Payout Rates And Rates Of Return For Income Annuities
June 9, 2020 by Wade Pfau
The pricing of an income annuity is typically described using either the monthly income amount it generates, or as the annual payout rate of the income received as a percentage of the premium amount. For instance, using the example in Exhibit 4.1, an income annuity might offer $481.67 per month for a $100,000 premium. For twelve months, that sums to $5,780, which is 5.78 percent of the initial premium amount. The annuity payout rate is 5.78 percent. I generally describe annuity pricing using this annual payout rate, as the payout rate is directly comparable to a sustainable withdrawal rate from initial retirement date assets for an investment portfolio. Both rates incorporate the idea that principal is spent in addition to any investment returns.
It is important to recognize that the payout rate is not a return on the annuity, which may create some confusion. It is wrong to compare the payout rate to an interest rate that involves the subsequent return of principal. For instance, if you can earn 1 percent by holding a CD and 5.78 percent from an income annuity, the income annuity is not almost six times more powerful than the CD