There are several types of immediate annuity, but regardless of the differences, they all do one fundamental thing: they enable you to convert a lump sum into regular income.
Although the graphic above shows lifelong income, you could opt instead for the income from your annuity to be paid for a specific number of years; for example, you could buy an annuity that will pay you a monthly income for 20 years and then stop. The more years you would like to be paid an income for, the lower the income will be.
When buying an immediate annuity, most people choose one of these three options:
- The Single Life Annuity: This is the option to choose if you would like the income to last until the end of your life. The income then stops and your heirs inherit nothing.
- The Joint Life Annuity: This is the option to choose if you would like the income to continue until both you and (most likely) your spouse have reached the end of your lives.
- The Term Certain Annuity: This is the option to choose if you would like the income to stop after a fixed amount of time – ten, twenty or thirty years, for example. If you die during this annuity’s timeframe, payments will continue to be made to your heirs.
What factors affect how much income I’ll get after buying an annuity?
Let’s say you’ve decided to buy an immediate, fixed, life annuity. You dangle your money in front of an insurance company and ask them how much you’ll be paid each month if you buy an annuity from them.
The interest rate the insurer offers you will be higher than you could expect from a bank. You should understand that the higher interest rate isn’t offered as an act of charity. A bank pays pure interest on the principal you give them. You can get the principal back when you ask for it. With this annuity, the monthly payments you receive are part interest and part principal, so it’s actually better to refer to a payout rate on an annuity rather than an interest rate.
The payout rate from this annuity is also helped by other people who go to meet their maker soon after buying their lifetime annuities. Their money remains in the general pool that provides payouts to surviving annuity holders.
Annuity Payouts are Higher than Bank Interest Rates
The exact payout rate you are offered when you buy an immediate annuity depends on the general economy and on you.
If interest rates and bond yields are generally low, annuity payout rates will reflect this and also be lower.
All other things being equal, the younger and healthier you are when you buy a life annuity, the lower your payout rate will be. Women get lower payout rates than men.
Putting it bluntly, if the insurers think there’s a good chance you’ll soon be pushing up daisies, they’ll offer you higher income payments than if they think you’ll be around for a long time. The older and sicker you are, the greater income you can expect from a life annuity.
You’ll get less income from a joint life annuity than a single life annuity – it’s likely the insurers will have to make payments for longer waiting for two people to die than one person to die.
Life annuities: Will you or the insurance company win?
When you buy a life annuity, you are effectively playing a game of chance with the insurer. If you live for a long time, you win. The payments you get from the insurance company will be worth more than the money you bought the annuity with. On the other hand, you might die within a few months – weeks – days – hours! of buying the annuity. You will than have paid the insurer a lot of money and received very little in return.
The feeling that it’s possible to ‘lose’ in this way actually deters a lot of people from buying an annuity. This is a pity because, should they be fortunate to live a long life, it’s likely the annuity will provide them with a higher guaranteed income than other methods could.
Perhaps it’s best to think of it this way: if you die soon, the loss of income hardly matters, but if you live a long time, the annuity is guaranteed to keep paying you, no matter how long you live.