3 Types of Immediate Annuities to Compare

What type of immediate annuity is best for you?

Pocket change representing types of annuities.
Annuities are confusing. Find out which type may work for you. Walker and Walker

Immediate annuities, also referred to as SPIAs (single premium immediate annuity) come in different varieties. The three primary types are:

  • Fixed payout
  • Inflation-adjusted payout
  • Variable payout

Below, I discuss how each works, and which may be best.

Fixed payout

With a fixed immediate annuity, the amount of income you receive each month will be a set amount; it will stay the same throughout the term of your annuity contract.

To determine the approximate amount of income you would receive from an immediate annuity, depending on how much you invest, visit Annuities.direct. The site will ask you for your age, spouse’s age, state, and the amount to invest, and will then provide you with an estimate of monthly income depending on the term you choose.

Research has shown that using a fixed immediate annuity as part of your retirement income plan can improve the probability that your retirement income lasts throughout your lifetime. If you want to get into the geeky details, check out Wade Pfau's writings on the subject. In The Power of Single Premium Immediate Annuities, he provides a detailed case-study on the use of an immediate annuity for a 65 year old single male, and for a couple. One of the things he acknowledges is that the annuity looks more attractive over longer-time periods. This means this type of financial product makes a great longevity hedge; it protects your income should you live longer than average.

Inflation-adjusted payout

An inflation-indexed immediate annuity is a form of a fixed annuity. You receive a guaranteed stream of income from the insurance company, and that income will rise each year based a pre-determined formula; usually the increase is tied to changes in the CPI (Consumer Price Index).

An inflation-indexed annuity will provide a lower initial amount of monthly income than a non-inflation indexed immediate annuity, but over time, as inflation continues, the monthly income will gradually increase, surpassing the amount you would be receiving from an equivalent non-indexed annuity. It can take anywhere from 12 - 20 years for the monthly amount to grow the point it would have been at if you had taken a fixed payout non-inflation payout from the start.

Once again, Wade Pfau's research on the use of inflation-adjusted annuities is outstanding. In Efficient Frontiers: Inflation Assumptions, Fixed SPIAs, & Inflation-Adjusted SPIAs he states that, "Today, one of the results that really caught me off guard was that fixed SPIAs performed so much better than inflation-adjusted SPIAs." Because the payout for an inflation-adjusted product start so much lower, it can take a long time to catch up.

Variable payout

With a variable immediate annuity, the insurance company does not provide a guaranteed stream of income; instead the amount of income you receive will depend on the performance of a portfolio of underlying investments, usually stock and bond mutual funds. Thus your payment will vary each month, or reset once a year, depending on the way the annuity is structured.

As the purpose of an immediate annuity is guaranteed income that you can rely on, I am not partial to the variable type. A retirement income fund can accomplish something similar, but without the loss of liquidity.

If you want to get quotes on both fixed and variable payout SPIAs, you might want to start with Vanguard, as they offer no-load (no-commission) products.

Which type is best for you?

If you want to add guaranteed income to your retirement income plan, I believe the fixed payout immediate annuity makes the most sense. It creates a floor of guaranteed income that you cannot outlive.

If you are concerned about high inflation later in life, then the inflation-adjusted product can protect against this. However, before buying the annuity you may want to consider other investments that offer inflation protection such as TIPS and IBonds.

Make sure you put together a thorough financial plan before buying an immediate annuity. A well structured retirement income plan helps you see what products make the most sense for you.