Annuity vs 4% rule

[lazysundays]

I'm super noob here so bear with me.

This weekend my FIL was telling me his colleagues are talking about an annuity where they put $400,000 down and get a guaranteed $2500 income for his and spouse's lifetime.

I tried to see if this was a good deal and used an online calc that allowed me to figure our the monthly payout per month. Conservative number said 2999 per month, aggressive said 3500 or more. Don't remember. That calculator was oversimplified anyway.

So now I apply the 4% rule (just read the article) since it pretty much guarantees not dying broke, and take that same $400,000, withdraw 4% 1st year, and I get $1333 income per month. So why wouldn't I choose the annuity with almost double guaranteed income until death?

 

[treeofpain]

If they die, what happens to the $400K?

 

[lazysundays]

The company keeps it. They bought the annuity. The original amount has been spent.

If I'm not aiming to give to heirs why not just pick the annuity?

 

[RetireAge50]

$1,333 first month and adjusted for inflation thereafter. Annuity gets no inflation increase.

 

[lazysundays]

1333 for first Year* and what if inflation only allows me to up it to 1500/mo following year. I'm still feeling young and want to travel. Why wouldn't I pick the 2500? What if the annuity had a rider that let me get extra income if the stocks are doing well?

 

[REWahoo]

How old is the couple when they purchase the annuity? I plugged $400,000 for a couple age 65 into Immediate Annuities - Income Annuity Quote Calculator - ImmediateAnnuities.com and came up with $1900/mo. Had to increase the start date to age 75 to get $2500/mo.

 

[REWahoo]

What if the annuity had a rider that let me get extra income if the stocks are doing well?

I smell a variable annuity sales pitch. Tread very carefully before buying the sizzle.

 

[lazysundays]

I didn't even know age mattered. Thought it was fixed. These are men in early 60s discussing this. I think it was a prudential plan.

 

[lazysundays]

Rewhoo ?

 

[RetireAge50]

Use the gain from the $400,000 to go on vacation. Meanwhile person with annuity can only go on $2,500 vacation. Wait no he can't, inflation is eating away his income.

 

[lazysundays]

So while I was reading the 4% article it said the 4 only mattered the first year. I have no concept. What % will it be adjusted to for inflation? 5, 6 8% ?

 

[lazysundays]

I am to clueless to deliver a pitch. I just learned today that what FIL was referring to was an annuity.

 

[REWahoo]

So while I was reading the 4% article it said the 4 only mattered the first year. I have no concept. What % will it be adjusted to for inflation? 5, 6 8% ?

You need to do more research and reading on your own, then tell us what you think the adjustment should be.

 

[lazysundays]

Anyway off to bed. Good night but yes, I see your points about inflation. A bad year can really leave someone with barely any $ to live off.

 

[lazysundays]

Ok tell me what to read next

 

[razztazz]

How old is the couple when they purchase the annuity? I plugged $400,000 for a couple age 65 into Immediate Annuities - Income Annuity Quote Calculator - ImmediateAnnuities.com and came up with $1900/mo. Had to increase the start date to age 75 to get $2500/mo.

I plugged the in a couple both age 65 and it gave me $2,365 on $400,000. This sounds a little closer to what I would expect and is in the neighborhood of the annuity lazysundays seems to be talking about.

 

[Al18]

Don't forget to check with your state and find out what the maximum amount the life insurance company is guaranteed to pay in case they go out of business. This limit is $100,000 in some states.

 

[lazysundays]

Rewahoo- just looked up historical inflation rates. Like I thought- it's all over the place from 1%, 5% 22%! Yikes. Even a 4% inflation on year 2 of retirement leaves the annuity without enough buying power for the year.

And that is the answer I was looking for. Thanks peeps

 

[donheff]

Lazy. I am not a fan of annuities but you need to do a lot of reading before you take one or reject the concept entirely. They can have a place to cover a portion of expenses but there are a lot of gotchas. Most people here (among those who would even consider an annuity) would direct you toward an SPIA and not a variable annuity, equity indexed or other flavor which likely has high expenses and weak benefits.

SPIAs are available with inflation riders (or fixed yearly increases). The cost of those are more comparable to the "4%" rule but you may have a hard time finding calculators online that will give you a quick answer for what you will pay for one of them. It is easier to pop out an unchanging figure, like your $2500 and the big figure appears much more compelling that a low but gradually rising figure.

 

[pb4uski]

Don't forget to check with your state and find out what the maximum amount the life insurance company is guaranteed to pay in case they go out of business. This limit is $100,000 in some states.

The credit risk of an annuity is so close to inconsequential that it can be ignored for all practical purposes. First, solvency regulations put in place in the 1990s require regulators to intervene long before a company is insolvent. Second, if a company becomes troubled, usually either the company is sold or its policies are sold to a more financially stable insurer. So the guaranty funds kick in only where the insolvency happens so fast that regulators can't intervene in time and the company is in such poor condition that no one will buy it or its policies.

The fact is that there have no been any significant insolvencies since the late 1990s and to the best of my knowledge for the small ones that have occurred policyholders have received what they were entitled to under their contracts. Even through the recent great recession where banks were falling like dominos there were no significant insurance company failures.

 

[REWahoo]

I plugged the in a couple both age 65 and it gave me $2,365 on $400,000. This sounds a little closer to what I would expect and is in the neighborhood of the annuity lazysundays seems to be talking about.

You're looking at single life results on Chart 1. The OP's $2500 was based on joint life:

...they put $400,000 down and get a guaranteed $2500 income for his and spouse's lifetime.

Scroll down to Chart 3 for those payouts.

 

[jerome len]

Get a comparative quote; Call Vanguard and ask what they would give compared to the annuity that's been offered. I'm assuming they can get the $400,000 without giving part of it to taxes. Personally, I'm against annuities but if you don't care about leaving an estate and want the security of lifetime income you may want an annuity; then, get the best one with a highly rated company so you don't have to worry about a bankruptcy. Years ago, my company's original profit sharing program allowed a high income annuity to retiree's. Then, it went bankrupt.....the bankrupt insurance company was bought but the annuities were substantially reduced.....but it was far better than getting nothing. Good luck with making good choices.

 

[pb4uski]

So while I was reading the 4% article it said the 4 only mattered the first year. I have no concept. What % will it be adjusted to for inflation? 5, 6 8% ?

4% is the first year. Assuming 3% inflation, subsequent years are 4% *(1+3%)^n. So the second year would be 4.12% of the initial balance ($400k in this case) and the 10th year would be 5.37% of the initial balance and the 20th year would be 7.22% of the initial balance, etc.

Given that SPIA joint life quotes have payouts of about 5.5% for a 62 year old couple, the 7.5% payout implicit in the OP seems far too good to be true. Do annuity payments start right away or later?

 

[lazysundays]

Ah that's how that works. Thanks for the equation. Now all the pieces are in place.

 

[REWahoo]

Ok tell me what to read next

I'd start here: How Do Annuities Work? - For Dummies