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Using an Annuity for Retirement Income

If you are concerned about running short of money, as you grow older, you can buy an immediate annuity, also known as a “payout” or “income” annuity. To do so, you make one upfront payment to an insurance company. You get can a check every month for as long as you live.

At age 65, for example, a man might invest $50,000 in an immediate annuity. If this annuity covers only his life, he might receive about $325 per month ($3,900 a year) as long as he lives. A 65-year-old woman, with a longer life expectancy, will receive less per month.

Moreover, part of your cash flow from the annuity will be tax-free. The payout may be based on an assumption that for example a 65-year-old man has a life expectancy of 21 years. With a $50,000 immediate annuity, about 1/21 of every payment would be a tax-free return of capital until $50,000 has been returned: Each year, then, about $2,381 will be untaxed, in this example, and only $1,519 subject to income tax each year. If he outlives his life expectancy, all ongoing annuity payments will be fully taxed.

It’s possible to buy an annuity that will cover another person or last for a minimum time period, but such annuities will have lower monthly payouts.