The Savings Game

When you buy can affect how much you will pay for an immediate annuity

By Humberto Cruz
July 13, 2010

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A white-knuckle stock market ride since May has rekindled interest among readers at or near retirement age in immediate annuities, which turn a lump sum premium into a guaranteed income for life. But, many wonder, is this a good time to buy?

“Do prevailing interest rates affect the price of an immediate annuity?’’ asked a reader in a typical e-mail. “With rates so low, I am thinking the price is relatively high right now.’’ Yes, it is. The lower interest rates are, the higher the premium will be; more money is needed to generate the income.

Other factors include age and sex, which determine average life expectancy. (Women tend to live longer than men.) The longer you’re expected to live — and therefore, the more payments you’re expected to receive — the higher the premium will be, others things being equal.

Determining the premium for a particular income stream may involve 30 calculations for an annuity expected to pay out for 30 years, said Dick Duff, who lectures and writes extensively about immediate annuities. As a rough guide, assume the interest rate implied in the payout — and therefore, the amount of the premium — is tied to the 10-year Treasury note’s rate at the time of purchase.

Do not confuse immediate annuities with variable deferred annuities, complex products that offer mutual-fund-like investments in a tax-deferred insurance wrapper. Many variable annuities (but not all) levy high fees and should be avoided.

Immediate annuities, recommended by many financial professionals and academicians, are relatively low-cost. A recent paper by the Center for Retirement Research at Boston College, “Making Your Nest Egg Last a Lifetime,’’ concluded people approaching retirement should consider “annuitizing sufficient financial assets to secure at least their minimum standard of living.’’ In other words, buy an immediate annuity that covers minimum basic expenses for life.

But do it now, or wait for rates to rise?

The case for waiting: In July 2008, when I was 63 and my wife was 64, I paid $100,000 for an immediate annuity that pays $585 a month until we both die, with 20 years of payments totaling $140,400 guaranteed even if we die sooner.

Today, though we are older, a $100,000 premium would give us only $496 a month. It would cost $118,000 to get $585 a month. By waiting, we increase the future payout even if rates don’t rise because we’d be older. Assuming we were two years older today, $100,000 would get us $507 a month.

The case for not waiting: Rates may stay down or go lower, and the money we need to set aside and keep safe for the future premium would earn next to nothing while we wait. Also, medical advances may lengthen average life expectancy, lowering annuity payouts. A better solution may be “laddering,’’ or buying smaller immediate annuities periodically rather than a large one when rates are low.

Humberto Cruz can be reached at