When planning for retirement, an annuity is one option to consider for creating an additional stream of income. With this type of insurance contract, you can receive payments on a schedule that you determine, but there’s one key question to ask: how much do annuities pay? An annuity can be a more complex retirement planning tool compared to something like a 401(k) or individual retirement account and it helps to understand the basics. Here’s what you can expect from an annuity payout. Consider working with a financial advisor to get valuable advice on retirement planning.
What Is an Annuity?
An annuity is an insurance contract that provides income to you during your lifetime. Generally, here’s how it works.
You purchase the annuity contract from the company selling the annuity, with the agreement that you’ll make one upfront premium or a series of premium payments. This is called the accumulation phase, since you’re paying money into the annuity. At a specified date, the insurance company begins making payments back to you. This is known as the distribution phase.
When you begin receiving payments and the amount of those payments depends on the type of annuity you have. An annuity is something you might want to use for retirement if you’re looking for a reliable income stream you can count. You could use an annuity to complement the money you’ve invested in an IRA or workplace retirement plan. An annuity can also be useful if you want to defer taking Social Security benefits to increase your monthly benefit amount.
How Annuity Payments Work
There are two broad categories of annuities and the one you choose determines when you begin receiving money. The first is an immediate annuity.
With this type of annuity, the payments typically begin within the first year of purchasing the contract. You might choose an immediate annuity if you’re planning on retiring soon and you want to get an additional income stream in place sooner, rather than later.
The second kind of annuity is a deferred annuity. With a deferred annuity, your payments begin at a later date. For example, you might purchase the annuity at age 55 with the intention of beginning your payments when you retire at age 65.
Aside from that consideration, there are also different guidelines for how long annuity payments will last. Depending on the option you choose, you could structure your annuity to pay:
- Lifetime monthly benefits to you, with no survivor benefits for your spouse
- Lifetime monthly benefits to you and your spouse
- One lump sum payment
- A minimum number of payments for a fixed term, called a period certain
- Systematic withdrawals until the funds in the annuity are exhausted, rather than being guaranteed payments for life
Each one has its pros and cons. If you choose a single life annuity, for example, you’d receive higher payments from the annuity during your lifetime but your spouse would receive nothing once you pass away. On the other hand, you could choose a joint and survivor annuity, which would offer payments to both you and your spouse for the duration of your natural lives. The trade-off is that by structuring your annuity this way, your payments would be smaller.
How Much Do Annuities Pay?
The amount an annuity will pay out to you (and your spouse or beneficiary) depends on several factors, including:
- The type of annuity
- How much you pay into the annuity in premiums
- When you want payments to begin and end
- The interest rate your annuity earns
The interest rate is an important consideration because the amount of growth you can expect from an annuity varies widely. With a deferred income annuity, for example, you’re typically earning a fixed interest rate. That means the income the annuity generates is predictable, though you may not experience huge growth.
A variable annuity, on the other hand, can offer the opportunity to realize better returns, based on their underlying investments. For example, your annuity may be invested in actively managed mutual funds versus passively managed exchange-traded funds. But there’s a trade-off. These types of annuities tend to be riskier than an annuity that offers a fixed rate of return.
In the middle, you have indexed annuities. An indexed annuity attempts to match the performance of a stock market benchmark or index, such as the S&P 500. Part of the income you receive may be based on a fixed rate of return while the remainder is based on how well the investments in the annuity perform, compared to the rest of the market.
The best way to determine how much annuities pay is running some numbers through an annuity payment calculator. This can help you estimate your payments using different annuity scenarios.
For example, say that you plan to retire in 2045. You decide to use $100,000 of your savings to purchase a single life annuity. Your monthly income from the annuity would be $1,140. Now, assume that you’d like to receive those payments for a set time frame, with the option to leave the remainder of the annuity to a designated beneficiary. If you choose a 10-year period certain to receive payments, the monthly payout would drop to $1,093, with a minimum payout to you of $131,160.
Now, assume that you’re married and you and your spouse are both 60 years old and planning to retire in five years. You purchase a $500,000 joint and survivor annuity. If you choose to receive annuity payments for both your lifetimes, the monthly payment would be $2,549. The payment would drop slightly to $2,537 if you were to choose the 10-year certain payout option.
Watch Out for Annuity Fees
How much do annuities pay is a good question to ask, but you also need to pay attention to the cost. Annuities can come with a slew of fees, including:
- Annual contract fees
- Investment management fees
- Mortality and expense risk fees
- Fees associated with optional riders, such as a living benefit payout
- The commission paid to the broker who sold you the annuity
- Early withdrawal tax penalties
- Surrender charges if you cash out some or all of your annuity before a specified date
Adding up the costs of an annuity and comparing that to the amount you stand to receive in benefits can help you decide if purchasing one is the right choice. Remember, the less you pay in fees, the more of your overall returns you get to keep.
The Bottom Line
There is no one-size-fits-all answer for how much annuities pay, but it’s possible to estimate your payments using an annuity calculator. One final consideration to keep in mind is the quality of the insurance company you’re thinking of buying the annuity from. If the company selling the annuity isn’t financially stable, it’s possible that you could pay in premiums, but your payouts won’t be guaranteed. Checking out the company’s reputation beforehand can reduce the risk of being left empty-handed when it’s time to receive annuity payments.
Tips on Retiring
- Consider talking to a financial advisor about whether an annuity should be a part of your retirement planning and, if so, what type. If you don’t have a financial advisor yet, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Consider how annuity income will be treated for tax purposes when you begin receiving payments. Whether you’re purchasing a non-qualified annuity or a qualified annuity determines your tax liability.
Photo credit: ©iStock.com/domnicky, ©iStock.com/erenmotion, ©iStock.com/Natali_Mis