The Hidden Benefit In Annuities

Annuity sales are soaring, but still only a minority of retirees own them. If more people were aware of one key advantage of annuities, they probably would reposition part of their retirement portfolios into annuities.

In this post I’m talking about annuities that pay guaranteed lifetime income. These generally are the single premium immediate annuity (SPIA) and deferred income annuity (DIA
), also known as a longevity annuity.

Two factors probably are behind the recent surge of interest in annuities.

The aging of the Baby Boomers is one factor. Many people want some guaranteed lifetime income when they leave the working years behind. Annuities are the main source of guaranteed lifetime income available.

There are other ways to deploy retirement funds that might generate higher lifetime income or allow one to leave a larger legacy. But those results aren’t guaranteed. The money could run out or be substantially less than anticipated.

The cash flow from the annuity also is uncorrelated with the investment markets. The income continues to appear in your financial account regardless of what’s happening in the markets. That is very appealing to many retirees, especially after the market volatility of the last few years.

Higher interest rates are another factor. Long-term interest rates are one consideration insurers use when determining how much income to pay annuitants. The rapid rise in interest rates since 2021 translates into higher annuity payouts.

But a major advantage of annuities is one you can’t find in any other financial product and that most people don’t know about. It’s known as the mortality credits.

Mortality credits are why a SPIA or DIA will pay higher guaranteed income than a bond or other safe income investment.

An insurance company sells annuities to a large number of people. One factor it uses to determine the amount of income to pay is the average life expectancy of the group.

About half the people will pass away before the average life expectancy. Those people will receive less lifetime income than expected at the time they purchased the annuities.

When the insurer calculates the income it will pay each annuitant, it doesn’t assume it will keep all the extra money from those who pass before life expectancy. Instead, the insurer knows this will happen and plans to pay that money to the other annuity owners.

This extra money is known as the mortality credits, and it enables the insurer to promise to pay its annuity owners more than it would be able to pay from investment returns alone. Mortality credits allow annuities to be competitive with other ways retirees could position their nest eggs.

Mortality credits are a feature of any annuity that pays lifetime guaranteed income, including some versions of fixed indexed annuities and variable annuities.

Mortality credits are one reason why surveys indicate retirees with annuities generally spend more in retirement, and spend with more confidence, than many other retirees.

Mortality credits are why SPIAs and DIAs are better than bonds for the conservative portion of most retirement portfolios.

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