What Is an Immediate Annuity?

Immediate Annuity definition
Immediate Annuity definitionImmediate Annuity definition

Key Takeaways

  • Immediate annuities involve a lump sum payment to an insurance company in exchange for a guaranteed stream of income.
  • The income can start immediately and last for a specific duration or the individual's lifetime.
  • Immediate annuities offer financial security, default protection, and a fixed income stream.
  • Payout rates vary based on factors like age, contribution amount, and chosen payout options.
  • They can benefit retirees, guarantee-seekers, and inheritors looking for stable income.

You've probably spent the majority of your life working hard to provide a secure future for yourself and your loved ones. Between paying the bills that come like clockwork and funding your children's education, you may have managed to sock away some money for your retirement. But do you worry it's still not enough? That's where an immediate annuity could help.

There are four different types of annuities: immediate, fixed, variable and fixed indexed. When you purchase an immediate annuity, you pay a lump sum into an annuity, and the insurance company begins paying you regular payments. These types of products can help you convert your assets into a predictable income stream that's similar to a regular paycheck from an employer.

An immediate annuity could ensure that you have a regular income in retirement and help provide additional assurance you won't outlive your retirement savings. And compared to investments like 401(k)s or 403(b)s — or putting money into the stock market — an immediate annuity comes with more guarantees and protections.

How Immediate Annuities Work

Before you decide whether to purchase an immediate annuity, it can be helpful to understand how annuities work. With an immediate annuity, you pay one lump sum to access income you can use either immediately or during retirement. Unlike life insurance, you don't have to pay a monthly premium. Instead, you make a single contribution to your insurance carrier, and the company will give you a portion of that money every month as regular income for you and your family.

Funding your immediate annuity

When you purchase an immediate annuity — also referred to as a single premium immediate annuity — you may wonder how to fund this lump sum premium payment to an insurance company. You might get those funds from an employer's retirement plan, an inheritance or another source. The insurance company then gives you payments over time and could help provide income you can't outlive.

Frequency & duration of income payments

You can receive income payments from an immediate annuity every month, every year or possibly a different frequency that fit your needs. You also can decide how long you want to receive payments. For instance, payments may last for as long as you live or for a certain number of years. No matter what you choose, the insurance company will continue to pay you the agreed-upon amounts, even if that means paying you significantly more than you initially deposited.

Benefits of Immediate Annuities

Aside from helping provide financial security in retirement, immediate annuities have other benefits:

  • Safety: Have you recently sold your home at a profit? Have you received an inheritance or a significant cash payout? If so, you may be afraid to put the money into an investment because of the risks that come with the ups and downs of the stock market. But you could consider putting this money into an immediate annuity that can help with financial security.
  • Default Protection: Since an immediate annuity is an insurance product, it's protected from default. If your insurance company experiences financial troubles, many states have laws protecting the money you've contributed. The protected amount varies by state, however, so it's important to do your research before signing up.
  • Permanence: While an immediate annuity is permanent, the owner of the annuity has no access to the premium, which converts to an income payout stream. The annuity cannot be surrendered and has no cash value. Contract terms cannot be changed, including payment amount and frequency, unless commutation is available and elected. Also, because of its permanent nature, an immediate annuity should not be purchased if access to the premium may be needed for things like living expenses or other needs.

How to Use Immediate Annuities

Another key advantage of immediate annuities is pretty obvious — they're immediate. You could access this income right away. You could choose to receive income from an immediate annuity for as long as you like. That could be 10, 15 or 20 years — or the rest of your life.

Tax considerations

Withdrawals of taxable amounts from an annuity are subject to ordinary income tax. Also, if the withdrawals are taken before age 59 1/2, they may be subject to a 10 percent penalty from the Internal Revenue Service (IRS).

Financial protection & income flexibility

If you're counting on your retirement savings or Social Security to provide income after you stop working, an immediate annuity could offer an added layer of protection and income flexibility to your portfolio. This financial protection could help you live more comfortably in your later years.

Payout Rates for Immediate Annuities

Immediate annuities have a payout rate, which can either be a fixed amount every month or an amount that gradually increases over time in response to cost-of-living adjustments and inflation. However, this differs according to the policy you choose.

Your payout rate also could vary depending on when you start collecting a monthly income from the annuity and the lump sum you contribute. If you've already hit retirement age or are nearing your 70s, you'll likely have a higher monthly payout because you may not collect as long as someone who begins to receive monthly annuity payments in their late 40s or early 50s. Also, payouts end at the annuity owner's death, unless a certain period or refund option is selected.

When Immediate Annuities Could Make Sense

Immediate annuities may help if you want to turn assets into a stream of guaranteed payments. An immediate annuity may be beneficial for:

  • Retirees: Pension plans with guaranteed lifetime payments used to be the norm, but employers increasingly leave retirees to figure out retirement income for themselves. With an immediate annuity, the goal could be to achieve the same result as a pension — income for the rest of your life. Using retirement assets to fund an immediate annuity converts a lump sum of money into regular payments.
  • Guarantee-seekers: Perhaps you've done an excellent job of building assets over your lifetime, but you're not comfortable keeping your money in the stock market throughout retirement. Poorly timed market crashes can rattle your nerves or potentially drain your funds early. An immediate annuity provides a guaranteed stream of income, which you receive regardless of what happens in the financial markets. You know exactly how much to expect, and you may not need to adjust your budget when the markets misbehave.
  • Inheritors: If you're fortunate enough to receive a significant inheritance, it's important to use that money wisely. But a sudden influx of money can be intimidating. How much of it can you spend, and how much should you set aside? Understandably, some inheritors overspend and exhaust the funds too soon. An immediate annuity can help set up an income stream from an inheritance — and can help the money last. With a predictable income stream, it can be easier to plan for the future and manage your spending.

Could an Immediate Annuity Be Right for You?

You shouldn't have to worry about whether you can pay for necessary living expenses or keep a roof over your head in your golden years. After years of sacrifice, you deserve a well-funded and comfortable retirement. Even if you've already invested for retirement or plan to rely on Social Security or a pension, an immediate annuity could help offer a way to achieve greater financial peace of mind.

When you're no longer working, but you want to be able to count on a guaranteed income stream, an immediate annuity may be a good option for you. After you pay a lump sum up front, you'll get a consistent "paycheck," which may help you better manage your savings over the years. But whether an immediate annuity is right for you will depend on your unique situation. Consider speaking to a financial professional to determine whether it's a good choice for your needs.

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