Originally, annuities had one purpose: to convert a lump sum of capital into a stream of income, either for a lifetime or for a certain time period. They were designed for people at retirement or those who had a specific need for fixed, guaranteed income payments. Today there are different types of annuities, which can be used to accumulate capital in addition to providing a guaranteed income.
- Annuities provide a fixed monthly income for either a set period of time or for the rest of your life.
- The amount of monthly lifetime payments is determined by your age at purchase and your life expectancy.
- An annuity should not be your sole source of retirement income, as over the years inflation lessens its value.
Annuities Answer the Need for Lifetime Income
For most retirees the need for a secure income stream they can’t outlive is the overriding concern. The question as to the best age at which to get an annuity depends on a number of factors, including a person’s current circumstances and investments, risk tolerance, longevity prospects, and expected income needs in retirement. The best age to get an annuity is when you are able to optimize its benefits for your particular needs.
With people living longer and having to rely more heavily on their own capital to meet their retirement needs, the notion of converting a portion of their capital into a guaranteed income stream has a lot of appeal. Income annuities were designed for that purpose. When you buy an income annuity, you enter into a contract with a life insurance company in which the insurer agrees to make fixed monthly income payments in exchange for a lump sum of money. The payments are guaranteed for your lifetime or for a specified number of years.
How an Income Annuity Works
The monthly payment amount is based on several factors, including your age and gender, interest rates, and the amount of capital invested. Annuities are designed to pay out the full amount of principal and interest by the end of a certain period. If you want payments made for a 10-year period, the payment amount is based on the principal and total interest to be earned during the period, divided into 120 monthly payments.
If you want a lifetime income, the payment amount is calculated based on the number of months between your current age and your life expectancy age. If you are 65 and your life expectancy age is 80, the payment amount is based on 180 months. However, should you live beyond your life expectancy, the monthly payments continue due to the insurer’s guarantee of lifetime income.
In general, the longer you wait to annuitize your capital, the better off you will be.
The Wait Can Be Worth It
Based on this formula, a shorter annuity payout period results in a higher monthly payment. For those who want to maximize the guaranteed monthly payment, waiting as long as possible to annuitize their capital proves the best option. Should you live past your life expectancy, that higher monthly payment continues to arrive until you die.
Consider the example of a person who invests $250,000 in an income annuity at age 65. If the interest rate is 2.5% and life expectancy is 15 years, the monthly annuity payout amounts to $1,663.66. If you wait five years until age 70 to annuitize, the monthly payout amount is $2,353.54. Wait until age 75 and it becomes $4,433.75—guaranteed for life. No one can know for certain how long a person may live, but for those whose family genes are built for longevity, starting an annuity at a later age is probably the best option.
Waiting until a later age to annuitize assumes that you have other assets along with Social Security to meet your income needs, such as a retirement plan and a savings account. It is generally not advisable to tie all or a majority of your assets into an income annuity, because once the capital is converted to income, it belongs to the insurance company.
Also, while a guaranteed income is highly desirable as insurance protection against longevity, it is a fixed income, which loses purchasing power to inflation over time. Investing in an income annuity should be considered as part of an overall strategy that includes growth assets that can help offset inflation throughout your lifetime.
The Bottom Line
Under the right circumstances, the best age for starting an income annuity is between 70 and 75, which allows for maximum payout. However, the more important consideration is when the need for a secure, guaranteed stream of income arises, which could be at any age.