Retirement - Joint Life Immediate Annuities?

Q. I am thinking about buying a joint life immediate annuity for part of my retirement package ($640,000 to buy $41,000 a year). I have an additional $550,000 in 401K and $250,000 in money market account paying 3.25 APY.

I will retire December 2005. I am 59 and my wife is 57. My father is 87 and my mother dead of lung cancer at 72. My wife is in good health and her parent died at 76.

Does it make sense to buy a joint life immediate annuity for part of my retirement?

Is there an alternative to an Immediate annuity that will give me the same income stream without any risks?

A. These are great questions!

There are several issues to consider when deciding whether an immediate annuity is right for your situation. It would be helpful to know what you expect your annual expenses to be so I could run some calculations with those--let me know and I'll add that to the suggestions.

The insurance company is going to use an actuarial table to estimate your (or you and your wife's) life expectancies. They then calculate out what payment will return all of that money plus an assumed interest rate over that life expectancy. Of course, they leave room for profit, but most of their profit will come from using that money to earn more than they pay you.

If we assume a 25-30 year life expectancy for you, then the internal rate of return on the immediate annuity is between 4 and 5%. There are several things to keep in mind with this.

First, if it is on your life only (and there isn't a 'period certain') then if you died a year after getting it your wife would get nothing. In this situation the life insurance got the $640,000 with very little expense. Even if it is a joint-survivor annuity, if you both die, say before age 70, then the insurance company has won the lottery again.

On the other hand, if you live longer then the insurance company expects you to, you ended up earning a little more than the 4-5% internal rate of return.

Second, you give up any access to that money if you do an immediate annuity. It's true you have access to the 401(k) and money market money, but you will be giving up access to over half a million dollars.

Thirdly, your annual payment in an immediate annuity is mostly made up of a return of principal. In other words, most of the payment is just getting back your original investment. So when comparing it with other alternatives, you want to compare the internal rate of return (4%-5%) to what is available, not the $41,000 payment. In other investments you can always use some of your principal as well, but it is competely at your discretion.

Lastly, the interest rate. 4-5% today sounds OK based on where current interest rates are. But your payment won't change if interest rates go up in the future with the immediate annuity. Historically, interest rates have a much higher average then they do today. In other words, as interest rates go up it becomes much easier for you to get the equivelent income off of other investments.

Very few people use immediate annuities because of the lack of control. It seems to me that 4-5% isn't enough reward for giving up $640,000.

One thing to keep in mind is that you don't have to get the immediate annuity right now. Another option is to roll that money into an IRA and to wait for interest rates to get closer to their historic averages. You can then purchase an immediate annuity which would be using a higher internal rate of return which will result in a higher annual payment.

There are many alternatives that should allow you to average greater than 4-5% a year. You mention alternatives without any risk, but that isn't a correct comparison because there is considerable risk of loss in the immediate annuity--if you die early you lose significant dollars!

With the right investment advisor and a proper mix of investments and strategies you will be able to retain all of your control and flexibility over that money, be able to pass it on to your heirs when you die and still have access to it whenever you want. You won't be locked in to a set amount each year. For instance, I use a stable investment with my clients that pays a monthly dividend between 6-7.25%. There are many other alternatives I can suggest as well. (If you would like me to put together a recommended portfolio just let me know.)

Regardless of whether you get the immediate annuity, be sure to read my articles on choosing a financial advisor. You have a big target painted on your back and every broker and insurance agent is going to be aggressively seeking the huge commissions they can make off of you. I highly recommend avoiding a commission-based advisor at all costs. Also avoid any investment that will lock you in for many years with surrender penalties.

Feel free to ask me as many questions as you like--what to do with this money is probably one of the biggest decisions you will make in your life!

Q. Dear Jeff,
Thanks for your advice.
I can defer my lump sum until I reach 62. As you know the lump sum is based on the 30 year US note. My lump sum uses the average of the month of August 30 year note. Last year it was 5.03%. This year it should be lower, giving me a higher payout. I also get an additional 5% added to the lump sum every year until I reach 62. I am now 60.

To answer your question, I need $66,350 a year before taxes for yearly living expenses and my house is payed for. We also have long term care insurance.
If you don't mind maybe you could run some numbers and give me an example of a portfolio.

A. How about some good news?

It looks like if you were to retire today that you would have right at about $1,500,000 in investable assets.

Based on needing $66,000 a year, you only have to earn 4.4% to make ends meet without touching your principal. Once you turn 62 you can begin drawing SS which will probably be around $15,000 per year. When your wife begins getting SS that would even further reduce the demand from your investments.

It's not hard to see that by earning just 5-6% per year (which is very doable) that you could live comfortably, increase your income each year and still see your nest egg grow!

In other words, you and your wife have already successfully accoplished what very few people do--you are financially free. Managed correctly you won't have to worry about money the rest of your life! Congratulations! You should both feel proud of what you've accomplished.

So, you can retire when you want to. You don't have to keep working if you don't want to. On the other hand, if you want to keep working you can and that will only increase your security. Getting a 5% kicker on your pension each year quickly adds up.

One thing to keep in mind is that many people have things they've always wanted to do. Maybe it's to travel or to take the grandkids to Disney World. Maybe it's buying that home on the golf course. It doesn't matter what it is. The thing to think about is what are the dreams you and your wife have always had but still haven't been fulfilled?

How would retiring or working another two years impact fulfilling those dreams? Some people make the mistake of waiting too long, thinking that they will always have time only to find out that their health, energy or desire can quickly change.

My father and step-mother found that out the hard way. He is 71 and still works probably 70 hours a week because he loves what he does. He and his wife always wanted to travel and thought they would have time once whatever project he was working on was finished. She has since had 3 open heart surgeries, blind in one eye and losing sight in the other.

They waited too long.

Life is precious. I'd hate for you to look back in twenty years and have regrets. There are many things that are much more important than money.

http://www.guardingyourwealth.net/investing/articles/investinginlife.htm

I may have gotten off the subject a little. If so, forgive me.

Financial freedom is a significant accomplishment.

I am happy to help in any way I can. I act sort of as a private mutual fund manager for my clients and provide them strategies that are designed to protect their money while helping it grow. The strategies I use are proprietary--you won't find anything like them anywhere else. As you getting closer to retiring, let me know and we can talk about it further...

Your posted comments on this and other questions are welcome.
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Find a wealth of information at Jeff's website.