What Is an Immediate Annuity?

Planning for retirement can be challenging. Figuring out exactly how much you need to sock away can be tricky, even if you use a retirement calculator. And many retirees are concerned about running out of savings. If thinking about your financial future makes you nervous, you may want to purchase an annuity. Here’s a look at what an immediate annuity is and what to consider before buying one. You can also work with a financial advisor to get all of your questions answered regarding your retirement plan.

An annuity is a long-term investment vehicle. After entering into a contract with an insurance company, an investor can receive regular payments for a fixed period of time or for life. Annuities are popular tools among seniors who want a steady stream of income after they retire. While there are different types of annuities, they fall into two main buckets, deferred annuities and immediate annuities (or single premium immediate annuities).

Deferred annuities allow investments to grow tax-deferred and provide investors with payments at some point in the future. But immediate annuities (also known as income or payout annuities) provide investors with income almost immediately after they make a one-time investment.

Depending on the type of immediate annuity you buy, payments can be distributed on a monthly, quarterly or annual basis. You can also receive a single, lump-sum payment. The amount of income you receive from an immediate annuity depends on factors such as your age, gender and the length of your payment period. Interest rates affect the size of payments, too. You can expect to receive a bigger payment if you’re older and interest rates are high.

Types of Immediate Annuities

Deferred and immediate annuities generally come in two flavors: fixed and variable annuities. Fixed annuities provide a specific amount of guaranteed income throughout the term of your contract. With variable annuities, however, payouts fluctuate based on the performance of the investments tied to the annuity.

In addition to fixed and variable annuities, there are joint life annuities for partners who want their surviving spouses to continue to receive payments after their deaths. There are also qualified annuities and non-qualified annuities. Qualified immediate annuities are used in conjunction with tax-advantaged retirement accounts (like IRAs). Non-qualified annuities are not used with these accounts.

Once you’ve selected the type of immediate annuity that you want, you’ll need to decide how long you want to receive payouts. You can receive payments from your insurance company for the rest of your life. Or you can receive payments for a certain amount of time, such as a 10- or 20-year period.

The Benefits of Investing in an Immediate Annuity

Immediate annuities provide payments right away. That’s why they can be great tools for seniors who may have trouble monitoring their spending in retirement. Plus, they usually provide higher returns than other savings vehicles like CDs.

If you opt to receive payouts for life through a fixed annuity, you won’t have to worry about running out of money for as long as you live. Even if you decide to receive payments for just 10 years, you’ll know that you can pay your bills for at least a decade.

If you’re concerned about inflation, you can purchase a variable annuity that allows you to invest in multiple types of securities. You can also buy an inflation-indexed immediate annuity so that your payments are indexed based on the inflation rate.

Immediate annuities offer tax benefits as well. Investment earnings aren’t taxable until you receive them. So you’ll avoid paying taxes on the entire payment you made when you initially purchased your annuity.

The Drawbacks of Investing in an Immediate Annuity

An immediate annuity is irreversible. This could be an issue if you need the money you invested for an emergency. What’s more, once you die, your benefits disappear. Your heirs can’t inherit any of the leftover funds from your annuity.

Fixed annuities can limit your purchasing power when there’s inflation. And having a variable annuity can make managing money difficult, especially if you end up with low-performing investments.

The Bottom Line

It’s important to think carefully before buying an immediate annuity. Once you make your initial investment, you won’t be able to get your money back. Weighing the pros and cons can help you decide whether purchasing an annuity is a good idea as part of your overall retirement plan.

Tips for Retirement Planning

Working with a financial advisor can increase your opportunities to plan accordingly. They can give you insight that you’re not aware of and make it specific to your situation so that you hit your retirement goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When looking at how much you need to save for retirement, consider a retirement calculator.