How to deplete most of your assets before you die by using single premium immediate annuities.
In this episode, you’ll learn:
- What are individuals top financial worry.
- How wealthy are pre-retirees.
- What are the traditional three-legs of retirement income.
- A way to create your own pension plan without having to rely on market returns.
- How do single premium immediate annuities work and how are they priced.
- What happens if an annuity provider goes bankrupt.
I mistakenly said the WII Black Friday debut was in 2008. It was in 2006.
One Solution To Retirement Worries
Each year Gallup releases a poll where they ask Americans about their top financial worry.
Every year going back to at least 2001 that top financial worry was retirement, followed by unexpected medical costs. 59% of those surveyed listed retirement, specifically not having enough money to retire, as their top financial worry.
The concern is understandable given the median net worth of Americans ages 55 to 64 excluding equity in their home is $45,000, according to 2011 data released by the U.S. Census Bureau. That means half of Americans in that age cohort have a net worth less than that.
And that was the “richest” age cohort as the median net worth for Americans younger than 55 and older than 64 is even less.
According to the Employment Benefit Research Institute, only 11% of Americans have access to a defined benefit pension plan where an employer promises to pay certain retirement benefits for life based on years of service.
That leaves most retirees and near-retirees heavily dependent on Social Security and their meager savings to fund retirement.
Single Premium Immediate Annuities
One avenue retirees can pursue to increase the impact of their savings is to convert a portion of it into a single premium immediate annuity (“SPIA”).
At its simplest, an immediate annuity is a contract with an insurance company. A retiree gives the insurance company a lump sum (i.e., the premium) and the insurer promises to pay a specific periodic dollar amount, usually monthly, for the rest of the retiree’s life and depending on the contract the lifetime of the surviving spouse.
Annuities have been around since ancient Rome when contracts known as annua promised individuals a stream of payments for a fixed term, sometimes for life, in an exchange for an upfront payment. Single premium life annuities were available in the Middle Ages and have been available in the United States for over 200 years.
SPIAs are priced so the present value of the annuity payments approximately equals the premium paid by annuitants who live to the median expected age.
That means if you are age 65 and buy a SPIA and then live 19 more years until age 84, which is the median life expectancy for 65 year-olds, then the value in todays’ dollar of the annuity payments you received will approximately equal the lump-sum premium you paid.
In practice, the present value of the annuity stream is slightly less than the annuity premium due to reserves for insurance company administrative costs, profit and the potential that the assumptions for life expectancies are too conservative due to mortality improvements.
Of course, if you die before your 84th birthday, you would not get your money’s worth. The present value of the annuity payments would be significantly less than the premium paid. Conversely, the present value of annuity payments will be much greater than the premium paid for those 65‐year olds who live well beyond their 84th birthday.
Most purchasers who buy an annuity do so to mitigate longevity risk because they believe they will live well beyond their 84th birthday.
Those who live longer partially benefit from the premiums paid by others who didn’t live as long.
This is no different from other types of insurance. The payout insurance companies make to policyholders who suffer a house fire comes partly from the premiums of policyholders whose homes didn’t burn down.
Some Other Considerations
Here are a few things to consider with SPIAs.
1. The older you are when you buy a SPIA the higher the monthly annuity benefit because your life expectancy is shorter.
2. The higher interest rates are, the higher the monthly annuity benefit because insurance companies can earn more investing the premiums and thus can afford to make higher benefit payments.
3. Most SPIAs’ are not indexed to inflation so the purchasing power of the monthly premium benefit decreases over time.
4. While it is important to purchase an annuity from a highly rated insurance company, the risk of issuer default is low.
Insurance companies are regulated by individual states who are responsible for making sure the insurance company has sufficient reserves to cover annuity payments.
In a worst-case scenario if the insurer defaults on the annuity payments there are state insurance guaranty pools that will step in and continue to make the annuity payments.