Annuities come in various forms, but immediate annuities are potentially the least complicated types of annuities (and possibly the least abused). Immediate annuities can help you plan for needs like retirement income, planned expenses, or managing a significant lump sum so that the funds aren’t depleted quickly.
What Is an Immediate Annuity?
An immediate annuity is an insurance contract that pays income over time based on assets you provide to an insurance company. Payments typically begin in the month after you purchase the annuity, but the specifics may vary, depending on your contract.
How it works: When you use a single premium immediate annuity (SPIA), you deposit a lump-sum of cash (your “premium payment”) with an insurance company. Then, that company makes regular income payments to you. For example, you might receive monthly or annual payments. Those payments might come as paper checks or electronic deposits directly to your bank account.
Can't be undone? Once you buy an immediate annuity and start taking income (also known as “annuitizing”), there’s usually no turning back: You typically make an irrevocable decision, and it’s difficult or expensive to get out of the arrangement—but it may be possible. In return, the insurance company promises to continue making payments, and you tend to receive more if you commit to an irreversible payment stream.
Immediate or deferred? Immediate annuities are different from deferred annuities, which hold on to your money and may allow you to take withdrawals, transfer your assets, or cash out (although you may face tax consequences when doing so).
How Much Do Annuities Pay?
The amount of income you receive depends on several factors. Obviously, the more you contribute, the more you’ll get back. But you also have several options on how the insurance company pays you. For example, you might choose one of the following:
- Lifetime: Guaranteed payments for the rest of your life, no matter how long you live.
- Period certain: Payments for 10 or 20 years, and your beneficiaries receive any remaining payments if you don’t live that long.
- Joint lifetime: Payments that last as long as you or your spouse are still alive.
- Other options: Depending on your insurer, other choices may be available.
The largest payments often come with the first choice—a single lifetime income. If you want the payments to last as long as two people remain alive, the insurance company is taking more risk and will reduce your payments accordingly.
What Happens at Death?
If you annuitize and choose lifetime payments, the payments usually stop at death (or the second death, if you chose joint lifetime payments). Whether or not you come out ahead depends on several factors, including how long you live. Insurance companies are intimately familiar with statistics, so if you live an unexpectedly long life, you may end up receiving more than expected. But if you die within two months of taking income and do not choose a “period certain” (such as 10 years), the insurance company keeps the principal that you put into the annuity.
Unless you can predict how long you’ll live, there’s always some risk when using an immediate annuity. As a result, it’s essential to carefully evaluate the risks and compare alternatives. Perhaps you can just spend down your assets without using an insurance company, or you might limit your annuity investment to a portion of your assets.
Costs and benefits: In addition to the risk of living a short life, immediate annuities can be complicated instruments. Numerous different providers offer a dizzying variety of options. Some products include inflation protection and additional features, but there’s always a price to pay for extra features. But you don’t always see a “cost” with annuities. Instead, you may pay an opportunity cost.
Another risk is the possibility of your insurance company going belly-up. Insurers are not government-guaranteed like FDIC insured banks or federally-insured credit unions. As a result, it’s crucial to choose strong insurers (and hope they continue to stay secure throughout your lifetime).
Buying an immediate annuity is a big decision. An annuity can provide regular income, similar to the paychecks you received during your working years, but annuities are not for everybody. Speak with a trusted financial planner and discuss all of the alternatives before you make a decision.
This page contains general educational information about annuities, but it does not take your individual situation into account, nor is it necessarily relevant to any specific policy you are considering. Discuss your options with a financial planner, tax advisor, and licensed insurance agent. Read all insurance company documents carefully. The terminology in your policy might be different from what appears here, and things might have changed since this writing. You don’t want to make any assumptions about something as important as converting assets to income.