11/19/2001

A Guaranteed Income Stream

There are many different ways to approach this turbulent market in light of these unprecedented times. While I am limited by policy to write about specific investment strategies in this generic format, let me use this article to discuss one vehicle for creating a fixed income stream.

In meeting with retired individuals, and adult children who assist parents with their assets, I am consistently finding a need for more income and greater security attached to that income. One solution very interesting solution is the Immediate Annuity.

What is an Immediate Annuity?

Essentially an Immediate Annuity is an insurance contract in which you invest a one-time lump sum of money. In return, the insurance company guarantees to pay you a fixed amount of money for the remainder of your life, starting immediately.

For example assume you are a male age 70. If you invested $100,000 into an immediate annuity you monthly income payment would likely be over $850. That is a 10% return on your invest guaranteed for the rest of your life. That is what makes these contracts beneficial -- it is very hard, if not impossible, to duplicate a guaranteed 10% return.

Your specific rate of return will vary of course with your age, health, company from which you are purchasing the product. If you are older than age 70, your monthly payout will be higher, if you are younger, your payout will be lower. Why? The insurance company knows that if you are older, you will generally have a shorter life span, so the company is will to pay a higher rate for the older individual. The opposite is true for the younger individual.

Before you get overly excited about the returns, you should know that the above payout rate was quoted on a lifetime contract with no "term-certain." This means that the immediate annuity will payout the monthly income ($850 in this example) for the life of the annuitant, however there is fixed time period. This means that if the annuitant lives 50 years it is a very good deal, but if the annuitant lives for only one year, it amounts to a bad deal for him or her and a great deal for the insurance company. This is because the insurance company retains the principal - the amount of money initially invested ($100,000 in this example).

The Term Certain Contract

Most people, of course, do not want to gamble on living a long life to insure that they get a good return from their investment so when they purchase the immediate annuity the also elect a ten-year or twenty-year term certain. The advantage of the term certain contract is insuring that if you die shortly after you purchased the annuity, those monthly payments would continue to your heirs (the contract beneficiary/s). It works like this: you buy a twenty year term certain contract - if you live 50 years the contract pays out the regular installments for the entire 50 years; however, if you pass away in one year, the insurance company must continue to make payments to the contract beneficiary for the remainder the 20 year term certain.

When electing a contract with a term certain -- be it 10 year, 20 years or more, you payout will be less than a straight lifetime contract with no term certain.

Usage of the Immediate Annuity

There are many different circumstances in which a fixed annuity might be useful and appropriate. One obvious use is for the retired individual who: 1) wants/needs more income from investments, 2) wants to reduce the extent to which assets are subject to market volatility 3) wants another guaranteed monthly check to "count" on 4) has other investment assets that can still be used for growth.

The last point -- other assets for growth -- is important. The fixed income stream of the immediate annuity does not change, yet inflation will continue over the life of the annuitant. Therefore, it is usually necessary for other assets to be there if a lump sum of money is needed and/or for growing the asset base and staying ahead of inflation.

Payouts

In my example I have talked about a monthly payout. Actually, you choose the frequency of the payout - monthly, quarterly, semi-annual or annual. Monthly is the most common.

In Summary

Immediate annuities are attractive ways to secure a fixed, and possibly larger, income stream. Used wisely, they can be a true benefit and enable one to have a better life style. However, one must be careful to purchase the right product, consider the need for long-term growth of assets, and how to maintain access to principal of selected assets.

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Please send questions or comments to dcoffin46333@wradvisors.com.