Many people, especially seniors, would like to leave an inheritance for their children or grandchildren. At the same time, they want to maximize retirement income in an era of low yields for savers. Here’s one possible strategy to achieve both goals:
1. Buy an immediate annuity. Carol Williams, a widow in her mid-70s, might purchase a $200,000 immediate annuity. At her age, she could get over $20,000 (10 percent) each year, for the rest of her life. The income tax bite would be small and Carol probably would clear around $18,000 a year, after-tax.
2. Buy an insurance policy. If Carol Williams puts $200,000 into an immediate annuity on her life alone, her heirs will get nothing from that $200,000. To protect them, Carol might buy a $200,000 insurance policy on her life, so her beneficiaries would get at least the $200,000 she started with. The premiums for such a policy might cost Carol around $5,000 a year, depending on her health.
Thus, Carol will leave the same $200,000 to her heirs. She might pay $5,000 each year, for insurance premiums, yet receive $18,000 per year, after-tax, from the annuity. Thus, her annual income from this parlay might net to around $13,000 a year, 6.5 percent on her $200,000, after taxes. That’s much more than she’d receive from a bank CD.
Shop for the highest annuity payout as well as for the lowest-cost life insurance policy.
Another strategy is to "ladder" annuity purchases. The benefits of laddering are similar to those of dollar-cost-averaging in stocks. You don’t want to put all of your money into stocks when the market is at a peak. By gradually investing a portion of your money over time, you can reduce your risk. Laddering is commonly used in buying bonds and CDs. You don’t want to make a large commitment when interest rates are at low levels because you’ll lock in low yields for many years. Thus, you might buy a one-year CD, a two-year CD, a three-year CD, etc. If rates rise in the future, you can reinvest at higher yields when your short-term CDs mature.
A similar concept can be applied to immediate annuities, which typically pay a fixed amount for a certain time period, which can be the rest of your life. You may not want to buy a large immediate annuity when interest rates are at low levels, locking in a relatively meager stream of cash flow. Instead, you can buy a small annuity in 2008, another one in 2009, and so on, until you’ve invested a substantial amount in immediate annuities.
Laddering reduces the risk that you’ll be locking in low interest rates. Moreover, immediate annuities pay more to older purchasers, who have a shorter life expectancy. Assuming interest rates stay the same, an immediate annuity you purchase at age 67 will pay more than an immediate annuity purchased at age 65. And an immediate annuity purchased at age 69 will pay even more.
