Lifetime Income Annuity: How does it work?

The Annuity Man

When it comes to retirement planning and making sure that you have enough retirement income in place, most people are relying too much on their Social Security payments.  For all of you “annuity haters” out there, Social Security is the best inflation annuity on the planet...and every American owns one.

With over 10,000 baby boomers reaching retirement age every single day, most are realizing that they need more guaranteed income and are asking the question, “Are lifetime annuities a good idea?”  The answer is maybe, but you need to at least be aware of lifetime income annuity pros and cons in order to make an informed decision.

Lifetime income annuities are annuity contracts and are issued by life insurance companies, but they are not all the same.  Let’s dig into those details, without the sales pitch, so you at least know what’s out there.

Roman Monopoly

Annuities were first introduced in the Roman Times as a pension gift to the dutiful Roman Soldiers and their families.  Those payments were called “annuas,” which is the origin of the word annuity.  Bet you didn’t know that.

Single Premium Immediate Annuities (SPIAs) are a fixed annuity type that is pretty much the same structure as that early Roman pension.  Hail Annuity Caesar!  Deferred Income Annuities (DIAs) and Qualified Longevity Annuity Contracts (QLACs) are “cousins” of the SPIA structure, so the Roman annuity family tree lives on.  There are deferred annuity types like Variable Annuities (VAs) and Fixed Index Annuities (FIA) that offer attached Income Rider benefits for guaranteed income as well.

All of these types (SPIAs, DIAs, QLACs, Income Riders) can be classified as Lifetime Income Annuities or a Guaranteed Income Annuity.

Actuarial Risk Transfer

When you are buying a Lifetime Income Annuity, you are putting in place your own personal pension plan.  It’s a transfer of risk strategy because you are moving that risk to the annuity carrier to pay you regardless of how long you live.  They are on the hook, period!  I always say that there’s no ROI (Return on Investment) calculation until you die. Up until your demise, it’s a pure transfer of risk.

Annuity companies have the big buildings for a reason because they know when we are going to die.  That’s what actuaries do.  They predict our death based upon our age and life expectancy, and then the annuity companies price their income guarantees accordingly.

All Lifetime Income Annuity payments (regardless of the type of annuity) are a combination of principal plus interest.  So when people call me up and ask about “annuity rates,” they are primarily asking me what the annuity companies are paying based upon their life expectancy at the time they want the payments to start.  Most people think interest rates drive the pricing train, but they don’t.  Interest rates play a secondary pricing role.

Some frequently asked questions that I get are “How much does a lifetime annuity cost?” or “How much does a $100,000 annuity pay per month?”  The answer to both is primarily based on your life expectancy at the time you want the income to start.

When you quote a lump sum Lifetime Income Annuity, the contractually guaranteed number is a combination of return of principal plus interest based on your life expectancy at the time you start the payments.  If you draw down your account to zero, the annuity company is still on the hook to pay regardless of how long you live.

That is the true benefit proposition of a Lifetime Income Annuity.

Single or Joint?

Lifetime Income Annuities can be structured either “Single Life” or “Joint Life.”  Single Life always pays higher because the annuity company is only on the hook to pay for one life expectancy.  A Joint Life income payment will cover 2 lives, and primarily prices the payment on the life expectancy of the younger of the 2 annuitants.

SPIAs, DIAs, and Income Riders can all be used with Traditional IRAs, Roth IRAs, and non-IRA (non-qualified) accounts.  QLACs can only be used in qualified accounts like Traditional IRAs and some employer sponsored plans (i.e. 401k).

Lifetime Income Annuities can be structured and customized to meet your specific goals. Contractually guaranteed payment options can include a lifetime guarantee with a period certain (specific period of time) as a back-up in case you die early in the contract.  This is done to make sure that your policy beneficiaries get paid if your Learjet hits the mountain right after you bought the annuity.

With SPIAs and DIAs, there are over 30 ways to contractually structure the payments. QLACs have a handful of options, and Income Riders have numerous choices as well.

Commodity Crunch

If you are considering placing some of your retirement savings into a Lifetime Income Annuity, you have to quote all carriers in order to find the highest contractual guarantee for your specific situation.  Just think of annuities as commodity products, and like buying a plane ticket.  Not one annuity is better than the other.  You are just shopping for the best deal, and then you start considering the claims paying ability of the carriers that are offering the highest contractual numbers.

It’s important to find an objective guaranteed lifetime income annuity calculator or lifetime annuity calculator that shops all carriers for the best deal available.  Remember that Lifetime Income Annuity quotes are like a gallon of milk and expire ever 7 to 10 days unless you lock them in during the application process.

As part of your overall “Income Floor,” a Lifetime Income Annuity can provide that additional income source that is contractual and guaranteed regardless of how long you live.  It might just be worth getting a quote.

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