To gauge your investment return from a retirement annuity you need to understand some of the investment economics. This posts explains how you will know if you are getting a "good deal" and how much you are being paid.
A single premium retirement annuity provides you with fixed monthly payment for the duration of the annuity. This particular duration can be a fixed number of years and for the rest of your life, your choice.
The insurance company fixes the amount to be paid by accounting for the premium you are willing to deposit, current interest rates, operational expenses, and beneficial annuity tax in the case of a life policy.
Most companies will quote month-to-month annuity payments and not the interest rate. You will ask the actual interest rate so that you can compare to other investments but the insurance company won't tell you. Nevertheless, since the company's earnings depend on interest-based investments, the higher the prevailing interest rates the greater your monthly payments. Let's calculate what you're actually earning.
Earnings and taxation regarding retirement annuity
The earnings are what you receive over-and-0above your initial premium. In the matter of retirement annuity, each payment comprises both earnings and return of premium.
To elucidate, let us please take a hypothetical payout over a decade to illustrate both taxation and the actual effective interest or earnings. Let's use the average monthly pay out quote from 16 insurance companies for a premium associated with $70,000 for a 10-year payout for a 70-year-old man. The average quote is $635 per month. Prevailing interest rates for 10-year treasury securities is 2%. Let's take a look at what you're actually earning on the retirement annuity.
The total sum paid out during ten years is $76,200 (10 yrs x 12 months x $635). This implies the earnings on the invested premium is actually $6,200 ($76,200 received less $70,000 invested). This is the difference between your premium paid and the sum gotten. If we plug these figures into a financial calculator we get 1.7%. But let's assume you don't have a financial calculator and will show you how to come close with pencil and paper.
Effective interest rate on retirement annuity
As you know, your retirement annuity payment is made up of both earnings and premium. This means that the annuity company can only earn interest on the premium not get paid out to you. Initially, the company has a lot of the premium to invest (the entire $70,000). However, this premium lessens linearly to nothing when the annuity ends. a statement to summarize the foregoing would be that the annuity company begins with $70,000 and ends with zero or the average that they have of your money during the period is $35,000.
As a result, one can calculate the retirement annuity 'effective interest' through assuming that only $35,000 (50 percent of the premium) earned $$6,200 during 10 years. Therefore, $6,200/$35,000 = 1.77%. Divide by 10 years and we have 1.77%. one could correctly conclude that this is not such a great deal and we would agree. In general, using a retirement annuity for fixed period such as 10 years undermines what we believe is the real value of a retirement annuity. That value being the option of selecting a lifetime income. When you select a lifetime income, the insurance company must pay you as long as you live. This provides a tremendous degree of financial security.
By the way, of the $635 received above, only 8% would be subject to tax because the beneficial annuity tax treatment of retirement annuity payments.
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