What is the most effective, least costly, way of generating monthly income from an investment of $500,000 or more? Are annuities too costly?

  • 17
    You need to define your idea of cost, particularly as it relates to risk. Jul 8 '20 at 6:00
  • 4
    Are you talking about an annuity that will start paying you money now, or are you talking about an annuity that will start paying money decades from now? Jul 8 '20 at 11:07
  • 2
    It would be helpful to know what country you are in. Also, can you live with 6% a year? (That’d be $30,000/year)? Jul 8 '20 at 16:29
  • 1
    I would say REITS together with Some Index Funds is the way to go. Diversifying across that area is a secure way (even in this time) to generate a steady income with dividends going up to as high as 25% a share. If you have a sum of money that large it would be a good way to sit easy. There are plenty of Horizontal Markets out there as well that you can buy (especially in the ETF space) and have a steady income as well. Jul 8 '20 at 19:09
  • Investment grade preferred stocks might be an alternative to an annuity because they avoid the high annuity commissions. They currently pay 5+ pct. With some occasional swapping, the yield could be bumped up, sometimes to more than double that. The drawback is that they are tied to longer term interest rates and since most are callable in 5 years, there's no guarantee that you'll get the same yield after call. Jul 10 '20 at 11:38

It is definitely not the least costly if you are looking at it in terms of generating $X in income per month per $Y invested. The benefit of Annuities is that they are one of the least RISKY investments. Unless the company you bought them with defaults you get a guaranteed income stream even if we experience an extended bear market.

For that safety you likely give up some return compared to just investing in cash-flowing investments. What you are buying is that risk reduction.

In a nutshell you are buying insurance to protect your income stream.


If you need the income to last for life (of an individual or couple) but no longer, then an annuity is likely the best option. This is because an insurance company can diversify your longevity risk with that of other customers. Investments you make on your own would not be able to hedge your longevity (you're facing a sample of 1); you couldn't spend as if you'll die at 80, because you might live to 105.

  • This should be the best answer. The risk is transferred to the party most able to bear the risk. The risk for the individual is that they will live longer than forecast or that they will live shorter than forecast and have been spending less than they could have. The insurance company can average over many people and offer an annuity at a level that takes that into consideration. Unfortunately, in the US, the fees on these are quite high and the offerings are not so simple-there is a part that depends on the insurance company investment returns. Read the fine print carefully, but +1. Jul 10 '20 at 2:14
  • @RossMillikan Immediate fixed annuities are the simplest product and help avoid the fees and uncertainties you mention.
    – nanoman
    Jul 10 '20 at 3:05
  • When I did some looking I didn't find those offered retail. I was surprised because I thought there would be a good market for them and insurance firms should be eager to satisfy that market. If they are out there, you are right. Jul 10 '20 at 3:08
  • @RossMillikan I'd guess that the situation in the question i.e. "Have lump sum, want monthly income now" is too rare. Much more common is some delayed version like "Can save smaller sum each month, want monthly income starting at retirement age", which puts you into the realm of private retirement schemes, for which there is indeed a big market and a lot of offers (at least in Europe).
    – mlk
    Jul 10 '20 at 9:04

Another consideration when looking at the cost of annuities is how regular your income needs are.

In the UK, annuities are taxed as income. If your income needs tend to fluctuate over a year, you may find that you are getting an annuity income every month that you may not need in its entirety, but you will still get taxed on that income.

If you are just pulling income out of investments or an drawdown scheme, then they may still be taxable, but at least you only pay tax on income that is actually necessary.

A reasonable approach may be to blend your income approach - purchase an annuity to cover that income that is essential to you (getting the benefit of the guarantee for life) and then draw income from other sources as and when you needed to cover life's little luxuries.

N.B. A lot of this depends on how much income you are looking for and how much tax you might wind up paying - everyone's circumstances are different.

  • 4
    For annuities purchased from a DC pension pot, it's true about the income tax. However for annuities purchased with other assets, there are some monstrously complicated rules about "exempt sum"/"exempt proportion": some of the annuity payments is simply treated as return of the purchaser's capital (and not subject to tax). It's a curious situation as the level of tax paid will depend on their life expectancy according to actuarial tables!
    – timday
    Jul 8 '20 at 9:44
  • If your needs fluctuate over the course of a year but are consistent year-to-year then as tax is charged annually, month-to-month variations shouldn't be a problem. Jul 10 '20 at 0:24

In addition to the considerations others have mentioned, you also have to take inflation into account. Some annuities are fixed, some may be indexed to the CPI, but even those aren't necessarily indexed to medical inflation or housing inflation or some other expenses that may rise dramatically over your lifetime.

For an example, assume you are a man age 65 today, and your annuity starts paying $30,000 immediately. You have a remaining life expectancy of approximately 18 years (in the US), or until 2038.

Now let's look at inflation over the past 18 years (remember, past performance is no indication of future results, but absent a crystal ball, it's the best data we have available). One dollar in 2002 bought as much as $1.43 today. Or said differently, your standard of living will decrease substantially. By the time you pass on, your standard of living will be whatever you can afford with approximately $21,000.

  • Are any securities indexed to medical inflation or housing inflation or just a given that they may rise dramatically over your lifetime? Your inflation concerns are valid. One must include them in income projections. I think that a variable annuity with a 6% defeered side growth (GMIB, GRIP, GRUB, etc.) would be a better choice than an immediate. Guaranteed 6% income base, more if the market performance exceeds 6%. Begin withdrawals at 59-1/2 and be in their pocket by age 75 (after that, it's their money supporting you). Jul 10 '20 at 11:33
  • I'm not enough of an annuities expert to know what products insurance companies come up with, but I doubt that any exist pegged to medical or housing inflation, in part because those rates aren't even tracked as formally as the CPI. Even if there was such a product, it would likely be extraordinarily expensive. Another issue to consider is that we don't know future politics or economics. Maybe medical cost will be brought under control, or your annuity provider goes out of business (think AIG). Jul 11 '20 at 22:25

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