My post last week advocated that you consider using a portion of your retirement savings to invest in an immediate fixed annuity as one way to generate a lifetime retirement income. Here I'll talk about the best way to go about buying an immediate annuity.
With an immediate fixed annuity, you give an insurance company a lump sum of money, and they immediately begin paying you a monthly income that's payable for the rest of your life, no matter how long you live. One common variation, called a joint and survivor annuity, continues a specified percentage of your income after your death to a spouse or beneficiary. It's also possible to build in a specified annual increase in your monthly income, say 3 percent, in case you're worried about inflation. Of course, either of these variations will cost you more money.
So what should you look for when buying an immediate fixed annuity? It boils down to two things:
- Price: How much monthly income does your investment buy?
- The safety of the insurance company: How secure is your annuity?
Here are my five tips for shopping for an annuity that best fits your needs:
- Shop, shop, shop. There are many highly-rated insurance companies that offer immediate fixed annuities, and at any point in time, one or two might be offering more monthly income for your investment dollars than the rest, due to their own capacity and marketing strategies. I recommend getting quotes from five to ten insurance companies, and making sure it's on an apples-to-apples comparison for the same type of annuity.
- Safety first. An immediate annuity should be considered the safe part of your retirement income. I'd suggest just investigating insurance companies with the highest two or three ratings from the rating agencies, such as A.M. Best or Standard & Poor's. If you think you'll be rewarded by taking an investment risk, do that with the portion of your retirement savings that you don't invest in an immediate annuity and invest these amounts in the stock market where there's more potential reward for taking investment risk.
- Keep it simple. Resist arguments from insurance agents to add costly riders, such as coupling the annuity with life insurance or long-term care insurance. These just make it difficult to comparison shop and add to the cost of your annuity.
- Understand the treatment of sales commissions. These come right out of your investment -- higher commission to the agent means less monthly income for you. The best way to deal with this is to make sure that the amount of the monthly income quoted is net of sales charges, so that your comparison shopping takes the commission level into account. Whether you're working with an insurance agent or a shopping service, ask about the commissions. If you can't get a straight answer, go somewhere else.
- Consider diversification. You might consider spreading your annuity purchase among two or three insurance companies to reduce your exposure to insurance company bankruptcy. For example, suppose you have $300,000 to invest in an annuity. For each insurance company, get quotes on investing $100,000, $200,000, and $300,000. If you spread your investment among two or three insurance companies, your total income might not be much less than putting all your investment with one company, and you'll have more peace of mind.
- You can bid your investment among several insurance companies.
- You can see the safety ratings of all the companies.
- There should be transparent disclosure of commission costs.
- You can easily vary the amount of investment with each insurance company to help you analyze the benefit of diversification, as discussed in the last point above.
- There's no agent trying to talk you into costly riders.
Buying an immediate annuity is a complex decision, and usually you can't change your mind once you've made the purchase. That's why it's critical to do your homework first. You'll learn a lot from the online services mentioned above, but even still, it's reasonable that you might need some professional help. If this describes you, here's one more tip: I wouldn't work with someone who has a stake in your decision.
This includes commissioned insurance agents who might steer you to the insurance company that pays them the highest commissions, or try to talk you into expensive riders. It also includes fee-only planners who charge a percentage of assets under management. They might be tempted to talk you out of buying an annuity, since that reduces their income by reducing the amount of assets under management. Instead, I'd work with a qualified planner who charges on an hourly basis.
In future posts, I'll cover a few strategies for getting the most out of immediate annuities, such as delaying the purchase, staggering your purchases, and whether immediate variable annuities make sense. Understanding these tips and strategies and then doing your research may sound like a lot of work, but considering that you're building a monthly paycheck for the rest of your life, it's certainly worth the effort.
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