Most financial advisors will tell you that the best age for starting an income annuity is between 70 and 75, which allows for the maximum payout. However, only you can decide when it's time for a guaranteed stream of income.
Key Takeaways
- Annuities provide a fixed monthly income either for a set period of time or for the rest of your life.
- The amount of monthly lifetime payments is determined by your age at purchase and your life expectancy.
- An annuity should not be your sole source of retirement income, as over the years inflation reduces its value.
A Secure Income Stream
For most retirees, the overriding concern is for a secure income stream for the future. As people live longer and rely more heavily on their own savings, the notion of converting a portion of that capital into a guaranteed income stream has its appeal.
Annuities traditionally had one purpose: to convert a lump sum of capital into a stream of income for life, or for a certain time period. They were designed for people who were retiring or otherwise needed a fixed, guaranteed monthly income. Today, there are various types of annuities that can be used to accumulate capital through investment, in addition to providing a guaranteed income.
When you buy an income annuity—also known as an immediate annuity or an immediate payment annuity—you enter into a contract with a life insurance company in which the insurer agrees to make fixed monthly income payments in exchange for a lump sum of money. This type of annuity starts paying income as soon as the policy has been initiated, in contrast with a deferred annuity, which doesn't start to pay out until years later.
Income annuity payments are guaranteed for your lifetime or for a specified number of years.
Fixed vs. Variable Annuities
Fixed annuities guarantee a minimum interest rate on money invested in the contract for some period. Then there is a renewal interest rate after that period ends.
The interest on variable annuities, in contrast, can fluctuate because it is based on the performance of the owner's investment portfolio for the annuity. Thus, fixed annuities have more predictable returns than variable ones.
How an Income Annuity Works
The monthly payout amount of an annuity is based on a number of factors, including your age and gender, interest rates, and the amount of capital invested.
Annuities are designed to pay out the full amount of principal and interest by the end of a certain period. If you want payments made for a 10-year period, for example, the payment amount will be based on the principal and total interest to be earned during that period, divided into 120 monthly payments.
If you want a lifetime income, the payment amount is calculated based on the number of months between your current age and your life expectancy age. If you are 65 and your life expectancy age is 80, the payment amount is based on 180 months. Even if you live beyond your life expectancy, the monthly payments will continue.
How Long Should I Wait to Buy An Annuity?
This depends on how long you expect to live, and what your lifestyle goals are.
In general, a shorter annuity payout period results in a higher monthly payment. If you want to maximize the guaranteed monthly payment, your best option is to wait as long as possible to annuitize your capital. Put another way: the longer you wait to annuitize your capital, the larger your monthly payment will be.
Waiting until a later age, of course, assumes that you're continuing to work or have other sources of income, such as a 401(k) plan, a pension, and/or Social Security benefits.
Can a 40 Year Old Buy An Annuity?
Any adult can buy an annuity. However, it is relatively uncommon among younger people. Annuities typically come with higher fees than other investment vehicles, and some financial advisors recommend maxing out other options—such as a 401(k)—before turning to annuities. Many younger investors cannot afford to do so, so annuities are typically reserved for older adults.
When Should You Not Buy an Annuity?
It is generally not advisable to tie up all—or even most—of your assets in an income annuity, because it is less liquid than other vehicles. And if you have enough savings in retirement plans, such as a 401(k), an annuity might not be right for you at all. If you're sure that you won't outlive your savings, there's no reason to sign up for an annuity and pay the comparatively high fees.
The Bottom Line
Investing in an income annuity should be considered as part of an overall strategy that includes growth assets that can help offset inflation throughout your lifetime. While a guaranteed income via an annuity may be highly desirable as insurance protection against longevity, it is a fixed income, which means it will lose purchasing power to inflation over time.
The best age to get an annuity depends on a number of factors, including your current circ*mstances and investments, risk tolerance, longevity prospects, and expected income needs in retirement. Given these factors, the best age to get an annuity is when you are able to optimize its benefits for your individual needs.
