Q. I'm 65, my wife is 63 and we have about $600,000 saved. She thinks we ought to consider buying an annuity. I feel we don't need an insurance company to give us a monthly payout when we can do it ourselves. What do you think? -- R.B., Philadelphia, Pa.
A. I think the fact that your wife believes an annuity is worthy of consideration means the two of you should at least have a serious talk about an annuity's pros and cons.
To make the discussion more worthwhile, you both should acquire a solid understanding of how annuities work -- and what you get and what you give up when you buy one. You can get the lowdown on all that and more by checking out the Annuities section of our Ultimate Guide to Retirement.
As you probably know, annuities come in a dizzying array of types and styles.
But if you're looking for a steady payout you can count on throughout retirement, I think the version you ought to focus on is a plain-vanilla immediate annuity.
This is the kind that's been around for hundreds of years and that often pops up in classic English literature. (Believe it or not, there's actually a research paper titled "Actuarial Issues in the Novels of Jane Austen" that examines the assumptions characters make about life expectancies and payouts.)
What I like about immediate annuities is that they're simple, least as far as annuities are concerned: You give an insurer a lump sum and in return the insurer guarantees you a fixed monthly payout for life.
The payment you receive depends on the current level of interest rates (higher rates translate to a higher payment) and the age when you begin receiving payments (the older you are, the more you get). If you want your spouse to continue to receive the payments after you die (or for them to go to you if your spouse dies first), you would buy an immediate annuity with a joint-and-survivor option.
Today, a 65-year-old man investing $100,000 in an immediate annuity with lifetime payments would receive about $554 a month. A 63-year-old woman would get less than a 65-year-old man, about $503 a month, both because she's younger and because women have longer life expectancies.
A 65-year-old man and a 63-year-old woman investing $100,000 who want payments to continue as long as one of them is alive would receive $455. That's less than either would get on their own because the chances that at least one of them will be around at some point in the future are greater than their chances individually. (You can get annuity quotes for different ages and investment amounts at immediateannuities.com.)
You contend that you don't need an annuity to create a payout on your own. That's true. But you can't be sure those payments will last for life as poor investment returns could deplete your assets. Nor can you create as large a monthly payment from the same amount of assets as an annuity can, unless you're willing to take on more investment risk. That's because annuity payments include not just an investment return but another component referred to as a "mortality credit."
When you buy an annuity you are pooling money with a bunch of other investors, some of whom will die sooner than others. The insurer essentially shifts money that would have gone to the people who die early to those who are still alive. These little transfers -- the mortality credits -- are an extra that only an annuity can provide.
Of course, if you and/or your wife die early, your money will be fattening the payments of other investors who bought the annuity. At first glance, many people think this is bad deal. They feel they've thrown money away if they die before they can collect more in monthly payments than they've put into the annuity.
But even if you die unexpectedly soon after buying one, you haven't thrown your money away any more than someone who bought car insurance but never ended up in a horrific accident did. With an annuity, you're buying insurance against the possibility of living so long that you outlive your assets.
This insurance isn't free. Once you buy an immediate annuity that makes lifetime payments, you no longer have access to the funds you've invested. (If people could tap that money, everyone would withdraw it once they got sick or needed extra cash, and there wouldn't be enough left to make the payments to the other annuity owners.)
So even if an annuity's benefits seem particularly attractive, you wouldn't want to put all of your assets into one. You'd want to make sure you have enough money in investments outside the annuity to fund emergencies and to give you a buffer against future inflation. (Read more on how to combine an annuity with traditional investments like stocks and bonds.)
However much you may decide to commit to an annuity, you'll want to assure that you can count on collecting those payments as long as you're alive.
To do that, stick to annuities backed by insurance companies with high financial strength ratings from companies like A.M. Best and Standard & Poor's and limit the amount you invest in any single annuity to the maximum coverage provided by your state's insurance guaranty fund.
Unfortunately, as interest rates have declined in recent years, annuity payments have also come down. But I don't think that's a reason to postpone buying an annuity if you really need the income now. On the other hand, if you don't require immediate income or you're unsure about investing in an annuity, today's depressed interest rates are all the more reason not to rush into one.
If you decide to go ahead, you may want to spread out your investment among two or more separate annuities over the course of a couple of years. This way you hedge against the risk of investing all your dough when rates are especially low.
It may very well turn out that an annuity isn't right for you and your wife. Perhaps the guaranteed income you'll get from Social Security, plus judicious withdrawals from your $600,000 nest egg will see you through retirement just fine. But if for no other reason than insuring domestic tranquility, I think you and your wife should at least explore the option.