An annuity worth looking at (part 2)

In the last post we looked at the basics of the longevity annuity. Simply, give an insurance company money today and at a specified time in the future it pays you until you die. It is like Social Security - a simple product that avoids the number 1 fear of retirees - running out of money.

The longevity annuity can be held in an IRA up to $130,000 and reduce required minimum distributions at age 70 and a half.

So, although I am against insurance products that are used as investment products (which includes most annuities) this is one that can be a good fit for many investors.

The last time we looked at 

an annuity calculator .

Here is another 

annuity calculator at Schwab 

As you can see I put in data for a 55 year old purchasing a $130,000 longevity annuity to begin paying in 20 years at age 75. 

The result would be a monthly payment of $2,353/month beginning in 20 years. This equals $28,236/year.

Here's where a little bit of math starts to come in. If we apply the Bengen 4% rule whereby retirees can withdraw 4%/year and have a low probability of running out of money we can divide $28,236 by .04 to get $705,900. Thus, a portfolio of $705,900 would be required to satisfy the Bengen rule and provide an income of $28,236/year.

Now divide $705,900 by $130,000 and get 5.43. Finally, take the .05 root (1/20) of 5.43 to get 1.088.

So, to get a portfolio that generates $28,236/year would mean the $130,000 would have to achieve an annual annualized return of 8.88%/year. 

To be clear the investor would prefer to have a portfolio that grows at  8.88%/year to reach $705,900 20 years from now versus a contract that pays $28,236/year simply because the portfolio is available for heirs, provides more choices etc. 

Still the annuity is a good fit for some. One important consideration is that it can free up assets to take more risk and thereby generate a higher return over the longer term.