The Synthetic Term-Certain Annuity

McCormack, Joseph P.; Perdue, Grady
February 2009
Journal of Financial Planning;Feb2009, Vol. 22 Issue 2, p38
Academic Journal
•Retirees without a spouse normally choose one of two payout options from a defined-benefit plan or a private annuity: a life annuity or a life annuity with a guaranteed period. The retiree may prefer the life annuity with a guaranteed period, however because he or she doesn't want the insurance company or employer's plan to benefit" should the retiree die soon after payouts begin, perhaps because the retiree wants an heir to receive some of the benefits. But this option can result in a smaller life-time payout. This article presents what is often a superior alternative: the synthetic term-certain annuity. • A synthetic term-certain annuity is a life annuity option combined with decreasing term life insurance or a level-term policy with the value of the coverage lowered each year. This study compares the synthetic term-certain versus the traditional life annuity with a guaranteed period by comparing the cash flows of the two options on an after-tax basis. • To make a valid comparison, the advisor must determine an appropriate nominal discount rate and how long the cash flows might continue. Interestingly, however the choice of the discount rate does not noticeably change the outcomes. • While some similarities exist, the synthetic term-certain annuity is quite different from the much-criticized pension maximization strategy sometimes recommended for a married retiree with a defined-benefit payout. • The study here uses a ten-year guaranteed period for a 60-year-old male for comparison purposes, though the process is identical regardless of the retiree's age or the guaranteed period. • The study carefully notes that while the synthetic term-certain annuity is often the superior choice, higher insurance premiums can make it an inferior choice.


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