Immediate or Income Annuities
An annuity is a contract, purchased from a life insurance company, that provides for a set stream of payments or income for a set length of time, usually until the death of the annuity holder.
The concept of an annuity can be confusing because life insurance companies use the term to describe two different types of contracts: deferred annuities and immediate annuities.
Deferred annuities allow investors to put away money on a tax-deferred basis so that a lump sum can be accumulated at a later date; that lump sum can then be used to fund an annuity (the stream of payments), although many investors choose to simply withdraw the accumulated amount as a lump sum rather than use the annuity feature.
An immediate annuity has no accumulation period—an investor simply pays the insurance company a lump sum, and then receives the stream of payments for the set time period.
Annuities are primarily used as a means of securing a steady cash flow during retirement.
Immediate annuities are also called income annuities. Immediate annuities exchange a lump sum of money for a guaranteed stream of income over a period of time. These payments can be guaranteed for a set time period or until death. Many times people will convert the lump sum from a deferred annuity that has reached its full value.
All aspects of the annuity (payments, time period and rate of return) are set at the time the annuity contract is generated. For lifetime annuities, payments are calculated based on interest rates and the holder's life expectancy. If the contract holder lives longer than expected, he or she will keep receiving payments, but as soon as the holder dies, the payments stop. Essentially those contract holders who die earlier than expected are helping to secure payments to those who live longer than expected. Interest rates are based on market rates and are fixed throughout the annuity's life.
In addition to the typical lifetime annuity described earlier, the growing popularity of annuities has created a variety of interesting options:
- Set terms: This annuity allows you to purchase an annuity for shorter time periods like five, 10 and 15 years. At the end of the defined period, the payments cease. If you die before the set period has elapsed, the remainder of the annuity passes to your heirs. This can be useful for retirees who do not expect to live long. These will generally have larger payments than a typical lifetime annuity because the payments are spread over a shorter timeframe.
- Survivor benefits: This option allows annuity payments to continue until the survivor dies (i.e., a widow). One disadvantage is that payments are usually smaller than with a single-life annuity.
- Variable payments: Some immediate annuities allow holders to draw larger sums than their regular monthly stipend at pre-determined times.
- Inflation component: Some annuities allow you to add an inflation rider to the immediate annuity which keeps payments on par with inflation.
- Variable rates: This type allows your payments to be based on the type of investments you've chosen, unlike fixed immediate annuities, which are based on whatever the company decides.
Finally, some immediate annuity contracts also allow you the option to withdraw some of the principal or cancel the annuity outright in case of an emergency. This option typically leads to lower monthly payments.
Because there are a wide variety of annuities, it is best to do your homework before purchasing one. Speaking with an investment advisor who does not benefit from your annuity choice is one way to be sure you are adding the annuity in a way that is beneficial to your retirement plans.
Annuities are sold by a variety of insurance and investment firms. As illustrated earlier, types vary so be sure to comparison shop for the best annuity for your circumstances.
Immediate annuities can be a great addition to a retirement account. The guaranteed income means less worrying about running out of money. However, if leaving money to heirs or a spouse is a priority, depending on the annuity type, this may not be able to happen.
Immediate annuities are also suitable for healthy retirees who have a good chance of outliving peers. Retirees with health problems will likely not benefit from a typical annuity.
As with any investment, you should never put all your eggs in one basket. An annuity can be a good way to guarantee a steady stream of income over a specified period of time, but should not be the sole source of retirement income.
If you have financed the lump sum of the annuity with money from a tax-deferred account, each payment is subject to income rate taxes. If the lump sum has come from money that has already been taxed, then the payments are not taxed.
- Guaranteed Stream of Income
A lifetime annuity guarantees payments each period until death. For retirees worried about running out of income, this can be a way to guarantee having money until the end. - Healthy Retirees Can Benefit
Healthy retirees who think they will outlive peers (and in turn the actuarial projections), can end up winning in this situation with a lifetime annuity. Payments do not stop until death. Any years over the actuarial projections represent a "win." - Choices
There are a variety of annuities to choose from, allowing this type of investment to work for more retirees. Of course, some of these options with greater flexibility come at a price of lower payments.
- The Benefit Dies With You
As soon as the annuity holder dies, payments are stopped regardless of how many years might be left in the original contract. If the annuity contract was for 10 years and the holder dies after only six years, the annuity company keeps the money. This, in essence, means you cannot pass any money that has gone into an annuity on to your heirs. - No Access to Lump Sum
With a typical lifetime annuity, once the money is turned over, there is no turning back. The money cannot be taken back for anything including an unexpected illness or emergency that requires a large amount of cash. Annuity holders are out of luck. - No Control Over Payments
Again, with a typical annuity, once the lump sum is turned over, the money is out of your hands and control. You may be able to earn greater income with another investment.
AAII.com
www.aaii.com
AAII offers a number of articles discussing annuities. Simply use the Search function to find a list of related articles. "What You Need to Know About Immediate Annuities," by Peter Katt, which appeared in the May 2007 AAII Journal, offers a great comparison between income annuities and other income-generating investments like bonds.
Bankrate.com
www.bankrate.com
Bankrate.com is a Web site that offers news, tips and advice for investors to compare interest rates on a variety of investment products. The Retirement and Insurance sections provide a wealth of articles about annuities and financial planning. One article in particular, "Immediate Annuities: Do-It-Yourself Pensions," by Jenny C. McCune, explains the annuity in great detail.
Immediate Annuities
www.immediateannuities.com
This site offers free annuity quotes. Simply enter your state, age and gender and either the lump sum you have to invest or the monthly dollar amount you'd like to receive and multiple annuity options are shown.
