The amount you receive from an annuity depends on when you invest, the rate of return your particular annuity offers, and the details of your specific contract. Because of this, it’s difficult to give a specific answer to what a single person can expect from this financial product. However, we can provide some estimates to help you with your financial planning. For example, if you purchase a $1 million annuity at age 65 and begin taking payments immediately, you can expect to receive between $4,700 and $6,000 per month for the rest of your life. It’s best to consult a financial advisor to determine if an annuity is a good option for your retirement plan.
What is an annuity?
Annuities are contracts that you enter into with a financial institution or insurance company where you agree to purchase the contract and its terms in a lump sum payment or a series of payments. In return, you receive a series of payments that are made every month for a period of at least one year. While some annuities pay you for a fixed number of years, such as 10 or 20 years, others are what is called a “lifetime annuity.” This is an annuity that you pay into your retirement and continue to pay every month for the rest of your life.
The idea here is similar to the interest payments you receive from a bank. The company issuing your annuity holds your money, uses it, and invests it. In return, you get a return and guaranteed payments. For annuities that pay on a fixed term (as opposed to lifetime annuities), this is structured specifically like a loan. You get your entire initial investment (the principal) back plus the interest that accrues over the life of the contract, usually compounded annually.
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How an annuity works
To get a better idea of how a specific annuity works, let’s look at an example of a $1 million annuity. Your annuity purchase would look like this:
In this case, you would purchase the annuity for a lump sum payment of $1 million. In exchange, the insurance company would begin paying you payments at age 65 and continue to pay you monthly payments for the rest of your life.
Annuities from private investors are primarily retirement products, so most are structured to pay you back at or near retirement age. Most people who use this product to save for retirement buy lifetime annuities because they provide guaranteed income throughout their retirement.
Each annuity offers returns that vary based on companies and their individual products. In particular, companies calculate lifetime annuities and fixed term annuities very differently. Lifetime annuities work differently because the company does not know how long it will make payments, so the value of the annuity is based on interest rates and life expectancy.
Common types of annuities
There are different types of annuities that vary based on when you pay into the annuity, when you receive payments, or even who makes the payments into the annuity. Let’s take a look at the most common or well-known types of annuities:
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One-time annuity: You purchase your annuity with a one-time payment in advance.
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Regular Payment Annuity: You purchase your annuity with regular payments over time.
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Period Certain Annuity: Also known as a fixed term annuity. You receive fixed payments for a set period of time.
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Variable annuity: You will receive variable payments for a certain period or for the rest of your life. The payments are determined by your contracts, such as a variable interest rate or an indexed payment system.
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Single annuities: You will receive a fixed amount for the rest of your life.
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Joint/survivor annuities: You will receive fixed payments for the rest of your life. After you die, a named spouse will continue to receive fixed payments for the rest of his/her life (although this second set of payments may be a different amount than the first).
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Qualified Employee Annuity: You will receive the benefit through an annuity that your employer has taken out.
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Tax-free annuities: You will receive benefits through an annuity taken out by your employer if your employer is a tax-exempt organization.
A financial advisor can help you better understand the differences and the pros and cons based on your goals.
How much does a $1 million annuity pay?
If you buy a $1 million annuity, you will receive monthly payments over a period of time. How much you receive and for how long depends entirely on the individual contract you buy, when you buy it, and who you buy it from. For example, let’s say you buy a lifetime annuity that starts paying you at age 65. That annuity will pay you more per month if you buy it at age 40 than if you buy it at age 60.
At the time of writing, annuities offered an average yield of between 3% and 4%. This means that the annuity provider would, for example, add 3% compound interest to your annuity each year, starting when you purchased it. Your annuity would continue to earn interest as you collected payments, and would end when you received back the full value of the principal and interest.
If you purchase your $1,000,000 annuity between the ages of 60 – 70 and begin receiving payments immediately, you can expect to receive between $4,000 and $5,500 per month for the rest of your life or for the period of your annuity payment. That is the best estimate you can receive without knowing the specific terms and clauses in your contract.
Calculating the return on a lifetime annuity
Calculating the return on a lifetime annuity is much more difficult because these products are not structured around a fixed period of time. It is also important to note that while many institutions advertise lifetime annuities as high as 10%, these high-interest accounts are usually what is known as an “income rider.” With an income rider annuity, you only receive the interest payments. You do not necessarily receive the capital in the account back. This functions more like a return on a traditional investment product than the debt structure of an annuity.
For example, you could purchase a lifetime annuity for $1 million and begin collecting payments at age 65. If you purchase that annuity at age 65 and begin collecting payments immediately, you can expect to receive about $4,700 per month for the rest of your life ($56,400 per year), which equates to a repayment rate of about 5% per year.
On the other hand, let’s say you buy that same annuity at age 35. By buying the contract farther up front, you’re locking in a much higher payment rate. In this case, you can find institutions that will offer you repayments as low as $23,000 per month ($276,000 per year).
A financial advisor can help you create annuity and other income projections so you can determine the best option for your circumstances.
Disadvantages of annuities
The biggest problem with an annuity is that it ties up your money for a very long time. These products can provide financial security, as they guarantee payments for the rest of your life (assuming the insurance company doesn’t go bankrupt), but they generally offer relatively low returns compared to other investments.
For example, take our annuity purchased 30 years in advance. It would give you an annual payment of $276,000 at retirement. Over 30 years, you would receive over $8 million from this contract. On the other hand, the S&P 500 generates an average return of about 10.5%. If you were to take that same $1 million and put it into an S&P 500 index fund for 30 years, with an annual return of 10.5%, you could potentially have $19.9 million in the bank.
The annuity would have earned you $8 million by the time you turned 95. The S&P 500 index fund would have earned you $19.9 million to start your retirement. Sometimes the guarantee isn’t always the right move, but the answer will always depend on your specific financial situation.
Conclusion
An annuity is a contract that gives you regular payments over a fixed period of years. They are most commonly used in retirement, as products that give you money every month for the rest of your life. If you buy an annuity worth $1 million, you could earn a significant amount of money back on that investment, but exactly how much can vary widely. The total amount you can earn depends on the factors in your annuity contract.
Tips for investing in annuities
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How can you calculate annuity returns for yourself? Luckily, we’ve put together a handy cheat sheet for you to use to plan your investment options.
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Annuities can be a great investment option for the right person. It really depends on what your overall retirement plan is. If you’re not sure, it can help to talk to a financial advisor who can work on getting you to the right investments. Finding a qualified financial advisor doesn’t have to be difficult. The free tool from SmartAsset will pair you with up to three financial advisors who serve your area, and you can interview your advisors for free to determine which one is the best fit for you. When you’re ready to find an advisor who can help you achieve your financial goals, start now.
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Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid—in an account that isn’t subject to big swings like the stock market. The tradeoff is that the value of liquid assets can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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