Why Buy Immediate Annuities?
With an immediate annuity, you exchange a lump sum of money for a guaranteed stream of income. Like other annuities, immediate annuities are offered by insurance companies. Immediate annuities can provide a fixed or variable stream of income, depending on the type of immediate annuity you buy. There are numerous different types of immediate annuities. Some will provide an income stream for the remainder of your life. Some will only provide income for a fixed period of time. And some can be a combination of both. In addition, if you want to protect your spouse, you can purchase an immediate annuity that is based on the life expectancy of both you and your spouse.
The actual income stream you receive is based upon an actuarial calculation done by the insurance company. There are numerous factors that they consider, but the main two factors are your life expectancy as well as the prevailing interest rate environment.
People who buy immediate annuities are looking for guaranteed income and want the assurance of knowing the income will last throughout a specific period of time: that may be their lifetime, or some other pre-determined period of time. They understand they will no longer have access to their principal.
The main reason people consider an immediate annuity is reliability and predictability of income. They are looking for a way to supplement other means of retirement income, including social security and pensions. Purchasing an immediate annuity is like buying a monthly pension check. You pay an annuity provider a lump sum in exchange for a guaranteed income stream. The monthly payments start immediately -- usually within 30 days of handing over your money, but could be as long as one year from the time you give the insurance company your lump sum of money.
Things to consider:
Inflation. An immediate annuity can provide an inflation rider, but most don’t. An inflation rider is something that would increase your annual payments received from the insurance company. They may be a set percentage, or this increase might be tied to the Consumer Price Index. Make no mistake, however…this sort of rider will decrease your initial income payments, but is made up over time.
Irrevocable. Generally speaking, purchasing an immediate annuity is an irrevocable decision. This means that you can’t take it back. You are agreeing to the contract with the insurance company. If you purchase an annuity that would pay you income for the rest of your life, you have to understand that you’ll need to live with the terms of the contract for the remainder of your life.
You may win…and you may lose. In the case of a lifetime immediate Annuity, the income payments will be made to you for the remainder of your life, regardless of whether you die one month after purchasing the annuity, or 40 years after purchasing the annuity. It is an insurance product. The thing that you are insuring against is longevity. Most people who consider immediate annuities would like to have some degree of assurance that they won’t outlive their income. If you live a long time, you might likely come out ahead. However, if you die before your life expectancy, you might consider it as though you “lost.” This is the tradeoff.
Like any other investment options, annuities should be given careful and thoughtful considerations. It is not suitable for everyone. It is an irrevocable contract, and if you plan to place all your assets in a single investment, then step back and plan again. With this kind of investment, it is always important to have some money available in cases of the unexpected and unplanned.
Annuities are best suited for long term investors. Any withdrawal prior to age 59 ½ is subject to a 10% tax penalty as well as regular income tax. Annuities often also have a surrender schedule, meaning that withdrawals may be subject to a penalty by the insurance company if not left in for a predetermined amount of time. Any guarantees on principal invested is based upon the claims paying ability of the underlying insurance company.