3 Types of Immediate Annuities to Compare
What type of immediate annuity is best for you?
Immediate annuities are sometimes referred to as SPIAs, which stands for "single premium immediate annuities." They come in different varieties, but the three primary types are:
- Fixed payout
- Inflation-adjusted payout
- Variable payout
Which is best? How does each work?
Fixed Payout Annuities
The amount of income you receive each month from a fixed immediate annuity is a set amount. It will stay the same throughout the term of your annuity contract. Visit Annuities Direct to determine the approximate amount of income you would receive from an immediate annuity depending on how much you invest. The site will ask you for your age, your spouse’s age, your state of residence, and the amount you want to invest. It 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 increase 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, as well as for a couple. One of the things Pfau acknowledges is that this type of annuity looks more attractive over longer periods of time. This means that this type of financial product makes a great longevity hedge—it protects your income should you live longer than average.
Inflation-Adjusted Payout Annuities
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 predetermined formula. The increase is usually tied to changes in the consumer price index. An inflation-indexed annuity will provide a less initial monthly income, but the monthly income will gradually increase over time and as inflation continues. It should eventually surpass the amount you would be receiving from an equivalent non-indexed annuity, but it can take anywhere from 12 to 20 years for the monthly amount to grow to the point it would have been at if you had taken a fixed non-inflation payout from the start.
Once again, Pfau's research on the use of inflation-adjusted annuities is outstanding. As he states in Efficient Frontiers: Inflation Assumptions, Fixed SPIAs, & Inflation-Adjusted SPIAs, "Today, one of the results that really caught me off guard was that fixed SPIAs performed so much better than inflation-adjusted SPIAs." The payout for an inflation-adjusted product starts so much lower that it can take a long time to catch up.
Variable Payout Annuities
The insurance company does not provide a guaranteed stream of income with a variable immediate annuity. Instead, the amount of income you'll receive will depend on the performance of a portfolio of underlying investments, usually stock and bond mutual funds. This means your payment will vary each month, or it will at least reset once a year. It depends on the way the annuity is structured.
The purpose of an immediate annuity is guaranteed income that you can rely on, and the variable type of annuity lacks in this respect. A retirement income fund can accomplish something similar but without the loss of liquidity.
Which Is Best for You?
The fixed payout immediate annuity makes the most sense if you want to add guaranteed income to your retirement income plan. It creates a floor of guaranteed income that you can't outlive. But if you're concerned about high inflation later in life, the inflation-adjusted product can protect against this.
You might want to consider other investments that offer inflation protection such as TIPS and IBonds before buying an annuity. Make sure you put together a thorough financial plan first. A well-structured retirement income plan can help you see what products make the most sense for you and, of course, the advice of an expert financial planner can be invaluable. What is an SPDA?