactly how much you’re paying for it, and you know exactly how long the payments will last.  See Annuities Explained for a more detailed explanation of what this product entails.

Buying Certainty

Immediate annuities are perfect for those in retirement who need a steady income to live on.  You can think of them as your own private pension plan, except instead of your employer setting the terms of the payout, you get to set them yourself.  An immediate annuity’s most valuable attribute is that you know for certain your income will never fall below a certain level as long as you live.  If your annuity pays $2,000 per month, you will never have to worry about bringing in less than $2,000 per month.

Because of this stability, many people choose to make guaranteed income part of their asset allocation in retirement.  For instance, a retired couple might have 50% of their portfolio in stocks, 30% in bond, and 20% in a guaranteed income stream provided by an immediate annuity.  For a $1 million portfolio, that $200,000 annuity contract would be worth $1,167 per month for a 65 year old couple, payable as long as one of the spouses was still alive according to immediaetannuities.com.  That kind of stability is extremely valuable to somebody in retirement and I see no reason why an annuity income stream couldn’t be used as a replacement for a cash allocation in most retirement portfolios.

A Word Of Caution

While extremely unlikely, it is possible for the insurance company holding your annuity contract to go bankrupt, causing you to lose both your original investment and your income stream.  In most real-life circumstances, another insurance company would likely buy up the failed company’s assets and continue payments or the government would step in and guarantee you’d get at least part of your money back.  But the danger, though very small, cannot be dismissed.  You should check with various insurance company rating agencies to verify the financial condition of any company before deciding to do business with them.  You may even decide to take it one step further and diversify your income sources.  In the example above, you may choose to buy two $100,000 annuities from different companies rather than one $200,000 annuities as a hedge against uncertainty.  You might even decide to buy four or five different annuities from different companies depending on how much money you’re investing.  Certainly I would advise against depending on the financial health of just one insurance company if I were devoting a significant part of my net worth to an immediate annuity strategy.