There Is One More Income Option

A lot of people ask me how an insurance company makes an income annuity work.  How are they able to pay such high rates for a lifetime?  I don’t have specific insights into the investments of an insurance company but I can use some readily available numbers to illustrate the point.  If you learn how to think about it you’ll understand why it makes sense.  This is a problem I solved years ago and it helped me develop alternative strategies so that people have a choice.  It’s not complex but another example of what other advisors don’t explain.  Once again I’m telling you something that no one else will tell you.

Last week I wrote about a case where one guy was trying to decide between a single premium immediate annuity and a guaranteed lifetime withdrawal benefit.  When I met that guy three years ago I actually showed him something completely different.  If you don’t want to lock into the lifetime guarantee, there is a more flexible option and a lot of people decide to go this route.  It means that you will retain some risk and I’ll explain how that works and what you need to keep in mind if that’s what you do.  

Back when rates were low, I noticed something interesting.  People were buying income annuities that barely paid out 5% of the initial premium.  It would take most people 20 years or more to even get back the initial outlay.  For people in their mid-60s they might be close to 90 years old before they saw any profit from the deal.  I started telling people to get rid of the income rider and just buy a contract for accumulation.  They could use the free withdrawal provision to copy the guaranteed income payout.  Knowing their principal would last 20 years, after earning some modest interest they actually had quite a bit of money left in the account.  And they stayed in control of the money the whole time.

You can still do the same thing now and that’s why I show it to everyone.  I’d say that 40% of my clients still prefer the flexible route.  Income annuities have much higher payouts but you can also get a lot more growth from an accumulation contract and no income rider.  Depending on the situation the advantage usually tilts heavily to one side or the other.  I honestly don’t think any advisor is doing a thorough job without running an analysis like this.  You as consumers should at least be curious if there’s a lot of money on the line.

Let’s use last week’s example when we found that New York Life would pay a couple $82,000 per year starting in four years, for the upfront cost of $1M.  It was guaranteed to pay at least 20 years if they didn’t live that long so that’s what we will compare it to.  What if they want to maintain flexibility and have control of the asset?  They could buy a multi-year guaranteed annuity instead that doesn’t have the guaranteed income.  Right now they can get a ten year deal that pays 5.1% and allows 10% free withdrawals every year.  It will accumulate on a guaranteed basis for four years and then they can take withdrawals that match the $82000 per year from New York Life.

After taking free withdrawals for 20 years, they have $497K left in the contract.  The guarantee period from the income annuity would have expired so taking the flexible route is ahead of that total payout by nearly a half million dollars.  There are two problems with this.  First, they run out of money if they live into their late 80s, and second, the 5.1% rate is only guaranteed for the first ten years.  They don’t know how long they will live or what interest rates will be available in ten years.  I chose that MYGA for a reason because it has a contractual guarantee to pay no less than 3% annually.  If better rates are available they will be able to move the money and if not they have the guaranteed minimum as a solid back-up plan.

This is where you can see it’s important to shift some of the risk to an insurance company.  If we reduce the rate to 3% from years 10 thru 20, we get an entirely different outcome.  Then it shows only $208K remaining in the account.  It still beats the income annuity but it’s a little too close for comfort.  Most people would pass on that number because it defeats the purpose of getting a lifetime guarantee.  In that example you would be stressed out about income in your 80s and that’s the last thing anyone wants.

This shows what an insurance company does on a minute scale.  They go long on interest rates in a secure portfolio and stamp a guarantee on your contract.  Your money is pooled with thousands of other people.  Some people check out early and leave a whole bunch of money in the insurance company’s general account.  Others defy time and live longer, depleting the general account.  When all the dust settles the insurance company figures it correctly, everybody gets the guarantee, and they end up making a little profit from everyone, on average.

You are welcome to carry the risk yourself and this gives you a serious choice to make.  As soon as I started to show these numbers to people several years ago it made a big difference in how people planned for retirement.  I’ve had many clients who used flexibility as a short term strategy and moved over the guaranteed income several years later.  Even with income payouts at a high level, lots of people still choose the flexible route.  For every single income annuity I’ve sold, I ran the calculations for a flexible strategy just to make sure I’m recommending the best path.  Every case is different with single or joint life, the deferral period, and life expectancy showing different results in every case.

Then I realized that you don’t have to take money from the flexible annuity every single year.  You certainly can but when the market does really well you can trim gains from those assets and let the annuity grow.  In reality you only need a guarantee because you can’t trust the timing of the stock market.  An income annuity provides income in all years of retirement.  But if the market is generally climbing, perhaps you only need an annuity in certain years when the market is down in value.  When you do this it naturally balances your portfolio over time and there’s a lot more money left in the annuity when you are in your 80s.

That’s why the calculator app I created is so important.  It shows you two strategies for using annuities to show you how an annuity affects your portfolio.  In most cases the two annuity strategies produce the same amount of portfolio value in the long run so a lot of people choose the guaranteed income.  But others want control and flexibility so they take that route and keep all options on the table.  The point is that no one else goes to this level of detail to help you figure out a retirement plan that works for you.  If that’s important to you and you really want to understand all sides of this, get on the calendar and I’ll take you through it.  Or, skip it and just cross your fingers.  I hope it works out for you as well.

Have a great weekend!

Bryan

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Last Updated on May 1, 2026 by Bryan Anderson