Calculating the Extra Yield Provided by a Life Annuity

A common question is how annuities compare to other financial products that seem similar such as bonds, certificates of deposit (CD) and money market funds.  After all, each of these products promises to provide some type of fixed return in exchange for your investment. 

Looking at a simple life annuity can help answer this question and may also highlight what makes the life annuities unique among all financial products. 

Briefly, a life annuity (sometimes referred to as an immediate annuity or an income annuity) provides guaranteed payments to you (or you and a spouse if you are married) as long as you live.  These guaranteed payments are in exchange for a lump sum premium that the annuity owner provides to the insurance company. 

As discussed in a recent post, life annuities provide their owners with a unique yield component.  This extra yield (and therefore additional income for the owner) is referred to as the mortality yield. 

The mortality yield is a function of survival probabilities so it increases with age (because survival probability decreases as we age). 

Calculating the mortality yield helps demonstrate one of the key differences between annuities and other products such as bonds, CDs and money market funds. 

The following table shows the mortality yield at various ages for a hypothetical man and woman.  It is assumed that both are in excellent health, and the survival probabilities are based on living 1 additional year at each of the listed ages. 

Calculations are based on the current 10 year Treasury rate of 2.125 percent. 

The results show the extra return provided by a life annuity over the course of 1 year.