Life-insurance companies have historically been the go-to choice assuming that your goal is to receive a known and predictable amount of secure lifetime income. The product offered by life insurance companies that best meets this need is fixed income annuities.
Annual lifetime income from an investment of $1 million
Let’s look at an example to see how much annual lifetime income you can expect to receive from the investment of $1 million in a deferred income annuity (DIA), one of the three types of fixed income annuities, the other two being single premium immediate annuities (SPIAs) and fixed index annuities (FIAs) with income riders.
Key factors that will determine the answer to this question for all DIAs include current age, sex, marital status, and income start date. Other important considerations include:
- The selection of a lifetime vs. term benefit, with the numbers of months or years an essential factor in the case of the latter
- Lifetime benefit guarantee type, i.e., certain period including number of guaranteed payout years, cash refund, or installment refund
- Whether a pre-income death benefit is chosen if available
- Survivor payout percentage in the case of multiple annuitants for lifetime payouts
Let’s assume a 55-year old single male living in California applying for a DIA with lifetime monthly income beginning at age 65, 10-year certain payout, and return of premium in the event of death prior to the commencement of income distributions.
The monthly lifetime income from the five insurance companies that fulfill the specified parameters through my life-insurance agency, all of which are highly rated, currently ranges from $7,299.09 to $9,283.75. This translates to annual income of $87,589.08 to $111,405.00. Each of these amounts can be divided by five to determine the approximate amount that you would receive if your investment amount is $200,000 instead of $1 million.
Assuming that you survive until at least 65, you and your beneficiary(ies) are guaranteed to receive income payments totaling $875,890.80 to $1,114,050.00, depending upon the product you choose, because of the 10-year certain feature. The payments continue for life if you live beyond age 75. If you live until 85, your total payments would be double the foregoing amounts.
The monthly income would be greater if you’re older than 55, the income start date is deferred beyond age 65, or a term vs. life payout option is chosen. It would be less, however, for a younger annuitant, a single female, a married couple, a longer certain payout period, or a payout that begins sooner.
Source of funds is key
While the income payment amount from any type of investment is obviously important when doing retirement income planning, the source of funds is a key consideration in the case of a DIA. If your investment is coming from a retirement plan such as a 401(k) plan or a traditional IRA, 100% of your distributions, reduced by basis in nondeductible contributions, will be taxable as ordinary income.
If, on the other hand, you’re investing nonretirement funds, otherwise known as nonqualified money, DIAs and single premium immediate annuities, or SPIAs, enjoy a distinct income tax advantage unavailable with other types of investments. A portion of each payment is considered to be a return of principal, and, as such, is nontaxable.
The amount that’s nontaxable is based on the total premiums paid relative to the expected return over the annuitant’s lifetime and is referred to as the “exclusion ratio.” Assuming that nonqualified funds are the source of the premium in the example, 42% to 54% of each monthly payment would be nontaxable until 100% of principal has been recovered, depending upon the product chosen.
Assuming that you’re planning for and getting close to, or are already in, retirement, would you rather invest $1 million today in a variable return portfolio or do you prefer the safety and security of a known and predictable amount of lifetime income? Your answer to this question will likely influence your ability to maintain your desired lifestyle throughout retirement in most cases.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.