Annuity vs. Investments: How to Calculate the Break-Even Point

What a Break-Even Point Actually Measures

The break-even point is the age at which total cumulative annuity payments equal the value you would have accumulated by investing the same premium in a diversified portfolio. Before that age, the portfolio wins. After it, the annuity wins, assuming you are still alive to collect.

The break-even calculation rests on three variables: the annuity premium, the annual payout, and the opportunity cost rate, meaning the annualized return you could earn by investing that premium instead.

The core formula in plain text:

Break-Even Years = Premium / Annual Payout

That ratio gives you the raw payback period before accounting for investment returns on the forgone premium. The full break-even, adjusted for opportunity cost, requires comparing two compounding curves, which the sections below walk through explicitly.

The Opportunity Cost Side of the Equation

Every dollar paid into an annuity is a dollar not compounding in a taxable brokerage account or a Roth IRA. The future value of the forgone premium at a given return rate sets the hurdle the annuity must clear.

Future Value of Premium = Premium x (1 + r)^n

Where r is the annual portfolio return and n is the number of years elapsed. Cumulative annuity income at year n equals Annual Payout x n, ignoring time-value adjustments for simplicity in the first pass.

The annuity breaks even when:

Annual Payout x n = Premium x (1 + r)^n

Solving for n requires iteration, not algebra. Use a spreadsheet or a purpose-built retirement calculator to test year-by-year values until both sides match.

Worked Example 1: A $250,000 Single-Premium Immediate Annuity (SPIA)

A 65-year-old woman purchases a $250,000 single-premium immediate annuity from a highly rated insurer. The SPIA pays $1,380 per month, or $16,560 per year, for life, with no survivor benefit.

Raw payback period: $250,000 / $16,560 = 15.1 years. She recovers her premium in nominal dollars at age 80.1.

Now apply a 6% annual portfolio return as the opportunity cost. Projecting the $250,000 forward at 6% annually:

• Year 10 (age 75): Portfolio value = $250,000 x (1.06)^10 = $447,744. Cumulative SPIA income = $165,600.
• Year 15 (age 80): Portfolio value = $250,000 x (1.06)^15 = $599,141. Cumulative SPIA income = $248,400.
• Year 20 (age 85): Portfolio value = $250,000 x (1.06)^20 = $801,784. Cumulative SPIA income = $331,200.
• Year 25 (age 90): Portfolio value = $250,000 x (1.06)^25 = $1,072,968. Cumulative SPIA income = $414,000.

At a 6% opportunity cost, the SPIA never breaks even against the growing portfolio. The portfolio's compounding outpaces the fixed income stream at every point. The SPIA makes mathematical sense here only if she lives well past 90 and the portfolio return drops significantly, or if longevity insurance and income certainty are the primary goals.

Worked Example 2: A $250,000 SPIA at a Conservative 3.5% Return Assumption

Reduce the portfolio return assumption to 3.5%, reflecting a more conservative allocation of 60% bonds and 40% equities common among retirees who cannot tolerate sequence-of-returns risk.

• Year 10 (age 75): Portfolio value = $250,000 x (1.035)^10 = $352,426. Cumulative SPIA income = $165,600.
• Year 15 (age 80): Portfolio value = $250,000 x (1.035)^15 = $418,143. Cumulative SPIA income = $248,400.
• Year 20 (age 85): Portfolio value = $250,000 x (1.035)^20 = $496,027. Cumulative SPIA income = $331,200.
• Year 25 (age 90): Portfolio value = $250,000 x (1.035)^25 = $588,419. Cumulative SPIA income = $414,000.
• Year 28 (age 93): Portfolio value = $250,000 x (1.035)^28 = $659,948. Cumulative SPIA income = $463,680.

Even at 3.5%, the portfolio still outpaces cumulative SPIA income through age 93. But the gap narrows substantially. At age 93, the portfolio holds $659,948 versus $463,680 in total payments received. A woman reaching 65 today has a 50% probability of living past 87 and a meaningful probability of reaching 93, per Social Security actuarial tables. The SPIA becomes a credible alternative when the realistic return falls below 3.5% or the investor expects to live past 95.

Where Variable Annuity Fees Change the Math Entirely

The Fee Drag on Variable Annuities

Variable annuities are not SPIAs. A variable annuity wrapper adds mortality and expense charges averaging 1.25% per year, administrative fees of 0.15% to 0.30%, and subaccount expense ratios averaging 0.50% to 1.00%. Total internal costs routinely reach 2.3% to 3.0% annually.

A variable annuity subaccount that tracks the S&P 500 and earns a gross 7.0% annual return delivers a net return of roughly 4.5% to 4.7% after fees. A direct S&P 500 index fund in a taxable brokerage account at 0.03% expense ratio delivers 6.97% net. The fee drag alone shifts the break-even point by 5 to 8 years in favor of the self-managed portfolio.

Surrender Charges Add a Liquidity Penalty

Most variable and fixed-indexed annuities impose surrender charges, typically 7% to 10% in year one, declining 1 percentage point per year over a 7 to 10 year surrender period. Withdrawing $250,000 in year two at an 8% surrender charge costs $20,000 immediately, before any tax consequences. Factor surrender charges into the break-even timeline whenever the holding period is uncertain.

Tax Treatment Shifts the Break-Even Calculation

Annuity Taxation Inside and Outside Qualified Accounts

Annuity income from a non-qualified annuity, meaning one purchased with after-tax dollars outside an IRA or 401(k), receives an exclusion ratio. The IRS allows the cost-basis portion of each payment to come out tax-free under IRC Section 72. For the $250,000 SPIA paying $16,560 annually over a 25-year expected payout period, the exclusion ratio is $250,000 / ($16,560 x 25) = 60.4%. Roughly $10,002 of each $16,560 annual payment is tax-free. The remaining $6,558 is ordinary income.

A taxable brokerage portfolio generating 6% annually produces long-term capital gains and qualified dividends taxed at 0%, 15%, or 20% depending on income. For most retirees in the 22% to 24% federal bracket, the after-tax advantage of the portfolio's preferential capital gains rate narrows the annuity's exclusion ratio advantage considerably.

Annuities held inside a traditional IRA or a 401(k) rollover lose the exclusion ratio entirely. Every dollar of distribution is ordinary income, identical to a direct IRA withdrawal. There is no tax advantage to wrapping an annuity inside a tax-deferred account.

The Right Way to Run the Break-Even Comparison

Start with four inputs: the premium, the guaranteed annual payout, your expected portfolio return net of fees and taxes, and your planning horizon (target age). Then build two columns in a spreadsheet, running year by year from the purchase date to the planning horizon.

Column A: Cumulative annuity income = Annual Payout x Year Number.

Column B: Portfolio value = Premium x (1 + net return rate)^Year Number.

Find the first year where Column A exceeds Column B. That year is the break-even age offset from the purchase date. If Column A never exceeds Column B within your planning horizon, the portfolio dominates under your assumptions.

The CalcMoney Retirement Calculator handles this projection automatically. Enter the premium, payout amount, and your expected portfolio return, and the tool outputs the year-by-year comparison alongside the break-even age. Run the calculation at multiple return scenarios, 3%, 5%, and 7%, to see how sensitive the break-even is to market assumptions. That sensitivity analysis tells you more than any single projection.

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Results are estimates for informational purposes only. Consult a licensed financial professional before making financial decisions.