When you annuitize a tax-deferred annuity, you agree to a lifelong stream of income-even if you live until age 120. You also can get an annuity that will pay as long as you or your surviving spouse is alive.
Often, the best tactic is to spend down other assets and delay annuitizing the contract. The longer you wait, the shorter your life expectancy–and the more income you’ll receive. A man who annuitizes at age 70, for example, might get 10 percent of the contract value every year for the rest of his life while a 76-year-old man might get 12 percent per year.
Consider the case of Lou, age 76, and his wife Nancy, 71. They owned $400,000 worth of municipal bonds yielding around $16,000 per year, or 4 percent, tax-exempt. Lou and Nancy sold the munis and put that $400,000 into an immediate annuity on Lou’s life. Due to his age, he was able to get a 12 percent payout, or $48,000 per year, for the rest of his life. Although this income no longer is tax-exempt, most of it is untaxed, leaving them with about $40,000 per year, aftertax. The risk here is that Lou could die soon and the annuity would cease. To cover this risk, they bought a $600,000 insurance policy on Lou’s life. Even after paying the life insurance premiums, Lou and Nancy will net almost $20,000 per year, after tax, more than their $16,000 interest income from the municipal bonds.
At Lou’s death, the annuity payments will cease but Nancy will receive $600,000 in life insurance. She can buy municipals paying $24,000 a year, at 4 percent. What’s more, at Nancy’s death, their children will inherit $600,000 in municipal bonds.
The bottom line: By cashing in their munis and buying an immediate annuity, Lou gets a raise, Nancy gets a bigger raise, and their children get a much larger inheritance–all at no additional risk.
