By Sarah Morgan
For retirees interested in an annuity, it can be difficult to figure out which (if any) is right for you. Though the premise – guaranteed income for life – is attractive, there are hundreds of different kinds, all with slightly different conditions and pages of tiny type. Furthermore, the fact that annuities often have high fees and that payout rates have slumped recently makes the issue even more complicated.
A new study from the Employee Benefit Research Institute sheds light on the issue, looking at two types of annuities, immediate and longevity, to determine how retirees can best allocate their assets to wind up with a 90% chance they won’t outlive their income, even considering long-term care costs. An immediate annuity starts providing a steady stream of income, well, immediately, but a longevity annuity doesn’t start paying out until later. Because of that delay, a longevity annuity gives you more bang for your buck: based on current prices, this study assumes that a 65-year-old man retiring today could buy an immediate annuity that pays $3,791 every year for a $50,000 premium, while a $50,000 longevity annuity that kicked in at 85 would pay $39,501 annually.
Here’s how the math works out: a 65-year old buying an immediate annuity should use 80 to 90% of his nest egg, keeping the rest invested to prepare for health care costs. With a longevity annuity, he can annuitize just 20 to 35% of his nest egg, investing 70% of his remaining wealth in stocks to cover those health care costs. So a longevity annuity is the better choice for retirees who are nervous about locking up too large a portion of their assets: You can buy the same insurance against outliving your savings with less money. The immediate annuity, on the other hand, would make more sense for those whose primary concern is securing a stable stream of income.
Long-term care costs, by the way, make a big difference in these results – considering either the immediate or longevity product, the models require more money allocated to stocks to be sure of having enough money for a nursing home or other intensive health care needs.
One other footnote: these numbers were crunched for a hypothetical 65-year-old man. The study’s author, Young Park, a research associate at the EBRI, says the basic difference between a longevity and an immediate annuity wouldn’t change, but the best way to divide a nest egg between the annuity and other investments might be different for women, given their longer life expectancies.