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Immediate Annuities Explained – What They Are & How They Work

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Your golden years are supposed to be… well… golden. The last thing you want to worry about in retirement is money. That’s why retirement planning is such a big business. 

If you’re like most people, you have most of your retirement savings in the stock market through retirement accounts like IRAs, 401ks, and pension plans. But these accounts are typically at the mercy of the ebbs and flows of the stock market, so they might not provide as much peace of mind as you hoped. Social Security income is a decent fallback, but it may not be enough to sustain your lifestyle in retirement. 

The good news is that there’s a way to supplement your retirement income in the event that your traditional options don’t pan out according to plan: buying an annuity. Annuities are essentially insurance policies that help to bolster your stream of income throughout retirement. One of the most popular and attractive types of annuity is the immediate annuity.

Immediate annuities are insurance products that are designed to provide near-immediate income. Immediate annuity payments typically start quickly, within one month to one year, and are paid out according to the “Mode” of annuity you select. 

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Immediate Annuities At a Glance

  • Immediate annuities provide long-term, regular income, starting within a year after you sign the annuity contract. 
  • Your initial deposit is tax-deferred, which could reduce your current tax burden. 
  • You must pay ordinary income tax on payments you receive from your annuity. 
  • Annuities are designed to be a supplement to (not a replacement for) more traditional retirement options like IRAs, 401ks, pension funds, and social security. 
  • The size of your regular payments depends on your age and your initial premium payment. 

Immediate annuities are also called single-premium immediate annuities (SPIAs) or income annuities. That’s because they’re typically funded with an immediate lump-sum payment and they’re designed to provide regular income to the annuitant.

The size of your annuity payments depends on two factors:

  • Your Age. Immediate annuities are typically designed to provide life-long income. So, your age plays a significant role in how much income your annuity will generate each month. Your insurance company will pay less money monthly if they expect you to live longer.
  • Your Initial Deposit. Your initial deposit and the money it earns, either in the market or in interest, are the sources of funding for your monthly, quarterly, or annual income. 

In most cases, immediate annuities require a minimum initial payment of $10,000 or more. 

If you’re looking for meaningful income, your initial deposit should be much larger. According to The Annuity Expert, if you’re 65 years old and want $1,000 in guaranteed monthly income, you will have to start your annuity with about $200,000. These figures may vary from one annuity provider to the next though.

Immediate annuities start with a lump sum premium payment and a contract between you and your insurance provider. 

Immediate annuity payments start nearly immediately and depend on the mode of the annuity. A one-month mode annuity provides you with monthly income that typically starts one month after you sign the contract. 

Purchasing these products is similar to providing your insurance company with an unsecured loan. Your investment is backed by the promise that the company will provide the guaranteed income it agreed to in the contract. 

Although annuities are not FDIC insured, they are insured on a federal or state level. Variable annuities have federal SIPC insurance up to $250,000. 

Fixed annuities typically have state-provided insurance. The minimum insurance coverage is $100,000 in Puerto Rico and $250,000 in the 50 states. Some states have significantly higher coverage limits:

  • States With a $300,000 Coverage Limit. Arkansas, Georgia, North Carolina, Oklahoma, Pennsylvania, South Carolina, and Wisconsin. 
  • States With a $500,000 Coverage Limit. Connecticut, New Jersey, and Washington. 
  • States With a $1,000,000 Coverage Limit. New York. 

This means that if you live in New York, and your annuity provider is unable to make the payments it agreed to, you’re entitled to up to $1 million in reimbursement. 

There are multiple types of immediate annuities. The key distinguishing features are how long you receive payments and how your annuity’s value grows. 

How Long You Receive Payment

All immediate annuities are designed to provide regular income. You decide if you’d like annual, quarterly, or monthly income. 

You also need to consider is how long you want the distributions from your annuities to last. In some cases, your payouts last your entire life. In others, they last a specific period of time, known as a “period certain.”

Lifetime Immediate Annuity 

The name of the lifetime immediate annuity, also known as a single life annuity, says it all. These products are designed to provide you with lifetime income throughout your golden years, with payments that last as long as you do. 

There is a catch to the lifetime immediate annuity, one that means the insurance company can come out ahead in a big way. 

These annuity prices and payment sizes are based on how long the insurance company expects you to live after you sign the annuity contract, but the payments only last for the rest of your life and don’t usually get paid to your beneficiaries. 

If you live longer than the insurance company expects, you can end up with a substantial windfall. Conversely, if you don’t live as long as the insurance company expects, you may end up with a significant loss. 

Period Certain Immediate Annuity

Period Certain immediate annuities provide you with a guaranteed stream of income, but that income stream may not last your lifetime. Instead, these annuities make payments for a set period of time. 

For example, under a 10-year period certain immediate annuity contract, the insurance company guarantees to make payments for a period of 10 years. Once the 10-year period is over, the payments stop. 

Although these payments may not last for the rest of your life, they do come with a death benefit. That means you get what you pay for regardless of how long you live. If you live out the defined period, the insurance company pays you directly as agreed. If you die before the defined period is over, the annuity provider makes the rest of your payments to your beneficiaries. 

Joint-Life Immediate Annuity

Joint-life immediate annuities are similar to lifetime immediate annuities, but they’re designed to provide lifetime payments for two annuitants, typically you and your spouse. Regardless of which annuitant passes away first, the other name on the annuity contract continues receiving payments. 

This is an important consideration, as your spouse likely relies on your annuity payments just as much as you do. If you purchase a joint-life annuity, you don’t have to worry about leaving your spouse high and dry while they’re still grieving your death. 

How the Annuity Grows

Annuities are an insurance product, but they act more as retirement investments. Like most other retirement accounts, annuities must grow in value over time to be practical, but they don’t all grow the same way. 

Variable Immediate Annuity

When you purchase a variable annuity, the insurance company uses the funds in investment portfolios known as subaccounts. These portfolios are very similar to mutual funds because insurance companies pool investments from a large group of investors and use the dollars they collect to purchase stock market assets each member has a claim to. 

The upside to a variable immediate annuity is that they tend to grow faster than fixed annuities. On the other hand, they are exposed to stock market volatility, and market declines could wreak havoc on your annuity’s value. 

Fixed Immediate Annuity

Funds in a fixed annuity grow at a fixed interest rate. The growth is similar to what you would expect from long-term bonds. It’s not quite enough to keep up with the stock market, but profits are meaningful. 

Inflation-Protected Immediate Annuity

Under an inflation-protected annuity contract, the insurance company guarantees that the annuity will produce a real rate of return at or above inflation. That’s important because money that doesn’t grow at or above the U.S. inflation rate is losing value. 

Inflation-protected immediate annuities are also commonly called COLA annuities, or cost of living adjustment annuities. That’s because they are designed to keep up with the ever-increasing cost of living throughout your retirement. 

How You Pay the Premium

When you purchase deferred annuities, you typically have multiple payment options. But immediate annuities usually offer just one: a single premium. 

Under single-premium annuities, you make one lump-sum payment upfront when you purchase the contract. You purchase an immediate annuity to guarantee yourself payments starting within a year. But that doesn’t give you much time to build meaningful savings, and the insurance company can’t very well advance you years’ worth of payments. So flexible payment options generally aren’t available. 

An immediate annuity is an effective way to supplement your retirement income, but it’s not right for everyone. Before signing the dotted line, consider the pros and cons. 

Pros Cons
Guaranteed income. Loss potential based on length of life.
Your annuity is insured on a state level. A large lump-sum payment is required.
Some immediate annuities can add to your estate. Lack of liquidity.
Your premium is tax-deferred.

Pros of Immediate Annuities

Immediate annuities are popular among retirees who are looking for a way to guarantee long-term income with a relatively large chunk of money to invest immediately. Their key selling points include: 

  1. Guaranteed Income. These annuities give you a guaranteed stream of income, typically for the rest of your life or at least for a relatively long, guaranteed period of time.  
  2. State-Level Insurance. Annuities aren’t FDIC insured, but they are insured for somewhere between $100,000 and $1 million depending on the state or territory you live in. 
  3. May Add to Your Estate. Although most immediate annuities don’t come with a death benefit, if you decide to sign up for a certain period annuity, your beneficiaries will receive your remaining payments in the event of your death. You may also be able to add a rider to your annuity contract that provides a small death benefit on lifetime immediate annuities.  
  4. Your Premium is Tax-Deferred. Annuities qualify as retirement investments. That means you pay your premium on a pre-tax basis. This could greatly reduce your current year’s income tax burden. Of course, you do have to pay ordinary income tax on the income you receive from the annuity.  

Cons of Immediate Annuities

Immediate annuities are an interesting way to add to your retirement income with multiple benefits, but there are also some drawbacks to consider. Those include:

  1. Potential Losses. Most immediate annuities don’t have a death benefit. That means you could lose a substantial amount of money if you don’t live as long as your insurance company expects you to.  
  2. Large Lump-Sum Payment Required. Most immediate annuities require a minimum lump-sum payment of $10,000. However, if you want to generate meaningful income — say, more than $500 per month — you may need to make an initial investment of $100,000 or more. That’s a major entry barrier for many people. 
  3. Lack of Liquidity. Annuities aren’t liquid investments. You can get out of most annuities, but it’s complicated and may involve steep fees. So only invest money you know you’re not going to need to access quickly.

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Immediate annuities aren’t right for everyone, but they are a great option if you’ve already tapped out maximum contribution limits on more traditional retirement investments. 

They’re also useful if:

  • You’re the Beneficiary of a Windfall. Did you win the lottery? Did you outlive a return-of-premium life insurance policy and receive a significant sum of money? These events give you a lot of money to play with — but may have significant tax consequences. Annuities are tax-deferred and spread income over time, which can greatly reduce your tax burden in the current year and overall in terms of income taxes on your windfall. 
  • You’re Worried About Outliving Your Retirement Funds. Do you feel like you may outlive your IRA or 401(k) and have a large sum of money in savings or in liquid assets? Consider locking that money into an immediate annuity to help secure your retirement. 

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Annuities are confusing for nonexperts. Below, you’ll find answers to some of the most frequently asked questions about immediate annuities in particular. 

What’s the Difference Between an Immediate & a Deferred Annuity?

There are three key differences between immediate and deferred annuities:

  1. Funding. Deferred annuities can be funded in one lump sum or through a series of payments. Immediate annuities are typically only funded in one lump sum. 
  2. Payments. Deferred annuities typically start making payments several years after you sign the annuity contract. Immediate annuities typically start making payments within a year or even a month of signing the contract. 
  3. Death Benefit. Lifetime immediate annuities typically don’t come with a death benefit, while deferred annuities usually do. 

What Are the Payout Rates for Immediate Annuities?

Annuity rates vary by provider. So, it’s important to compare your options. In addition to your annuity mode, or payment frequency, your specific payout rate depends on three main factors:

  1. Your Provider. Some providers make larger payments than others. Always shop around for the best deal. 
  2. Your Age. Most immediate annuities are designed to provide lifetime income, so your age and life expectancy will play a major role in the size of your payouts. 
  3. Your Premium. The amount of money you pay into your annuity has a direct impact on the amount of money your annuity pays you. 

Can You Surrender an Immediate Annuity?

You can surrender, or cash out, an immediate annuity. However, you may have to pay a significant fee to do so. 

Surrender fees typically start out at 10% of the cashout amount in the first year. They typically decrease at a rate of 1% per year. So if you want to cash out the entirety of your immediate annuity five years after funding it, you’ll likely pay a 5% fee. On a $100,000 annuity, that’s $5,000. 

Final Word

If you’re interested in signing up for an immediate annuity, make sure to read the contract carefully. These investments and their benefits vary significantly from one company to another. 

It’s also important to keep in mind that no retirement investment comes without risk. As mentioned above, if you die before your insurance company expects you to, you could incur significant losses on a lifetime annuity. Moreover, your annuity payments are always at the mercy of your annuity provider’s financial strength, or claims-paying ability. Sure, your annuity is insured, but only to a set limit. 

If you’re not sure whether or not immediate annuities are best for you, or you want help choosing one, consult a licensed financial advisor or certified financial planner. 

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