Annuity rates confusion

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Q. I know that the TSP annuity means giving up your money forever, something to be carefully considered. I’m still trying to understand the math. If at age 62 I bought a $100,000 annuity, even at today basement rates of 2.37 percent, it would pay $497 a month, or $5,964 a year. That’s equivalent to earning a steady 5.964 percent on your money! How does 2.37 percent turn into almost 6 percent? I’m guessing that Met Life is figuring that some of us aren’t going to live long enough to collect a great amount on the annuity. Is that it?

A. It’s not at all like earning a steady 5.964 percent  on your money, since your account balance falls to zero the day you buy the annuity. If you die before receiving your first payment, your return is minus 100 percent. Even if you live the nearly 17 years it will take to recover your contribution through payments, you’ll have earned a zero rate of return at that point. In fact, in order to earn a 5.964 percent rate of return on your $100,000 contribution, you’ll have to collect the $497 monthly payments for 89 years! If you live to your life expectancy, which is age 84, your rate of return will be closer to 2.6 percent.

 

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Mike Miles is a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Vienna, Virginia. Email your financial questions to fedexperts@federaltimes.com and view his blog at money.federaltimes.com.

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