Personal Finance

Money Matters: How to determine whether an annuity is right for you

Q. I’m a 69-year-old man and am thinking of purchasing an annuity with some of my investment portfolio. I would put $120,000 into it now and at age 74 I would begin receiving a monthly income stream of $1,000. My partner is older and not in as good health as I am so I would opt for the single payment option with the higher pay-out. The income stream is guaranteed for as long as I live but stops upon my death. If I die prior to age 74, my partner would get the $120,000. This seems like a good way to diversify and reduce my exposure to the stock and bond market, do you agree?

A. I’d need to know more about your financial state of affairs, risk tolerance and life expectancy before providing my opinion on whether this product makes sense in your situation. What I can do is help you compare it to alternatives.

According to the life expectancy table on the social security web site, the average life expectancy of a 69-year-old male is 16.5 years or until age 85 1/2. If you bought a jumbo CD yielding 2.27 percent (available according to bankrate.com) with your $120,000 now it would be worth $134,252 at your age 74. This lump sum would generate $1,000/month for 12 years (age 86) if you were able to achieve a 1.174 percent rate of return. If you think you will live longer than the average life expectancy and want to replicate the annuity payments you’d need to achieve a 4.10 percent rate of return on $134,252 to generate $1,000/month for 15 years and a 6.5 percent rate of return would generate $1,000/month for 20 years or until you reach age 94.

The annuity may be appropriate for you if you find the future guaranteed income stream appealing, expect a longer than average life expectancy and don’t mind the fact that if you die sooner than later the insurance company wins big time and your partner gets nothing from the annuity. With interest rates at all time lows, I’d be willing to bet that you would be able to build your own “annuity” using laddered FDIC insured CDs.

With this approach, you would be able to assign a beneficiary via a payable on death form and have the potential for greater income if you achieve higher rates of return. You could begin by purchasing a two-year CD yielding 1.47 percent and at maturity buy several CDs with various maturities. Consider buying the CDs in increments of $12,000 so you will have your $1,000/month available in future years.

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