A Guarantee of Lifetime Payments Is Itself a Return of an Annuity
by Shane Flait, ©2010

You measure an investment by its risk and return. Generally, the less the risk, the less return you should expect.  Unlike other investments, a life annuity offers you a unique opportunity of an almost riskless investment with a possibly high return. This article shows you how to view the return that an immediate life annuity can give you.

A life annuity pays you until you die. It’s a unique investment that’s offered by an insurance company because the company uses other people’s money to assure you your return.

It’s not your money but the company’s money

In fact, the fixed life annuity is a contract you make with the company who promises to pay you a fixed amount of money until you die for a given premium. It really says nothing about your money. That’s because the premium becomes the insurance company’s money. It only owes you what it promises to pay in the contract.

The company takes your premiums along with those of its other clients for fixed immediate life annuities and figures out how to pay all those clients until they die according to mortality tables.

The company’s many clients allow the mortality statistics to accurately predict how long each will live – statistically.

It then pays each client a fixed monthly amount based on his statistical remaining life expectancy when he begins. For a given premium, the monthly payout increases the older a client begins his life annuity because his remaining life expectancy, of course, decreases with age.

Of course, some clients will live longer than their remaining life expectancies, while other will die early than expected. The longer-lived clients can receive more than the premiums they paid while those who die early receive less than they paid – which accrue to the company. The statistics, though, for reasonable and competitive payments schedules offered, allow the company to fulfill all its obligations and compete with other annuity companies.

What’s your return for your premium?

Here’s where your annuity offers you a return that’s, in part, fundamentally different from your other investments – like CDs, stocks, bonds, and mutual funds. All these other investments represent your money. They each have a risk to your money and return on it. But none of them offer you more than your principal plus whatever earnings that principal may produce.

Your annuity does. It offers you the assurance that you’ll get paid a fixed monthly payment for the remainder of your life – no matter how long you live. That’s an important ‘return’ for your money if you’re not loaded with money. If you could live on the earnings of your treasury bonds, then you needn’t worry about depleting your money if you live a long time.

But suppose you had only a $100,000 for your upkeep with a remaining life expectancy of 10 years. If you earned no money on it, you could withdraw $10,000 per year (or $834 per month) for those 10 years. And, let’s suppose that $834 per month is just about what you needed to get by. What should you do?

Perhaps you can earn 5% on your money in a CD, but you need to live on the money too. You could arrange to take $10,000 out for living this year, and invest the rest in a CD for a year. Then do the same the following year. But, you’d run out of money in 11 or 12 years – rather than 10.

On the other hand you may be able to purchase an immediate life annuity with the $100,000 with the promise that you’d receive $834 per month (i.e. $10,000 per year). What’s the better deal?

Some might say you’re earning nothing on your money if you live the 10 years since you could pay yourself that with your own $100,000 at no earnings. – So it’s a bad investment.

But, I would say that it’s a better deal to buy the immediate annuity since the assurance it gives you that you’ll always have an income no matter how long you life is itself a return – and a better return than earning the 5% or more that can leave you broke. …What about you?

Shane Flait is a writer and educator. Get more info at www.EasyRetirementKnowHow.com