What Are Immediate Annuities
Immediate annuities are annuities that do not have an accumulation phase and begin making payouts to the owner within 12 months of purchase. Immediate annuities can be fixed annuities, meaning they pay a fixed rate of return, or they can be variable annuities that pay a rate of return that is dependent on an underlying investment. Because variable annuities involve securities, the life insurance agents who sell them must be registered with the National Association of Securities Dealers (NASD).
The primary purpose of an immediate annuity is to provide guaranteed monthly income after an annuitant has retired or if he or she has been without earned income for several years. Immediate fixed annuities are probably the most common type of annuities and the easiest to understand. They are purchased with one payment, known as the premium.
They are not purchased as part of a retirement plan, although they can be purchased with distributions from one. Unlike annuities purchased as part of a retirement plan, immediate annuities can be funded with unearned income such as the after-tax proceeds from the sale of a home or property, an inheritance or even lottery winnings.
How Can Immediate Annuities Guarantee Income
In exchange for providing the insurance company with the premium, the owner of an annuity can choose to receive income for life or income for a set number of months. If he or she chooses to receive income for life, the amount of the payout each month will be based on the amount of the premium and his or her life expectancy at the time of purchase. If he or she chooses to receive payouts for a predetermined number of months or years, the payouts will be based on the number of months or years and the amount of the premium.
Immediate annuities that are purchased jointly between spouses can also provide income for the surviving spouse when the original annuity owner dies. The amounts of the guaranteed lifetime payouts depend on the amount of the premium and the ages of both spouses at the time of purchase. If one spouse is significantly younger than the other, the payouts will be smaller as the insurance company has to guarantee the payouts over a longer period of time.
What Rates Can Be Expected from Immediate Annuities
Current rates on immediate fixed annuities range from 2% to 5%. The rate will vary by insurance company and on whether a single or joint annuity is purchased and whether any options are included. Immediate annuity options include cost of living adjustment (COLA) protection and premium refund.
A cost of living adjustment protects annuitants from inflation. Each year, the amount of the payout increases in order to offset the loss of purchasing power that results from inflation. A refund of unreturned premium can also be added to ensure that money is not lost if the annuitant dies early in the contract period. If, for instance, an annuitant purchases an immediate fixed annuity for $100,000 but has only received $55,000 back in payouts at the time of his or her death, the beneficiary can receive the balance owed, which in this case would be $45,000.
Who Should Consider Immediate Annuities
Immediate annuities are appropriate for investors seeking guaranteed monthly income in retirement. For investors without a company sponsored pension or significant retirement savings, an immediate annuity can provide the income needed to maintain an expected standard of a living.
Newly retired investors who have significant after-tax cash reserves and who don’t want to begin taking 401(k) or other tax-deferred distributions can also benefit from immediate annuities. Receiving guaranteed monthly income without having to deplete retirement savings allows for all of an investor’s savings to continue to grow. Immediate annuities, like all annuities, grow tax-deferred. And, the only amount of an annuity that is taxed upon payout is the amount that is credited as earnings.
What Are the Differences Between Fixed and Indexed Immediate Annuities
Immediate fixed annuities pay a fixed rate with each payout. The premium paid for fixed annuities is invested in safer debt-backed investments such as United States treasury bills and bonds. Some insurance companies will also include high-rated corporate bonds of Fortune 500 or even Fortune 100 companies.
Knowing the exact amount that will be paid each month or each year can be of significant help to retirees looking to meet budgeted expenses. Further, other types of investment income such as dividends are not guaranteed. Corporations may have to cut the amount of dividend payments or even suspend them to conserve cash should the need arise. An immediate annuity, on the other hand, will always pay the guaranteed amount, regardless of market conditions.
Indexed annuities pay a return that is based on a stock market index. The S&P 500, which is made up of the 500 largest stocks in the United States by market capitalization, is the index most commonly used. The premium used to purchase the annuity is invested in equity mutual funds. Depending on the insurance company, an investor will usually be able to choose from a range of conservative and aggressive mutual funds.
However, investors are advised that risk is often increased when attempting to achieve higher returns. As with any type of investment, investors are always advised to make sure that their risk tolerance matches the investment they’re in.
Investors are also advised to make sure that they understand that an immediate annuity represents a contract. The insurance company will not return the premium used to purchase the annuity other than in the form of guaranteed payouts. In other words, once the contract is signed, an investor cannot get his or her money back except as the payouts as defined in the contract.
Investors are also advised to make sure the insurance company from which they are buying the immediate annuity has the best possible credit rating from Standard and Poor’s or Moody’s. Investors must make sure that the insurance company has the ability to meet its long-term debt obligations, as annuities are not insured by the Federal Deposit Insurance Corporation (FDIC),
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