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Choosing Among Pension/Annuity Options

A reader writes in, asking:

“My wife recently turned 65, and I am 66. Both of us are retired. My wife has a relatively small annuity that is now valued at approximately $46,800. She can take a lump sum or choose one of many annuitization options.

For example, there are some long term periods of withdrawal, almost 20 years, which we’re not interested in. There is a lifetime option that pays $277/month that also guarantees payment for at least 5 years. Then there is a straight 5-year payment option with nothing after that, which has payments of $860/month. I’m strongly leaning to this latter option.”

When you need to select one out of several annuitization options (or payout options on a pension), I think a helpful first step is to get quotes elsewhere to see if one of the options being offered is an unusually good (or bad) deal.

For example, using, as of today:

  • The annual payout for a 5-year annuity is 20.29%, and
  • The annual payout for a fixed lifetime annuity (with a 5-year guaranteed period) for a 65-year-old female is 6.51%.

With this information we can calculate that on the private market, it would cost $50,862 to purchase an annuity that pays $860 per month for 5 years. (That is, $860 per month x 12 months per year to get the required annual income, divided by a 20.29% annual payout ratio.)

Similarly, we can calculate that it would cost $51,060 to purchase $277 per month for life, with 5 years guaranteed. (That is, $277 per month x 12 months per year to get the required annual income, divided by a 6.51% annual payout ratio.)

In other words, it looks like the lifetime income option is an ever-so-slightly better deal than the 5-year option with no lifetime income (because it has a slightly higher market value). And they are both significantly better deals than the $46,800 lump sum option.

Given how close $51,060 is to $50,862 though, I probably wouldn’t pay much attention to which one is a slightly better bargain. Rather, I would choose based on which one fits better into my overall financial plan. In other words, do you want to further annuitize your portfolio — that is, turn it into lifetime income rather than liquid assets?

When making this decision, it’s helpful to remember that you already have some lifetime income via Social Security. And, in most cases, “buying” more Social Security by delaying benefits provides more bang for your buck, so to speak, than an actual annuity from an insurance company. So, for most investors, annuitizing via an actual lifetime annuity only becomes desirable if they still want more lifetime income than what they can get from Social Security.

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