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Friday, July 22, 2011

Create Your Own Pension

One of the puzzles of modern finance is why people don't utilize annuities more fully. Part of the reason, I believe, is that annuities in general have gotten themselves a pretty bad rap. Simply, insurance companies are notorious for pushing insurance products that  take advantage of people's lack of financial knowledge. Salespeople have pushed product that have led consumers to believe would perform one way and, in reality, they didn't.  Word gets around.

This is too bad because there is one type of annuity that is exactly what many people need and are looking for. We know this because a popular past-time of people approaching retirement is bemoaning the lack of a pension. Well, a single premium, immediate pay (SPIA) annuity, in effect, creates an annuity.

The beauty of an SPIA is that it is one of those rare products in today's investment world that is straight forward, easy to understand, and easy to comparison shop. You simply give an insurance company a sum of money (the "single premium"), and they pay you a specified amount.

Let's look at a particular example. Go to and click the "Income Calculator" tab at the top. This will bring you to :

Source: Income Solutions
CLICK TO ENLARGE Notice I have entered information for a 70-year-old female who is interested in getting a ballpark estimate on the monthly payment she could receive for a SPIA of $100,000.  Explore this calculator a bit further, and you can see approximate quotes for additional features and their costs. These features include survivor benefits as well as guaranteed payout periods.

Click the "Calculate" button and you find that for the given assumptions, the 70-year-old woman would receive approximately $630.month.  To review:  this payment would be received each month as long as she lived. It is important to know that the annuitant would have control of the $100,000 in the sense that, if she needed money 2 years from now to get her roof repaired, say, this money couldn't be tapped. Also, purchasing the annuity means forgoing the inheritance. If the papers are signed, the check passed, and she walks out of the room and gets hit by a Mack truck, the insurance company wins - big time!

If you live in Maryland, you should know that the state maintains a guarantee fund that insures these types of insurance products for up to $250,000. Thus, if you are considering buying an annuity for more than this amount, you would want to use more than one company.

Secondly, unless you are financially astute, you would want an independent advisor to look it over. Insurance companies are adept at pushing products that are unsuitable for customers.

Other sources for annuity quotes include AARP and Vanguard. Shop around!

What Do the Quotes Depend On?

A little thought reveals that the amount received will be affected by interest rates and the annuitant's age. Many observers believe that interest rates are headed higher. Thus if, in the future, yields are 1 to 2% higher, the payout on annuities will be greater. In terms of age, the older a person is, the greater the payout. Both of these factors are obvious. Interest rates are important because insurance companies invest the premium in the market and earn their profit by the spread they earn.  Age is critical in that, the older you are, the less the number of years the insurance company will likely have to pay you. The same phenomena occurs with Social Security.


  1. Interesting post Robert. For me, the annuity payout in the calculation was just 4%. I'm 41. I suppose, if I was older, the payout would be higher. Do you think this means that it would be a bad idea for a young retiree to go this route?

  2. Robert, I'm with you on this. I've always thought annuities can be a very powerful tool for retirement. In a best case scenario, I would collect social security and a guaranteed annuity to cover regular living expenses. Then, my investment savings, income, and dividends would cover the rest. Now things only need to work out perfectly for the next 40 years...