Turning a lump sump into a lifetime annuity. Does this financial service exist?

Factual Questions
1

This doesn’t concern me but I’ve wondered about the following.

Let’s say I come into an inheritance of 500 000$. I don’t really know what to do with that sum; all I want is to make sure that I get as much of a cushion as I can to live on until I die. I want to be able to collect this money even before I get my pension.

I do not want to undersave and have little money late in life. I do not want to oversave and have a large amount of capital when I die. I do not know when I will die.

Is there someone I can go to and say: “I’m giving you this 500K$, in exchange for which, you have to give me X$ per year until I die. Then you don’t owe anyone anything. If I die early, you make a profit. If I die late, you lose money. You make your actuarial calculations and figure out what you’re willing to offer per year.”

Does this financial service exist?

2

Of course it does. It’s called* buying an annuity*. Most every bank does it. When I was in banking, if a customer came to my desk because he’d just inherited half a million dollars and wanted to open a checking or savings account, I’d be expected to immediately refer him to the investment officer, who’d offer to set him up with accounts with better rates of return. Periodically we’d stay after work, look at people with large CDs or or large & idle savings account balances, and call them to offer them better investment opportunities, including of course annuities.

3

Yes, you’re looking for an immediate fixed income annuity. They are offered by many large insurance companies and financial institutions.

Here’s some information from Vanguard and Fidelity.

4

Immediate annuity is correct as you’re putting up the whole amount up front. keep in mind most of the ways you could get that kind of money involve you owing taxes on it, so keep some aside for that!

Fixed annuity isn’t implied though, the annuity could be fixed (same payment for the rest of your lift) or variable (invested in stocks or bonds so payments will (hopefully) rise with the market over time)

5

It’s also a slick way of handing over a fat commission to a ‘consultant’. Listen to the ‘spiel’ - did the ‘consultant’ mention the fee? No. Then wait until you get to the point where your pen is hovering over the documentation - look the consultant in the eye and say “Now my friend , what exactly are your fees”?

I did this and discovered my ‘investment’ would immediately drop by $10,000 upon my signature.

6

There are many types of annuities, the trick is to pick the one that is best for you, not the commission of the agent.

I have heard that a SPIA - single premium immediate annuity - is one of the best, Warren will happily sell you one - http://www.brkdirect.com/spia/ezquote.asp

7

The issue with annuities nowadays are that they are based on current interest rates (which kinda makes sense.) Guess where interest rates are right now? Gues what’s not a good lifetime investment?

We have no idea what the interest rate will be in 20 years. We don’t know whether the USA will abandon its cherished desire to fight inflation above all other monetary goals. After all, when the government is in too big a debt hole, if the bond rates are fixed for a decent long term - several years - inflation is an easy way to “reduce” the debt by making it worth less.

Canada has the RRSP, similar to an IRA or 401K in the States. The old rules required the owner to convert that savings fund to an annuity payout by age 69. However, interest rates were so low in the last decade or so, that the payout ($ per year) was far too low. SO rules were changed to allow the savings fund to remain invested, there was instead a mandatory minimum that had to be withdrawn each year. You can keep the fund invested in stocks, bonds, etc. as long as it is slowly drawn down according to guidelines.

The other difficulty is - do you trust the group issuing the annuity? At least investment funds can be diversified so no one failure impacts your wealth a lot. After all, if you bought an annuity from a large American bank or other financial institution, no chance they’d renege or go bankrupt - not even in the next 40 years? Our financial institutions are rock solid… Eh?

8

Commissions on annuities are usully low, because the market is competitive, because many insurance companies offer them, and they are all working off the same information as regards mortality tables, and as regards long-term bond yields, which are the two factors which determine the price of annuities.

For the same reason, annuities are a low-risk, low-profit product for insurers. They use them to draw in funds to bulk up their overall amounts under management and so spread their fixed costs, but they make more money out of sexier products.

From that point of view, it’s not an expensive investment - certainly it’s cheaper than most other products you will get from a life assurance company. But nor is it an investment which generates huge returns for the investor, since its return is linked to long-term bond rates rather than to anything more exciting. It is, however, very low risk, and it’s a very efficient way of laying off your own mortality risk.

9

So, someone who’s still young would be better off investing in the stock market until they get to their 50s/60s and then buying an annuity?

10

Not today.

Interest rates are at an all-time low. A better strategy would be to keep investing in other items (bonds? Stock funds?) that could have a better rate of return. Then, when rates recover (if rates recover) is the time to convert to an annuity.

If you think returns are going to stay at 1% for the next 40 years, buy an annuity now. If you think they’ll get better, wait.

If you aren’t close to 50 or 60, put your money into mutual funds. Riskier stock-based ones promise a pretty good return long-term. However, the same proviso applies - if you are looking at a fund, see what the management fee is. If it has a 2% management fee, it has to make more than 2% just to show a profit.

the standard “what to invest in” speil the Canadian banks give investors (for their RRSP funds) - when you are young, invest in stock funds. These are riskier, they go up and down, but when they go up it’s pretty good. When they go down, they recover within a year or 10. When you can’t really wait 10 years for your fund to recover, you should move some of it over to bond-based funds which can’t grow as fast in good times but also don’t drop as badly in bad times. Most funds will have a prospectus. If they wrap in the 2003-2008 performance, they’ll look good - high average rate of return. The last few years - not so good. Read carefully.

IANA investment advisor. Good luck!
Another bit of advice- pay off your mortgage. If you are paying 4% or 6% on a mortgage, that’s better return than a lot of funds. (of course, in USA, subtract tax benefit of mortgage interest). This is also only good if you promise yourself the money you don’t put into a mortgage in future thanks to this, will go into savings funds not a new boat…

11

How much did you say you had? I think we can work something out.

12

Not surprisingly, there are floating rate annuities and equity-linked annuities as well. Of course, it’s more difficult to do estate planning when your future cashflows are variable like that.

13

As an alternative to life annuities:

There’s one interesting kind of UK government bond called a Consol, first issued in the 1750s, that offers a 2.5% annual interest rate indefinitely. You could buy up a bunch of those for the income.

Or, some stocks have paid stable and increasing dividends for a very, very long time. P&G for example, has paid a dividend since 1890, and increased it yearly for 56 years. If you can buy up enough of that or similar stock to live off the income, you’ll be sitting pretty with some security.

14

I hear you!

A few years ago I scored handsomely on some securities and a large sum of money that I considered taking out of an investment account and putting into a managed annuity.

My scenario was almost exactly as you describe, we got to the signing and learned that the fees were 4% and paid up front. Needless to say that money is still in my investment account and doing well.

15

I just got one from money I got from a pension buyout. I won’t say which one I got (I’m over 60) since it might not work for you.

One important difference between annuities is survivor benefits. Looking at discussions on-line I found that annuities which go when you do (except money to your spouse) are often the best. However I wanted my kids to get the money even if we died fairly early, so that made me choose another type. It is something to ask about depending on your situations. Pensions are of the former type - if I kept the pension I could choose to get less each month in return for my wife getting 50% if I kick off first. If we all go together (when we go) or if she predeceases me, our kids would have gotten nothing.

I don’t think I’d want all my money locked up in annuities, but I had pretty much discounted this pension for retirement planning (I left this company 17 years ago) and it is not much relative to my other investments, so it was a good source of guaranteed income. I get nothing from it now, it starts paying when I hit 65, just like the pension would.

16

I have sold many annuities in my day. One thing you should note is that many annuities contain riders to avoid the ‘if I die early you make a profit’ thing. It is almost customary to offer a rider that guarantees a payout of a certain amount, so if your annuity costs $XXX, you collect $XXX-$YYY because of an early death then your heirs inherit the balance. The insurance company makes it’s money not on you, but on the bet that they can pay you X% on your money for a long time, and make X+1% (or whatever).

Note, too, that there can exist deferred annuities. SunAmerica sold one for a while back in 2012 that, if you bought in with $XXX at age 50-55, they’d hold it for 10 years and then begin paying you your monthly income based on DOUBLE the amount you put in.

The value here isn’t just the money, it’s the guaranteed income. I always advise my clients that the way to truly thrive is to save save save until their mid-50s, then annuitize with a schedule to collect upon retirement at 65 or so. It’s a process, and it works well.

17

Just to follow up, my firm requires that all fees be disclosed up front before and actual discussions occur about whatever form of investment happens. It’s better that way. And it allows me to discount my commissions when needed.

18

There’s a few other undated UK gilts floating around, War Loans from WWI mostly. There’s not a huge amount by value (after inflation) I wouldn’t have thought, but it’s a steady guaranteed income for the holders.

19

Same here. Annuities are bullshit for many people, although they’ve become something that people think they must have or surely ruin will follow. While an annuity may be right in some cases, I can manage my own money for free, thank you. We have medical/long term insurance to cover catastrophic health issues that could arrive, and my wife and I have mutual powers of attorney to manage any funds. Annuities are just another way for a bank to take your money.

20

The part that I find appealing is the insurance company is sharing the gamble of my outliving my money. I don’t know if annuities work exactly like this, or if I’m misunderstanding something, but I’d buy an annuity on the following basis:

Me: “Here is $100,000 for you to keep. For the next ten years, it’s yours. If I die in the next ten years, you’ve made $100,000 free and clear. But starting in ten years’ time, I want to withdraw $20,000 from this account, and then $20,000 per year as long as I live.”

Insurance Company: “OK, your life expectancy, we see, is about another 15 years, so it looks like we can invest your original $100,000, pay out five years to deplete your $100,000, and get to keep the interest, earnings, dividends from your your $100,000 during the 15 years we had to manage the money. Deal.”

What I’m paying for, IMO, is the possibility that I’ll live much longer than 15 years and so I’ll have some source of income if I make it to my 90s. If I croak sooner, well, it’s basically my last $100,000 that I’ve sent to the insurance company that I wouldn’t have touched in the next few years anyway, so what do I care that they got to keep it? The insurance company, of course, can do with this thousands of clients, the odds being that on average they’ll each live to their predicted lifespans, losing a lot of money on those who live a long time, but making a lot on those who drop dead next week. I’m assuming the figures can be jiggered so the insurance company makes a decent profit overall from the thousands of people they sell annuities to.

Of course the figures need to be jiggered, but it seems a reasonable bet to place. IF, of course, this is roughly how annuities work.