If you don’t have a pension from your company when you retire but need to set up a steady stream of income, you may consider purchasing an immediate annuity. This is essentially an insurance plan that’s usually created with a lump sum payment and is designed to pay you a guaranteed amount for a set period.
Single-premium immediate annuities have gained popularity recently, with sales hitting $3.3 billion in the first quarter of 2023, according to data from financial trade organization LIMRA. The figure represents an increase of 120% for this segment from the first quarter of 2022.
For retirees who feel they could use additional funds to cover their ongoing expenses or are concerned about outliving their savings, an immediate annuity could be an option. It might provide a sense of security during a fluctuating market. But the amount you receive will depend on various factors, and there are potential downsides to consider.
[READ: What Is a Deferred Annuity?]
Before signing any contracts for an immediate annuity, the following can be helpful to decipher what you’ll be getting:
— What is an immediate annuity?
— When does an immediate annuity begin making payments?
— What are the benefits of an immediate annuity?
— What are the drawbacks of an immediate annuity?
What Is an Immediate Annuity?
Set up as an insurance plan, an immediate annuity is funded with an initial amount and then makes payouts. You start by putting in money you have, which might come from your savings account, a 401(k) or an IRA. After this deposit, the insurance company makes regular payments back to you.
“Immediate annuities can be used to generate an immediate cash-flow stream from a pot of money that is intended to last a lifetime or set number of years,” says Aaron Maassel, owner and founder of Voyageur Advisory Group in Maumee, Ohio. “Doing this gives stability to the recipient but there are tradeoffs, usually in the form of fees and growth limitations on the pot of money should the client ever wish to cancel the payments and retain the balance of the account.”
There are other types of annuities on the market, including deferred annuities, in which the money is invested and payouts begin at a later date. “If a client is looking for the market protection that some annuities offer but has only an occasional or reasonable need for cash, there may be more suitable options available than an immediate annuity,” Maassel says.
When you purchase an immediate annuity, the insurer will look at factors such as your age and how long the payments will last to determine the amount of the payment. From an income perspective, you can calculate your fixed expenses and use that amount to determine how much you need in the income stream. Some annuity programs include a rising income stream to keep pace with inflation. This could give you the comfort of knowing that your living costs will be covered in the future.
[READ: How Much Does a $1 Million Annuity Pay Annually?]
When Does an Immediate Annuity Begin Making Payments?
You’ll start receiving payouts based on the timeline and details of your immediate annuity. “Typically, you can start taking money within a month of your deposit, but you usually have to take it within the first 12 months,” says Jeff Kronenberg, founder and president of Imagine Wealth Group in Ridgefield, Connecticut. You can ask to have payments made monthly, quarterly or on an annual basis.
You’ll also select a payout period, which might consist of a certain number of years or for the rest of your life. Many people opt for the lifetime annuity plan, meaning their payments will continue for as long as they live.
“The payment term can be customized in numerous ways to fit the individual’s needs,” says Ken Nuss, CEO of AnnuityAdvantage, an online annuity marketplace. “Sometimes, you may not need a lifetime annuity.” Perhaps you retire at age 62 and want to delay taking Social Security until you turn 70. You might buy an immediate annuity that is set for eight years to cover the income gap. “An eight-year annuity will produce much higher payments than a lifetime annuity,” Nuss says.
Benefits of an Immediate Annuity
When taking out an immediate annuity, you can ask for a guaranteed income for both you and one other recipient such as your spouse, regardless of how long you both live. In an immediate annuity that covers two people, the income payment will usually be lower since the contract is covering two lives.
“This functions just like pensions, and you’ll be able to count on money to pay your bills no matter what happens in the economy or in the stock market,” Kronenberg says. “This can provide you tremendous amounts of safety from an income perspective as well as peace of mind that you can live the lifestyle that you’d like to in retirement.”
If you purchased an annuity with pretax savings, you will be taxed only on the income that you withdraw annually from the immediate annuity. If the account grows and accumulates more than you take out during a year, you won’t be taxed on the additional earnings until you receive them as income. “This can be quite attractive from a tax-savings perspective,” Kronenberg says.
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Drawbacks of an Immediate Annuity
Once you deposit money into the annuity plan, you generally don’t have easy access to those funds. If you want to cancel the contract and take back the money you put in, there will be barriers. “Surrendering a policy early will come with penalties,” Maassel says.
Another potential disadvantage lies in what you will pass on in the form of inheritance from the annuity. “In many of these contracts, although you will get an income stream for life, you will not wind up leaving any death benefit to your heirs,” Kronenberg says. “There are, however, contracts that if you die prematurely, a lump sum death benefit would go to your heirs.”
Before deciding what is best for you and your household, you’ll want to evaluate your level of savings and look at your current expenses. You may find that an immediate annuity suits you, especially if you want guaranteed payments that won’t go away during the set timeframe. However, if leaving money to your children is important, you might consider other options.
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The Pros and Cons of Immediate Annuities originally appeared on usnews.com
Update 09/05/23: This story was published at an earlier date and has been updated with new information.
