For people 65 and over, the after-tax cash flow from immediate annuities might be greater than the yields on municipal bonds. What’s more, when you receive money from an immediate annuity, your payments will include a tax-free return of principal. The older you are when you buy an immediate annuity, the greater the amount that will be excluded from your income and the less tax you’ll owe.
Suppose Ted Johnson, age 65, invests $100,000 in an immediate annuity. He chooses a single-life annuity that will pay him as long as he lives, with no payments to anyone after he dies. Ted might receive over $9,000 a year (9 percent), at today’s rates. After-tax, assuming a 28 percent tax bracket, Ted might net almost $8,000 (8 percent). After 20 years, the annuity payments would become fully-taxed so Ted would net around 6.5 percent per year on his original investment, if he is still alive to receive annuity payments.
The catch? With this type of annuity, there would be nothing left for Ted’s heirs. So Ted might prefer an annuity with, say, a minimum of 15 years’ payout; if he dies sooner, a beneficiary would get the remaining payments. Such an immediate annuity would pay Ted slightly less than the straight-life version described above.