retirement

How Much to Invest in an Immediate Annuity

One strategy is to add up your regular expenses and subtract your guaranteed income--and use an annuity to fill the gap.

I’m 72 and I have a very small pension. I’d like to buy an immediate annuity to supplement my income. How do I figure out how much I should invest in the annuity?

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A good way to calculate how much to invest is to add up your regular expenses in retirement, subtract any guaranteed sources of income, such as Social Security and your pension, and buy an immediate annuity that provides enough income to fill in the gaps.

With an immediate annuity, you give an insurance company a lump sum and it promises to pay you a set amount of money every month or year for the rest of your life, starting right away. It can be a good way to convert some of your savings into income you can’t outlive, especially if you don’t have enough money coming in from a pension or Social Security to cover your bills in retirement.

When you do the calculations, consider all your expenses and sources of income in retirement. For example, if your housing, food, car, insurance and other regular expenses add up to $3,000 per month and you get $1,900 per month in pension and Social Security income plus $300 in rent (after expenses) from an income property, consider getting an immediate annuity that provides $800 per month in lifetime income. If a 72-year-old man invests $120,000 in an immediate annuity that pays out only as long as he lives, he’ll get about $810 in monthly income. If you’d like the income to continue for as long as you and a 72-year-old spouse live, you’d need to invest about $160,000. The older you are when you invest in the immediate annuity, the higher your annual payouts will be. You can run the numbers for your situation at www.immediateannuities.com.

The stability of immediate annuities is both a blessing and a curse. You know exactly how much you’ll get every year for the rest of your life – no matter what happens to the market or interest rates in the future. But payouts for annuities purchased now are based on today’s low interest rates. Also, because your payouts never change, their buying power shrinks over time because of inflation (some insurers offer immediate annuities with inflation-adjusted payouts, but they start with much lower payouts in the beginning).

You don’t want to tie up too much of your retirement savings in an immediate annuity. Most retirees need to continue to invest some money in stocks to earn higher returns that keep up with inflation. And once you’ve handed over your lump sum for an immediate annuity, you can’t tap it, even in an emergency.

For more information about how an annuity fits in your retirement portfolio and how to invest the rest of your retirement savings, see How to Invest After You Retire.

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